Cards and Competitors

We’re reaching peak talking about peak card.

Dateline: Woking, 16th April 2024.

Recent figures (from the Nilson Report) shows that US merchants paid a record $161 billion in processing fees to accept $10.6 trillion in card payments. The total value of fees paid was up 17% from 2021, even though purchases for goods and services tied to all card payments grew by only 12% year-over-year. This is because credit cards made up a larger share of spending and credit cards cost merchants more to accept. Credit card spending in fact grew by 19% in 2022, more than three times the growth rate for the (less costly) debit cards. Given this trend (banks pushing premium credit cards with generous rewards paid for by the merchants), the management consultants Bain forecast of peak card (in the US market) in 2029, may actually be slightly behind the curve as these costs push merchants to look for alternatives.

How to Compete

With profit margins being squeezed, merchants have responded by surcharging for card use (payment consultancy TSG reckons between five and ten per cent of the eight million card-accepting small businesses in the US now charge fees for credit card usage), by discounting for cash or by encouraging customers to bypass cards completely and switch to alternatives such as payments direct from the customer’s bank account to the merchant’s bank account. With big billers such as Verizon, AT&T and T-Mobile asking customers to shift monthly payments from their credit cards to bank accounts, they are leading a trend that will only grow stronger as instant payments, open banking and digital wallets gain traction.

Now, I understand perfectly well that the factors that point to cards continued for dominance are real but if we take them altogether then it seems to me that there are two key factors that will determine the shift from cards to account-to-account (A2A) payments. These are consumer protection and customer rewards.

Consumer protection first. It is often suggested that it is the issue of fraud and consumer protection that protects cards market share. The argument is that consumers are well used to the protections afforded by card schemes (what we in the UK call "Section 75” protection) and the unconditional ability to charge back transactions. If I buy an airline ticket and the airline goes under before I fly, I get back my money for service not rendered and its someone else’s problem of getting the money back from the bankrupt company.

However, in many cases consumers just don’t need those protections because they have a well-founded expectation of redress from the merchant. I’m flying to San Francisco soon on British Airways. If the flight gets cancelled, I expect British Airways to find me an alternative: I have status, so I don’t need a credit card company to intermediate on my behalf. On the other hand, if I am buying a cheap ticket on a carrier I have never heard of, I will use my credit card even if offered triple miles, because I do not have a well-founded expectation of redress from them. Similarly, if I go and buy some meat at my local supermarket and the meat turns out to be off, I will take it back to the supermarket and they will exchange it for a fresh pack. I don’t need an intermediary. If I buy a sweater from Marks & Spencer and it has a hole in it, they will exchange it for a new one without a flaw. And so on. Hence where customers have such an expectation of redress, they will more likely switch to A2A in return for rewards.

© Helen Homes (2021).

This brings us on to rewards, which are the other key factor. The management consultants McKinsey point to the consumers' love of card rewards as the biggest challenge to American adoption of A2A. The arguments about rewards have been going on for a long time. Durbin argued that the European Union's 0.3% interchange limit for credit cards hasn’t eliminated rewards programmes and that is true, but those rewards are sharply reduced in the EU. The interchange fees that fund those rewards stand at more than $800 per American household. The top six issuers use that income to spend around $67 billion per annum on rewards for consumers.

(There’s another aspect on rewards issue that is worth noting. As “The Points Guy” says, someone is subsidising the habit. In the case of my British Airways co-brand, for example, it is other customers. A 2022 Federal Reserve paper estimates that in the US, credit card rewards induce an aggregate annual redistribution of over $15 billion “from less to more educated, poorer to richer, and high to low minority areas”. In short, well-off cardholders typically earn money with the use of reward cards while less well-off cardholders lose out.)

Pushing Alternatives

These two factors can come together to generate the shift toward cards for certain merchants then. Here’s what I mean. Back to that flight to San Francisco. My ticket was purchased in the most expensive way imaginable (for the airline) using a platinum cash back corporate card. This means that British Airways paid through the nose to the issuer so that the issuer can reward me with their points. You can see why the airline might prefer to have the money come from my bank account, bypassing the card, so that they can reward me directly with their own miles rather than have me rewarded with a rival airline’s miles, Amazon vouchers (which is what I always use my issuer points for) or anything else. If they offered me triple miles to pay from my bank account, I would do it.

If merchants were to move their loyal and high-spending customers away from cards, they and the customers could benefit. But how? One obvious way forward would be through open banking and to introduce a standard Request-to-Pay (R2P) services and what we in the UK call Variable Recurring Payments (VRPs). VRPs (somewhat similar to Direct Debits but with a better transaction flow) enable organisations to collect payments from a customer’s account on an ongoing basis without asking for permission each time. VRPs offer increased speed (with instant payment confirmation, as opposed to the two- to three-day wait with Direct Debits), transparency and (most importantly to me as a consumer) control.

So, to use my British Airways example again, when I book a plane ticket I would expect to see an R2P request pop in on my phone within a second or two. To use the supermarket example, when I checkout of my local store (where I have already authenticated my loyalty scheme “identity”) I would expect to see confirmation of a VRP pop up on my phone within a second or two.

New Routes

There’s a win-win here. In a YouGov survey of Brits, more than half of the respondents said they would sign up for more subscriptions if they had one easy way to cancel them. VRPs are a continuous mandate but with some intelligence: if I give VRP permission to the supermarket VRP access then I would set some basic rules (transaction under £100, no more than three times per day, no more than a cumulative total of £500 per week, or whatever) so that I can go about my day without having to think about it.

As VRP and request-to-pay (R2P) services open up new pathways for retail payments, merchants will undoubtedly start to shift volume in their direction. Forrester expect the number of consumers using open banking services in the UK to treble over the next five years and for payments driven by open banking to account for a tenth of all electronic payments by 2027, with growth powered by VRPs.

Whatever I think about it, it is important to note that serious players are looking in the same direction. Zach Perret, the CEO of Plaid, says that he thinks 2024 will be the year when at least one major US retailer puts A2A to the test and I am sure he is correct: Bain’s forecast of peak card five years from now might actually turn out to be conservative.

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