A guest article by Paul Paradis, co-founder of Sezzle. Sezzle simplifies how people move money.
Without a doubt, the high cost of payment processing consistently rises to the top. And for good reason. The S&P 500 continually rates the retail industry among the least profitable in its annual look at returns on equity and net margins. Online-only retailers often see net margins as low as 2.5%. Walmart, the world’s largest retailer by far, experienced only a 3% profit margin in 2016.
The four largest payment companies, on the other hand, have made between 10%-50% profit margins over the past five years. So when retailers are forced to pay north of 3% of every transaction to the credit card networks, just to facilitate the exchange of cash online, most are justifiably peeved.
The Payment Oligopoly
In essence, retailers are paying for a ubiquitous payments infrastructure that enables anyone in the world to buy goods or services from you. Mastercard, Visa, and American Express were all launched by different banks in the 60s and 70s to bring a unified financial instrument that consumers could use to make purchases all over the world. The name Visa was, in fact, chosen because the word was instantly recognizable in many languages and denoted universal acceptance. So as a retailer, you are paying for access to this infrastructure and the millions of consumers that use it.
Like other businesses that create expensive infrastructures that many people use, these credit card networks have created a virtual monopoly (technically, it’s an oligopoly because there is more than one player, but you get the point). Think railroads and utilities. But where railroads and utilities have been broken up by antitrust lawsuits and heavily regulated by the US government, the credit card companies have gone largely untouched. Credit card companies set their own interchange fees, and despite claims of price-fixing, antitrust lawsuits, and congressional investigations, there is still very little regulation of these companies in the US. Many other countries have successfully regulated these fees. The EU, for example, capped interchange fees to 0.3% of the transaction value for credit cards and 0.2% for debit cards. These same fees average 2% in the US!
The Durbin Amendment, which passed as part of the Dodd-Frank Act in 2010, is the only significant legislation passed against the credit card networks since their inception. Durbin requires the Federal Reserve to limit debit card interchange fees (they currently sit at 0.05%+21c per transaction), allows businesses to offer a discount to customers who pay with cash, and enforces minimums for credit card transactions (since interchange fees eat up a larger portion of small transactions). And while US banks will argue that retailers have pocketed $36 billion from the provision, “turning it into nothing more than a merchant markup that pads bottom lines,” according to a statement from the Electronic Payments Coalition, a trade group that represents banks and card networks, the banks have found a way around it.
Because debit cards are no longer very profitable, banks have no reason to incentivize their use or to pay the cost of sustaining their rewards programs. Cue the end of free checking, the beginning of increased checking account fees, and the slow death of debit cards that earn points and miles.
In addition, because the Durbin Amendment does not deal with credit card transactions, credit card fees have skyrocketed to compensate for the loss of revenue from debit cards. Prepaid cards are also unregulated by Durbin, and not surprisingly, we’ve seen a huge increase in the number of these products in the market, many of which have exorbitant fees attached.
The Durbin Amendment also failed to address third-party processing companies that decide whether to accept or decline transactions and ultimately pay you, the merchant. These processors often have extremely opaque pricing models that charge well above the fees imposed by issuing banks (the banks that issue credit and debit cards to consumers). This is, perhaps, the largest problem of all, as processors not only increase the overall cost but overcomplicate the entire payment system to a point where it’s difficult to know what or who to fight against. You don’t know how many times I’ve talked to a merchant that claimed to be getting a surprisingly low rate from their processor when after asking them to check their statements, they realize hidden fees brought their actual rate to something much higher.
There is good news, however. Don’t despair! The payments industry appears ripe for disruption, and it’s due in large part to a payment network that’s been around as long as credit cards have. We’ll get to this new hope in payments shortly, but first, let’s examine how we got into this expensive mess.
Card Not Present
Card not present (CNP) fees are another device the networks use to increase your processing costs. CNP is a payment card transaction made where the cardholder does not or cannot physically present the card for a merchant’s visual examination at the time an order is given and payment made, including transactions by mail, phone, or the internet. CNP transactions have historically been a major source of credit card fraud because it’s been very difficult for a merchant to verify that the actual cardholder is indeed authorizing a purchase. Due to the higher risk of fraud, CNP transactions are much more expensive to process than card present transactions.
However, the risk profile for card not present and card present transactions is changing. With the introduction of secure browsing protocols, two-factor authentication, biometric authentication, and more, online transactions are becoming harder to scam than card present transactions. A payment security executive confirmed this much to me over a cup of coffee last month. At Money20/20 this past fall, a panel of retail representatives stated they had begun fighting for the removal of the card not present designation entirely, for this very reason.
In the end, this bloated, complex payment system ends up hurting consumers more than anyone, especially those who prefer to pay with debit card, check, or cash, because they’re not earning any rewards. The credit card networks charge merchants a lot of money to process payments, merchants pass these fees onto consumers in the form of higher priced goods and services, and consumers continue to use their debit and credit cards, none the wiser. Cards are easy, consumers are completely unaware of the associated costs, and they’re almost never liable for fraud. Why change, right?
Well, what if there was a way for consumers to pay merchants that were just as easy as cards, just as rewarding, much less expensive, and more secure? Can the existing payment system be disrupted just like the taxi or advertising industries in recent years?
A bank-to-bank payment is not a new concept, in and of itself. In 2015, nearly 24 billion transactions with a total value of $41.6 trillion were processed via the Automated Clearing House, the largest bank-to-bank payment network in the US. This payment network is not typically used for day-to-day commerce, however, popular instead for payroll deposits, insurance premiums, mortgage payments, and other large, recurring transactions.
It hasn’t become prolific in day-to-day commerce primarily because of poor consumer experience and long settlement times. Merchants have wanted to adopt ACH for a long time, due to its extremely low cost. But to send a bank payment, consumers were required to enter their account and routing numbers - information that most people do not have memorized. And with the demise of checks, those numbers are becoming harder to find now, too. In addition, because these numbers are public information (if you write someone a check, they have these numbers), consumers had to verify ownership of their account by reporting the amounts of microdeposits placed into their checking account by the merchant - a process that could take days to complete.
If you sell common items online, would you force your customers to go through a multi-day checkout experience just to save a couple bucks? Probably not. What consumer, in their right mind, would shop with you? They want an easy, fast checkout experience. They’ll just shop at another store.
It can also take days for a bank payment to settle. Historically, bank payments were processed once a day, on business days. Let’s say a customer of yours bought something online on a Friday night and chose to pay with their bank account. Their account may not be debited till the following Monday evening when the next batch of payments is settled. If they overdraw from their account over the weekend, either they’re going to face an overdraft charge, or the payment won’t go through. Either way, you’re not happy, and neither is your customer.
PayPal was really the first payment processor to solve the bank payment conundrum. Because it was so inexpensive for PayPal to process a payment, they made it free to send bank payments to friends or family. Users didn’t mind the lengthy onboarding process because there wasn’t a good alternative. Then, once they became popular, they leveraged this large user base to get installed as a trusted, easy-to-use payment option in online stores.
But instead of redistributing the value created from processing low-cost bank payments to merchants and consumers, they charged the same high fees and kept all the profits for themselves. Merchants installed their payment button because it increased conversion rates, not because it saved them money on processing.
Fast forward to today and PayPal is getting farther and farther into bed with the credit card companies. In their bid to become the ubiquitous payment platform across every commerce channel, they began accepting debit and credit card payments, in addition to the bank. They entered into partnerships with Visa and Mastercard last year, agreeing to steer PayPal users toward card payments instead of bank, in exchange for access to the card companies’ in-store payment network. I’ve heard estimates that bank payments make up only 10-15% of PayPal’s payment volume now, all but guaranteeing that they won’t be lowering their fees to compete directly with the card networks.
A New Hope
Luckily, PayPal isn’t the only one in the bank payment game anymore, and advancements in financial technology, or FinTech, are allowing companies to overcome many of the old problems with ACH.
The painful onboarding experience has been solved using new bank authentication technology. Instead of requiring a customer to enter their account and routing numbers and complete a lengthy verification process, we can now collect those numbers and verify ownership instantly through bank login during the checkout. A customer simply selects their bank from a list, logs in using their pre-existing online banking credentials, and voila. A bank payment is initiated.
Lengthy settlement times are being reduced via a rule passed by NACHA, the ACH governing body, called Same Day ACH. Instead of a single batch of bank payments processed each day, multiple batches will now be processed, making settlement close to real-time. And if that’s not fast enough, an actual real-time payment rail is currently being built by The Clearing House, in collaboration with VocaLink and The Federal Reserve. Settlement times will soon be a thing of the past.
There are several companies trying to bring access to these new technologies to merchants like you. If you haven’t guessed by now, I do in fact work for one of them. I co-founded Sezzle a year ago with a friend from business school to bring a lower-cost payment method to eCommerce merchants. We went live on Shopify just over a month ago and are seeing lots of interest from online store owners wanting to reduce payment processing costs and to give their customers access to an exciting new way to pay.
Dwolla is a FinTech company that’s been around for a few years now, but they recently pivoted from offering consumer-facing payment apps to providing white-label payment APIs so businesses can send and receive bank payments.
Qalize is a company I met at Shoptalk this year. They have a similar mission to ours but are targeting brick-and-mortar retailers in Chicago, with hopes of expanding to the rest of the US.
I guarantee you’ll see more companies get involved with bank payments, including some of the major credit card players. From our limited time in this business, we already know that some companies are going to do what they can to prevent or at least slow, bank payments from expanding. But it’s not preventable. Bank payments are already the most popular way to pay in many countries, and it’s only a matter of time before the credit card racket is busted here in the US.
As a merchant, it’s in your best interest to push for the democratization of payments. I know PayPal uses that phrase in their mission statement, but there are too few companies controlling payments here in the US today, and ironically, PayPal is one of them. They’ve been able to fix prices and take advantage of merchants because viable alternatives haven’t existed. But that’s changing!
Exciting new companies doing exciting new things in payments are popping up every day, and you need to support them. Add them as a payment option in your store, encourage your customers to try them, work with them to make their solutions better. Because if you don’t, the unjust treatment you receive from the credit card networks will only continue.
For far too long, retailers have been losing their battle with the banks and credit card companies. The Durbin Amendment was the first real win, but it’s only been a win for the largest retailers who receive interchange plus pricing, which allows retailers to pay a separate, lower rate for debit card transactions. Most Shopify store owners use Stripe and PayPal, which only offer a flat, blended rate across all payment types, and that flat rate is typically closer to the credit card rate than that of a debit card.
So support these fledgling payment companies that are trying to make your life better. Get your customers excited about them. Push Shopify to open up to these companies more, too. Although Shopify is an open-source platform, their close partnerships with Stripe and PayPal make it very difficult for other payment companies to gain a foothold within the Shopify ecosystem. At a minimum, educate yourselves to the unjust payment processing reality here in the United States, and to all of the options available to you. Let’s do this!