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How Small Debit Payments Can Still Be Profitable After Durbin

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File under: Don't Shoot the Messenger.

If you're a card issuer, and are discovering that what should be the fastest-growing segment of the payments business  – low-value payments– is not growing for your business, don’t blame Durbin. If you're hearing from merchants that their margin on low-cost items is now being eaten away by transaction fees, don't blame Durbin. And if while on your way to work you find that the deli won’t take your debit card for your coffee and bagel, please, don’t blame Durbin. 

It is true that with the passage of the Durbin amendment to the Dodd-Frank act, transaction fees for low value payments (typically defined as those under $20) have risen dramatically, so much so that many merchants are finding them unsupportable within their own narrow margins, and are looking to take advantage of another provision of the new law and either offer discounts to encourage the use of cash, or disallow cards for LVPs altogether.  Issuers, meanwhile, explain that prior to Durbin, they could partially subsidize the transaction costs of LVPs through their fees for higher-value transactions, but now, their hands are tied by the real costs of processing a transaction. 

However, by setting a cap on transaction fees, Durbin did not so much make the economics of LVPs unsustainable as reveal the fundamental truth that they were unsustainable to begin with.  Further, since it is the LVP side of the market that is growing, even without the Durbin fee cap there would have come a point where the costs of subsidizing them would have become too great; sooner or later LVPs would have had to carry their own weight. 

There is a solution, but the answer is not in raising fees, but in lowering costs.

Is it possible to do so without fundamentally changing the entire payments system? After all, the costs associated with processing a transaction are largely independent of its dollar value. In some ways it is analogous to delivering merchandise: much of the costs remain the same, whether it is for a single $5 item or a $5,000 pallet of $5 items. Of course, in the case of merchandise, the folks in the warehouse won’t send out a truck for a single item. They'll wait until they have a whole load of small items, so that the cost of the delivery can be spread over the large quantity of items carried.

Can the same kind of logistical solution apply to LVPs? To do so would require a way of aggregating a number of LVPs into a single transaction, so that cost per purchase is brought down to a manageable level. Right now, this happens with cash payments. I do not go to the bank to withdraw a single dollar every time I want to buy a cup of coffee; I make a $50 or $100 withdrawal, put the cash in my wallet, and then use the cash throughout the day. The bank isn't involved in any of those smaller transactions; they are, in effect, bundled into a single larger payment. 

New aggregation technology, such as a software-plug-in on the EMV chip, could allow a debit card to work as a digital wallet. I'm talking about something different from the mobile phone "wallets" that have received much attention recently. This digital wallet is actually equivalent of the part of your leather wallet that holds cash today. A $50 withdrawal could be automatically initiated and loaded onto the chip in a single transaction while making a payment at the point of sale, enabling the consumer to then spend that money in small increments, at multiple merchants, without a further need to involve the issuer, or having to visit an ATM.  Meanwhile, on the merchant’s side, all the individual LVP transactions are aggregated and submitted at the end of the business day. The result is that the ten or more small payments can be processed at the cost of a single transaction.

While this would be a revolutionary approach to handling low-value payments, the infrastructure is largely already in place.  True, the EMV chip is not as widely in use in U.S. debit cards as it is in Canada, Europe and Asia, but most POS terminals already have the necessary hardware, and the chip’s broader use in the U.S. simply seems to be waiting for a compelling business case to be made.  That wait, we would suggest, is now over. 

By adopting the global EMV chip standard, and using software that enables LVPs to be aggregated, issuers can drastically lower their own costs to the point where they can remain competitive for merchants, and turn the growing LVP sector into a source of net income, rather than sustaining it as a loss leader.

The technology is there, as is the know-how. It's time for us to get back to work and discover that we can create value, to the mutual benefit of consumers, the merchants, and issuers,  whatever Durbin may have done.

Nebo Djurdjevic is the chief executive of Cardis International, a technology firm dedicated to improving the economics of low value electronic payments within the broader trend of moving toward a cashless society.  

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Comments (4)
As a consumer that wouldn't work for me. I carry a low balance in my checking account. I couldn't load $50.00 at a time. Also, when I pay for item or a bill I except the same amount to come out of my credit card or debit card account(S). We already have at least two items like that. One is a Mastercard/Visa gift card you can buy for fees which is not re-loadable. The other is a prepaid debit card which is re-loadable and come with fees. I don't know how LVP would work with a credit card. The reason the card companies couldn't tell if you used the funds for a purchase or cash. I am not a lawyer. I don't think the U.S. federal & states law would allow this. It could also cause problems with people wanting to access the checking account overdraft coverage. If this happened, I would be forced to withdraw more cash from the atms, tellers use more ACH instead of debit card for my bills. I have withdrawn lower amounts from the bank. The lowest I have withdrawn was $1.00.

Here another example, Let say you have a doctor bills for $30.00, the bank require you to with draw $50 but you only have $31.00 in your account. Instead of using a debit card, you have to use a check. There are people that live paycheck to paycheck or get social security. Don't make it more complicated then it is. Just because you can take out $50.00 doesn't mean everyone can. Your analogy about this "in the case of merchandise, the folks in the warehouse won't send out a truck for a single item" actually they do send out a single item if that is the only item ordered. I hate to disagree with a expert but I do.
Posted by Greg P | Thursday, April 05 2012 at 8:44AM ET
Sounds like an attempt of Debit or Credit industry to get ownership of small payments. Will we be paying the industry exchange fees for every cup of coffee we buy? Sure we will. Doesn't sound to me like a plan coming from someone who think about consumers too much. I'd rather stay with my wallet. Thanks
Posted by tttrrraaa | Saturday, April 28 2012 at 6:39AM ET
I agree with tttrrraaa.
Also, this cup of coffee will now be documented somewhere in my EMV history. Will I be getting e-mails from Starbucks in addition to those I am getting from Macy's?
Thanks, but no thanks
Posted by pam,a | Saturday, April 28 2012 at 6:48AM ET
The article provides just a high level explanation of the aggregation concept. Actual implementation details provide for high degree of control and flexibility to the consumer. Lets assume that we are looking at a debit card with the LVP functionality. Normally, the parameters are configured in such a way that LVP transactions (lets define them as those below $20) are processed using the spendable balance on the chip, while transactions above $20 are processed as debit transactions from the funds in the current account.

Whenever the spendable balance in the chip is insufficient to cover the LVP, another withdrawal is automatically initiated asking the consumer to authorize the amount used for the previous withdrawal (e.g. $50). At that point the consumer can proceed with the same withdrawal amount as last time, or choose a different withdrawal amount within the valid range defined by the issuer (e.g. $20 to $100 - parameters in the chip). If a different amount is entered, that amount becomes the default amount to be offered when the next withdrawal is required. This is analogous to the way we withdraw cash from ATM's with the difference that the consumer does not need to monitor the cash balance in his wallet and maintain it by visiting ATMs. With this solution the consumer just presents the card for any amount and if the spendable balance in the chip is insufficient the withdrawal is completed in one transaction while making the payment - with full control over the withdrawal amount (as at ATM).

Various border conditions are also covered. For example, lets assume that the spendable balance in the chip is $2, the LVP amount is $10, and the account balance is $15. If the withdrawal for default amount (lets say $30) gets declined, the terminal automatically tries mini-withdrawal for $8 (amount that provides for $10 needed to complete the purchase). Etc., etc.
Posted by Nebo | Tuesday, May 08 2012 at 2:56PM ET
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