Why Gasoline Retailers Are Fuming

  Interchange has always been a sore spot with gas station owners. Way back in the 1980s, it was common to see owners offer a discount of a few cents per gallon to customers paying with cash or a proprietary card to prevent credit card interchange from eating into their profits.
  For station owners, the payoff was a slightly higher margin on gasoline sales, which were slim to begin with. Eager to grab a larger percentage of gas sales, the card companies cut interchange rates for station owners installing pay-at-the pump card readers. Interchange is the amount of a Visa/MasterCard sale that the merchant acquirer must forward to the issuer; acquirers simply pass on the expense to merchants through their discount rates.
  The strategy worked like a charm with the major oil companies and their franchisees. By the mid-1990s, pay-at-the-pump was a standard feature, and the incentives for accepting general-purpose plastic began to get phased out. As a result, station owners have seen margins dwindle on general-purpose card sales even as transaction volume has risen.
  During the past decade, station owners, many of whom are convenience store operators, have watched fees for general-purpose card sales grow from an estimated $2.3 billion of annual sales to $3.2 billion, or about 1% of total c-store sales, according to the Washington D.C.-based National Association of Convenience Stores (NACS). By 2007, general-purpose card transaction costs are expected to take 1.5% of total c-store revenues. To put the cost into better perspective, general-purpose card fees represent the fourth-largest expense on a gas station/convenience store owner's ledger, following labor, rent and utility costs.
  For Kevin Scragg, a partner with Cedar Park, Texas-based 24/7 Convenience Stores Inc., card fees amount to about $3,000 a month. "As a percentage of total sales, card sales don't represent very much, but on a dollar basis, it is a lot of money," says Scragg, an Exxon franchisee, who along with his partner operates two c-stores.
  And there is the rub. Many c-store owners are small businesses that operate on tight margins and thus require all the cash flow they can get. Sure, cards represent a small percentage of overall c-store sales, but many c-store owners do not generate enough volume to qualify for the lowest merchant fees from processors, which in turn cuts into their cash flow. Typically, interchange accounts for about two-thirds of card acceptance fees.
  In 2002, general-purpose card sales in c-stores rocketed 35% to $108.5 billion, according to NACS. The increase was attributable to consumers' growing preference to pay with plastic. A recent MasterCard survey revealed that 49% of cardholders polled carry less than $20 in their wallet. In addition, 86% of cardholders polled expressed a desire to pay with cash less often.
  Given cards' growing popularity, NACS predicts that card fees will exceed utility costs for c-store owners within a decade and equal property rent by 2020.
  "Card fees are becoming a large enough cost that they are catching the attention of oil company CEOs," says Chris McNulty, senior vice president and general manager for Louisville, Ky.-based National Processing Co., a leading acquirer for gas/c-store transactions.
  Arguments that station owners are enjoying fat margins in the wake of skyrocketing gas prices since the first of the year don't hold water. As prices at the pump rise, so does the cost at which station owners purchase fuel from their suppliers. Crude oil prices represent 98 cents of every gallon purchased by station owners, compared to about 43 cents between 2000-2003, according to NACS. Concurrently, refining costs have risen from 15 cents per gallon to 46 cents.
  No Correlation
  "There is no real correlation between higher prices at the pump and higher margins for station owners," says Gray Taylor, a Denver-based c-store consultant. "Like credit card processors, station owners don't set the basic rate used in pricing the product. What they earn is based on the price they set per gallon above what they pay to get the gas and deliver it to the customer."
  Granted, there are some station owners willing to start a gas war by slashing prices below cost in the hope they can attract enough long-term incremental business to make up the difference on volume. But these owners can't keep prices below market costs for very long.
  Card fees are a major reason. Visa USA has set a credit card pay-at-the-pump interchange rate of 1.5% plus 5 cents per transaction; MasterCard International's rate is 1.8% of the sale. For debit card transactions, the card associations have set rates at 70 basis points plus 17 cents. On a per-gallon basis, for which consumers pay an average of about $2, blended credit and signature-based debit card interchange now comes to about 6 cents, compared to 3 cents during 2000-2003, according to NACS.
  The jump in the actual amount interchange now costs station owners to deliver a gallon of gasoline to customers is directly linked to interchange being a percentage-based expense. Hence, as the price of gasoline rises, so does the amount eaten up by interchange, because consumers spend what's needed to fill up their tanks. "It is one of the oddities of this business," says Taylor. "Interchange is a sliding scale, so when there is volatility in gas prices, interchange takes a larger bite out the transaction."
  One solution to reducing such volatility in transaction costs would be to set a flat interchange fee, suggests Taylor.
  With 60% of all c-store sales now taking place at the pump where only cards are accepted, compared to 49% in 2003, some c-store owners are looking at alternative payment options to lower their card acceptance costs. One option is to revert back to a discount for cash customers. Anecdotal evidence indicates some c-stores owners are experimenting with this strategy, but there are no hard numbers as to how many are actually doing it, says a NACS spokesperson.
  Furthermore, many of the pumps deployed at c-stores and gas stations cannot be programmed for dual pricing, which limits the opportunity to offer a cash discount, adds Taylor.
  Easy In, Easy Out
  Station owners also contend that consumers are not as driven by price as much as convenience.
  "As an Exxon station, our prices are usually above average," says 24/7's Scragg. "Customers are drawn to the brand, but what they really care about is convenience. At the end of a long day or when the weather is bad, they want to gas up and grab something quick at the convenience store. Easy-in, easy-out is what customers want."
  A more effective solution, then, is to lower processing costs. NACS has teamed up with Greenwood Village, Colo.-based processor First Data Corp. to create an aggregate processing program for small to mid-sized c-store owners.
  Launched in late 2003, the program targets c-store owners who operate up to 200 locations. This group represents about 5% of the c-store market and tends not to be affiliated with a major oil company brand, according to Michele Hansen, vice president of market development and enterprise for First Data.
  "These operators tend to pay higher processing fees than larger operators and so card acceptance fees represent a much larger portion of sales dollars," says Hansen. "By aggregating their volume, they lower processing costs."
  So far, First Data has 400 c-store sites participating in the program. Another 287 c-store operators representing 3,000 sites have expressed interest, according to Hansen. Many of the c-store operators in discussions with First Data are waiting for their current processing contracts to expire before enrolling, Hansen says.
  On average, participants are cutting acceptance costs between 5% and 10%, although some c-store owners are reporting savings of 12% to 15%. In the case of the latter, that translates to about a $2,700 savings annually. While not a huge sum, Hansen says c-store owners are interested in anything that can reduce card acceptance costs.
  "That's why we see PIN debit as an opportunity for these business owners," Hansen says. "PIN debit costs less to accept than credit, but the cost of accepting those cards is rising."
  Currently, personal identification number-based debit card transactions account for just 5% of non-cash sales at c-stores, according to NACS. With 60% of all pay-at-the-pump card readers equipped with PIN pads, however, consumer education may be the answer to increasing PIN-based debit volume at the pump, says Hansen.
  In Canada, gas stations offer the option to pay at the pump using Interac cards, in addition to credit cards. Interac is Canada's national PIN-debit network.
  "Debit is very pervasive at the pump in Canada, but it is because consumers are offered a clear choice with Interac," says James Hicks, vice president, product development and marketing for Global Payments Canada GP, a unit of Atlanta-based merchant processor Global Payments Inc.
  The Hard Truth
  In the U.S., Visa and MasterCard own the national PIN-based point-of-sale debit networks Interlink and Maestro, respectively. Though the two networks, especially Interlink, are gaining traction with banks, they still don't register very much in the minds of consumers. Hence, merchants are not inclined to promote acceptance of those brands. Meanwhile, promotions with regional debit networks are limited. And processors can only do so much to lower costs. The hard truth is that processing fees represent only about one-third of the costs c-store owners pay to take cards. Most of the rest, as noted earlier, is interchange.
  "Interchange represents the largest part of card acceptance fees and what is getting people's goat is that Wal-Mart has successfully flexed its muscles to get a lower interchange rate from MasterCard when it costs no more to process a card transaction at a c-store than at Wal-Mart," says consultant Taylor, referring to Wal-Mart Stores Inc.'s recent decision to again accept the signature-based debit MasterCard card after refusing since February to take it.
  Not surprisingly, the card associations decline to comment on interchange rates. What they do say is that card acceptance delivers incremental sales through higher average tickets and that cobranded oil cards are a way for c-store owners to engender greater customer loyalty.
  The card associations also have adopted rules to allow a $1 authorization prior to dispensing gas and now give station owners chargeback protection up to $50. The initial $1 authorization is intended to create an open-to-buy on the cardholder's account to activate the pump, without limiting how much the cardholder can spend based on a preauthorized amount. Such an amount normally is determined, in the case of credit cards, by how much the cardholder has available on his credit line, or, in the case of debit cards, on how much money is in his checking account. If the gas transaction causes him to exceed his credit limit or the amount of funds in his checking account, he would pay the usual penalty fees assessed by his card issuer.
  In addition, the need for a cardholder signature at the pump has been eliminated and printing of receipts made optional. Rules have also been modified to allow service stations to prompt customers to enter a ZIP code as part of their address-verification system to minimize fraud.
  In a prepared statement, MasterCard said that these programs have "helped the petroleum industry implement and expand 'pay at the pump,'" which in turn has enabled service stations to reduce overhead and increase sales. MasterCard added that its interchange rate for the industry has not changed since 2000.
  Special Deals
  Still, special deals apparently are being cut on interchange by some big merchants as is now permissible under terms of the settlements Visa and MasterCard reached last year in the class-action merchant debit card lawsuit led by Wal-Mart ("The Retailers' Home Run," July, 2003). Wal-Mart, which prefers PIN-debit, is widely believed to have its own interchange deal with Visa, though neither organization will confirm that. Now acquiring-industry insiders believe Wal-Mart struck a similar deal with MasterCard after the giant retailer complained that debit MasterCard wasn't worth its acceptance costs.
  "It appears as though Wal-Mart has gotten a better rate, because it is again accepting MasterCard debit," says NPC's McNulty. "There comes a point when interchange becomes too high and the merchant does something drastic, which is what Wal-Mart did."
  Petroleum and card industry experts are certain that Wal-Mart's about-face on debit MasterCard will resonate with oil companies and c-store owners. "I think we are about 50 basis points away from the petroleum industry reaching the breaking point with interchange," predicts Taylor. "When that happens we are going to see them take action."
  What type of action will be taken is uncertain, although Taylor says there are four primary options for station owners: litigation, legislation, regulation and competition.
  Litigation and competition appear to be the most viable options, since legislators and regulators have taken pretty much a hands-off approach to the acquiring side of the card industry.
  What makes litigation viable is last year's merchant class-action victory that resulted in the repeal of the card associations' "honor-all-cards" policies requiring merchants that accepted credit cards to also take signature-based debit cards. In addition, several leading merchants, including Home Depot, Best Buy, CVS and Meijer Stores, opted out of the class action to pursue separate actions against the card associations ("Cutting Their Own Deals," July).
  Meijer Stores has dropped its suit, reaching a settlement on its own with the card companies. Although the terms were not disclosed, some analysts believe Meijer probably got favorable terms on interchange going forward.
  'Scary'
  The downside to litigation, however, is that it can drag on for years before trial or a settlement. The class-action suit took about seven years.
  Competition can create immediate results, but often is unpredictable. "Imagine 25% or more of all major merchants announcing they have formed an association to issue their own card brand," Taylor says. "The card would have enough utility to make it attractive to consumers."
  As scary a thought as that may be for the bank card industry, the odds of such an occurrence happening appear minimal with so many big retailers and oil companies today showing little inclination for direct involvement in payment functions. For example, scores have sold their proprietary card portfolios to third-party operators in recent years. In June, Sunoco Inc. became the latest by announcing plans to sell its oil card program to Citigroup Inc.
  If nothing else, card experts predict that c-store owners and the oil companies will increase pressure on the card associations to lower interchange. The continued threat of a merchant rebellion in this segment could be downright inconvenient for the card industry.