Merchants’ Double Whammy

Merchants have been skirmishing with networks and issuers over acceptance costs since the days of cardboard cards. As 2020 approaches, interchange rates are stable, but merchants are seeing more sales on high-cost rewards cards while paying more network fees.

Not so long ago, if you wanted to get a card-accepting merchant riled, just mention interchange. Today, it’s different.

Sure, merchants still love to gripe about interchange—the amount of a bank card sale they pay to the issuer of the card the customer presented for payment. Interchange, assessed to merchant acquirers who invariably pass the expense down to their merchant clients, traditionally has been the single largest fee for accepting cards.

With little fanfare, however, interchange expenses for common transactions on consumer credit cards have shown little or no upward movement since at least 2012, according to studies by the Federal Reserve Bank of Kansas City.

That doesn’t mean merchants are paying any less, however. With interchange on big banks’ debit cards regulated since 2011 thanks to the Dodd-Frank Act’s Durbin Amendment, banks have been nudging consumers toward unregulated credit cards, especially premium cards that command higher interchange rates than the shrinking ranks of plain-vanilla cards.

What’s more, the fees levied by the big card networks are becoming a bigger expense item (“Fee Fest,” November, 2017). U.S. merchants paid just over an estimated $15 billion to Visa Inc. and Mastercard Inc. last year in network fees, says Callum Godwin, chief economist at CMS Payments Intelligence Ltd., which maintains offices in Manchester, England, as well as Atlanta and specializes in data on merchant-acceptance costs. That breaks down to $10.8 billion to leading network Visa and $4.2 billion to No. 2 Mastercard.

“Network fees, generally, have increased,” says payments consultant Eric Grover, principal of Minden, Nev.-based Intrepid Ventures. “Like clockwork, every couple years they add a basis point here, a basis point there.”

In fact, CMSPI research indicates some 24 such fees have increased since 2012. Rising fees paid to Visa and Mastercard will reduce merchants’ estimated $9.37 billion in savings from the Durbin interchange caps this year to $4.6 billion, CMSPI estimates.

Visa declined comment, and Mastercard did not respond to a request for comment.

Harder Forecasting

For merchants, especially small and mid-size ones with no negotiating power with the networks, these new patterns are making the task of forecasting card-related costs harder.

On paper, interchange rates have been remarkably stable. Every year, Fumiko Hayashi, payments policy advisor and economist at the Kansas City Fed, and her staff analyze interchange rates in the U.S. and abroad. Their latest report, published in August, shows little change in interchange for many Visa, Mastercard, and Discover consumer credit cards. Their calculations are based on the networks’ published interchange schedules, though actual costs may be lower for large merchants with enough transaction volume to negotiate lower rates.

The researchers present their findings in a format that shows costs on a typical sale with a credit or debit card in a major merchant category, such as a $40 purchase at a supermarket, retailer, or gas station, or a $10 purchase at a quick-service restaurant.

Average interchange for a basket of 13 standard and premium credit products used at large supermarket companies qualifying for the lowest rates was 61.5 cents on a $40 sale in 2012. By this year, the basket’s average large-supermarket rate had risen only 4.4%, to 64.2 cents, less than the rate of inflation. Interchange on several Mastercard premium cards rose 15%, but rates on other cards didn’t change at all.

The costliest card is the Visa Signature Preferred card, on which a $40 sale at a large supermarket generated 94 cents in interchange for the issuer.

For large non-supermarket retailers, there was just one minor rate increase over the seven years for the same basket of credit cards.

“In the U.S. we don’t see much change, except for corporate credit cards,” says Hayashi.

Rewarding Everyone

Against this background of rate stability, however, is the continuing evolution of credit cards into higher-interchange premium varieties. Data in an August report from the federal Consumer Financial Protection Bureau show that about 85% of consumer credit card purchase volume was on a rewards card in 2018, with the rewards share edging up slightly each year since 2015.

About 60% of overall credit card account originations in 2018 were for rewards cards, though that has slipped a couple of percentage points in the past few years. But even such risky consumers as those the CFPB dubbed “deep subprime” now put nearly 60% of their credit card purchases on rewards cards.

Another study shows credit cards’ growing popularity. The Federal Reserve’s 2018 Diary of Consumer Payment Choice says 21% of research participants named credit cards as their most frequently used payment instrument in 2017, up from 18% in 2015. The popularity of debit cards slipped, with 27% of participants naming them as their most frequently used payment instrument compared with 30% two years earlier.

That’s no surprise to Intrepid Ventures’ Grover. Big banks, whose regulated cards generated 63% of debit transactions in 2018, according to the Federal Reserve, have incentives to promote credit cards, he says. The Fed’s regulation implementing the Durbin Amendment in 2011 extinguished about half of their debit-interchange revenues. And consumers like their credit card rewards, be they cash back, airline miles, free hotel stays, or other perks.

“They’re getting whatever currency they want,” he says. “Consumers are rational actors.”

The Kroger Co., the nation’s largest standalone supermarket company, tried to buck this trend by boycotting Visa credit cards beginning in August 2018 at Foods Co., one of its smaller nameplates, and later expanding it to the bigger Smith’s subsidiary. About 155 stores in all participated. Cincinnati-based Kroger said Visa credit cards cost more to accept than other brands’ cards, and the Kansas City Fed’s data at least partially verifies that claim.

In October, however, Kroger disclosed Foods Co. and Smith’s had resumed taking Visa credit cards. The company didn’t say how it made peace with Visa, but a number of analysts declared Visa the probable victor in this dustup.

“I see this as a win for Visa and the entire card industry,” Ted Rossman, senior industry analyst at CreditCards.com, an Austin, Texas-based card-comparison service, says by email. “We don’t know the specific terms here, and maybe Kroger got a better deal, but my view is that card bans and surcharges are consumer-unfriendly and could actually hurt merchants. While merchants don’t like paying 2[%] or 3% in interchange fees to card companies, that’s a lot better than losing sales.”

The odds are good that the continuing combo of more premium credit card transactions and more network fees means total acceptance costs will be rising. But probably not enough to spark anything more than grumbling.

“Merchants are price takers,” says Grover.

—With additional reporting by John Stewart