In April, for the first time since 1991, the credit card acquiring business will have to contend with a comprehensive increase in interchange rates.
Beyond the more limited increases of previous April/October interchange seasons, the change this April will affect most interchange categories and most merchants. For some acquirers, the interchange increase will necessitate widespread pricing revisions to avoid margin erosion.
For all acquirers, April represents a unique opportunity to revisit pricing in an environment in which market pricing in general is in flux.
Much of the industry employs interchange-plus pricing strategies, and a repricing may not be necessary for these segments. For segments that use fixed discount schedules, however, a repricing will be necessary to avoid margin erosion.
The name of the game of pricing a new merchant is getting the sale-it is an individualized, personal, sales situation. Repricing, however, is a different story. The name of the game in repricing is making smart choices regarding the tradeoff between revenue and attrition-a portfolio management situation. You may be quite willing to have attrition rates several points higher if your revenue increase sufficiently offsets it. Similarly, you may be willing to decrease pricing on a segment by 10 basis points if your attrition declines enough.
We recommend several steps of analysis to precede your interchange repricing.
First, revisit your pricing strategy and structure. Are there elements of your pricing strategy that you want to alter? For example, do you use a primarily bundled pricing structure but at the same time introduce some of the creative fees becoming more commonplace (for example, annual fees, minimum discounts). Do you want to change the discount calculation methodology?
Second, analyze your portfolio. Evaluate the profitability of different segments. Every portfolio we have analyzed has "sweet spots," segments which generate higher than normal margins and, in some cases, the bulk of the portfolio's value.
Unfortunately, every portfolio also includes segments that are not meeting margin targets and, in some cases, are losing money. Many of the pricing decisions in our industry are made through a cost-plus framework using average costs. When the costs associated with a particular merchant differ significantly from a portfolio's average costs, the merchant may be priced at an outright loss.
Your evaluation of the profitability of different components of your portfolio will influence your aggressiveness in testing repricing strategies. You are less sensitive to attrition in a segment in which you are not making any money than in one that is nicely profitable.
Next, we recommend you segment your portfolio in terms of historical attrition. You may have segments in which your attrition is bad enough to merit a downward revision in pricing. On the other hand, zero attrition in a segment is not necessarily a good thing and may be an indication that you are leaving money on the table. In any case, you should be well aware of your attrition profile as you consider strategies for dealing with higher interchange rates. Ultimately, you may wish to develop attrition probability models as empirical tools to aid in re-pricing decisions.
Also, make sure you have proper decision support tools in place. On the most basic level, we recommend you adopt pricing strategies within an active testing context. Set up control groups against which to compare your new pricing strategies and then measure the tradeoff between pricing changes and attrition analytically.
We have found acquirers that moved to empirical, fact-based processes have made better decisions. Over time, you may develop other decision- scoring support tools that will be of great use, including attrition scoring and profitability scoring.
The acquiring business has become characterized by intensifying competition, high expectations, and increasing difficulty in meeting aggressive financial projections. The acquirers investing in decision support and portfolio management techniques will have a performance edge over the rest of the field. Many view the April interchange increase as a negative event that is highly unpopular within the merchant community. We choose to view the increase as a golden opportunity to revisit and refine your pricing strategies.
