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Letter from the CEO: An Alternate Payments Paradigm (MAG Quarterly- Volume Six, Issue One)

Mark Horwedel headshot
By Mark Horwedel, CEO, Merchant Advisory Group

March 8, 2018

In recent years, the MAG has sought to channel merchant complaints and concerns by developing a list of recommendations for changes that would make U.S. card payments more equitable to merchants. On a few occasions, this effort has succeeded, as with the recent move to rid merchants of the requirement to capture signatures at the point of sale. Nevertheless, merchants remain dissatisfied with the pace of progress and the need to rely upon the same card networks that perpetuate injustices in the system to accept and lead change. 

The U.S. payments system has fallen behind that of many other countries. Some of the blame belongs with policy-makers and their failure to remove statutory provisions designed to protect our moribund banking industry. Another root cause can be attributed to the reluctance of regulators to enforce existing antitrust laws as well as debit routing requirements and other provisions of Federal Regulation II.  

While the merchant community as a whole may remain unaware of the astronomical costs the banks and the card networks impose on U.S. merchants, MAG members are better informed and cognizant of the fact that U.S. merchants bear a heavier burden than their peers in all other industrialized countries. As an example, European merchants pay only 30 bps for credit card acceptance while US merchants pay as much as 7-8 times more!

Given this situation, it may be worthwhile to consider what an alternate payments paradigm might look like, one that would restore some semblance of competition for merchants’ business in the U.S., restore and encourage innovation and rid the market of monopolistic practices which have increased costs to the vast majority of consumers while rewarding a precious few.

For merchants, the most objectionable feature of today’s card payment systems is the way interchange fees are set by the networks on behalf of their client banks. Individual banks are not required to compete for merchants’ business. Networks set interchange fees for them, while merchants are left to fend for themselves. Networks engage in a perverse form of competition in which they bid against each other for the banks’ business with little concern about merchant reaction to ever-escalating costs of interchange and other network fees. The system protects both the banks, as well as the networks themselves. While less obvious to most observers, the relative success of global and domestic card networks is primarily based upon how much income they generate for banks in the form of interchange as well as how much expense they can load on the backs of merchants rather than the banks. This is by far the most important criteria for banks choosing network affiliations, while cost efficiency, innovation and other more traditional competitive attributes of the networks are secondary or tertiary considerations.

The present approach to interchange pricing should be replaced by some form of collective bargaining in which all but the largest banks and merchants are represented by intermediates which would negotiate interchange. The present situation affords only the banks with the benefits of collective bargaining while the vast majority of merchants have little or no ability to negotiate at all. As a result, both merchants and consumers suffer.
Consumers suffer by paying inflated prices at the point-of-sale. They suffer due to the lack of convenience and payments innovation since banks have very little incentive to compete with one another and payments innovators are barred from entering their space. They suffer with a fraud-prone system that has counter-intuitively encouraged the use of worthless signatures rather than PINs to authenticate purchases at the point-of-sale.

Secondly, accredited open standards organizations should replace organizations like PCI and EMVCo. Merchants and consumer advocates should have equal representation to banks and networks.  As an alternative, they could simply reform their present closed structure by adopting democratic organization structures. Today, they exist primarily as agents for the global networks while posing as standards bodies. Their standards effectively impose most of the costs associated with card payment fraud on merchants rather than banks, as well as affording market advantages to the global networks over their domestic network competitors. 

Consumers should experience seamless payment experiences throughout the world. Adoption of uniform standards for fraud prevention, including payment authentication technology should be attainable in the near future.

Merchants should be comfortable that they will get paid when a bank authorizes a payment. While this was once the rule in card payments, it has been undermined by network rules that effectively provide banks with a myriad of ways to chargeback payments they have previously authorized. Merchants that do business on the Internet are particularly impacted since they bear both higher costs to accept card payments as well as incur most of the costs of fraud and fraud prevention. 

We need a new model for payments, one that encourages competition and innovation, one that encourages new entrants by eliminating the protections enjoyed by banks for far too long, and one that is focused on providing the best value proposition to all consumers, rather than a small minority of rewards cardholders.