Acquiring: Who’s Paying for All Those Rewards?

Backers of mobile-payments programs are more than ever relying on merchants to foot the cost of rewards and offers. But for merchants to buy in, the rules of the game have to change.

By Jane Adler

As the mobile-payments business gets off the ground and card issuers look for new ways to cut costs, retailers are increasingly being asked to fund rewards programs. While it’s early days and some retailers are signing up, they’re clearly looking for a new rewards model.

Take BankAmeriDeals. In January, after a public-relations fiasco in which Bank of America Corp. tried to impose a $5 fee in any month when customers used a debit card, the bank rolled out a pilot rewards program that offers Groupon-like discounts at merchants, with the deals underwritten by the merchants. The program is currently being tested with employees in a few locations.

The BankAmeriDeals rewards are offered through the customer’s online bank account. Customers who select the deal and use their Bank of America card to make the purchase get the discount as a credit on their next statement.

The Bank of America program, and others, could help boost merchant sales. But retailers already feel stretched by the ongoing cost of interchange and chargebacks. And after purchasing new payment terminals and software to meet security requirements or prepare for mobile payments, are they really ready to assume costs for the growing array of rewards programs?

Of course, the retailer benefits most from a transaction, many argue. After all, a shopkeeper that sells a product, even at a discount via rewards, is still making a sale.

But rewards programs linked to payment cards and store-loyalty programs are in the midst of a rapid evolution as consumers making a purchase reach for their smart phones instead of their wallets.

“Merchant-funded rewards are an evolutionary step toward what mobile will provide,” predicts Steve Mott, principal at payments consultancy BetterBuyDesign, Stamford, Conn.

Rewards Onslaught

A shift of sorts is under way, industry observers say. General rewards programs that give consumers redeemable points for using a certain payment card are being supplemented and replaced by transaction-based rewards distributed by a particular retailer to the right customer at the right time. The smart phone makes the delivery of targeted rewards possible.

According to senior analyst Adil Moussa at Aite Group LLC, Boston, merchant acquirers in 2012 will finally start forming a range of partnerships with consumer-marketing companies, such as daily-deal Web sites. That way, acquirers will be able to send customers to their merchants to increase transaction volume, says Moussa in a recent report titled “Top 10 Trends in Retail Banking and Payments, 2012.”

The push toward merchant-funded rewards has been accelerated by the recent enactment of the so-called Durbin Amendment. Sponsored by Senator Richard Durbin, D-Ill., the amendment was a last-minute addition to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. It places restrictions on debit card programs, including interchange caps for banks with assets of more than $10 billion.

As a result, debit interchange revenue at regulated banks has been cut by as much as 45%, according to some estimates. In the fourth quarter of 2011 alone, after the Durbin cap took effect Oct. 1, seven major banks, including top debit issuer Bank of America, reported a collective reduction of $1.1 billion in interchange income compared with the year-earlier period.

This has come at the very time when banks are faced with financing new rewards programs to support mobile and e-commerce transaction activity. “Merchant-funded rewards are the star because banks can’t fund them,” says Jonathan Silver, president and CEO at Affinity Solutions, Inc., a New York-based provider of rewards programs.

At the same time, consumers are quickly adapting to the onslaught of rewards offers from providers such as Groupon, LivingSocial, and Foursquare. Merchants like the programs too.

Traditional rewards programs are still popular, however. Consumers want to earn points for every purchase they make. From the financial institution’s perspective, rewards programs also drive card usage and boost activation rates.

‘Starting To See a Shift’

But as tempting as rewards programs funded only by the merchant may be among cash-squeezed banks, they are not popular among the clients of payments processor Fiserv Inc., Brookfield, Wis. About 94% of the rewards programs managed by Fiserv for its bank card clients are either funded by the financial institution alone or by the financial institution and the merchant.

Indeed, even though the merchant-only funding model is cheaper for the financial institution, it is not growing, according to Holly Krest, senior vice president of loyalty management at the Fiserv office in Morris Plains, N.J.

The reason has to do with results. Merchant-only programs produce a 20% higher spend rate when compared to having no program at all. But spending on issuer-funded or blended rewards programs shows an increase of about 150%. “That’s a big difference,” says Krest.

Differences like that are helping to usher in a sea change in rewards programs. The focus now is on bringing new and repeat customers to the retailer’s store. Instead of blasting out a wave of e-mails with coupons—everyone gets daily-deal offers that aren’t of interest—these programs aim to match deals to shoppers who are truly interested in a particular deal.

“We are starting to see a shift from [traditional] merchant-funded rewards to transaction-based targeting,” says Silver at Affinity Solutions. “We are leveraging our data to deliver the right offers.”

His company recently launched Spot on Deals, a platform that provides targeted offers to consumers. The program has been rolled out by Sovereign Bank, and is now in the process of also being launched by U.S. Bank. Spot on Deals currently includes 30 national retailers as well as many local stores. The program issues eight to 10 retailer offers a week.

Retailers fund the offers, and also pay a service fee which is shared by Affinity Solutions and the financial institution. Merchants have access to Affinity’s analytics to tailor consumer offers, says Silver. But, he adds, “The retailer foots the bill for everything.”

Direct to Consumers

With the advent of mobile commerce, daily deals, and a variety of loyalty programs and payments systems, merchants face a daunting array of options. And most merchants can’t afford them all.

“At the end of the day, merchants have to pick their poison,” says Scott Todaro, vice president of marketing at AisleBuyer LLC, a Boston-based firm that provides mobile-commerce applications including rewards programs. Merchants can’t have six different rewards programs, an e-commerce platform, and applications that all take a cut of the sale, he explains. “Margins would get razor thin,” he says.

AisleBuyer offers a mobile checkout system that works on the customer’s smart phone. Customers can choose a payment type on the AisleBuyer mobile wallet and check themselves out of the store literally while standing in the aisle. Roving store employees also have iPads for checkout.

AisleBuyer customer Big Y, a grocery chain based in Springfield, Mass., is rolling out a rewards program through its mobile application. AisleBuyer plans to integrate other rewards programs, such as Foursquare, into its application.

Though retailers fund the rewards, they only pay a fee when an actual transaction takes place. “Our goal is to create an application that drives [sales] conversions,” notes Todaro. The transaction fee is 1% or lower, based on volume.

Todaro envisions a day when retailers can pull out point-of-sale terminals because the transaction hardware will be in consumers’ hands. “Retailers’ margins will go up if they can eliminate old systems,” says Todaro.

Of course, some consumers will never have a smart phone and many smart-phone users may never shop with the device. But merchants are seizing the opportunity to access customers in a way they never could before the smart phone was introduced.

The coffee chain Starbucks Corp. has a closed-loop loyalty program tied to its mobile- phone application. To use the mobile app and make a payment with a Starbucks card via phone, the customer has to join the loyalty program.

Consultant Todd Ablowitz expects to see more closed-loop-type loyalty programs like the one Starbucks has rolled out. “Merchants will be able to make offers directly to consumers,” says Ablowitz, president at the Double Diamond Group LLC, Centennial, Colo. “Lots of rewards won’t be linked to a payment type in the mobile world.”

Apriva LLC offers a mobile wallet to merchant acquirers that includes loyalty platforms. “We are trying to help acquirers improve their revenue,” says Paul Coppinger, president at Apriva, Scottsdale, Ariz. The Apriva wallet keeps track of rewards and presents them as a voucher for redemption at the point of sale. The wallet application is free to consumers. Merchants pay for the cost of the offers, and a fee at the time of redemption.

“The merchant is not being charged unless we bring value—a new customer they would not have had otherwise,” notes Coppinger. The fee is a percent of the transaction, not exceeding the 15%-20% range, says Coppinger, and much less than the 50% retailers pay a service like Groupon.

Besides tailoring offers to the right customers, mobile rewards can cut program costs for merchants. SparkBase Inc. processes reward and loyalty card transactions. The Cleveland-based company also recently launched Paycloud, a mobile wallet for rewards. The application consolidates rewards programs in one place.

“The program cuts out the one thing merchants don’t like,” notes Doug Hardman, chief executive at SparkBase. “Merchants don’t have to produce physical cards that cost them money.”

So far, Paycloud has been downloaded by about 10,000 consumers. The program has enrolled about 300 merchants since its October launch. Paycloud is currently available in six markets, and the company expects to add another eight markets this year.

Merchants might also lower the cost of payment-linked rewards and loyalty programs by cutting out the middle man, the companies that run the programs, according to consultant Mott at BetterBuyDesign. “The only two parties to a rewards program should be the banks and their data, and the merchants and their data,” he says. “Merchants and banks could do better by themselves.”

Mott admits the third-party companies that run rewards programs for merchants and banks currently have the upper hand because they have the technology needed to generate meaningful consumer offers. But he thinks banks and merchants could share customer information, with permission of course, to craft offers as more rewards become transaction based and mobile.

The approach may be best suited to regional banks and merchants with a similar footprint, says Mott, adding, “The bulk of the money should be made by the merchants and banks.”

 

How Cardlytics Is Redefining Rewards

With companies vying for a piece of the daily-deal coupon market and interchange rates under pressure, Cardlytics Inc. scored a big win recently when it rolled out a pilot rewards program for Bank of America Corp. It was the latest in a string of deals for Cardlytics, a rewards program software startup that was founded only four years ago and already works with 200 banks.

Carving out a niche in what’s called transaction-driven marketing, Cardlytics acts as the middleman between banks and merchants. The Atlanta-based company, which is privately held, works with the merchant to create consumer offers based on transaction information.

Merchants can target offers based on the category of store, spending patterns, and other criteria. An offer placement system, hosted on the bank’s system, marries merchant data and bank-transaction information. Offers are made to consumers on their online bank-account statements.

If a consumer clicks on an offer, it is added to his card. When the customer makes the purchase, the offer is credited to the consumer’s account. “We enable a bank to provide offers to consumers from merchants based on where consumers spend their money,” says Rod Witmond, senior vice president of product management and marketing at Cardlytics. “But no transaction-level data leaves the bank.”

Merchants aren’t charged unless the consumer makes a purchase. Merchants pay for the offer, plus a 10% -15% fee to Cardlytics when the purchase is made. Revenue is shared with the bank, but the split varies depending on the size of the bank. The bank typically gets about 25% of the fee, according to Witmond.

Consumers are responding to the offers, Witmond says. On average, consumers visit their online bank statements about nine times a month. Twenty-five percent of consumers check their account online every day. About 20% of the offers are clicked on by consumers. Five percent of the offers are actually redeemed. “Those marketing results are groundbreaking compared to other marketing channels,” says Witmond.

Investors seem to like the Cardlytics business model and the company plans to expand. Cardlytiucs raised $33 million last September from Groupe Aeroplan, a loyalty-management company in Canada. Cardlytics plans to double its own sales force to about 50.

Next up for Cardlytics is a geo-location feature for its mobile application. The system will provide offers based on the location of the consumer. But in order to avoid the annoyance factor, consumers will be able to tell the system when they are shopping and interested in offers, so they aren’t bombarded with messages when they aren’t shopping. Witmond expects the new phase of the mobile application to be ready this year in the second or third quarter. “It will be cool,” he says.