Contactless payments, mobile NFC technology, prepaid cards, e-purses – around the world it seems everyone is looking for a solution to the elusive challenge of low value payments or LVPs. A variety of new technologies are promising to change the nature of the payments industry, offering both consumers and merchants a range of options for making and receiving payments. Consumers are discovering the benefits of using cards, phones, contactless fobs and other devices instead of cash, and there is increasing evidence to suggest that a move to debit and/or wireless payment forms is accompanied by an overall increase in card use and a corresponding shift away from cash.
Yet despite the benefits to all the parties involved, the move to electronic payments is running into a roadblock; specifically, the fundamental economics of the current card payment system, originally designed in the 1950’s. Under that system, the price-per-transaction had to be able to cover the costs of fraud and credit risk management checks, chargeback and dispute processing, transaction reconciliation, etc. These costs were low enough to be economically efficient for high value transactions, but for purchases under $20, they took a healthy bite out of the merchant’s margin.
Until recently, banks dealt with this problem by having a two-tier pricing scheme. Fees for low value payments (LVPs) were kept down, subsidized by higher fees at the upper tier (which were still low as a percentage of the total transaction). The Durbin amendment changed all that, by capping the transaction fees that could be charged, so that banks can no longer charge enough for the high-value transaction to keep down the costs for LVPs.
As a result, the fees levied on merchants for LVPs can have a considerable effect, particularly in already low-margin businesses or on those selling mainly low-value items. Currently merchants have little incentive to encourage their customers to turn away from cash and embrace electronic payments. Regulators, merchant groups and politicians are all beginning to look at this issue in more detail, and are putting more pressure on the payments industry to find a way to make electronic payments more affordable and, hence, more widely used. When you consider that over 70% of cash retail purchases are low value payments, you can see the urgency in finding a solution to this problem. The cost of processing for all types of electronic payments needs to be addressed. It is the true ‘elephant in the room’ for the payments industry in 2012.
Previous attempts to address this issue have generally involved simply moving the cost burden around the payments value chain, swapping winners and losers, but maintaining the same fundamental imbalance at the heart of the system.
A truly workable solution must do more than shift the pain – it must relieve it. But in order to do so, it must actually reduce the cost of processing these low value transactions. Can this be done? We look at this as a logistical challenge, and there lies the solution. Just as the cost of delivering a single small item of inventory to a store would be prohibitive if only that one item is being delivered, so with the low value payment. But by packing a large number of items into a truck, thus spreading the cost of delivery among the various items, so an aggregation of low value payments might be bundled up into a single digital delivery, so that both the issuer and the acquirer would each be processing one larger transaction instead of a dozen or so smaller ones.
Recent advances in both hardware and software technologies make it possible to digitally aggregate cash onto an EMV-chip enabled card or mobile phone, so that a loaded value can be spread over a multitude of low value purchases, with no ‘per transaction’ processing of individual LVPs, reducing the cost-per-transaction to a fraction of what it would otherwise be. The card or phone is automatically topped up at point of sale on the issuing bank side, and used for several small transactions. On the merchant acquirer side, all those small transactions are bundled, and settled with the acquirer bank at the end of each business day, again, in one transaction.
The approach we’re advocating reduces the overall costs, so that the economies can be shared among all players in the payments chain, making for an affordable and equitable overall solution which works as well for mobile phones and NFC as EMV chip enabled cards.
Nebo Djurdjevic is CEO of Cardis International, a technology firm dedicated to improving the economics of low value electronic payments within the broader trend towards becoming a cashless society.