There are only 3 major markets where credit card interchange is not regulated: US, Japan and Russia. In these markets, Issuers use interchange (US 130bps-270bps) to power consumer reward programs (see Tilting Networks Toward Merchants – 2015) and card marketing. The ROW has credit interchange regulated to ~30bps and debit 20-30bps, and the reward programs are much different (Barclays UK below). But regulating payment interchange HAS NOT resulted in volume loss for V/MA, to the GREAT frustration regulators.. this is a key point (more later).
As discussed in Changing Economics of Payments, US Merchants have long been frustrated by the lack of market forces operating on interchange. It is one of the few networks in the history of man to grow more costly over time (Thomas Fillippon NYU). Merchant frustration with V/MA in enabling new rate tiers, and growth of rates (within the tiers) provides a well justified view that the networks have an issuer bias. Recently the tide has shifted, with large merchants successfully negotiating significant rate reductions, both directly with issuers (see ChasePay/WMT) and through network agreements (see Amazon/Visa). Networks are becoming much more neutral as they realize the key to value creation is to be a service provider at the point it is delivered.
I am now 100% confident that credit card interchange rates in the US will be dropping. There are 4 primary drivers:
- Pricing Transparency. Merchant groups looking to gain insights into discounts provided to Amazon (See MPC complaint).
- Legal. For example, US grocers have the attention of FTC and Congress to enforce Robinson-Patman act. This is likely to include cost of payments.
- Competition forcing the unbundling of cards. V/MA alternatives, including BNPL, Venmo, FedNow, A2A and local payment schemes. Issuers recognize the threats .. and that interchange is the primary friction point. The loss of bank advantages in risk and authentication, together with mobile, have allowed Consumers can connect to a greater number of service providers. Affirm, PayPal, Klarna, Stripe, Square Cash, … are all capable of building two sided networks that run “on us”.
- V/MA Neutrality (tilt toward merchant). The networks realize their economic opportunity is in neutrality and enablement.
Visa and MasterCard have transitioned to become common network infrastructure, a position FAR MORE valuable than that of a closed credit delivery system. They are a network of networks.. (Hey did they steal that from me?). Changing Economics of Payments – 2015
V/MA are highly efficient networks that have proven their ability to price (5-7bps) and succeed in regulated markets. V/MA will be just fine, in fact most competing schemes depend on V/MA for routing and rails to the core bank accounts (ex through OCT/AFT). The impact of interchange reduction will be on card reward schemes and issuer marketing budgets.
Reduction (or elimination) of consumer reward programs will enable merchants to select from a greater number of alternatives, create white labels, develop price/promotion strategies that integrated payments (ex installments) and provide incentives (see How will BNPL evolve).
End state success will evolve toward the location of value creation, for example the consumer experience in eCom Checkout with credit moving toward commodity competition and merchant steering (ie price/promotion). The expansion of trust and ability to authenticate (see blog) thus pushes banks toward enablement (and Open Banking like roles).
This unbundling of card is beyond ironic, as banks forced merchants to develop the systems and processes for remote commerce, build consumer risk engines, and own fraud. Now these merchant competencies have led to their data advantage, with banks becoming commodity services and having little ability to manage either consumer or risk remotely (see Data Games and Authentication in Networks).
Consumer behavior continues to change. I was on the phone with a top 5 retailer this week “Tom the banks have completely missed the boat in key demographics. For example Gen Z no longer pays with a card.. They don’t even know what a card is for. They pay with Venmo, PIX or PayTM. Additionally, they want to pay their bills at my store or on my website (see UPI India), they want simplified and transparent financing of their purchases.. I’m now in a place to deliver that”. How can banks enable any of this without V/MA?
How will Issuers Respond?
As network effects take hold, value migrates toward the ends of the network. A January 2001 Harvard Business Review Article: Where Value Lives in a Networked World put it this way:
In more general terms, modern high-speed networks push back-end intelligence and front-end intelligence in two different directions, toward opposite ends of the network. Back-end intelligence becomes embedded into a shared infrastructure at the core of the network (cloud), while front-end intelligence fragments into many different forms at the periphery of the network, where the users are. And since value follows intelligence, the two ends of the network become the major sources of potential profits. The middle of the network gets hollowed out; it becomes a dumb conduit, with little potential for value creation. Moreover, as value diverges, so do companies and competition. …. In a connected world, intelligence becomes fluid and modular. Small units of intelligence float freely like molecules in the ether, coalescing into temporary bundles whenever and wherever necessary to solve problems.
Thus logically, the value of a “switch” like V/MA should diminish as consumer and merchant specialists grow in their ability to manage risks and work with a greater number of service providers which bundle banking services. Banks must work to be part of new bundles and compete where the customers are (not where they want them to be). In Open Banking/PSD2, standards define the interaction between Banks (PSPs) and PISPs and TPPs. There is no need for V/MA. To be clear, I’m actually very negative on PSD2 as it is a standard with no shared economic model. The benefit networks bring is the economic model, AND the network of specialists that can enable new models.
There are few examples of banks working collaboratively.. India’s UPI is perhaps the greatest success model in last 20 yrs. In the US, bank collaboration must go far beyond payments. The problem to be solved is bundle participation and how to enable consumers and merchants. Banks must proactively unbundle and provision services. This is the problem PLAID solves for FinTech: ubiquitous read only access to every US bank.
New product cycles at banks typically are 6-10 yrs. These cycles force bigger bets on larger releases. Some are successful (ie Zelle), most are not.. The issue is not functionality, but rather a focus on a bank goals vs the consumer or merchant experience. Banks must create a model that enables 100s of trials. As consumers migrate to the metaverse, the fed experiments with FedNow and CDBCs, Affirm unbundles cards, and Gen Z consumers use venmo how can banks possibly think they can guide the next phase?
While there are opportunities for banks to lead in new product creation, there are many more opportunities where they have to partner. Yet few start ups can possibly hope to deploy resources in partnering with a single bank, no less a group of them. Clearly SEPA and Open Banking are a poor regulatory approach to enablement. Each bank must be able to chose how or if they want to participate.
For example, there is substantial bank benefit to standardizing service definitions and terms. ISO 8583 is a 40 yr old standard that is well defined service, Stripe succeeded so dramatically because they made this service easy to consume, integrate and purchase. Beyond technical, they created the legal framework to standardize the merchant agreement and took on the role of PayFac to acquire. Stripe made payments easy.. Allowing any merchant to go live in 2 days.
In the same way banks have the opportunity to create services, and enable their own development community:
- OCT/AFT transactions (core banking rails)
- Account authorization
- Verified identity
- Account detail
- …Plaid should have no opportunity
Today, V/MA offer the only alternative to consistently work with 1000s of banks globally. Banks must look at their approach to community, standards and collaboration differently. Time to market must shift from 6-10 yrs.. to months. I would propose a GPL equivalent for Banking software (BSL). Enabling your own community of 100,000+ developers to participate in creating consumer metaverse experiences or integrating your credit into merchant installments. Common utilities and standards are core for any successful sector, from telecom (5G) to PCs (Windows/Intel), to Energy. Lay out reference models with dummy data.. enable test environments and empower your teams. You must rethink the structure of your IT teams supporting your product groups.. to the other way around (how it works in Google).
Yes this would enable more competition, but the alternative is world where Banks lose:
- Rails for core bank services (Debit/Interbank)
- Economic model
- Consumer account/interface
- Merchant account/interface
- Ability to partner
- Speed to market (dependency on 3rd party providers).
- Talent/Team that can execute in faster cycles
The impact of interchange going to 30 bps in US, Japan should be negligible for V/MA. Actually I see this as opportunity for networks to expand their services (ex Installments, OCT/AFT). The impact on card issuers, and loss of rewards, could bring about much lower growth, increase of churn and lower asset volume.
In markets where interchange cap regulation took effect (ex Australia 2017), network payment volumes actually increased. The same is seen in India, with 2021 UPI volume growing at over 103%, V/MA increased 44% (far above normal).
V/MA are top 5 brands with well ingrained consumer behavior. As I’ve often stated: to defeat V/MA you must overcome the combined investment of every single party that is integrated to them. Their economic model, and the combined infrastructure supporting their network is almost insurmountable. HOWEVER, switching costs are dropping and the ability of consumers and merchants manage participation in a greater number of networks has dramatically changed. While other players are well suited to manage the consumer or merchant connections more effectively.. they remain the only ubiquitous service.
From a timeline perspective, I see significant change to card CNP rates in next 3 yrs and overall card rates in 4-6 yrs.
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