Debit Makes it a Horse Race

  Little brother just got bigger than the number-one son. For many families, that can cause some sibling rivalry. For much of the electronic payments industry, it was the culmination of years of hard work and a cause of celebration.
  Last year, transaction volume on Visa U.S.A.'s signature-based Visa check card exceeded that of Visa's U.S. credit cards for the first time. A few years ago that might have meant panic in executive suites. Instead, reaction has been positive because it is further proof that consumers increasingly are turning to plastic for point-of-sale payments.
  In September, Visa reported that consumers used their Visa check cards for 3.04 billion transactions during the first six months of 2002, compared with 2.96 billion transactions conducted with Visa credit cards. That upset comes despite American consumers holding twice as many Visa credit cards as Visa check cards. Full-year numbers were not out in early February.
  Admittedly, the record is colored somewhat. We're only talking a difference in transaction volume of 3%. Total credit transaction volume eats debit's dust when you throw in all the credit card transactions from MasterCard International, American Express Co. and Discover Financial Services, not to mention private-label cards. And the average credit ticket is about twice that of debit's $40 or so.
  But the Visa record is a sign that American consumers have taken to debit.
  Debit transactions grew 29% in 2002, according to the annual EFT Data Book from ATM&Debit News, CCM's sister publication. All told, there were over 14 billion debit card transactions last year, according to preliminary figures from ATM&Debit News. That compares with 10.8 billion transactions in 2001, a 29% rise from 8.4 billion in 2000. There were 275.7 million debit cards in consumer's wallets in 2002, up about 3% from 267.9 million in 2001.
  Today, 8% of all consumer payments in the U.S. are made with a debit card, up from 2% in 1996, says Stacey Pinkerd, senior vice president, deposit access products, Visa U.S.A.
  "Debit is wildly popular with consumers," he says.
  Indeed. In a 2001 survey asking consumers to rank seven everyday items in importance to their lifestyle, automated teller machine cards/debit cards were topped only by the home telephone. Debit beat out the Internet, computers, cable TV and cell phones.
  The survey was conducted for the Houston-based Pulse EFT Association debit network.
  Pinkerd believes that debit cards will continue to grab another 1% per year of total consumer payments for the next several years.
  Visa owns the signature-based, or offline, debit card market, with a 78% share of the total sales volume through the first three quarters of 2002. The debit MasterCard card has the rest.
  Offline cards accounted for about 60% of debit transactions in 2002, according to ATM&Debit News. Personal identification number or PIN-based debit accounts for the remaining 40%, though its share has been growing faster than offline debit's.
  In 2001, online debit grew at a 32% pace, compared to offline's 26% rate, and credit's 7% increase (chart, page 43). Preliminary numbers for 2002 indicate online debit surging at a 39% rate with offline growing 24% and credit card usage increasing 9%.
  As consumers have embraced debit, merchants have come to appreciate the product too. That's contrary to predictions a decade ago that debit would compete with credit for customer favor.
  "Merchants feared debit would cannibalize credit," says George L. Albright, chairman of Atlanta-based consultancy Speer & Associates. "Instead, debit cannibalized cash and checks."
  And some assumed that consumers wouldn't want to give up the float that credit cards offer. The $64,000 question was: who would use a card that automatically debits your checking account, when you can put off paying the bill for 30 days or more?
  But consumers proved to be more sophisticated than that. Consumers carrying balances on their credit card accounts sometimes prefer to use debit so they don't add any new debt, according to a spokesperson for Chicago-based Bank One Corp., a leading debit card issuer. "The meter is running every time they make a purchase," the spokesperson says. "This doesn't roll up the interest."
  The ease of getting cash back at the grocery store with a PIN-based debit card also was an important draw, says Timothy L. Munto, senior vice president and general manager for national sales at merchant acquirer National Processing Co. That meant the consumer avoided the main drawbacks of ATMs-fees for cash withdrawals charged by some ATM owners and waiting in line, Munto says.
  Consumers soon understood their card could be used for both ATM withdrawals and purchases. In the 2001 study for Pulse, cardholders estimated they used their card an average of 4.78 times over the previous two weeks, 3.12 times to make a purchase and 1.65 times at an ATM. Over 71% of consumers in 2001 knew they could use their ATM card for purchases, up from 34% in a 1993 study.
  A survey last September from Visa of 1,000 Visa check card card holders confirms that debit is replacing cash and checks. About half of those surveyed said they carry a debit card so they don't have to carry a check book, and 60% said the primary reason they carried the card is to carry less cash.
  Transaction speed is critical with 76% saying the cards save them time and 59% saying they get through lines faster.
  And many consumers believe debit offers better tracking of their money. Seventy percent say they have a better idea where they spend because they use the card and 60% say they are more aware how much they are spending since they began using the check card.
  Debit makes merchants smile due to several characteristics it shares with its brother credit. Cash handling is reduced, lowering costs. A card transaction may take a minute less than a check transaction. And consumers spend more on an average plastic transaction compared with a cash purchase.
  For merchant acquirers and card issuers, it comes down to the bottom line. More plastic payments have meant more transaction income. As an added bonus, debit transactions allow for greater opportunities to build databases of consumer payment behavior.
  Challenges
  But debit faces challenges. Consumers sometimes get confused about credit and debit payments because most debit cards nowadays have both PIN and signature functionality, but POS terminals frequently prompt consumers to push the "credit" button when using a signature-based debit card.
  That structural defect at the moment seems minor compared with the giant shadow now covering the industry-the class-action lawsuit pitting millions of merchants against Visa and MasterCard. The case, filed more than six years ago, is scheduled for trial April 28 and is frequently called the Wal-Mart suit because of its lead plaintiff (box, page 42).
  The suit revolves around the bank card associations' "honor-all-cards" rules that require merchants to accept their debit cards if they accept their credit cards. Merchants object to accepting the offline cards because the interchange fees, they claim, are too high and too close to credit card rates for the risk posed. Interchange for online debit cards from the regional electronic funds transfer networks is considerably cheaper.
  In offline debit and credit card transactions, interchange is the fee set by Visa or MasterCard that the merchant acquirer must reimburse to the card issuer. Acquirers, of course, simply pass such expenses on to their merchant clients.
  Some cynics say it's no surprise that Visa chose not to raise interchange fees for its check cards in January, just a few months before the big trial, even though it raised some credit rates.
  But that's baloney, says William Sheedy, Visa U.S.A.'s executive vice president, Interchange Strategy. "Our broad debit objectives go beyond just check card rates," he says. "We want to incent merchants to accept Visa cards. We want to incent issuers to issue Visa."
  Keep in mind, Visa must consider the impact of increases on its own Interlink network, one of the largest processors of online debit transactions, Sheedy says. He also argues that offline debit wasn't the only category that saw no increase. Interchange remained the same for Visa credit and debit transactions at supermarkets, gas stations, airlines, hotels and a number of other categories.
  MasterCard forced the interchange issue in January by announcing rate increases for some credit and debit transactions that will take effect in April.
  Making a Point
  Whatever the outcome of the retailers' case, some believe the merchants have already made an important point. The interchange rates for debit, especially online cards, should be considerably lower than those of credit because there is less risk to the issuer. Interchange pays, at least in part, to fight card fraud, chargebacks and other issuer losses. Those losses rarely occur when an online debit card is used, because the cardholder's account is automatically debited for the purchase and only the legitimate cardholder should know his PIN.
  "PIN is the most secure transaction in the payment mix. Lower risk ought to translate to lowest cost," Munto says.
  Stan Paur, president and chief executive of Pulse, is less direct than Munto but agrees that interchange fees could use some changes. "PIN debit is a superior payment product," he says. "Neither merchants nor financial institutions believe the price is right."
  But not only are payment executives at odds about the proper price differential between credit and signature-based debit, they also have a hard time agreeing on the proper pricing and positioning of PIN vis-?-vis signature debit. Issuers want the higher revenue from offline debit.
  On a typical $40 debit sale, a Visa check card produces 60 cents in interchange compared with only 38 cents for the same sale on the Visa-owned Interlink point-of-sale debit network. Interlink interchange also has a maximum charge of 45 cents on a sale, no matter how large. Check cards carry no cap on their interchange fee so merchants pay more as the transaction rises. And the other online debit networks are often cheaper than Interlink.
  It's no surprise then that some issuers penalize cardholders with fees for using PINs at the point of sale, or run promotions prompting use of signature-based cards. At the same time, some merchants program their POS terminals to prompt customers to punch in their PINs.
  The challenge for the industry is to get merchants and issuers to compromise on a new revenue structure, according to Paur. He believes that financial institutions may be amenable to receiving lower interchange revenue if consumers were to pay a fee for using their debit cards.
  "You could see a bundled fee applied to consumers where they are charged $1 or $2 a month if they use their card X number of times," Paur says.
  PINs Preferred
  Interlink and other big online networks have taken to giving volume discounts on interchange. Star, a unit of Concord EFS Inc., set its supermarket interchange rates at a sliding scale last year of 12.5 cents, 14 cents or 19 cents per transaction. The more volume the grocer generates, the lower the interchange rates. The NYCE network, majority owned by processor First Data Corp., matched those charges.
  While the pricing issue rages, there's still little change in merchants' preference for the PIN. "As long as merchants operate on thinner and thinner margins, they will embrace PIN-based debit," says NPC's Munto.
  The growth of the networks could mean a stronger position when negotiating with the associations and their financial-institution members. Star is the largest network ranked by the number of cards. In 2002, Star had 127 million cards compared to number-two Pulse with 80 million, followed by Visa's Interlink with 63 million, and NYCE with 52 million, according to the EFT Data Book. The top three networks ranked by 2002 market share were Star, Interlink and NYCE which controlled 80% of online debit volume, according to a study released last December by the Federal Reserve Bank of Kansas City.
  Meanwhile, in an attempt to grow its debit market share, First Data last year bought PIN-based debit processor PayPoint Electronic Payment Systems from international petroleum marketer BP p.l.c. for an undisclosed price.
  PayPoint was created in 1984 by oil retailer Atlantic Richfield (ARCO) to process card transactions at the then-rapidly expanding sector of self-serve stations. ARCO expanded PayPoint to other retailers, then was swallowed by BP in 2000. PayPoint clients include home-improvement chain Lowes, upscale grocer Trader Joe's, top-three grocer Albertson's and McDonald's Corp.
  Fast Cash
  McDonalds, that giant of fast food, or quick-service restaurants, made news in 2002 when it announced it would roll out card acceptance at its 13,099 U.S. restaurants this year. American quick-service outlets generated $110 billion in sales last year, most of it in cash payments.
  Debit proponents began salivating over the opportunity to grab a piece of that pie because smaller purchases have been debit's bread and butter.
  NYCE quickly announced special interchange of 7.5 cents on an average ticket of $5 for the quick-service market. Star countered with a flat 12.5 cent rate for all fast-food transactions. NYCE claims fast food could generate 22 billion transactions per year.
  These network battles, the Wal-Mart case and the growing power of the networks are interesting for the industry. But don't forget that the most important factor in the growth of debit is the consumer, says Speer's Albright.
  "The customer doesn't care if he has Visa or MasterCard," Albright says. "If a transaction takes place, he doesn't care whether it goes to Star or Visa. What's important is that he knows it will show up on his statement."
  Making sure the consumer remains interested in debit is an increasingly important job for marketing executives at the card associations, banks and EFT networks.
  Marketing is taking on new importance at MasterCard, the distant number two in offline debit. Over the past year, MasterCard has hired new executives and put new resources into debit. In a new advertising campaign pegged to its long-running "Priceless" theme, MasterCard goes straight to consumers to convince them to replace cash with debit. In its debit MasterCard "Night on the Town" campaign, the Purchase, N.Y.-based association is running national television advertisements along with local radio and print ads.
  The campaign uses a television spot unveiled during the Super Bowl. In the ad, George Washington, Abraham Lincoln and Andrew Jackson wait impatiently for a friend to return from a date. Meanwhile, the friend uses his debit card to pay for everything instead of shelling out the $1, $5 and $20 on which the leaders' faces are prominently displayed.
  Rewards
  A sweepstakes running from April through May will offer 1,000 prizes with 100 top prizes that include a night on the town for a couple anywhere in the U.S. Winners can spend up to $2,500.
  Richard Lyons, MasterCard's senior vice president, North American Deposit Access, wants to encourage the trend for debit use beyond grocery stores and gas stations. Lyons won't reveal spending on the campaign but says past promotions have paid off.
  "We see an 18% increase in transaction volume during the time of a promotion," Lyons says.
  Issuers have gotten into the debit promotion game recently with rewards programs similar to their credit card promotions. Many are along the lines of an offer from Visa check card issuer Bank One. The cardholder earns discounts at online retailer Amazon.com if she makes a set number of signature-based purchases within a set time period.
  Bank One also is testing a program in Denver for cardholders of its United Airlines Mileage Plus Visa check card. Cardholders that pony up the $25 annual fee can earn air miles for dollars spent.
  Citigroup Inc.'s Citibank last year introduced a campaign for its AAdvantage debit card that rewards signature-based spending with miles on American Airlines.
  Along with the income from transactions, debit can benefit issuers with the opportunities offered by the information generated with each purchase, according to Milwaukee-based Metavante Corp., a major EFT processor and merchant acquirer that also offers its issuing clients data-mining of cardholder usage patterns. A typical program would be a quarterly analysis of the cardholder, including where she spends, how much, how often and any change in spending, says Frank D'Angelo, executive vice president and general manager, EFT and card.
  "We analyze for risk management, card activation, and watch if the consumer is only using (the debit card) at grocery or gas stations," says D'Angelo.
  With that information, the issuer can target the cardholder with e-mail, direct mail and phone promotions, he says. The goal is to increase the consumer's use of her debit card for her purchases.
  Debit clearly has the wind at its back. Consumers, issuers, acquirers and retailers all benefit from the product, notwithstanding disagreements over pricing.
  Albright sees growth continuing at over 20% for the next few years.
  "That is much stronger than (growth of) credit cards in the 8% to 12% range," he says. "Debit will continue to outstrip them."