Revolt Over Interchange: Home Depot, Wal-Mart Lead Way

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In the same month that Home Depot is moving its PayPal mobile-payment process chainwide, the home improvement superstore—along with more than a dozen of the world's largest retailers, including Wal-Mart and Target—is signaling its dissatisfaction with all of the current mobile-payment options by agreeing to fund an alternative. This retailer-owned effort has a lot of dollars to make its dreams come true, with more than $20 million pledged and more than a trillion dollars in combined revenue to funnel to the preferred approach.

But the group—composed largely of the chains' financial types—has the same hurdles that have weighed down so many industry consortium: potential infighting among the leading players; legal obstacles; the need to build a massive infrastructure, given the intent to shun current networks; and the tech questions, such as whether this new approach will have any better luck at mastering security than today's efforts.

"This all sounds vaguely familiar. Oh, yes. I believe ISIS had a similar 'vision' and $100 million," said Randy Vanderhoof, executive director of the Smart Card Alliance. ISIS "found out quickly that 'it ain't easy.'"

Through conversations with various participants in the organization—which does not yet have a public name—the advantages and challenges of the effort each appear to be monumental. At the heart of the movement is retail frustration with mobile payments, which initially fueled hopes of a radical new payment order.

In the same way that the business popularization of the Web in the mid-90s rewrote retail and software rules and briefly threatened to topple software giant Microsoft, some had hoped that mobile would rewrite payment rules, reshaping (or even destroying) the dreaded interchange payment system, customer-favoring dispute resolution, information security, CRM data sharing and even the burdens of PCI. Put another way, a chance to topple the card brands, especially Visa and MasterCard. Triple especially Visa.

Said one participant in an early organizing meeting of the group: "We're only going to get one chance in our lifetime to make a major difference, a major change in payments. And mobile is it," the participant said. "It all boils down to busting the interchange system."

Remaking those elements—security, interchange, data-sharing, dispute resolution and PCI—in a much more retailer-friendly way is what is driving the group. What makes this alliance of retailers potentially much more powerful—and effective—than earlier business groupings is the money. But like so much else here, the money specifics are amorphous, when they are being discussed at all.

Companies are joining at various levels, with various levels of pledged dollars, and the total pledged dollars are said to be in the "tens of millions," with a goal to raise $100 million. But a pledge is very different than cash. One participant described the amount pledged as an "as much as" figure, with the money there when the member company believes there is a need for that cash.People can differ sharply as to what constitutes need, especially when one of those people is being asked to write a seven-figure check. Also, the economy and the individual profit situation for each chain will almost certainly have a major impact on how much of the money is ultimately invested.

That raises the question: Invested how? Beyond the usual costs of creating a major group such as this—research, spec creations, legal work, coordination, negotiations, etc.—the dollars are earmarked to find and/or create a firm that will deliver a mobile-payment system that comes close to the goals described.

The initial hope is to find an existing entity and to use the money to help that firm, presumably in exchange for an equity stake if not outright ownership. "There are systems out there. People have already figured out how to do a lot of this," said another participant.

Another possibility—admittedly more remote—is for the group's efforts to force major changes from existing players. For example, if the group's financial and organizational efforts are succeeding, will we suddenly see Google Wallet, ISIS and PayPal change their security and other features, to try and become what this group is looking for?

Even more unlikely, would Visa and MasterCard change their tune on interchange and security, hoping that some major compromises would enable them to continue their existence? That scenario is admittedly the most far-fetched. First, the emotional reality would likely thwart acceptance of a Visa proposal. More practically, it's highly unlikely that Visa's business plan would permit concessions nearly deep enough to appease the retail group. Not that it might not try anyway.

Another possibility is that a major player that hasn't yet made its entrance into mobile payment—such as Apple—might be wooed to enter it in a retail-friendly manner.

Beyond the large chains, the group's initial members include major bank issuers, networks and technology providers, but not—as of yet—the card brands. Given the desire by some to undermine the card brands, that's not surprising.

One participant said that he would like to see transactions moved to a new infrastructure, one where account credentials are never transmitted in the clear. As the NRF has argued for years, if given a choice between banks and retailers, who is better positioned to handle and control payment systems?

To make that radical a change to the system, though, will require retailers to take over and make dramatic, wholesale changes. Ironically, said that participant, "to get out of the payments business, [retailers] have to get in the payments business."The $1.38 trillion in revenue that group organizers have pointed to, though, is also not without its footnotes. Participating companies will certainly have to pay money, and the group—or, more precisely, the majority of the group—will dictate how that money will be used. But there is nothing that will force retailers who may disagree with the group's decisions to embrace it.

Another important issue that the group must deal with is legal, specifically anti-trust. Our legal columnist, and former head of the U.S. Justice Department's high-tech crimes unit, Mark Rasch, said the group could avoid anti-trust problems, but would have to proceed carefully.

"Let's say this new retail consortium develops an awesome payment-processing technology that securely uses a user's cell phone to accept payments remotely. The retailers develop wicked cool tech to make it happen. So a Target engineer comes up with one idea, a Wal-Mart computer scientist another and a Sears employee a third. Who owns these patents?" Rasch asked. "Who decides which patented processes go into the final mix? How are royalties or licensing fees handled? In a retailer-owned consortium, a large retailer like Wal-Mart now has another tool—the patent—to use to reward or punish other retailers, which happen to also be its competitors. Although transferring the ownership of patents to an 'independent' third-party company may help, the influence of the retailers may make the process anticompetitive. And that may evoke the ire of the Justice Department."

Rasch said much of this also depends on how broadly "retailer" is defined. "If, by retailers, we mean anyone who accepts money for goods and services, then we would be including bankers, lawyers, accountants and the government as 'retailers' and, therefore, potentially part of this consortium. In the implementation of whatever technology the consortium comes up with, the technology and the fees charged for its use must be to a great extent either nondiscriminatory or at least the discrimination must be rational. Thus, a technology developed by big-box stores like Target and Wal-Mart should not punish online sales or mom-and-pop retailers. It should be available to all."

Rasch offered an example: "A small retailer may come to the table with a wicked awesome payment system, but Wal-Mart might say, 'No, we can make more money on the system we propose' and adopt that as the standard. Many companies were put out of business during these standards wars. But when the industry itself does this, it may raise antitrust issues."

And if the project can survive the politics, legal and technical issues, and fractiousness of more than a dozen huge competitors, the consortium's retailers will have to face another problem when its system is ready: It will still have to deal with the card brands for the foreseeable future.

Floating a new payments platform with better security, no PCI, lower interchange costs, improved data sharing and more retailer-friendly dispute resolution may sound good (though it probably sounds most appealing to the financial types pushing the consortium, who won't have to deal with pesky technical details). But actually telling customers they can't use their plastic rectangles at big chains? That won't fly far.

Until they've disposed of Visa and MasterCard, big chains (and their financial management) will still be stuck with PCI, interchange and all the rest. But how hard could that be?

Maybe they should try something much easier first—like, say, getting rid of magnetic stripes.