Want Out Of Interchange? It May Be A Question Of Loyalty Vs. Fear

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Can anything actually reduce interchange? With the interchange settlement inching toward approval in New York federal court, and announcements expected next week from Google Wallet, Isis and maybe Apple, it's easy to forget the underlying reality: Visa and MasterCard have their interchange stranglehold on retailers because interchange is the payment-card business model. Cutting interchange requires weaning customers off the card brands, and that means coming up with a widely used alternative to Visa and MasterCard. It's as simple—and impossibly difficult—as that.

And it can't be created the same way Visa and MasterCard were, because that's now illegal. If the MCX retailers' alliance wants to beat the card brands, that's going to require some seriously new thinking—and it should probably start with loyalty.

Nothing else is going to move the needle significantly. The interchange settlement that lawyers for Visa, MasterCard, Kroger and Safeway will ask a federal judge in New York to approve on Friday (Oct. 19) won't provide real relief, which is why Walmart, Target and most of the named plaintiffs in that class-action lawsuit are opposing it.

Then next Monday (Oct. 22), Google and Isis are both expected to make mobile-payments announcements: Isis to announce it is finally starting its trials in Salt Lake City and Austin; Google once again adjusting its payments system to try and get customers and retailers to use it. The next day, Apple has a new product announcement that probably involves either an undersized iPad or a scaled-down laptop or both, but it might also include something to prod its Passbook mobile wallet in the payments direction (it's unlikely, but hope springs eternal in mobile payments).

Unfortunately, because Google Wallet and Isis are just new form factors for conventional payment cards, there's no interchange relief there (and that would be a problem even if handing CRM data to Google isn't a deal-killer for some retailers). And Apple is a complete unknown, except for its reputation for taking a big bite out of every transaction it handles.

In practice, every alternative to payment cards has the problem that those plastic cards are virtually everywhere, and no alternative can come close to such penetration. Remember, all through the 1960s the card brands mailed out 100 million unsolicited cards in the U.S. That's how they primed the market. They stopped when that practice was outlawed in 1970. But by then, customers had been trained to love plastic—and merchants had been convinced to accept interchange.

Four decades later, both sides are addicted, so no retailer is going to simply walk away from the card brands. The everybody-signed-it-though-everybody-hates-it interchange settlement is just another demonstration of that. So is the talk about Congressional action, or a miraculous event involving Apple. Short of a retailer (or government) takeover of Visa and MasterCard, there's going to be interchange, and chains are going to feel helpless about it.

That is, unless chains come up with an alternative themselves—something as common as payment cards but controlled by retailers and valued by customers. Only one thing fits into that category: loyalty programs.

Why not Apple? Not a big enough installed base. Why not Congress? Banks and card brands can point to the debit-card swipe fee cap, which has helped retailers but not the consumers it was targeted at. Why not another lawsuit? The lame settlement terms demonstrate how well that worked. No, this is going to have to be a do-it-yourself project.How could that work? Suppose (once everything is in place) MCX chains tell their loyalty customers that they now instantly have charge (not credit) accounts as part of the loyalty program. You just ask to charge your purchase to your loyalty account at checkout, and you'll get a bill at the end of the month.

If the customer opts to do that, the charges (but not other CRM data) go to MCX. At the end of the billing period, MCX bills the customer for all the purchases made in this way—ganging purchases from Walmart, Target and other chains onto a single bill.

The customer then pays that bill (in full, because it's not a credit account) with cash (at any MCX merchant), check, ACH transfer or Visa/MC/Amex/Discover/Diner's Club. With the first three, there's no interchange. With the last one, there's a single large transaction with MCX, which theoretically should reduce the interchange hit slightly.

Then MCX deals with divvying up the income and dealing with deadbeats (which should be less likely because the loyalty data should help identify who's a lousy risk).

Could it work? Maybe. The technology isn't the hard part—it's really just another back-end billing system. Customers might go for it in exchange for another two weeks on average to pay the bill. Besides, they like retailer loyalty programs better than they like banks. For retailers, there's at least a prayer of actual interchange relief, along with competitive pressure on Visa, MasterCard and the banks.

In fact, except for the loyalty element, this works something like PayPal's in-store payments effort—the difference being that retailers have a real reason to push something related to their own loyalty programs. Paying via PayPal and giving away CRM data? Not so much.

What's missing from this picture? Trust. Sure, there's no love to lose between chains and the card brands and banks. But a new billing system that's run by a group of competitors? Yeah, that'll sure raise the comfort level of the finance folks who are pushing MCX (and have also pushed the lawsuit that gave us the interchange settlement).

Any payment that's delayed, any dispute resolution that's expensive, any cost apportionment that's unfair in any retailer's eyes—this isn't just Visa giving you grief, it's Walmart and Target and your other competitors handling your chain's money. Paranoia, anyone?

That, by itself, reduces the odds that MCX can make a real difference in the interchange wars, with a loyalty-based payment scheme or anything else. It doesn't help that Walmart has been throwing its weight around in the group (now Walmart's competitors know what Walmart's suppliers feel like), and that the most likely source of the MCX technology will be some startup Walmart bought.

Still, that's a bullet chains may have to bite if they really want to fight back on interchange. It won't go away or go down on its own, and lawsuits and lobbying are a crapshoot. In the end, it may come down to which it is that chains hate more: Visa or Walmart.