Check Conversion Moves To the Back Office

  Cashiers have been able to convert checks into electronic transactions at the point of sale since 2000. But many multilane retailers have rejected the inherent requirements of the automated clearing house point-of-purchase process as being too complicated.
  On March 16, a new ACH rule will take effect that experts believe will encourage more merchants to convert checks using ACH-based and other check-electronification methods, such as image exchange.
  Today, cashiers who convert checks into electronic transactions using the official ACH point-of-purchase (POP) code scan paper checks through magnetic ink character recognition line readers that detect account and bank-routing data. They then hand the voided checks back to customers, who are asked to sign slips of paper saying they authorize the electronic withdrawal of funds from their checking accounts.
  The new ACH option will not require customers to sign permission slips and will let cashiers keep paper checks. Someone else can decide later how to process them. That flexible, back-office option has earned the new ACH rule set the official code BOC for "back-office conversion."
  ACH and non-ACH conversion methods will complement each other under the new rules. But they also will compete as banks and nonbanks tout to merchants advantages of the check services they offer.
  Despite some uncertainty, check-services vendors are gearing up for a potentially big revenue opportunity. "We don't know if major retailers are going to adopt this," says Tom Kettell, vice president of marketing at RDM Corp. a Waterloo, Ontario-based provider of check-imaging equipment and processing services. "If they do, there are billions of transactions up for grabs."
  Another reason the old POP method has not caught on with most large retailers is that in-lane readers sometimes misread MICR lines. And cashiers sometimes scan checks ineligible for conversion, such as small-business checks that look like personal checks.
  NACHA recently made many business checks eligible for ACH conversion at the point of sale. But checks whose account owners opt out of conversion and checks for $25,000 or more still are not eligible.
  Settling POP transactions is more difficult after MICR misreads and mistaken conversions are discovered because original checks have been returned to customers.
  Some merchants have bought in-lane check readers that also capture digital check images. They can use the images to save MICR, amount and signature evidence in case the data are needed later. Or they can use images to route some checks as image-exchange documents based on rules of the Check Clearing for the 21st Century ("Check 21") law. But many more merchants have rejected the extra expense of deploying such equipment in each lane.
  EASY ADDITION
  Banks and vendors say the new ACH back-office conversion rule will be easy for them to implement, as it involves the same equipment and similar software used for other electronic check-conversion methods.
  CheckFree Corp. claims banks use its software to process two-thirds of the nation's ACH transactions, mostly mailed checks converted into electronic accounts receivable entry, or ARC, bill payments. CheckFree recently announced a new software module, PEP+ reACH/BOC, that will support BOC processing.
  "It really was not difficult for us to do," says Esther Pigg, vice president, global product management for CheckFree Software. "You're able to take a check presented at the point of sale to the back office, so BOC has a lot of similarities to ARC."
  Carson, Calif.-based MagTek Inc. makes in-lane MICR readers and check scanners that enable a variety of check-verification, guarantee, ACH and imaging functions. John Arato, MagTek vice president and business unit manager of retail products, says the third parties that provide its products to their clients are eager for the new rule's arrival.
  "I've had meetings with several large check processors, and they feel this is going to take off really quickly," he says. "We're trying to figure out whether people are going to do imaging or not."
  The new rules also will draw new vendors. ACH Direct Inc. provides ACH, credit and debit card processing services to government agencies, utilities, health clubs and other billers. But the company shied away from points of sale until the advent of back-office conversion.
  "We're definitely going to pursue it in a very substantial manner," says Jeff Thorness, ACH Direct president and CEO. "This is the first ACH product that I feel is a real viable solution for the retail channel."
  Merchants pushed hard for rules that keep options open for all electronic-check handling methods. "BOC was driven by the need to find a more-seamless solution: being able to have Check 21-types of solutions fit in with ACH check conversions," says Dan Miner, NACHA senior director of network development and risk management.
  NACHA projects its BOC code could reach 3 billion transactions annually within five years. That would surpass accounts receivable entry, which has dramatically outpaced other ACH check-conversion methods. ARC logged 495 million transactions in the second quarter, for example, compared with 60 million POP conversions.
  In a January survey by Boston-based Dove Consulting, 11 out of 16 retailers rated back-office conversion as "a significant opportunity" for their organizations.
  "The market will have some early action from some big players with complex transactions," says Dove analyst Ed Bachelder.
  But, he says, most merchants tend to watch how others fare with new transaction types before starting their own pilots. That may be a good strategy for nascent technologies with promise. But checks are over the hill, and despite their slow decline, the longer a merchant waits, the less sense any check-related new technology might make, Bachelder argues.
  Banks and third-party vendors hope to make their investments in one type of check-handling method or another pay off.
  Some tout the low cost of ACH methods. They cost merchants anywhere from 2.5 cents to 25 cents per transaction.
  Other banks and vendors push image exchange, in which scanners capture digital images of fronts and backs of checks to send through processing systems from merchants to banks. Such settlement tends to be a little faster than ACH, which can provide a float advantage for high-ticket payments.
  But because image exchange is new enough that many banks have only recently started implementations, it costs merchants from 20 cents to 30 cents per check.
  The drive to promote one conversion method over another can lead to mixed messages from vendors and banks. "When we're talking to merchants, we're telling them they can save a lot of money on lower bank fees [from ACH]," says Terry Stepanik, president and chief operating officer of US Dataworks Inc., a Houston-based provider of payment-processing software to banks and merchants. "But the banks are less enamored of doing BOC to ACH than to Check 21."
  Last year, US Dataworks commissioned a study of back-office conversion's implications for 43 department-store locations of one of its customers. Cambridge, Mass.-based Meta Software Corp. calculated that converting eligible checks into electronic ACH transactions using the new BOC rules could reduce bank fees for the chain by 97%, improve access to funds by 54% and decrease returned-item losses by 20%. Together, the savings from converting checks to ACH for the retailer would be 59.9% of total check-processing costs, or $4.4 million across its stores. By comparison, the savings from back-office conversion of checks into image exchanges would be $2.9 million to $3.5 million.
  DIFFERENT DRIVERS
  Bob Seltzer, Meta Software CEO, says the drivers encouraging the use of ACH and image exchanges under the new BOC rules will vary. A bridal shop may prefer image exchange for quicker settlement of pricey checks. Home-improvement warehouses likely will use image exchange for big-ticket business checks.
  "But most retailers will use ACH," Seltzer says. "The biggest compelling benefit will be reducing bank fees. They're going to get the biggest bang for their bucks going to the ACH [from paper checks]."
  The smart banks, Seltzer says, will offer both BOC and image-exchange services. "Those banks who view BOC as a challenge to their fee income, which it will be, will lose clients to the more-aggressive banks," he says.
  Keith Theisen, senior vice president and director of treasury management for Wells Fargo & Co., agrees. Wells has about 3,000 customers using or preparing to use its Check 21 services. "BOC will just be another enhancement to that suite of services," Theisen says. "We see it as a way to expand market share. It allows us to capture new clients regardless of geography."
  One processor is offering bank customers a service they can provide merchants that will enable three types of check conversion. Nova Information Systems, a subsidiary of U.S. Bancorp, announced in November its Electronic Check Service will add back-office conversion to its mix of image exchange and direct demand-deposit account access.
  Direct DDA uses the Visa POS Check Service to check availability of funds in accounts during transactions for the price of a PIN-debit transaction. Even after the BOC rule arrival in March, Nova still will recommend merchants use Direct DDA over other conversions when possible. But the service can access only 30% of accounts in the U.S. So Nova will recommend back-office conversion as the next option and push Check 21 imaging to third.
  Nova's Electronic Check Service will use existing in-lane MICR readers for optional verification and guarantee services and to initiate Direct DDA and ACH transactions immediately. Nova will continue to provide single MagTek Excella scanners for each retailer to scan all checks for archiving and to route images of any checks that must be handled under Check 21.
  POTENTIAL RISKS
  One snag back-office conversion and image exchange risk is both paper and electronic transactions being presented to check writers' accounts. Merchants also must keep paper checks secure until they can be destroyed and make sure additional equipment and software properly send check data to banks and headquarters.
  "We're pushing more and more of the bank processing out into the field to the merchants," Stepanik says. "If my software has to be installed on a local PC at a store, you're asking that store manager to be a data center manager for you."
  Some retailers prefer local control. But banks and payment vendors are offering checkout-to-settlement services for those who want someone else to do the heavy lifting, including handling toll-free customer-service questions, as required by the new back-office conversion rules.
  US Dataworks is among those who recommend merchants move as much check-handling activity as possible out of individual stores and into their headquarters or with service providers instead.
  Solutran allows merchants to scan their own checks if they prefer, but Barry Nordstrand, the Minneapolis-based company's president and CEO, believes more merchants will opt for its new Solutran POS and Imaging Network service. The service will determine if MICR line reader data and check amounts provided by points of sale qualify checks for ACH processing. Those that qualify are processed immediately. Those that do not will wait until courier services deliver paper checks to Solutran, which will scan and process checks appropriately.
  "Having scanners spread around every retailer's back office is more expensive than it needs to be," Nordstrand says. "They really only have to send us the MICR file, send us the checks in the bag, and we take it from there."
  To spite its critics, POP check conversion's 60 million transactions in the second quarter represent a big jump after years of flat growth. The process logged 42.4 million transactions in the first quarter of 2006, which was down 7.26% from the fourth quarter of 2005.
  The surge is widely attributed to Wal-Mart's much-publicized expansion of POP conversion to many of its lanes during the first quarter. Wal-Mart will not disclose much about store operations, but representatives of the chain said recently they have no plans to implement back-office conversion.
  COMING CALM?
  Miner says he believes POP conversion's growth spurt is not just because of Wal-Mart. With back-office conversion on the way, check-electronification rules are finally stabilizing under various legal frameworks after half a decade, he says.
  "We rolled out POP, then right on the heels of rolling out POP, Check 21 came out. Right on the heels of that, we rolled out BOC," Miner says. "That's why POP sat flat for awhile. Now that we have the rules in place, we'll have the early adopters, and the rest of the decision-makers will feel they know what all the cards are."
  Whether a future as transaction superstar is in the cards for back-office conversion, it adds another option to the check-electronification family for merchants and the vendors who serve them.
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