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Board Member Corner: Card Not Present Processing Rates: Who Carries the Burden? (MAG Quarterly- Volume Three, Issue Two)

By Troy Carrothers, Senior Vice President, Retail Payment Solutions & Multi-Channel Sales & Service, Kohl's Department Stores

June 4, 2015

Financial institutions, and for CU24 that means credit unions, are learning to live with the new realities of reduced interchange income and lack of control over debit transaction routing.  While merchants have understandably leveraged their regulatory prerogatives, placing downward pressure on interchange rates, there has been a resulting convergence on pricing among the various regional, PIN debit networks – even for exempt financial institutions.  Pricing variation among the networks is smaller.  Despite the pressure on interchange rates, according to the most recent Federal Reserve report, signature fees remain significantly higher than PIN debit.

This serves merchant interests, of course, reducing costs and even improving efficiency at the point of sale.  But there may be a point at which aspects of the downward pressure of the evolving interchange environment become counter-productive for merchants.

Transaction volume is the life’s blood of the regional networks.  A network’s most important tool to gather transaction volume is the delicate balance of interchange rates.  Interchange rates, particularly in the new regulatory environment, must be low enough to offer an attractive routing option for merchants.  On the other hand, networks must provide financial institution issuers sufficiently high interchange income to keep them as participants in the network.  If interchange rates are too high, merchants will turn to other options to route transactions.  If interchange rates are too low, financial institutions depart the network for greener pastures and higher income.  If these issuer departures become too numerous, or affect the larger issuers in the network, the network becomes unsustainable.  A network like CU24 strives to mitigate some of this tension by maintaining particularly low switch fees for both issuers and merchants.  When netted against interchange, this often creates a bit better path for both parties to the transaction.

In a world where commerce is evolving rapidly with the introduction of new payment channels and form factors, the fee structures merchants pay for acceptance of third party credit card transactions are becoming more outdated and inequitable.  This is evidenced in the distinction the large credit networks place on transactions defined as Card Present (CP) or Card Not Present (CNP).

Recent years have seen the introduction and proliferation of many new methods for consumers to receive and pay for merchandise.   Consumers can still visit brick and mortar merchant locations to purchase goods in-store, but the growth rate and investment by merchants in making non-traditional transaction methods available for consumers to purchase merchandise far outpaces traditional in-store methods.  Examples of the newer non-traditional methods include the Internet and mobile platforms.  There are even hybrid platforms that include a combination of traditional and non-traditional methods.  These hybrid platforms include buy online pickup in-store (BOPUS), buy online ship from store (BOSS), buy in-store ship to customer and payment by mobile wallet.

As merchants have invested in non-traditional channels to facilitate purchases and convenience for consumers, merchants have significantly increased the volume of credit card transactions that are considered CNP, as broadly speaking, basically every transaction that is not a traditional face to face transaction in-store is considered a CNP transaction.  Moreover, in many cases where a mobile wallet is involved, even a face to face transaction is now considered CNP.  What does this mean to the large credit networks?  It simply translates to a rapidly growing percentage of the credit card transactions that are processed under the CNP designation.

So, what is the difference between a CP and CNP transaction?  Traditional CP transactions are typically considered lower risk transactions due to the face to face nature of the transaction itself.  CNP transactions first began to grow in volume in the U.S. with the emergence of eCommerce in the last decade.  With higher than average consumer fraud rates, when compared to brick and mortar CP transactions, CNP transactions were priced at a premium compared to CP rates because of the assumed fraud protection the large credit networks would employ to help protect merchants, issuers, and consumers, alike.  This premium across large credit networks is approximately 20% greater than CP rates today.

With a 20% premium being paid by merchants for CNP transactions, it begs the question, what additional fraud protection do merchants receive today from the large credit networks when processing a CNP transaction?  The answer is not simple.  However, the most obvious difference between CP and CNP transactions for merchants, apart from the premium price, is the addition of transaction liability.  Yes, that’s correct; fraud liability is shifted from the issuer and consumer to the merchant in a CNP transaction.  

As the EMV requirements related to traditional in-store transactions become effective October 2015, liability is shifting on CP transactions as well.  With the implementation of the EMV requirements in-store, it’s expected that merchants will be able to avoid much of the in-store fraud present in the marketplace today, shifting the focus of major fraud rings to online transactions where the large credit networks do not have an EMV equivalent requirement and where merchants assume the majority of the risk.  In most business models, across industries, there is a base price for a service.  If you want greater protection or insurance for that service, you must pay a premium.  Inversely, if you’re willing to assume more risk, you pay a discounted price.  The acceptance of credit cards in a CNP transaction provides a clear example of the inverse. 

Assuming merchants continue to carry the burden of the fraud liability for CNP transactions in the future, a new pricing solution should be revisited by the large credit networks before they additionally alienate their customers, the merchants.  A modern, equitable and logical approach to CNP transactions would be one where the large credit networks price these transactions at a discounted rate to CP transactions while also proactively working with the merchants to design merchant-friendly fraud reduction tools that can be built-in to the processing of every CNP transaction, improving security and giving all parties greater fraud protection and confidence in the system.  The CP and CNP schemes put in place by large credit networks are not only outdated and inequitable; they ultimately cost merchants and consumers billions of dollars every year by transferring the burden away from the issuers and the networks.