By Pat Morgan

Accepting credit and debit cards costs retailers billions of dollars each year. Studies report that payment fees are often the second largest line item of expense — directly after the cost of personnel.

Given today’s economy, financial institutions must do whatever they can to protect the fee structure, as revenues from payments are estimated at 27 percent of total banking revenues and are approaching $300 billion¹.

And both sides are feeling squeezed to a greater extent than ever before: For retailers, consumer spending is down, lending to businesses is down, the need to reduce cost is greater and the necessity of keeping every customer is paramount.

The common denominator for retailers and financial institutions is to cut costs, protect customer bases, stabilize revenues and hunker down while the storm continues.

Will These Changes be Permanent?

Consumers are changing their spending habits due to the impact on their own net worth. Many have lost wealth in investment portfolios and their home value, and are trying to save more to make up for losses to increase their feelings of security.

Research by Hitachi Consulting explored how consumers will change their use of payment types given economic change. The firm found that many are shifting away from the use of credit cards and moving toward greater use of cash and debit cards.

While it’s unlikely that consumers will regress completely to checks and cash due to the value, convenience and rewards that payment cards bring, this change opens a window for the introduction of new alternative payment types.

First, what do we mean by alternative debit products? They can be many different things, but the standard definition is:

Products that involve transacting with an account that is separate from the funding account, usually a deposit account or a credit line. The ACH is used to gain access to the deposit account and access to the credit line can be supported with a credit card.

If alternative payment products can mitigate certain pain points, they may gain traction. And if history repeats itself, those who once stood on the sidelines will jump on board as the alternative payment gains momentum. Once that happens, a new payment product eventually becomes entrenched.

So what do these products need to do to ease the pain points? Quite simply, contribute to the common denominators stated above: cutting costs, protecting customer bases and stabilizing revenues.

During the past 20+ years, the vast majority of energy and investment has gone into two payment products: credit cards and debit cards. But over time, interchange and processing fees have soared in order to cover the increasing complexity in the payments infrastructure, including fraud management, compliance, customer servicing, reward programs, etc. These fees are now major pain points for many retailers — and as a result, we have reached the point at which storms begin to brew, innovation jumps in, and pendulums swing. Enter, alternative payments.

Market Examples

We are seeing several initiatives surface around alternative debit products, including PayPal, Revolution Money, Maverick Network Solutions, Optipay or National Payment Card.

PayPal is probably the premier example because the company has been working at it the longest. It started with a single product and has expanded into an array of offerings. American Express (Amex) is re-energizing its traditional charge card, positioning it through advertising as a way for consumers to better manage their spend. Amex also acquired Revolution Money, another alternative payment product, for $300 million. Brokerage houses are issuing ‘delayed’ debit cards, products where the consumer grants permission to pay the charges monthly from funds held in their account.

Decoupled debit is interesting for several reasons:

1. The issuer is not required to be a bank in order to offer an account and issue a card
2. The products can exist as private label products or co-branded products
3. The products can potentially build significant loyalty
4. The products reduce costs when delivered and managed correctly
5. The products leverage the existing payments infrastructure and standards

The TowerGroup made some interesting projections relative to debit in their 2009 study, which covered new products.

Note that these projections point to:

• Refinement and growth of newer product options, such as decoupled, prepaid, specialized debit products and contactless
• Taking out cost: fee structure changes, greater competition and more consolidation

To further our understanding, TSYS conducted consumer focus groups in the summer of 2009 to help us learn what causes consumers to prefer one payment product over another. Several simple things became apparent: Consumers readily grasp alternative payment ideas, they are driven by compelling rewards programs, fees are a big turn-off, security and identity theft are important issues and they think linking accounts from one bank to an account at another bank is feasible.

Alternative Payments In the Future

Many in the payments industry have brushed off decoupled options and are of the mindset that ‘this too shall pass.’ TSYS spoke with several companies that have had experience with decoupled products, and upon greater examination, found that programs were canceled for reasons other than the underlying viability of the product. The primary reasons programs were abandoned include the following:

• The systems were not ready, or the go-to-market strategy was not set
• The rewards programs offered to consumers were not compelling enough
• Getting consumers to register proved too great a challenge
• Expected cost savings were not being realized
• Losses were higher than projected
• Overall program management was weak

As a result, a program’s success will be a function of how it was launched, the value of the reward program, risk mitigation tools, and overall simplicity for consumers, rather than flaws in the product. Standards are emerging around methods and systems that will support the unique needs of decoupled products:

Enrollment. Since the issuer of a decoupled product does not have an existing relationship, nor do they own the account where funds will be withdrawn, there is a need to authenticate the person and assess the validity of the checking account given for debiting funds.

Transaction Authorization. The balance in the consumer’s account is unknown; therefore, there is a need to find other ways to assess the likelihood that the transaction will post.

Loss Mitigation. For transactions that are returned because of non-sufficient funds or the account has been closed, there is a need to handle and collect on these items.

Retail Business Case

Retailers have a different mindset when it comes to alternative or decoupled products because they are stakeholders in the product, not just the transaction. They look at the product as a way to help them:

• Reduce cost of payments
• Build loyalty
• Offer merchant-designed promotions
• Drive more store sales
• Segment and target customer groups
• Leverage ‘spend information’
• Lower payments risk

These retailers are likely to view the product as a niche play, not a product that will supplant traditional products. It is their hope that the product will appeal to a sub-set of customers, giving the retailer an option to better target those groups.

In the case of private label products, retailers avoid interchange. But the private label business requires payments expertise — usually not part of the retailer’s experience base. Costs must be carefully managed and rewards must be compelling. Even still, there will be some losses that retailers will have to absorb because ACH payments are not guaranteed in the way that debit and credit card payments are guaranteed. Retailers are responsible for non-sufficient funds and closed accounts in the same way they bear responsibility today for returned checks. In fact, the cost saved from avoiding interchange could be consumed by the cost of the program if not carefully managed. A better option might be for collaboration between retailers and banks where the expertise of each party can be leveraged to result in an innovative and efficient program.

The jury is out as to the future of consumer payments that are facilitated via the ACH rails as a decoupled or other type of payment. However, there is no better time for an entrance than now, given the overall economy in an industry waiting for someone to make a major move.

About the Author

Pat Morgan has been involved in the payments industry for more than 25 years while working with credit and debit cards, and more recently in emerging alternative payment products. She has been responsible for strategic planning, product development, marketing, competitive positioning, technology solutions and operational roll-outs. Prior to her tenure at TSYS, Morgan has held a variety of management positions at Visa International and Dove Consulting.

1 McKinsey and Company