POS Steering in the Age of Durbin

by Russ Jones on February 14, 2011

in Card Networks, Credit Cards, Debit Cards, Interchange, Point of Sale (POS), Regulatory Environment, Russ Jones

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Point of sale (POS) steering isn’t really part of the payments industry dialogue right now as various stakeholders praise, argue, and criticize the proposed Federal Reserve rules on debit card interchange and network routing. But, I think it could be a big part of how things could unfold in the near future.

Let’s start with some definitions. POS steering is a technique used by merchants to unobtrusively “suggest” to customers how they should pay when they purchase goods and services with their debit cards. The traditional definition would narrowly define this as happening in a PIN pad in a brick-and-mortar store, at the point the consumer goes to pay for a one-time purchase. Effectively, its what happens in the checkout lane at the local Target store when you pay with your debit card.

But I think POS steering is much broader than that and it is opportunistically happening today across all retailing channels today –– at the physical POS in retail, in the shopping cart during online checkout, and in call centers as operators take orders over the phone.

What’s interesting about POS steering is that, historically, it has been against card company rules to offer discounts or incentives to customers to select one payment method over another (the so-called “parity rules”). In other words, due to card network rules all payment methods had to be treated equally regardless of the underlying cost to the merchant to accept a particular network’s tender. Card networks contractually required their brands be treated equally to other brands.

But all of this started to crumble with the recent DOJ lawsuit with the major card networks –– the immediate settlements with Visa and MasterCard. Without diving into the details, the net effect is that Visa and MasterCard have agreed to allow merchants to offer incentives, discounts, and rewards for selecting one payment method over another. American Express, on the other hand, did not settle with the DOJ, and is fighting the lawsuit. Amex contractually requires parity in their merchant agreements, and those terms are still in place for merchants that accept American Express.

All of this is fine and good in an academic sense, but was actually kind of ho hum for many merchants. The DOJ lawsuit and settlement was interesting to some, but, quite frankly, irrelevant for most. But now the Durbin amendment comes along and requires the Federal Reserve to regulate interchange fees on debit cards in the U.S. in a way that is “proportional” to the cost of checking. That, of course, changes everything and puts POS steering in a whole new light.

The way I think about this is that the DOJ lawsuit and settlements makes POS steering legal (at least for Visa and MasterCard acceptance) –– and the proposed Federal Reserve rules make POS steering interesting.

Of course, attractive or not, skeptics say POS steering won’t happen –– nobody wants to see the customer confused just as they’re starting to pay, retailers don’t want to add friction to checkout line, blah, blah, blah. I say it’s already happening and it’s around us everyday.

Most blatantly, POS steering has been happening for last ten years in the checkout lane. PIN pads have long sensed the presence of a PIN debit card and prompted for the PIN in order to reduce the merchant’s acceptance cost. This has conditioned a whole generation of buyers that it’s okay for the merchant to steer the transaction. This practice is so common today that I’m actually surprised when I use my debit card at a major retailer and I’m not prompted for the PIN.

But this was steering within a payment method to some degree –– it is steering of signature debit to PIN debit. More subtly, perhaps, we are starting to see major retailers start to steer credit cards to debit cards. Ikea, for example, offers consumers a 1% rebate on their next purchase if they use their debit card instead of their credit card. The rebate steers the customer to use their debit card, the PIN pad steers the customer to use PIN over signature. Early on some Ikea stores experimented with 2% and even 3% discounts. It looks now like they have standardized on 1% as the sweet spot. While this has interesting acceptance economics, my sense is the return purchase incentive is worth a lot more to Ikea.

In the online environment, POS steering happens as well. PayPal, for example, famously steers consumers to fund one-time purchases using the lowest cost payment method available in the consumer’s PayPal wallet. Any PayPal balance, if available, is the default; bank funding (via ACH) comes next, debit cards are preferred over credit cards, and you get the idea. And PayPal continues to go to great lengths to get the consumer to register their bank account as a payment method. Consumers, of course, can change their preferred payment method for any one transaction, but that adds extra clicks and friction to the overall purchase. And the next time they go to buy something, everything defaults back to how PayPal would like it presented.

In the world of virtual goods, FooPets does a remarkable job steering the consumer’s payment preference. When the user goes to buy some more FooDollars (their virtual currency), the preferred method is plastic –– good old credit and debit cards. Of course, users have access to another half dozen (more expensive) payment methods but these are buried several screens (and several clicks) away. With some bill-to-carrier schemes charging merchants 30-45% transaction fees, it makes sense to position (and bury) these schemes as the payment method of last resort – yet having them available so that no sale is lost. In this case the merchant is steering the consumer to use their payment card, instead of one of the alternatives. So POS steering can cut both ways.

Going forward we expect to see a lot more online merchants steering consumers when they register and put their payment details on file. Online merchants know that once the preference payment method is on file, it is used over, and over, and over. And in most cases, with only one payment method on file, that method is always “top of wallet” for that merchant.

Merchants aren’t the only ones that know this. I recently noticed, for example, a promotion that American Express was running that offered 5 free iTunes song downloads if you put your Amex card on file with Apple. While this isn’t the merchant doing the steering, it certainly illustrates that American Express understands the advantages of having their card registered as my default payment method with iTunes.

And, it’s not just brick and mortar and eCommerce. Prior to the DOJ settlement, many of our clients told us that that it was much easier to steer consumers in a call center environment – because the transaction between buyer and seller is, after all, just between two people on the phone. Yes, they would honor the customer preference for payment method, but they weren’t shy about suggesting how the customer should pay — and the benefits of doing so.

So POS steering, broadly speaking, is real and it’s already happening. Later this year, once the Fed finalizes debit pricing, we expect to see more merchants take a fresh look at POS steering. Several of Glenbrook’s merchant clients are already developing their strategies for rewarding customers that select low cost payment methods at the point of sale. It will be interesting to see how others approach it, and exciting to see how retailers might bring their “merchandising” creativity to the checkout process.

Still, skeptics say that merchants will never attempt to steer the customer face-to-face, in the checkout lane, at the point of sale. They just want to complete the sale. I want to remind them of one simple question. “Will you be paying for this today with your Macy’s card?”

4 Responses to “POS Steering in the Age of Durbin”

  1. Nerijus says:

    Can anybody answer is it legal to charge bank account (ACH) as debit (pull) transaction what is PayPal doing? How they can access to anyone account without authorization? At least in Europe it’s illegal.

    • Russ Jones says:

      It is legal in the countries where PayPal offers bank account funding. Users wishing to fund transactions with their bank account have to give PayPal their bank account routing information and authorization to debit that account to fund transactions. PayPal will use that bank account as the primary funding source (if select by the user) or a secondary funding source if balance is inadequate or the selected funding source fails. The steering part is that PayPal will often treat the bank account (if available) as the default funding source.

  2. Great article, congratulations!

    POS steering is a key factor to boost growth of sales and retentions rates for traditional brick and mortar merchants. It is also a great way to drive online consumer to the offline world, where they could also use the different alternative payment methods available (ukash, moneybookers…).

    The game has just started, so lets hope that a new payments and commerce ecosystem develops the right way for everyone (consumers, merchants and payment providers…) who will win??

    Kind regards

  3. Andy Brown says:

    In the UK POS steering has been in place for some time with the additional charges that appear at the point of payment for some (not most) websites. Credit cards have the highest charge (unless it is the affinity card of the seller), then debit cards with either a low charge or no charge.

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