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Why transaction economics matter

Ever wondered why contactless / NFC payments are accepted and available today at only 2% of the POS locations? The contactless technology (NFC is its close cousin) is heavily marketed by payment industry players as perfect replacement for traditional cash payments ... naturally targeting everyday small value purchases like coffee + muffin (or two ;-) ... mostly an average ticket size between 2-5 $/eur.

Merchant discount fees (MDR) are often said to be in the range between 2-3% of the transaction amount. Well that may be true for higher value transaction tickets - those above 20 $/euro, but for the transaction amounts below 10 $/eur (especially those in 2-5 $/eur range) these merchant fees are effectively much higher.

Merchant discount fees typically comprise of the component which is independent of the transaction amount (in range of typically 15-22 cents) + component which is dependent on the transaction amount (in range typically 1-2% of the original transaction amount). When you add up these two transaction fee components you quickly realize that for the transaction ticket of 2-5 $/eur the total merchant discount fees are already in the 5-10% ranges at least !

No wonder then that the majority of the merchants, transacting mainly in small value amounts, are heavily resisting the mass rollout of contactless technlogy ... they simply know that if they install contactless readers they will open the flood gates for electronic cash replacement and expose themselves to paying 5-10% transaction fees on most of the credit card / debit card / NFC mobile transactions they process! Under those conditions they would rather fallback to the good old cash instead. That's what we are still seeing in reality, despite heavy marketing efforts in promoting the benefits of contactless and mobile payment technology. 

This is the main reason why ISIS and any other mobile wallets which are piggy-backing on existing credit/debit card payment infrastructures are struggling with wider acceptance. They are simply at the mercy of availability of the NFC / contactless infrastructure @ POS and are facing the exact same challenges as contactless card payments are still facing. It is not just contactless equipment that is expensive for the merchants to install (that is one time cost only) but it is mainly the fear of the ongoing transaction fees for the ticket sizes of 2-5$ which are are too prohibitive for most of the small to medium merchants! What does this tell us? It reveals the naked truth - that simply tweaking the form factor @ POS (tap NFC phone instead of tapping a contactless card / inserting the contact only card) isn't enough to force merchants to embrace the contactless payments as cash replacement mechanism on any large scale.

In order to have merchants willingly participate in mass rollout of any contactless / NFC technology @ POS, payment card industry must first and foremost properly and fundamentally address the low value transaction economics at its very core ... that unfortunately means avoiding usage the existing payment backbone / infrastructure for those transaction segments. But the politics of the interchange fees are obviously in the way of this and issuers, payment schemes and acquirers are all playing the game of preserving the 'status quo' by making it very difficult for alternative payment solution providers to get their code into the card chip, POS terminals, etc - thus creating the artificial 'chicken-egg' situation and protecting their turfs by preventing real fundamental and disruptive innovation.

The payment card industry obviously hopes that in the end their current strategy will prevail and that the small to medium merchants would have to swallow the bitter pill of paying the 5-10% transactions fees forever. Obviously the industry players may have grossly underestimated the power of the merchant resistance at least so far. The future is still to be seen.

But I believe that we will be seeing many more upcoming contactless and mobile wallet payment solutions which struggle for a very long time, as long as they are trying to ride on top of the innefficient traditional payment card rails built in the 70s for higher transaction amounts ... without fundamentally addressing low value transaction economics

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Comments: (3)

Nick Collin
Nick Collin - Collin Consulting Ltd - London 24 June, 2013, 10:14Be the first to give this comment the thumbs up 0 likes

Excellent blog Milos! I've always struggled with the economics of contactless/NFC transactions. The problem was understood by banks when contactless was introduced in the UK around 2007 and there was much talk about stripping out all the unnecessary cost elements of higher value card payments in order to drive the merchant service charge down to a reasonable rate which would be attractive to retailers, but in the event not much was done. As a result I think you are right and the industry faces a classic "Innovator's Dilemma" - ie a simpler, cheaper technology will eventually emerge for lower value payments unless the existing card payments industry gets its act together.

Ketharaman Swaminathan
Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune 28 June, 2013, 13:48Be the first to give this comment the thumbs up 0 likes

Dwolla is already available in the US. It charges zero fee for transactions below US$10. However, I've never understood why consumers would adopt them - no deferred payment or rewards!

A Finextra member
A Finextra member 01 July, 2013, 14:28Be the first to give this comment the thumbs up 0 likes

Dwolla faces the issues with consumer adoption, since it is expecting the consumers to change the way they already pay. That's hard without huge incentives to the consumers. 

Addressing the transaction economics for low value payments in order to be successfull must be done in such a way to make it fully (or almost fully) transparent to the consumers and still be able to offer much lower merchant discount fees for low value payments - all without jeopardizing the profitability of the payment networks, card issuers and acquirers.

Cardis International has such technology available NOW.