E-Check Growth Has POP

  In March, NACHA-The Electronic Payments Association introduced new automated clearinghouse rules that allow merchants to keep paper checks presented at the point of sale. That way, they can decide later whether to route the checks electronically as ACH debits, digital images or as old-fashioned paper.
  Called back-office conversion, or BOC, the new rules are a more-flexible alternative to the point-of-purchase ACH method NACHA implemented in 1999. POP check conversions require cashiers to use small scanners to capture the bank-routing and account information from magnetic ink character recognition, or MICR, lines on checks. Cashiers then return the voided paper checks to customers, who must sign separate papers authorizing the ACH conversion.
  The number of transactions converted under the POP method grew only incrementally for years, even though routing checks as electronic transactions costs pennies per transaction. Each check routed as paper can cost up to $1.50 to settle.
  But in the months just before and after BOC's implementation, POP conversions began to proliferate. ACH experts attribute the sudden wave of POP activity to Wal-Mart Stores Inc.'s chainwide adoption over the past year, as well as to growing consumer acceptance, improved check-scanning equipment and fewer checks being written, which makes it easier for retailers adopting POP to afford add-on check-guarantee services.
  Multilane merchants long had complained that POP was problematic. The process would confuse and annoy shoppers, they said. Merchants worried about high employee turnover that would require constant retraining of cashiers to avoid scanning and returning to shoppers voided money orders, travelers checks and business checks that were not eligible for ACH conversion. Most retailers used MICR line readers with check-verification services, but if the readers malfunctioned, merchants would be unable to collect funds because they had relinquished the paper checks.
  So POP was adopted mostly by smaller merchants who had smaller staffs and lower turnover. Some installed image scanners to capture backup images of checks converted to POP. At less than $500 to purchase single-sided models, such scanners were not onerous for merchants with only one or two checkout lanes to equip.
  Conventional wisdom said POP would remain in that niche, but then the number of check conversions suddenly shot up. NACHA reported 38.6 million POP transactions in the first quarter of 2005, which was down approximately 6.5% from 41.3 million the previous quarter (see chart, page 22). POP transactions stayed in the 40 million to 45 million range until the second quarter of 2006, when they jumped 42% to 60.1 million.
  That jump is widely attributed to the world's largest retailer. Wal-Mart began piloting POP check conversions in some of its stores in 2004 and announced in September 2005 that it planned to roll out the service to its more than 4,000 U.S. stores.
  "People tend to watch what Wal-Mart does," says Bob Johnston, Bank of America Corp. senior vice president. As BofA in recent months discussed its check-handling services with merchants, including remote deposit services for check images and planned BOC services, "a number of them told us they were looking at POP in light of Wal-Mart's pilot," he says.
  Mike Cook, Wal-Mart vice president and assistant treasurer, told attendees of NACHA's Payments 2007 conference in April that the final 300 Wal-Mart stores would complete POP rollouts within the week.
  "The hurdles with POP were not so high," Cook said. "It's truly beneficial to implement it on a chainwide basis."
  Because Wal-Mart already had MICR readers in each lane to use with account-verification services, implementing POP required only "minor" software changes and cashier training, which went well, he said.
  Other national multilane merchants have gotten on the POP bandwagon, including Auto Zone, the Gap and Office Depot. POP transactions have continued to grow, to 86.4 million in the fourth quarter of 2006 and to 127.7 million in the second quarter this year.
  Cook told conference attendees he considered BOC "a solution waiting for a problem that doesn't exist." He suggested BOC could introduce new problems, such as additional costs to sort and store checks. Moreover, thieves could steal stored checks, or catastrophes such as a hurricane could result in processing delays or checks being lost.
  Hurricane Katrina in 2005 and the 2001 terrorist attacks in the U.S. caused such problems, Cook said. "Some of the armored-car services had left the [Gulf region]," he said. "We had the same situation after Sept, 11, when the planes weren't allowed to fly."
  But Wal-Mart was able to process checks as POP transactions in areas affected by Hurricane Katrina using power generators and satellite systems for electronic communications, Cook said.
  Cook noted the enthusiasm of many financial institutions about the services that they and third-party vendors can provide merchants under the new BOC rules. "There is not as much need in the value chain for them with POP," he said. "Any time financial institutions get excited about something, I reach for my wallet."
  RULE CHANGE
  Another factor that helped sweeten POP for some merchants was a September 2006 rule change to allow the conversion of most small-business checks written for less than $25,000. Businesses that do not want their checks converted can add an auxiliary "on-us" field to the MICR lines of their checks, which make the lines long enough to require larger-sized checks that cashiers can more-easily distinguish as not eligible for conversion.
  Before the rule change, cashiers accidentally converted many small-business checks, especially those handwritten and the same size as consumer checks. Many passed through the ACH system even though they technically were ineligible, but banks could delay or reject payment on improperly converted checks if detected.
  Office Depot serves a mix of business and individual customers. Fred Witt, Office Depot's senior manager of credit governance, began exploring BOC and POP check-conversion options in April 2006. In September and October of that year, the chain rolled out POP conversions to all of its stores, backed up by TeleCheck's check-verification and guarantee services.
  "Our check volume is diminishing significantly year after year," Witt says.
  With checks now only 7% of Office Depot's point-of-sale transactions, spending a little extra so TeleCheck would guarantee payment on any checks it accepted was worth the money, he says.
  An increasing number of retailers share that sentiment, says Brian Mooney, TeleCheck president. As merchant customers present fewer legitimate paper checks, the percentage of checks that are fraudulent has increased, he says, adding that the reliability of MICR readers and technology to gauge the risk of each check has improved in recent years.
  The improvements made retailers more confident about not collecting back-up images of checks.
  "We got to the point where we could do POP without putting [check-image scanners] in each lane," Mooney says.
  Because Office Depot already had MICR readers in each lane, the POP conversion cost between $135,000 and $150,000 and needed minimal cashier training, according to Witt.
  He says Office Depot recovered POP costs by reducing the need for armored car service pickups or local bank accounts for quick deposit runs.
  Meanwhile, Witt says it did not make sense to embrace BOC, given the average price of $1,000 per back-office check imager and scanner for approximately 1,100 Office Depot locations. He says it would have cost Office Depot about $1.3 million for BOC hardware, software conversions and network tests. Witt also was concerned that store staff would not scan checks every day as required.
  MORE FLEXIBILITY
  Furthermore, as with paper checks, BOC would allow cashiers to ignore warnings from verification and guarantee services to decline or call for more information on some checks, according to Witt. "There's that potential confrontation at the point of sale, where the cashier doesn't want to tell the customers that their check is not accepted," he says. With POP, cashiers can truthfully say they cannot override the system because systems can be configured not to scan and process POP transactions on rejected checks, Witt says.
  A small headache POP has caused Office Depot is that MICR readers sometimes reject paper checks that customers print themselves because most of those checks do not contain the magnetic ink of professionally printed checks. "We sell the [check-printing] software, so it's a problem we created for ourselves," he says.
  Office Depot routes any checks that cannot be converted to ACH as paper transactions, Witt adds.
  Meanwhile, BOC transactions have started to trickle into the official ACH logs. NACHA reported 17,121 BOC conversions in the first quarter of 2007 and 248,919 in the second quarter.
  Michael Herd, managing director of ACH network rules at NACHA, says he is unsure which merchants are using BOC. He says the numbers indicate either that only small merchants are using the service, or large merchants are using it on a very small scale.
  Such slow starts are typical of new ACH methods, such as accounts-receivable conversion of checks mailed to billers, which started slowly five years ago then became widely adopted, according to Herd. "We didn't see that pick up until the nine- to 12-month range," he says. "That's probably the length of time it takes to implement and integrate these things."
  BofA's Johnston says the bank was "a little surprised by the slow rates of adoption" of BOC. BofA supports BOC along with paper-check processing and other services, such as remote deposit in which retailers send banks electronic files of digital check images. But Johnston says a few large national retailers are watching others while deciding whether to pilot POP or BOC in their own stores.
  SCANNING OPTIONS
  About 40 banks are ready to originate BOC transactions into the ACH network on behalf of merchants, which makes "a pretty good marketplace of available service providers," Herd says.
  TeleCheck offers BOC-related services for merchants who want to have their own employees sort and scan the checks. Or TeleCheck sets up its merchant customers with third-party BOC services from Solutran Inc. The Minneapolis-based firm offers its check-outsourcing service, called Solutran POS and Imaging Network, or SPIN, directly to its own retail customers or in partnership with TeleCheck.
  When cashiers scan checks through MICR line readers and enter check amounts at points of sale, SPIN determines if the checks quality for ACH processing. Those that do are processed immediately. Those that do not qualify wait until courier services deliver them to Solutran, which scans and processes check images to route digitally to banks using remote deposit capture.
  READY TO TEST
  TeleCheck's Mooney says "a couple of large national" retailers are considering working with the company on BOC pilots. He says most larger merchants "are looking at a Solutran-type third-party model, so they do not have to buy scanners, store checks, and train employees to sort and convert them.
  Smaller merchants seem more interested in purchasing or leasing their own back-office scanners as opposed to sending checks to third parties, Mooney says.
  Another option, of course, is to keep handling checks the old-fashioned way. In a survey Boston-based consulting firm Celent LLC conducted in July for a private client, 30% of 350 responding retail treasurers said they do not plan to electronify paper checks at all, says Bob Meara, Celent senior analyst. "They say, 'If checks continue to dwindle, who cares if they get more expensive'" to settle, he says.
  Meara says 45% of respondents said they are considering POP adoption, and 25% said they are mulling BOC. But the survey only asked retailers about using BOC by sorting and routing checks on their own. Meara believes BOC looks a lot better to merchants when third parties do the check sorting for them.
  That is because 75% of retailers already use MICR readers for check-verification and electronification services, and few will want to buy or lease back-office scanners to handle a tender that is in decline. "Do you really want to spend $1,000 for less than 10% of your point-of-sale items?" Meara says.
  NACHA presents BOC as another option for converting checks, not as an intended replacement to POP. And each method will find its niche as merchants test both systems and learn from the experiences of other merchants, Herd notes.
  That is why BofA and several other banks and payment vendors will continue to support a variety of check services, including POP, image exchange, self-service BOC, third-party BOC, and paper.
  "We try not to focus on single solutions," BofA's Johnston says. "It's not a one-size-fits-all product."
  Such flexibility will serve vendors and banks well as they try to please their merchant customers and, in the process, hold on to fee revenue from the slowly declining number of checks being written at the point of sale.
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