Interchange in Flux: How the Payments Ecosystem Could Be Disrupted By Mega-Retailers

Interchange in Flux: How the Payments Ecosystem Could Be Disrupted By Mega-Retailers

Interchange in Flux: How the Payments Ecosystem Could Be Disrupted By Mega-Retailers

Charles Keenan

Charles Keenan

Charles Keenan has written about payments since joining the American Banker as a staff reporter in 1997, a time when automated teller machines were appearing just about everywhere but people's living rooms thanks to the relaxation of surcharging rules.

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Interchange, long the underpinning of the payments ecosystem, might not face extinction any time soon. But who pays what — and how much — stands to undergo a significant transformation.

One large merchant shows the steady shift. For Lenovo, the computer retailing company, alternative payments made up at least 16 percent of its sales volume of its North American operations in the fourth quarter of 2018, according to the company. Lenovo, based in China and maker of the ThinkPad PC (once an IBM staple), has slowly been migrating its North American customers to alternative payment methods such as Amazon Pay, which links to a credit or debit card, and Klarna and Zibby, which offer consumers the option to purchase goods through payment plans.

These alternative payment methods not only offer Lenovo competitive interchange rates, but they also assume fraud liability, shifting a good deal of risk of the transaction away for the company. Over the last eight years, alternative payment mechanisms account for 16 percent of its sales volume, up from a negligible amount eight years ago.

"These alternative payments have stepped their game up, and they assume the risk for the fraud," says Shannon Murray, director of web operations for Lenovo North American division, based in Morrisville, North Carolina. "That's a pretty compelling argument."

Interchange won't go way

This isn't to say interchange will go the way of taxicabs, paper maps or home-buttons. For one, the card networks still make a lot of money on interchange. And e-wallets often link to higher-interchange card accounts via the major network brands, so issuers still derive rich fee income.

Yet the economics of interchange is in flux. Cash wallets are quickly gaining acceptance, including Square Cash, Apple Pay Cash and Zelle person-to-person (P2P) transactions. Cash wallets, for example, often link to checking accounts, which use the ACH network, offering no interchange to the banks. Then there's the rise of other providers, such as Klarna, Zibby and Affirm, which offer another way to pay, especially for consumers with little to no credit.

Perhaps the most threatening is the rise of Amazon Pay and Walmart Pay. The latter, for instance, was adding roughly 10,000 new users a day in the fourth quarter of 2018, according to Richard Crone, chief executive officer of Crone Consulting, based in San Carlos, Calif.

Merchant pay threats

These merchant 'pays' are threatening to the traditional interchange model due to their sheer size, Crone notes. He adds that they are laying down new rails that could eventually bypass the card networks, creating the possibility of what is known in industry parlance as 'over-the-top' clearing relationships. "The issuer who put that card in the wallet is no worse off," Crone says. "But over time, it sets the stage for over-the-top clearing relationships."

If that seems far-fetched, think of JPMorgan Chase, a major issuer and merchant acquirer. It is in the middle of a 10-year agreement with Visa for the routing of payments through VisaNet. Yet all bets are off when the deal expires in 2024, when Chase could theoretically cut Visa out of the payments stream.

$400: The additional amount per active user Amazon could generate per year from purchases using its own payment option.

For merchants, the interchange is an issue given its cost. Basic blocking and tackling by routing customers to online debit transactions can greatly reduce fees. Yet even more valuable to large retailers such as Amazon and Walmart, is the purchasing data they collect at the point of sale with their pay wallets. Looking at the long game, these retailers realize interchange is worth incurring if they can capture information surrounding the transaction.

"Data is the new oil," Crone says. "Payments are rich in data but untapped by most retailers, pumped like exhaust through dumb pipes to others that refine its value."

The Amazon clout

Crone estimates that Amazon could generate an additional $400 annually per active user that makes most of their purchases using its payment option. "They have a tremendous amount of margin for promoting Amazon Pay," Crone says. "They can give the payment processing away for free and simply use the data to increase the value of its promotional capability."

Amazon has even started selling Amazon Pay to retailers that don't compete with its online retail offerings, such as gas stations and restaurants. Expansion into brick and mortar only increases its economic reach, setting the stage for more disruption.

"Amazon has a massive constituency," says Omri Dahan, chief revenue officer at Marqeta, a cloud-based payment card issuing provider based in Oakland, Calif. "The entire business is designed around how [to] optimize the monetization of that constituency. At some point, it is going to make sense for them to monetize that constituency through financial services in a much more integrated way, whether that's a bank account or a closed-loop payment system."

As long as interchange remains a significant expense, merchants will look for ways around it. "Margins are slimmer and slimmer," Lenovo's Murray says. "So you have to take a look at operating expenses to find ways to reduce costs."

So while interchange lives on, who pays and how much may continue to change.

The statements and opinions of the writer do not necessarily reflect those of TSYS.

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Charles Keenan

Charles Keenan has written about payments since joining the American Banker as a staff reporter in 1997, a time when automated teller machines were appearing just about everywhere but people’s living rooms thanks to the relaxation of surcharging rules.

His work at the American Banker included writing about credit and debit cards, merchant processing, and bank stocks. He later freelanced for the Banker and industry publications such as Banking Strategies, Bank Director, Community Banker, and U.S. Banker. He also writes about investing, insurance and health care, and is based in Los Angeles.

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