“A New Business Model For Card Payments” (Via Diamond Management & Technology Consultants)

See below abstract from the Diamond Management & Technology Consultants report by Amy Dawson and Carl Hugener:

Credit and debit cards have been a major profit engine for issuing banks, but legal and possible regulatory challenges to the interchange model spell trouble for both issuing banks and the card associations that support them, MasterCard and Visa. The $150 billion card industry must recognize this threat to earnings and position itself for ongoing success.

For a well presented overview of the report, we are reprinting with permission the following blog posting by Sean Harper, co-founder of TransFS and TSS-Radio.

• Where Does Interchange Go?  The biggest component (about 80%) of the credit card processing fees that every merchant must pay is “Interchange”. Interchange is a fee collected by Visa and Mastercard and passed along to the bank which *issued* the credit card that was used for the transaction.
• A 2006 report by Diamond Consultants had some facts and figures that we found quite interesting. The report is worth checking out. It is no longer available on Diamond Consulting’s Website but it is available at the Internet Archive – A New Business Model For Card Payments. Highlights:

* “Credit and debit cards have been a major profit engine for issuing banks, but legal and possible regulatory challenges to the interchange model spell trouble for both issuing banks and the card associations that support them”

* “Card issuing banks and the card networks can’t be blamed for trying to maintain, or at least prolong, the current interchange fee model. It accounts, after all, for over $22 billion in annual fee income for Mastercard and Visa issuers and the associations”

* “Paying for issuer rewards programs consumes about 44% of interchange costs, but merchants get nothing out of these programs; they are competitive tools for issuers. Merchants likewise pay about 3% of their interchange dollars for association branding costs. Meanwhile, processing – the original reason for interchange – comprises only 13% of interchange costs.”

* “Merchants have little idea where their interchange dollars go. In addition to the 44% of interchange cost that goes toward rewards programs, our analysis shows that network branding takes 3% of the cost, and 35% goes to cover things such as cost of funds and profit margins.”

* “Merchants are especially irked because market forces as they understand them should be driving fees lower, not higher, and this is especially true for interchange. Their objections to this situation include: – card acceptance has reached a critical mass that no longer requires the same degree of brand building; – transaction volume has grown enormously and resulting economies of scale have driven down transaction processing costs; – fraud has decreased as a percentage of volume.”

* “Once transparency comes to credit card pricing models – as it ultimately does to virtually every industry and now may be beginning here with the recent decision by Mastercard to publish interchange tables – merchants will use the information to force an unbundling of interchange fee structures. The interchange structure as we know it will dissapear.”

As small business owners who have, in our previous businesses, felt significant pain from the cost of credit card processing, we at TransFS hope the above predictions occur. Our goal is to enhance tranparency in financial services by providing tools to help the consumers of financial products make better decisions and get better deals – for example, our credit card processing calculator and more detailed credit card processing report.