The cost of processing low value debit card sales (transactions less than $15.00) has dramatically increased for merchants since the implementation of the Durbin amendment on October 1, 2011. While this new regulation caps the debit interchange fees for regulated transactions and has saved billions of dollars for most U.S. merchants, it has created an unintended consequence of doubling or tripling the cost of interchange for small ticket debit transactions. Many merchants negatively impacted by the Durbin amendment feel helpless by the interchange increase, but there are strategies that they can employ to lower their overall cost of processing debit and credit card payments.
The pre-Durbin debit interchange rate for Visa and MasterCard was 1.55% + $0.04. So the cost of a $2.00 transaction was $0.071 to the merchant. After the implementation of the Durbin amendment, Visa and MasterCard eliminated the special rate for small transactions and subjected all regulated debit transactions to the 0.05% + $0.21 (+$0.01 for fraud adjustment) rate. Now, the cost of a $2.00 regulated transaction is $0.221…three times the cost from six months ago. Adding to the increased cost is also the increased complexity of a two-tier debit interchange system. The first tier is the capped debit interchange rates subject to the Durbin amendment for cards issued by large banks (those with $10 billion or more in assets). Based on our analysis, about 80% of the transactions in the U.S. are coming from regulated banks. The second tier of interchange rates is applied to unregulated transactions (cards issued by banks with less than $10 billion in assets). Currently, Visa and MasterCard’s interchange rate for unregulated small ticket debit cards is 1.55% + $0.04.
Using a mix of 80% /20% regulated and unregulated transactions, the table below shows the effective interchange cost based on average ticket sizes. The effective cost of debit transactions below $12 has increased by 6% to 238%.
So what can merchants do to offset this increased cost? Our consulting experience and research shows that merchants are taking multiple paths to lowering their overall cost of small ticket transactions, especially micro-transactions (ticket sizes less than $5.00).
USA Technologies and Apriva, two large facilitators of cashless payments in the vending industry, faced a significant hurdle with the implementation of the Durbin amendment. The average tickets for their vending machines ranged from $1.50 to $2.00, and the interchange cost was about to triple from $0.07 to over $0.22 per transaction. They were both able to negotiate directly with Visa and receive lower interchange rates that would make a $1.50 transaction viable and profitable. Merchants who fit a specific profile can take advantage of the “Visa Incentive Program” and receive lower than published interchange rates.
A second approach taken by micro-payment merchants is transaction aggregation. This is the ability to process a single transaction that is made up of multiple smaller transactions from one customer within a 48 to 72 hour window. The card networks have specific rules and limitations around transaction aggregation but this strategy is used by e-commerce merchants like Apple (iTunes) and some pay-by-cell parking operators. Consolidating multiple small transactions into a single larger transaction significantly reduces card processing fees but requires an investment in technology infrastructure. The merchant must inform their customers of transaction aggregation and provide them with a means to access details of aggregated purchases.
A third strategy employed by sophisticated merchants is to take key insights from customer analytics and loyalty programs and marry them with the overall effective cost of each payment tender available in the marketplace. Such merchants develop a payments “waterfall” or cost of payment tenders from the most costly to the least. Now, the challenge is to move customers down the waterfall to the least costly payment tenders without negatively impacting customer experience. There are various successful strategies and incentives that can be combined to achieve this goal. A fantastic example is the Starbucks mobile application that was launched in January 2011. The app’s main focus was to enhance customer experience and facilitate faster checkout. Starbucks also knew that the effective cost of processing a transaction via their Starbucks pre-paid card was lower than any other tender, including cash. So instead of allowing users to store their credit and debit cards on the Starbucks app, Starbucks forced the users to fund or load the pre-paid card within the mobile app. This is ingenious as the cost of funding a single credit/debit card transaction (be it $10, $20 or even $50) is significantly less expensive than multiple transactions of smaller amounts and the cost of processing a pre-paid transaction is mere pennies. The Starbucks app provides “value” to the user and in exchange for that value, users are willing to fund their pre-paid Starbucks cards. In less than a year, Starbucks has already processed 26 million transactions through its mobile app and saved over $2 million in processing fees while increasing sales and enhancing customer experience.
Lastly, a proven strategy to manage the cost of processing small ticket payments is to optimize current card processing operations. The fundamental costs of card processing are interchange, assessments, and acquiring fees. With the exception of assessments, interchange and acquiring fees can be managed and reduced through negotiations, interchange optimization, and least cost routing.
It is not uncommon for merchants processing small ticket payments to have the processing costs of their noncash payments exceed 7%-10% of sales. With such a significant overhead, these merchants should either develop internal expertise to manage and reduce these costs or hire external expertise. There are solutions and alternatives available in the marketplace and savvy merchants are already taking advantage of them.