Payments 2004: The Merchant Perspective

by Allen Weinberg on September 16, 2004

in Allen Weinberg, Writings

By Allen Weinberg

In his recent keynote address at the Direct Response Forum (DRF) conference in San Francisco, Glenbrook’s Allen Weinberg explored the payments acceptance landscape, how it relates to card-not-present merchants, and offered his assessment on what it may mean.

Given last year’s landmark court decisions in favor of merchants, many industry pundits predicted that 2004 would be the “Year of the Merchant”. While recent changes may seem striking to some, has anything really changed for merchants? The rules of the road for merchants haven’t really changed—and success is still defined as finding new ways to drive top line merchant revenues while minimizing the cost of payments acceptance.

The good news is that there are an increasing number of products and services that can help merchants improve their payments acceptance practices. The trick will be to implement those that make sense, while keeping a watchful eye on potential storm clouds out on the horizon. But before discussing some of the payments industry developments that we’re watching, let’s put card-not-present merchants into the proper context within the payments industry.

An Amazing Ride For Online Merchants

The U.S. Department of Commerce reports that consumers spent almost $56 billion with online retailers in 2003. Based upon recent Q2 2004 data points, current year-to-year growth is likely to be around 23%. But this growth story only paints part of the picture. For example, the Department of Commerce figures do not include online travel, financial services, and event ticket sales. When these other online payments are factored in, the U.S. eCommerce market was well over $100 billion in 2003. This is quite impressive when we remember that about ten years ago (when the first Web browser became available) this was a $0 billion market.

Also encouraging for online merchants is that, using the narrow Department of Commerce estimates, this only represents 1.9% of all retail spending. Forrester Research, which uses the more inclusive definition for eCommerce revenue, forecasts that online consumer spending will represent 7% of all retail spending in 2004—and will grow to 12% of all spending by 2010. Regardless which numbers you prefer, they all illustrate the growth that online merchants can expect in coming years as physical world face-to-face payments shift to remote non-face-to-face payments.

Here, I’m using the term payments in the broadest sense. While there has been some recent growth in the use of electronic checks and signature debit cards, the bulk of this spending is driven by growth in the use of general-purpose credit cards. But electronic checks, as I’ll discuss later, should represent one of the major new payment mechanisms—as online merchants are now beginning to adopt.

While online consumer spending is clearing growing robustly, not all merchants are uniformly benefiting from this growth. A recent study done by Internet Retailer
Magazine(1) reported that the top 100 e-Merchants in the U.S. generate 52.6% of all online retail sales. To put this concentration of spending in context, we estimate there are currently about 500,000 online merchants in the U.S. Obviously, in this case the old 80/20 rule is twisted somewhat, with 52% of the revenue going to 0.02% of the merchants. If you happen to be one of the top 100 e-Merchants, “It’s good to be King”. Or, said differently, the big get bigger. This concentration of payment volume in the hands of a relatively small number of merchants could have important implications for payment systems providers in the future.

The Bigger Picture: Card-Not-Present Payments

From a card payments perspective, it’s important to look at online payments in the context of the larger card-not-present (CNP) category. While there are a few payment system quirks specific to eCommerce, the card associations generally group the needs of eCommerce merchants along with merchants that are handling mail order/phone order (MO/TO) payments, recurring payments, and telephone-based services. The associations have concluded (correctly) that because CNP merchants don’t really know who the customer is, they generally have higher rates of fraud (the premise), and should consequently shoulder a larger percentage of the card acceptance costs (the conclusion.) As a result, online merchants do bear higher costs of fraud avoidance and fraud write-offs than their card-present brethren; how much merchants should pass back to issuers due to the nature of their card not present business is clearly a rather contentious topic.

How significant are card-not-present payments? It’s hard to be precise. Glenbrook estimates that eCommerce merchants currently represent about 25% of the total card-not-present volume in the payment system. Extrapolating from the Department of Commerce figures, Glenbrook estimates that consumers spent about $223 billion with CNP merchants in 2003. Put into context with all MasterCard/Visa credit card payment volume in 2003—$1,164 billion according to The Nilson Report—CNP payments currently represent a little over 19% of all Visa and MasterCard payment volume.

For some additional perspective, today’s CNP payment volume in the United States:

  • Is roughly the same as the entire Visa/MasterCard system-wide payment volume in 1986—which helps illustrate the extraordinary growth of electronic payments in the last seventeen years.
  • Is roughly the same as the total payment volume of all PIN-based debit transactions at POS—and look how aggressively everyone is chasing that growth market.
  • Is responsible for about $5.4 billion in payment acceptance and processing fees that are paid every year by CNP merchants.

In other words, card-not-present merchants are big drivers of the card associations’ dollar and transaction volume—and certainly the card associations know this!

Smooth Sailing or Turbulent Waters?

Given all this payments volume growth—and the tremendous size of the potential spending base—it would seem like we’re all just part of one big happy, shiny industry. Unfortunately, that’s not the prevailing view. If anything, the stakes have gotten so high that companies and careers can be built on growing, skimming, or eliminating just a few basis points. So perhaps it’s not surprising that the payments processing industry has changed more in the last twelve months than it has in the last five years.

Recent industry developments affecting merchants include:

  • Wal-Mart settlement. The big Wal-Mart class action lawsuit against Visa and MasterCard was settled on the courthouse steps. And although the $3 billion settlement amount was stunning, by the time the funds are distributed out to merchants, it amounts to little more than a one-time fee rebate of about 10% of their annual card acceptance cost. For many merchants, the anticipated benefits have already begun to fade.
  • New payment alternatives. Electronic checks are finally being deployed by mainstream merchants and are gaining in acceptance with consumers.This development, along with hybrid payment mechanisms like PayPal, is, for the first time, offering merchants some new payment acceptance alternatives.
  • Industry anxiety. We’ve also detected a distinct rise in tempers among and between the merchants, processors, and payment systems, resulting in, as is the American way, a plethora of new lawsuits flying every which way. While it’s hard to predict the outcome, some of these lawsuits could affect merchants.

In addition to these major developments, we’re also seeing a number of key payments-industry themes emerge—many of which could impact the payment acceptance practices of card-not-present merchants.

Revenue Enhancing Payments Products

Key theme: There are a number of new payment products that have been shown to actually increase top-line merchant revenues. With several alternatives available and growing consumer acceptance, what’s a merchant not to like? One of the most significant points is the movement this drives of payments acceptance decisions beyond the finance organization and into the marketing department.

The most positive development for card-not-present merchants is the availability of revenue enhancing payment alternatives, many of which should be on the radar screen of every card not present merchant. Traditionally, for most merchants, the payment function is handled in the finance department. What’s interesting here is that, for many of the largest merchants, deciding to accept a new payment product is largely driven largely by the marketing group. So, in addition to reducing costs, the most important factor in the decision is whether or not the new payment alternative is going to help increase top line revenues for the merchant.

Fortunately for merchants, providers of payment mechanisms like electronic checks—as well as specific payment products such as PayPal, Bill Me Later, and others—have been responsive to merchant needs and have a pretty good story to tell with respect to their ability to help drive new revenues.

Electronic checks, for example, have been around for a number of years, but now look like they’re here to stay. Merchants that have implemented eChecks are reporting revenue lifts, likely the result of new consumers who don’t have Visa- or MasterCard-branded debit or credit cards or are, for whatever reasons, uncomfortable using them online.

Aside from incremental sales, among the key issues on the card associations’ minds is whether merchants can actually affect a share shift from higher-cost bankcards to lower-cost alternatives. Suffice it to say that merchants are sure trying! For example, one of my partners recently registered his credit card to automatically pay his monthly telcom bill. But before he finalized the order, he was asked if he wanted to use the electronic check option instead of his credit card and get an extra hundred minutes of airtime as a bonus.

All in all, electronic checks and other new payment mechanisms that offer consumers access to new credit lines or purchasing power are a net win for card-not-present merchants. Merchants not yet evaluating these new payment products probably should be.

PayPal Acceptance and Growth

Key theme: PayPal’s market acceptance and volume growth is a net positive for card-not-present merchants. PayPal is aggressively expanding off eBay with payment features and capabilities, which in a number of ways actually surpass bankcards; coupled with aggressive pricing, we believe merchants will be the net winners.

In Glenbrook’s opinion, one of the most significant positive factors you will see over the next year or so is the acceptance of PayPal by many of the major CNP merchants. Even for those of us watching the company, PayPal’s success has been stunning. The payment service has over 50 million accountholders, and is growing at 55,000 new users per day. Until recently, growth in payment volume has paralleled growth in registered users. But with payment volume growth beginning to flatten, we expect to see PayPal become even more aggressive in its efforts to reduce its dependence on eBay auctions and increase its acceptance by major merchants.

PayPal has also t eamed with GE Capital to offer new transaction-level financing to purchasers including the ability for merchants to participate in offering promotional financing to buyers (e.g., 90 days same as cash for certain items).

Traditionalists in the payments industry may take the view that the bulk of amount of PayPal’s payment volume—which is greater today than the combined e-Commerce volume of American Express and Discover—is incremental to the card systems. While that might be true, remember that a significant amount of the PayPal payments volume is driven by ACH transactions, which is one of the key factors lowering funding costs and driving PayPal’s cost advantage.

While PayPal has done a good job serving the needs of small merchants that weren’t really well served by existing bank card acquirers—what about large merchants? e-Commerce merchants are reporting that a significant amount of their PayPal volume is being driven by new customers. Why is that?

  • With PayPal, enrolled consumers don’t have to enter their card information—they just use their email address and a password; consumers view this as both convenient and private.
  • Many merchants still don’t take electronic checks and PayPal provides a convenient way for consumers to pay with DDA funds; currently about 45% of PayPal’s transactions are funded by ACH or from funds in the user’s existing PayPal account.

Another driver for merchant adoption is reducing the cost of acceptance. Factoring together per-transaction fees, dispute management costs, and fraud losses, PayPal is actually more cost effective for many merchants than Visa, MasterCard, or American Express. It might get even more attractive to merchants as PayPal realizes additional revenue streams and lower cost of funds (COF) from GE-financed transactions—and passes some of the savings on to merchants in the form of lower cost along with demonstrating helping merchants drive top line revenue growth through the new item level and promotional financing.

Banks Rethinking ACH

Key theme: Banks—in conjunction with NACHA—are rethinking ACH with respect to functionality, pricing, and rules. There are so many options and proposals on the table, and NACHA is so early in its evaluation, that it’s hard to tell whether this will be a net positive or negative for merchants.

ACH payments are supported today through a “pull” system. The payee initiates the payment transactions from the payor for an extremely low fixed cost. The “pull” transaction is done without buyer authentication and is initiated in good faith that the account information is valid and sufficient funds are on hand. A “push” system, as a concept, would turn this model on its head, add new services, and likely cost more per transaction. This concept, originally developed as Project ACTION, was shelved a couple of years ago by the major NACHA banks.

NACHA is now taking another look at how ACH is packaged and offered in the market—and is doing so, in our opinion, for both offensive and defensive reasons:

  • Offensively . NACHA is considering new tools to help merchants better authenticate consumers and new bank-centric transactions flows. Its natural that NACHA’s banks would want to develop a service that could generate more revenue on both a per transaction and in aggregate, than “pull” ACH. That is, of course, based on the presumption that merchants will pay more for a fully authorized, guaranteed transaction. That also presumes that the customer interface can be crafted in such a way that allays merchants’ fears that their customers are going to abandon their carts if sent to an external site.
  • Defensively . Banks aren’t real keen on merchants (both card-not-present and card present) flooding the ACH system with incredibly cheap transactions that provide them with zero revenue, noting that this was never the intent when the ACH system was originally built. NACHA is in the early stages of evaluating pricing changes, rule changes, and procedural changes surrounding pull ACH transactions. These include implementing rules change such as standardized authentication requirements to improve quality and reduce risk. In fact, data quality and NSFs indeed imposes real costs on the financial institution receiving the ACH transaction. NACHA is also in the process of evaluating new rules and tools such as authentication databases (e.g., positive and negative files.)

While these developments are all potentially significant to merchants, it’s still too early to assess whether these efforts will turn out to have a positive, neutral or negative impact on merchants. Our advice for merchants is to keep abreast of these developments and stay involved. The good news is that NACHA appears to value merchant input.

Cardholder Authentication

Key theme: Despite predictions to the contrary, Verified by Visa and MasterCard SecureCode are still alive and kicking. Many of the early problems have been or are being addressed; but the biggest problem is that after two years, the industry still has a bad implementation hangover.

It’s fair to say that merchants that adopted Verified By Visa (VbyV) and MasterCard SecureCode last year have seen “mixed” results. The good news is that the card associations have taken a hard look at the early results and tweaked the rules and mechanisms to better meet merchant’s needs. Some of the merchants that have stuck with these programs are now reporting positive results. Unfortunately, too many in the merchant community still have a bad first-generation, implementation hangover.

To overcome this, Visa continues to fund advertising for the service, and continues to support VbV with a significant staff focusing on implementation assistance, operations, and product management. This support, along with a rumored increase in the issuer reimbursement fee (IRF) differential from 5BP to 15BP, may be enough to nudge merchant interest back to the table.

Given the pricing advantage, operational enhancements, and perhaps more significantly, the chargeback liability shift, we feel VbV should have a net positive impact on the merchant community over the next year or so.

Emerging Payment Alternatives

Key theme: Since the mid 1990s there has been a continuous stream of new payment initiatives; and with very, very few exceptions, most of these don’t make it. The trick for merchants, of course, is to only invest time and effort on the likely winners.

Merchants looking for alternative payment acceptance strategies have never had so many vendors to evaluate. But all of these vendors face the proverbial chicken and the egg challenge; how to build a critical mass of consumers to get the merchant’s attention and how to recruit enough merchants to get the consumer’s attention.

Going forward, merchants must take much more responsibility for their own fate. In particular, the top 100 or 200 CNP merchants as well as the large gateway providers (that in effect serve as gatekeepers and enablers for the hundreds of thousands of smaller merchants) can’t afford to just sit back and complain about the need for lower cost, more merchant centric payment mechanisms without putting a little skin in the game.

That means actually spending time working with some of the new initiatives that show some genuine promise—helping to ensure that the functions and features are solid and that the value proposition they bring to the table is compelling, not only for the people in the finance department, but also for merchants’ operations and marketing groups as well. All too frequently, everyone forgets that at many merchants, the Chief Marketing Officer is the key driver in whether or not to accept a new payment alternative.

Irrespective of the merits of any of these new vendors of payment products, it’s clearer than ever that the CNP merchant community needs to be involved earlier if any of these are players are going to emerge and be successful.

Payment-Related Lawsuits

Key theme: We are in the midst of an unprecedented wave of payments-related lawsuits; at the end of the day, most of this litigation will make little difference to card not present merchants.

The payments business is certainly well represented in the litigation arena:

  • Visa vs. First Data Corporation vs. Visa. Visa is suing FDC, which is suing Visa, over the requirement to route potential “on-us” transactions through the Visa network; FDC contends that there is no need to pay Visa service fees if the transaction never routes through Visa.
  • MasterCard vs. Visa. MasterCard suing Visa over the penalties Visa will levy against its debit issuers who switch brands to avoid paying a share of Visa’s $2 billion Wal-Mart settlement. On a related note, there are a number of high profile merchants that originally chose not to join the Wal-Mart class and are still duking it out
  • Visa and MasterCard vs. American Express and Discover. Visa and MasterCard appear to have lost (pending a final Supreme Court decision) their ability to prevent their members from issuing American Express and Discover cards. Indeed, MBNA has already announced an agreement to issue American Express cards as soon as the final decision is announced.
  • U.S. and States vs. Visa and MasterCard. Following the lead of plaintiffs in California, there are a number of similar lawsuits against the card systems over currency conversion fees, as well as a lawsuit filed by a merchant against MasterCard’s chargeback policies and fines.

Of all of these lawsuits, the only one that holds any promise of lowering merchant costs is the FDC litigation. Part of what FDC is suing for is avoiding paying service fees to Visa on transactions that don’t flow through the Visa network, some of which could presumably flow back to merchants in the form of reduced pricing.

But even if the courts side with First Data, we don’t think this will end up having much impact on merchant fees—the size of the First Data network is shrinking (particularly as FDC stops processing card accounts of Chase, their largest issuer) and the card associations could just raise fees in other areas in order to replace the lost service fee revenues.

While these lawsuits are all interesting to watch, we believe that the outcome of these cases will have little to no impact on merchant’s payment acceptance strategies, alternatives, and costs.

Continued Wal-Mart Fallout

Key theme: Despite high expectations, the settlement of the Wal-Mart class action lawsuit against Visa and MasterCard has been a disappointment for card-not-present merchants.

For card-not-present merchants, the Wal-Mart class action turned out to be one big yawn on a number of fronts:

  • Visa and MasterCard are paying out $3 billion in settlements, but a very small percentage of it will ever make it down to the average CNP merchant.
  • Interchange fees fell for a couple of months, but then rebounded.

The sky didn’t fall on debit issuers—as some were predicting—when the settlement was announced. Sure, their interchange revenues declined, but their debit cards are actually growing both in consumer popularity and remain very strategic for banks as a paper check replacement.

For consumers, it was also a huge non-event. With the notable exception of Wal-Mart ceasing to accept signature based MasterCards for a short while, you’d have to look really hard to find a merchant that stopped accepting either Visa or MasterCard debit or credit cards following the settlement. In the case of Wal-Mart and MasterCard, it really came down to a game of chicken with respect to pricing vs. acceptance, and MasterCard’s large debit issuers blinked.

While most merchants had high expectations about the settlement of the Wal-Mart class action, it unfortunately has turned out to be a big disappointment.

Bank-Issued American Express Cards

Key theme: Assuming the Visa and MasterCard appeal to the U.S. Supreme Court is unsuccessful, CNP merchants will soon be seeing bank-issued American Express cards, which in our opinion, may not be a good thing for card-not-present merchants.

In our opinion, bank-issued American Express cards—assuming they come to pass at the end of the judicial process—will be a net loss for the merchant community. This issue is driven by the decision of the courts in the recent U.S. Department of Justice anti-trust lawsuit. The lawsuit attacked prohibitions in current association rules that preventing member banks from issuing American Express and Discover cards. MBNA has already announced plans to issue American Express cards to many of its convenience users.

Why is this as bad news for merchants? Let’s use MBNA as an example. Why would they go to the trouble to move their convenience users over to American Express? Clearly because of higher interchange fees they’ll receive from merchants on American Express transactions. Adding insult to injury, Visa and MasterCard may also increase their interchange fees to merchants in an effort to try to keep their issuers from defecting to American Express. The card payments business is one of the few industries where increased competition (at least for card issuance) leads directly to higher prices to one major group of stakeholders.

Even if Visa and MasterCard lose their appeal to the Supreme Court, there still might be some factors that could mitigate the negative effects of replacing Visa and MasterCard-branded cards with American Express cards:

  • Branding. The big retail banks like THEIR brands; remember originally Citibank left Visa in a dispute over putting their brand on the front of the card and moving the association brand to the back of card. Will any of the banks risk diluting their brands with American Express?
  • Consumer Demand. Doesn’t everyone who wants an American Express card already have one? What motivation will a consumer have to carry an additional bank-issued American Express card in their wallet?

As a merchant, if you are thinking about potentially dropping American Express, broader bank-driven issuance could soon make this a much, much harder decision than it already is. Needless to say, CNP merchants have a very real stake in how this issue plays out in the marketplace over the next 12 months.

Glenbrook’s Action Plan

Moving forward, merchants should get engaged and be proactive. The following action plan makes sense to us:

  • Re-consider implementation of Verified-by-Visa and MasterCard SecureCode.
  • Participate in relevant NACHA working groups; while they are certainly a bank-centric organization, they have been eager to better understand merchant needs and encourage your participation in their dialog.
  • Engage with Visa, MasterCard, American Express, and Discover to stay informed, voice requirements, and identify win/win opportunities.
  • Evaluate new payment acceptance alternatives (electronic checks, PayPal, and Bill Me Later) to increase revenues and lower acceptance costs
  • Experiment with alternative payment systems that offer unique advantages

Finally, merchants need to stay plugged into industry developments so that you can look ahead of the curve—capitalizing on key opportunities early and voicing your concerns before it is too late.


  1. Internet Retailer Magazine, Top 300 Guide, 2004.

Publication History

Initial Publication Date: September 16, 2004

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