Consultant: Change is coming to credit-card business

The balance of power between merchants and banks has shifted as merchants have confronted the credit-card industry’s interchange fees in court and, in some cases, have moved toward alternative payment products, according to Diamond Consultants, a firm in Chicago.

Retailers likely to benefit from this power shift, expected to evolve over the next three to five years, include petroleum marketers and convenience-store operators, Carl J. Hugener, a partner in Diamond Consultants, told NPN MarketPulse in an interview this week.

For petroleum marketers and c-store operators, payment costs as a percentage of revenues and profits are “a lot higher” than in many other retail channels, Hugener said.

Hugener and Amy Dawson, a principal in the financial services department of Diamond, recently wrote and distributed a paper titled “A New Business Model for Card Payments.” Hugener said of consultants at Diamond, “periodically we publish our opinion on certain industry topics.” In writing such papers, he said, “we try to [cover] things that we think are important for our clients” – in this case, the banks and credit-card companies.

“We’re doing it as a call to action for them,” Hugener said. “We look at this [issue of interchange fees] and see that there’s a coming change in the way the market is going to be.” Diamond wants banks and credit-card companies “to be in front of it rather than have to react to it,” he said.

In the paper, Hugener and Dawson wrote, “We believe these challenges to the current credit-card business model will result in greater transparency to the components of the interchange model, and ultimately, to the unbundling of interchange pricing and shifting of roles in the payments value chain among current and new players.”

Another factor likely to affect the status quo, Hugener said, is that MasterCard made an initial public offering some months ago, and Visa has announced plans for one. As a result, he said, “the governance of both MasterCard and Visa is now going to become more independent– and by ‘more independent’ I mean more independent of the card issuers.”

For example, Hugener said, card issuers are likely to make decisions about “how the business model of credit cards will operate,” possibly creating “more balance.”

In their paper, the authors wrote, “Consider the components of interchange
pricing. Paying for issuer rewards programs consumes about 44 percent of interchange costs, but merchants get nothing out of these programs; they are competitive tools for issuers. Merchants likewise pay about 3 percent of their interchange dollars for association branding costs. Meanwhile, processing — the original reason for interchange — comprises only 13 percent of interchange costs. Given the merchants’ lack of perceived value for what they pay, the situation is clearly unstable.”

A transformation of the card payments industry has begun, the authors pointed out, “and unsurprisingly, the payments market is responding” with workable, cheaper alternative payments vehicles that have potential “to siphon payments volume away from credit cards and magnify the bargaining power of merchants at the expense of issuers and the associations.

“As these alternatives become more and more prevalent, issuers and associations will likely be forced to lower interchange rates to keep their products competitive,” the authors predicted.

“Issuing banks will ignore this trend at their peril,” the authors warned their clients. “Aside from losing a large fraction of their $19 billion in interchange fees, they stand to lose a significant slice of the transaction volume that drives their card interest income, usually estimated as 70 percent of total credit-card revenue.

“This market trend raises important questions about the future of the credit card business model and, we believe, will facilitate new interchange pricing, followed by the dis-aggregation of the traditional payments value chain within three to five years,” the authors wrote.

The complete 16-page report can be viewed on the consulting firm’s Web site, diamondconsultants.com.