The banking industry has been predicting practically limitless growth for signature debit cards, which banks, Visa U.S.A., and MasterCard International have all been promoting like wild.
But retailers have simultaneously been pushing PIN-secured debit transactions, because they are less expensive for them to accept. The pricing discrepancy is what led to the Wal-Mart suit, in which the nation's retailers successfully sued the card associations for lower interchange as well as the right to reject some payment types while accepting others.
The conventional wisdom, propagated for the past year by a variety of analysts, is that the Wal-Mart settlement will ultimately represent no more than a hiccup: Signature debit will continue to grow rapidly, and banks will quickly recoup the revenue they lose to lower rates as transaction volumes rise.
But now comes a contrarian report saying that signature debit will stagnate and decline, starting in 2007, while PIN debit will continue to flourish. This prediction reflects what seems to be a growing point of view that merchants will exercise more clout in the payments industry in the coming years than they have in the past.
There is already evidence of this phenomenon. Wal-Mart Stores Inc., which was the lead plaintiff in the eponymous lawsuit, no longer takes MasterCard debit cards in conjunction with a signature, apparently because it was unable to wrest from MasterCard the same discounts it got from Visa. Another big-box discounter, Costco Wholesale Corp., does not take signature debit at all but does take PIN.
And merchants like these will increasingly lead the retail industry to exert greater control over financial services companies, concludes a report released in March by the Financial Insights division of IDC Co., a financial services consulting firm in Framingham, Mass. Though it is considered provocative to suggest that large retailers could nudge banks from their position of supremacy over the payments system, Financial Insights goes so far as to predict that both credit cards and signature debit cards will suffer because of the interchange they charge, which is higher in both cases than with PIN debit.
"Offline [signature-secured] debit cards should be viewed as a transitional product," the report said. "Issuers should focus on building up their online [PIN-based] debit portfolios, since online debit will set the interchange rate for all debit cards in the near future."
The research and consulting firm offered further conclusions that are unlikely to please the bank card industry, including:
- Card issuers have become too dependent on interchange, and must start to wean themselves from this revenue stream.
- Given the precedent set in Australia and Europe for government regulators to mandate lower interchange, there probably will be further antitrust action against the card companies in the United States, and that lower interchange will result.
- Interchange reductions will bring further consolidation to the U.S. cards business;
- More banks will follow MBNA Corp.'s example and cut issuing deals with American Express Co.
Aaron McPherson, a research manager at Financial Insights and the author of the report, noted that merchants have been busy installing PIN pads to steer cardholders to the less expensive debit option. He said that merchants have been emboldened by their victory in the Wal-Mart suit, in which they won a one-third reduction in signature debit interchange, and other concessions.Though interchange rates for PIN (or online) debit will also increase, "the value provided by an online debit card to consumer and merchant is even greater than that provided by an offline debit card because of its higher security," Mr. McPherson wrote. "Raising online debit rates will also stem the decline in growth of offline debit and preserve issuer revenue streams."
Visa executives took issue with a number of the report's conclusions, particularly that signature debit will have zero transaction growth by 2007. For instance, while the report predicted that signature debit transaction volumes would grow 12.8% during all of 2004, they have already grown at 25% during the first two months of 2004, when volumes were that much higher than they were during the same two months of 2003, said Stacey Pinkerd, the senior vice president of debit products for Visa U.S.A.
Mr. Pinkerd predicted "very robust growth rate for years to come on our Visa check card." He also said that though PIN pads are becoming more ubiquitous, 75% of all merchant locations still do not have them.
He further pointed to the potential for growth in offline debit in newer markets, such as e-commerce transactions, fast-food restaurants, and telephone orders.
Executives from both Visa and MasterCard said that their companies' decisions to raise interchange on credit cards this year had nothing to do with their obligations, under the Wal-Mart settlements, to lower interchange for offline debit last year. They were permitted to raise those rates in January, but did not.
Richard G. Lyons Jr., the senior vice president in charge of MasterCard's North American debit strategy, said the Financial Insights report overstates banks' dependence on interchange. Interchange is just one component of the "overall" demand deposit account relationship "that a bank has with its customers," he said.
Avivah Litan, a payments industry analyst and vice president at Gartner Inc., of Stamford, Conn., agreed that Visa and MasterCard might be targets of further litigation, particularly over credit card interchange. But she called the prediction of 0% growth for signature debit by 2007 "radical."
John Gould, the director of consumer lending and bank cards at TowerGroup, a Needham, Mass., research and consulting firm that was recently bought by MasterCard, called the Financial Insights report "nonsensical." He also said that contrary to the report's assertions, interchange has gone down for many merchants. The associations have broken retailers into tiered groups, with grocery stores and other high-volume merchants being charged lower interchange rates.
Tony Hayes, the managing director of the financial services practice at Dove Consulting of Boston, called the report "misguided." He said most merchants that might deploy PIN pads have already done so, and he pointed to numerous growth markets in signature debit, such as recurring payments and the fast-food market.
But Mallory B. Duncan, a senior vice president and the general counsel at the National Retail Federation in Washington, said it would "not surprise me in the slightest" if signature debit volumes stopped growing in 2007. "Even the card associations realize that signature debit is a flawed mechanism for delivering debit," he said. "In the technological age that we're in now, PIN debit is the future."
