Trends & Tactics

Trends & Tactics

Android’s Edge in the Smart-Phone Skirmish

The splashy news in smart phones last month was Verizon Wireless’s announcement that it will start marketing the iPhone, breaking AT&T Mobility’s long-held exclusivity on Apple Inc.’s popular device.
But there was quieter mobile news that will be of greater consequence for payments executives: Not only is Google Inc.’s Android operating system overtaking the iPhone, it turns out Android users are more interested than smart-phone users in general in harnessing their phones for a wide range of financially related tasks.
Indeed, data from several sources—including tracking firms comScore Inc. and The Nielsen Co., as well as Javelin Strategy & Research, a payments-research firm—have documented Android’s frenzied climb up the usage charts.
By the end of 2010, Android had already passed the iPhone in terms of adoption rate, with a 27% share of of smart phone users, compared with 30% for BlackBerry and 22% for the iPhone, according to Javelin. By contrast, the Google OS claimed just a 4% share as recently as July 2009, shortly after its introduction.
Android now bids fair to dethrone Research in Motion’s BlackBerry software. By the end of this year, Google’s product will command a 37% adoption rate, Javelin predicts, topping both the iPhone (31%) and BlackBerry (26%). “If you don’t have an Android plan in place, you’re already behind,” says Mark Schwanhausser, a senior analyst at Javelin Strategy & Research.
Even more compelling, owners of smart phones powered by the Android OS are more interested than owners of other types of smart phones in using their handsets to buy things at the point of sale, buy tickets, track gift and loyalty cards, and make price comparisons (chart).
In a number of payments and financial categories, Google’s OS holds a wide advantage. While 34% of all smart-phone users are interested in using their device to make a POS purchase, 43% of Android owners are. The same numbers for buying event tickets are 41% and 51%; for organizing and tracking gift and loyalty cards, 38% and 48%; and for making price comparisons while shopping, 55% and 61%.
That’s according to a report issued in January by Pleasanton, Calif.-based Javelin and primarily authored by Schwanhausser. The report, “Keeping up with the Android,” documents the startling rise of Google’s mobile OS and its meaning for banks, merchants, and vendors of mobile-banking and mobile-payments technology.
Android also commands the lead among younger consumers and among women, the report says. This dominance among the younger demographic means Android could shortly cement its margin over its two primary rivals. “From a sheer numbers point of view, Android is a very compelling thing to do,” says Schwanhausser.
Yet 2-year-old Android’s fast ascent has caught many financial institutions and app developers flat-footed. Indeed, of 19 mobile-banking services Javelin surveyed, only 37% offer an Android version.
The iPhone still enjoys a security advantage over Android, Schwanhausser says, owing to Google’s open-source platform and Apple’s apparent insistence on vetting apps more closely. Javelin finds that while 38% of Android users consider the OS to be either unsafe or very unsafe, the corresponding number for the iPhone is 28%.
Because security is critical in mobile payments, “a valid argument could be made the iPhone has an advantage,” Schwanhausser says, though he also points out that as more and more Android users perform functions without problems, they will grow in confidence. “The perception of security will be less of an issue,” he notes.
Indeed, though some financial institutions might be more comfortable with the iPhone for security reasons, they will have to reckon on Android’s surging popularity. “The flipside” to the security issue, says Schwanhausser, is “where are the numbers going to be?”

Durbin’s Debit Puzzle for Small Issuers
Small financial institutions have long felt that the bank card networks are the handmaidens of the big banks that generate most of the networks’ volume. But with debit card interchange regulation looming, Visa Inc. early last month assuaged some of their fears, at least temporarily, by publicly committing to develop a two-tier interchange schedule.
One schedule will have regulated rates arising from the Dodd-Frank financial-reform law’s so-called Durbin Amendment. The other will have unregulated rates applicable to banks and credit unions with fewer than $10 billion in assets.
The Federal Reserve is developing final regulations to implement the Durbin Amendment. In keeping with the amendment’s narrow prescriptions, the Fed’s draft proposes caps of 7 or 12 cents per transaction for regulated issuers, which would amount to a cut of 70% or more from current revenues.
Visa’s move was at least a mild surprise. In comments to investors, Visa has said that running a two-tiered schedule would be difficult operationally. Plus, there is nothing in Dodd-Frank that prevents either Visa or MasterCard Inc. from imposing one interchange schedule that makes the law’s mandates applicable to every issuer in their networks, even though 99% of financial institutions fall below the $10 billion regulation threshold.
Howard Polack, a senior analyst at Boston-based Aite Group LLC, says that “without a doubt” a single rate schedule was smaller issuers’ top immediate fear. A two-tier schedule would enable them to continue offering rewards on debit cards and avoid imposing account fees as some big banks are already planning to do, he notes.
“This puts them in a position to grow a nice profitable business,” he says.
Visa disclosed its plans for a two-tier system during a Jan. 6 Webinar for credit-union executives, according to the Credit Union Times. Only three big credit unions are subject to interchange regulation.
The Fed is supposed to come out with final regulations by late April. Visa, according to the Credit Union Times, said its unregulated schedule would be ready at about that time and expects the rates would be fairly close to existing rates.
“We have said that we will support a two-tiered debit interchange structure,” a Visa spokesperson said in a Jan. 7 statement. Visa “has committed to helping our clients navigate the current regulatory environment and determine how best to plan for an uncertain future and move their business forward.”
MasterCard has yet to declare its intentions and, in an apparent dig at Visa, said in a statement that, “We believe it is not prudent to make such a decision in advance of knowing all the facts.”
Credit unions and small banks have expressed many anxieties about the Durbin Amendment ever since U.S. Sen. Richard Durbin, D-Ill., proposed it last spring. Besides the implications of regulated interchange, smaller issuers worry that the amendment’s other provisions could erode any rate advantage they gain.
Dodd-Frank, which doesn’t distinguish between signature and PIN-debit, bans all debit cards from offering only affiliated networks, for example Visa for signature debit and the Visa-owned Interlink network for point-of-sale PIN debit.
Also, networks and issuers cannot interfere with merchants’ transaction-routing choices. With debit cards soon to offer merchants at least one unaffiliated network choice, networks with lower rates could get more traffic, which would mean less revenue for exempt issuers.
“Even if the smaller banks have an advantage on signature debit, if merchants decided to route [transactions] on a different route, then they lose all that interchange they thought they were maintaining,” says Polack. And with less interchange, smaller issuers could see their cards “diminish in value” because they wouldn’t be able to pay for rewards or avoid imposing consumer fees to compensate for the lost revenue, he adds.
“The pressures will likely align the two tables, I would say, over the not-too-distant future,” Polack says.
Such fears are reflected in a Jan. 3 letter to the Fed from two executives at Eau Claire, Wis.-based Royal Credit Union, an institution with about $1 billion in assets. “Merchants … have no reason to support two levels of interchange they pay,” the letter says. And despite RCU being exempt from interchange regulation, the executives urged the Fed to reconsider its proposed cap so that all debit issuers can “retain a reasonable profit.”
“The consumer is the real loser in the implementation of this cap and … will end up replenishing the income for the financial institutions in other ways,” the letter says.
Besides small issuers’ interchange, Dodd-Frank leaves the interchange of government prepaid card programs and general-purpose reloadable prepaid cards unregulated.

Fraud Rate Sinks, But ‘Cleaner’ Fraud Rises
Good news for online merchants: For the second year in a row, fraud losses expressed as a percentage of revenue went down last year. They came to 0.9%, down about $600 million from 1.2% in 2009, according to the latest research from CyberSource Corp., a unit of Visa Inc. (chart).
At the same time, e-commerce retailers are disputing more chargebacks, winning a high percentage of those disputes, and accepting fewer orders that later turn out to be fraudulent.
But the war on online fraud is far from over, experts caution, pointing out that cyber-criminals probe relentlessly for weak links in any e-commerce chain. Merchants “can’t rest on their laurels,” says Doug Schwegman, director of customer and market intelligence at Mountain View, Calif.-based CyberSource and principal author of the company’s 12th annual fraud survey, released last month. “If they did, the fraud rate would go up.”
For one thing, fraudsters are getting cleverer about the way they dress up bogus orders so the transactions can evade merchants’ detection routines. This can include lower dollar amounts and other characteristics that criminals know are less likely to trigger alarms. Some 52% of merchants told CyberSource that fraudulent orders are, so to speak, cleaner than they were a year earlier, up from 48% in the previous survey. Fighting such fraud “is a little harder than it was a year ago,” notes Schwegman.
Though it’s hard to measure, friendly fraud—where consumers later try to repudiate orders they actually placed—also appears to be increasing. This is especially troublesome for digital-goods merchants, since they have a tougher time proving delivery, Schwegman says.
And fraud originating overseas, but affecting U.S. e-commerce retailers, continues to run rampant. More than half of merchants accept international orders, and for these sellers such orders constitute on average one-fifth of all of their orders. But transactions from overseas continue to be much riskier, overall, than those from North America, with 2.1% of all orders accepted later turning out to be fraudulent, little changed from 2% in 2009 and more than twice the domestic rate. Even so, that’s an improvement from the 4% registered in 2008 (chart, page 8)
Considering that most online merchants are combating fraud with little or no increase in budgets, they’re doing a creditable job, says Schwegman. “They’re finally seeing a payback on all their investments in training and tools,” he says.
Consider the basic job of stopping bogus orders before they can do any damage. U.S. and Canadian merchants rejected 2.7% of incoming orders on suspicion of fraud, up only slightly from 2009. But merchants also kept a lid on the number of accepted orders that later turned out to be bad, as indicated either by a fraud-coded chargeback or issuance of a credit to a customer who says he didn’t place the order. This percentage leveled off at 0.9% for all online merchants, down from 1.3% as recently as 2007.
The process of manual review of orders, widely considered inefficient because of its cost, played a bigger role in stopping bad orders last year. Of all orders reviewed by humans, some 4% later turned out to be fraudulent, an improvement from 6% in 2009. The same was true on a dollar basis, with dollar volume manually reviewed and turning out to be fraudulent dropping to 4% from 6%.
Merchants are also challenging more chargebacks and succeeding with a significant number of those challenges. According to the survey, they disputed 55% of all fraud-coded chargebacks last year, up from 53% in 2009 and less than half a few years ago. Of those cases they re-present, merchants are winning 41% overall. The success rate rises to 79% for merchants with between $5 million and $25 million in revenue. “The win rates are pretty good,” says Schwegman.
For its latest study, CyberSource researchers took responses last fall from 334 online merchants, down slightly from 352 in 2009. Acquired last year by Visa, CyberSource is a provider of transaction-gateway and anti-fraud solutions for e-commerce.

Letter to the Editor

The article, ??Reasonable and Proportional? Should Mean Close to Par,? which appeared in your December 2010 issue, was a good summary of the National Retail Federation?s position on the Dodd-Frank Act?s debit card interchange provisions, but it left out several important points that I wish had been addressed.
To begin, the claim that ?reasonable and proportional? ought to mean zero, based on the observation that checks clear at face value, is highly misleading. Obviously, checks do have a processing cost associated with them; ironically, this cost is covered by debit card interchange, enabling banks to offer ?free checking? to their customers. Without that interchange, the banks will be forced to add fees for check writing and acceptance to cover their costs. This offsets any savings realized by merchants and consumers.
This leads to the next issue, which is that the benefits to merchants of this so-called victory are mixed at best. As you point out in your ?Gimlet Eye? column [in December], acquirers have discretion as to how much of the interchange fee reductions to pass along to merchants. For that matter, nothing prevents Visa and MasterCard from raising their acquirer switch fees to offset any reduction in the issuer switch fees, further reducing any merchant savings. Finally, if consumers find they must pay fees to use their debit cards and checks, many will seek to increase their use of cash, at the same time that banks will be raising their fees to handle that cash. Do retailers really want to be handling more cash?
Finally, the NRF completely ignores the collateral damage to prepaid cards and alternative payment providers, such as PayPal. Since the Fed chose to include reloadable gift cards within the scope of their interchange cap, an entire product category (which retailers make money by selling) will no longer be profitable without prohibitively high monthly fees. Most of the alternative payment schemes use linked prepaid cards to increase their reach with retailers; without those cards, their growth will be severely impacted, and their competitive influence will wane, to the benefit of large banks.
The NRF is free to pursue further legislation to address these issues, but would it not be more productive to promote technologies like targeted rewards and cross-promotions that benefit both merchants and issuers? More regulation just means more legal fees, and less innovation.

Regards
Aaron McPherson
Practice Director, Financial Services
IDC Financial Insights
Framingham, Mass.