Visa Inc. is overhauling its pricing to spur merchants to route transactions its way and defend a dominant share of the U.S. debit card market, a position endangered by new regulations.
The payment network plans to lower an existing variable fee that merchants and their acquirers pay on each card transaction. To compensate, Visa will introduce a fixed "network participation" fee that merchants will have to pay to accept any of the network's cards, debit or otherwise.
The carrot-and-stick approach "offers merchants an even greater incentive to route more transactions over our network by providing them an opportunity to lower their per-unit transaction costs and take advantage of economies of scale that are now more readily available to them," Joseph Saunders, Visa's chairman and chief executive officer, said on an earnings conference call Wednesday.
The company's executives refused to give detailed answers when analysts asked about how the fee changes will work, how they will affect Visa's bottom line and how much retailers could save.
But it was clear that management believes the debit card market is Visa's to lose.
The Federal Reserve Board last month finalized rules putting into practice the Dodd-Frank Act's Durbin amendment. The provision instructed the central bank to set debit interchange fees that are "reasonable and proportional" to issuers' costs. The law also gives merchants greater ability to control processing of debit card transactions. The Durbin rule bans arrangements that networks such as Visa have had with banks under which it exclusively processes both an issuer's signature and PIN debit transactions. Now, issuers must equip their debit cards with at least two networks that are not affiliated with each other — Visa's signature network and First Data Corp.'s Star PIN network as an example.
The intention is to give retailers a choice about which network to route their customers' transactions in hopes of lowering costs. Visa is expected to lose a substantial portion of its PIN debit volume as a result, as issuers add networks to replace or accompany Visa's Interlink PIN network.
Visa's "got a lot of exclusive debit cards in the marketplace, more than anybody else, so they're trying to protect their volume as much as possible," says Jason Kupferberg, a senior analyst with Jefferies & Co.
The price changes will be mandatory for merchants that accept the company's cards. "They can opt out if they don't want to accept Visa cards."
Whether Visa's pricing changes will be enough to entice merchants to keep routing transactions over its network is unclear, but some analysts say the strategy, in theory, makes sense.
"It seems like a creative means of benefiting all … parties involved," says Sanjay Sakhrani, an analyst with Keefe, Bruyette & Woods Inc.
But Brian Dodge, the senior vice president of communications and state affairs for the Retail Industry Leaders Association, is skeptical that merchants would see any cost savings.
"This is exhibit A in how Visa is able to leverage its market power to determine rates, fees and whatever they wish … to impose … on merchants," Dodge said.
Merchants won't have any real routing choice, he says, because the Fed chose a less onerous interpretation of the network exclusivity rule, requiring only two unaffiliated networks on each card instead of two networks each for signature and PIN transactions.
Tien-tsin Huang, an analyst with J.P. Morgan Securities, likens the price to a fixed annual golf membership fee plus variable cart and green fees.
Retailers will pay the fixed annual network fee to merchant acquirers, which will pass them on to Visa in monthly installments, Huang wrote in a research note on Thursday. "We expect the annual pricing grid to be complex and based on merchant size, number of outlets" and category.
At the same time, the variable processing costs that merchants pay will go down. "This fixed fee … is not a fee that sits on top of what merchants are paying," Saunders said. "It is part of what we consider to be a reduction in the fees that merchants will pay."
Whether the changes actually result in lower prices for merchants also is in question because it is uncertain how their acquiring banks will pass along the costs. The idea is that retailers who route more of their transactions over Visa's network will reap more economic benefits over time. That is likely to be true for large merchants such as Wal-Mart Stores Inc. and Home Depot Inc., which do more direct negotiating with card networks and exert more pressure on fees.
But for small and midsize merchants, the cost savings aren't as clear, at least initially.
For example, the acquiring banks could mark up the cost of the network participation fee charged to merchants to boost their own profit margins, Timothy Willi, a senior analyst with Wells Fargo Securities, wrote in a research report on Thursday.
Visa may be overestimating merchants' ability to control routing in the new price environment, says Eric Grover, a principal with the consulting firm Intrepid Ventures and a Visa veteran.
While many issuers include multiple PIN networks on their cards today, Grover says he expects most will go with a single PIN network that offers the highest interchange fees to protect their own revenue.
"The issuers that today are aligning with multiple PIN debit networks [are] not going to want to continue that," Grover said. "Any issuer would be foolish to provide multiple PIN networks on their debit cards, which thereby provides merchants with choice, because if merchants have choice … between two networks they're going to pick the less expensive network. They're going to drive down interchange fees and network fees." Visa has about 75% signature debit market share and 55% PIN debit share, according to a June 30 research report by Huang. Grover says he does not expect Visa's signature market share to be substantially affected by the new rules but predicts the network could lose a large portion of its PIN share.
"We thought very clearly" about "what our competition would do," Saunders said. "We think we have put ourselves in a position where we are more than capable of responding. We have no intention, nor do we think we have to start, a race to the bottom" on pricing.
A spokesman for MasterCard Inc. wouldn't comment on Thursday, citing the company's upcoming earnings report next week.
Saunders reiterated Wednesday that it would suffer the bulk of the damage from the Durbin amendment in fiscal 2012. The company reiterated earnings guidance it gave earlier this month for fiscal 2012, saying the projections take into account the new pricing changes.
In the fiscal third quarter, Visa's net income rose 40.4% from a year earlier, due partly to a gain it recognized from revaluing a put option tied to Visa Europe, which operates as a separate entity. Excluding the gain, Visa's net income rose 23% to $883 million in the quarter that ended June 30, or $1.26 per diluted share.
That beat analysts' estimate of $1.23 per share, according to Thomson Reuters.
The San Francisco company's operating revenue rose 14.4%, to $2.32 billion, due to higher service, data processing and international transaction revenue.
Visa's shares rose as much as 1.4% on Thursday to $88.97.