Merchants Target Interchange Costs

  Merchants continued their assault on the card associations' interchange fortress this spring, though it appeared to be more talk than a furious battering ram breaking down doors.
  The verbal debate moved to the Midwest in May at the 2005 Payments Conference held by the Federal Reserve Bank of Chicago. Merchant action over rising interchange rates, meanwhile, was taking place in Georgia.
  Merchants contended in Chicago that interchange fees never decline even though card fraud has dropped, new payment markets have opened and transaction volume keeps growing. Visa USA and MasterCard International long have argued that interchange revenues are used to fight fraud and create new payment markets for cards.
  Indeed, Visa Senior Counsel Tom Brown noted at the Fed forum that the interchange rate for a weighted average of its commercial cards, consumer credit cards and consumer debit cards experienced a modest combined annual growth rate of 1.86% from 1990 to 2004.
  Visa and MasterCard, though, may be facing opposition from some of their newest customers. Richard Lautch, vice president and treasurer at Starbucks Co., told the forum that the Seattle-based coffee purveyor pays interchange of 2.7% on a $3 transaction when the consumer uses a signature-based (offline) debit card. The associations have aggressively promoted card acceptance in recent years at high volume, low-ticket merchants such as Starbucks.
  Industry analysts estimate that the average blended interchange rate is 1.75% of each credit card transaction. Merchant acquirers pay issuers interchange and pass the expense on to their merchant clients.
  Along with turning off merchants old and new, interchange may be shutting out promising segment opportunities. An executive at PHH Mortgage said interchange makes it cost prohibitive for a mortgage-service provider to accept credit cards for monthly payments. PHH is a third-party mortgage service provider and is the seventh-largest retail originator of residential mortgages.
  Sergio Gargurevich, PHH director of loan servicing, said many consumers want to pay their mortgage with a credit card to garner reward points. But the interchange on a $1,500 mortgage is about $26.25, and providers will not pick up the tab or pass the interchange expense on to the consumer, he said.
  The card associations rebuffed PHH and other mortgage service providers when they requested a flexible approach to interchange on large payments, says Gargurevich. A Visa spokesperson said it does not support credit card payments for mortgages. In addition, Visa's no-surcharge rule bans merchants from surcharging any Visa payment card transaction.
  "The merchant reaps the benefit of guaranteed payment but does not want to pay the costs," the spokesperson says. "That penalizes the cardholder."
  Merchants, however, say that Visa also is taking the wrong strategic approach with consumers by promoting its Signature card and its rich rewards programs. Merchants may pay as much as 3% of the sale in interchange when consumers use Signature cards, which are marketed to upscale consumers.
  Alan Frankel, senior vice president at Lexecon Inc., a Chicago-based economic consultant, says merchants end up paying the interchange on Signature cards and passing the costs on to all of their customers, regardless of how they have paid. "The economic defenses of interchange are tenuous," he says.
  The broad consumer cost of interchange is at the heart of an Atlanta-based retailer's class-action challenge to Visa's no-surcharge rule filed in May. Pet supply store Animal Land Inc. filed the suit in the U.S District Court, Northern District of Georgia, claiming the rule is anticompetitive and inflates the cost of goods and services.
  Friedman & Shube, the New York City-based law firm representing Animal Land, says that merchants should have the right to surcharge consumers for paying with plastic to cover their interchange costs. The suit claims that merchants cover their interchange costs by raising prices for all customers, including those that pay with cash or check.
  Noah Shube, Animal Land's attorney, says that merchants typically pay an interchange rate of about 1.6% of the transaction on a purchase made with a card from Discover Financial Services.
  Merchants should have the right to post their surcharge costs at the point of sale so consumers would understand they either could pay with Visa to earn rewards or with Discover to save money, said Shube. Visa would not comment on the suit.
  The Chicago forum follows a similar brouhaha over interchange at a May forum in Santa Fe, N.M., sponsored by the Federal Reserve Bank of Kansas City. Before that get-together, retailers from about a dozen major trade organizations formed the Merchants Payments Coalition to argue their interchange case.
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