Commissioned by MasterCard. Why Savings from Private Label ACH Debit Programs May Not Always Add Up. A detailed cost comparison between ACH-based store loyalty programs and network debit cards. Edgar, Dunn & Company
Why Savings from Private Label ACH Debit Programs May Not Always Add Up In an effort to reduce cost, merchants are increasingly considering alternative forms of payment. Among these alternatives are programs that involve settlement through the Automated Clearing House (ACH) network. In an effort to reduce cost, merchants are increasingly considering alternative forms of payment. Among these alternatives are programs that involve settlement through the Automated Clearing House (ACH) network. Merchants often perceive ACH transactions as having lower costs than debit card transactions, citing only the differences between debit card interchange or merchant discount fees and the ACH fees charged to the merchant by its bank. This simplistic comparison, however, does not accurately reflect actual, total costs incurred by a merchant for either service. When evaluating the costs of a private label ACH debit program, merchants should consider items beyond just the processing fees charged by their bank. Although ACH-based programs appear to have a lower per-transaction cost than debit, depending on merchant type and size, understanding the cost of these additional items can often reverse this perception. credit card transaction. Consequently, ACH program incentives may primarily shift debit users, potentially impacting the merchant s overall cost versus expected benefits. Merchants tend to compare the cost of ACH processing with the all-in cost of debit card acceptance, which can lead to inaccurate cost comparisons. This paper discusses the cost comparison between debit cards and ACH-based private label programs. The objective is to identify and evaluate fully the elements that a merchant should consider when comparing the cost and benefits of each program. By running a private label payment card, merchants are in essence playing the role of a bank in terms of customer onboarding and verification, payment processing, and account management. These costs need to be taken into consideration when calculating a total cost of payment. Conversely, these activities and costs are handled by the debit card issuer and thus part of the merchant discount. While some merchants may consider ACH programs a means to shift consumer spend away from costly credit to reduce acceptance costs, ACH programs are more likely to replace debit and/or cash spend. We have also included some sample comparative results from a model that can be adapted to an individual merchant s situation and business. Since the Durbin Amendment to the Dodd-Frank bill, most debit programs no longer offer rewards, and most private label programs must offer rewards/incentives to encourage usage. Credit cards often have existing rewards programs that consumers will compare to the private label store loyalty program and will expect greater incentives to shift spend from one to the other. In contrast, ACH program incentives may look attractive to existing debit users whose average transaction size is similar to the normal ACH transaction, but significantly smaller than a 2
Edgar Dunn & Company Identifying, Measuring and Comparing ACH Program Costs to Network Debit Cards The costs associated with a private label ACH debit program can generally be separated into three buckets: Direct Costs Transaction processing (bank costs), NSF/fraud, and float costs. Indirect Costs Private label payment card management costs, staff cost, IT and system costs. Consumer Incentives Private label discounts/rewards to consumers. Direct Costs Direct costs primarily include the costs of transaction processing including: assessments, losses and fees due to non-sufficient funds (NSF), fraud costs, float costs, and staff support at the point-of-sale (POS). For example, direct staff costs include tender time, register pick-up, and processing the cash drawer. Most of the direct costs for accepting network debit cards, other than labor, are included in the merchant discount or through a specific fee to the merchant. By contrast, for private label ACH debit programs, merchants must identify and account for their internal costs separately and add those to the fees charged by the merchant s financial institution. The direct cost elements that can significantly impact the merchant s total cost are: Payment Processing: This is the most visible and oft-cited cost element to a merchant s organization. In the case of card payments, payment processing costs account for almost all of the acceptance costs that a merchant incurs related the card transaction. They are generally collected through the merchant discount. With a cap on regulated debit interchange, the merchant s cost of processing debit card transactions has decreased for a significant percentage of their debit business. ACH processing costs charged by the merchant s bank is often the only cost a merchant compares to debit cards. These can be just a few cents per transaction for large merchants but can be much higher for merchants with lower volume. Our cost model assumes a 4 cent-per-transaction processing fee for an ACH payment and similar labor costs at the point of sale for both programs. Fraud & NSF: In contrast to debit, ACH does not have a realtime authorization of funds availability and does not provide a funds guarantee to the merchant. Thus, when initiating an ACH transaction, merchants typically do not know if sufficient funds exist in the consumer s account for up to 3 4 days. As a result, the risk of not getting paid continues after the merchandise leaves the store as opposed to before the transaction takes place, as is the case with debit cards. When there are insufficient funds, merchants pay a fee on these returned transactions, as well as potentially take the loss of the goods sold. ACH does not have a real-time authorization of funds availability and does not provide a funds guarantee exposing merchants to significantly higher risk when using the ACH network for payments. The delayed settlement of funds when using ACH is a primary cause for inadvertent NSF on the part of the consumer related to the sales transaction. Depending on the size of the transaction and the bank fees related to processing returns, merchants may choose not to employ collection strategies on some payments and instead take them as losses. To mitigate the risks associated with ACH, merchants can pay additional fees to guarantee funds. However, this guarantee adds to the overall cost of acceptance and the additional expense should be taken into consideration when evaluating such programs. Another option for merchants is to be more selective about who to approve for such programs or limit purchase lines both of which can lead to a negative consumer experience and limit or eliminate the consumer s purchases, thus reducing the potential impact of the program. 3
Why Savings from Private Label ACH Debit Programs May Not Always Add Up Indirect Costs Indirect costs, including staff, IT and systems costs related to managing the private label card program, can be significant and difficult to consolidate into one P&L as they may be spread across the merchant s organization. For example, costs such as onboarding and customer communications are often managed by the marketing department; platform costs are absorbed by the IT department; and treasury maintains visibility into the transaction processing costs as well as the staff costs to manage payments at the backend. Our analysis shows that these indirect costs (not including consumer discounts/ rewards) could account for almost 30% of the total cost of payments in such a program. These costs include: Staff Costs to Manage Payment Processing: Both ACH and debit require indirect staff costs to manage processing, vendor relationships (with banks, acquirers, etc.), reconciliation, and reporting. However private label ACH payment card processing is more labor intensive and may require additional resources to manage aspects like return processing, error processing and resolution, etc. Private Label Payment Card Management Costs: Private label ACH debit programs include additional customer interactions such as new account marketing and solicitation charges staff time spent onboarding, card issuing costs, customer service expenses, promotion and marketing costs, etc. ACH costs are typically spread across different areas of the organization, making it difficult for merchants to quantify the total cost of acceptance. Whether insourced or outsourced, there are also costs associated with operating the program on an ongoing basis internal training, ongoing marketing, etc. For debit cards, these costs are largely incorporated into the Merchant Discount Rate (MDR) as card issuers and acquirers take on most of the costs of onboarding customers and servicing the relationship. IT Costs: IT and system costs are similar or shared across ACH and debit cards including terminal costs, telecommunications, system downtime, etc. However, the cost of integrating the merchant s loyalty program with payments requires significant investment to build and maintain. Integrating payments involves establishing connectivity to networks, as well as integrating risk tools. Such systems are not only expensive to build, but also costly to maintain. As a consequence, the merchant needs to create scale on the ACH program to reduce the per transaction cost of these in-house platforms. Our cost model assumes a very modest (and probably low) IT investment. Merchants must evaluate how much it would cost them to build and maintain such platforms. Indirect costs for a private label ACH debit program (not including consumer incentives) account for around 30% of the total program costs. Consumer Incentives Private label programs generally require upfront and ongoing incentives with the objective of getting consumers to sign up for the program, to buy more, and consolidate or shift spending. These incentives must be sufficient to offset the customer service and satisfaction issues such as: Completing the enrollment process typically a cumbersome multi-step process since most programs require collection of IDs, a cancelled check or other forms of account verification in addition to other documentation. Entrusting the merchant with banking information and account routing number details which given recent data breaches could be costly to both the merchant and the consumer. Carrying and using a separate card versus using their primary debit or credit card. 4
Edgar Dunn & Company Summary Given the cumbersome onboarding process and the typically limited use of the card, most consumers enroll and remain engaged only when they are offered a significant discount on all purchases (like 5% discount on a leading private label store loyalty program) or attractive rewards (like a cash back program). Increased Basket Size and Break-Even: There is no guarantee that the cost of these incentives will be offset by an increase in usage or transaction size. This is especially true for merchants that have a limited product offering which restricts the consumer s ability to consolidate spend from other merchants they shop with. For example, a consumer enrolled in an ACH loyalty program with a large discount store will have the option to buy everything from groceries and appliances to clothes at that merchant thereby shifting a broad range of spend to take advantage of the topline discount. Limited-line merchants cannot consolidate consumer spend as effectively. We estimate that depending on the consumer incentive, the break-even point, compared to debit, requires consumers to spend 15% 30% more using their private label card. For example, with an average 3% consumer discount/reward incentive, the incremental spend required to break-even would be about 15%, assuming typical gross margins. Under the same assumptions, a 5% discount/reward would raise the break-even point to a 25 30% increase in required transaction size. For merchants running an ACH-based program, the break-even point when compared to debit, requires consumers to spend more. Taking an overly simplistic approach and comparing only the bank fees on ACH-based programs to the total cost of accepting debit or credit cards could be a costly mistake for merchants. All aspects of the programs need to be considered in order to make an informed decision on whether to accept or emphasize one payment method over another. Our analysis shows that bank-direct charges for ACH are a small percentage of the total cost and indirect costs alone can account for approximately 30% of the overall cost of a private label ACH debit program. By contrast, direct costs of a debit program (in the form of the merchant discount) account for almost all of the costs associated with accepting debit cards. In short, the scheme and banking system can deliver many of the costs of the program for the merchant at a much lower level than any merchant or merchant group may be able to do on their own. It is important that merchants identify and consolidate all of the costs of running ACH programs into one program P&L to appropriately compare it to projected benefits, such as customer loyalty, spend and data insights in order to ensure it is delivering incremental value to the organization. Merchants are in essence taking on many of the roles of a bank when offering a private label ACH debit program and these costs should be taken into consideration. Merchants also need to carefully evaluate the shift in payment behavior they can influence or expect with ACHbased programs, especially in verticals with heavy debit spend. For such everyday spend merchant categories, ACH-based programs could very well incent consumers to move spend from their debit card to the merchant s storebranded loyalty program and actually increase the overall cost to the merchant. To shift spend from credit, the merchant may likely have to provide incentives that could end up being more expensive than the acceptance costs of debit/credit cards and result in lower revenues. Finally, in addition to costs, merchants need to consider the overall impact of integrating and managing a payment program on their core business and brand reputation. Ultimately, merchants must evaluate how either or both alternatives can contribute to their strategic goals and deliver increased sales and profits. 5
Why Savings from Private Label ACH Debit Programs May Not Always Add Up Sample Cost-Comparison The following is a cost comparison between a sample private label ACH debit program and a bank-issued debit card using industry and merchant category data. In this example, the cost of private label is higher than debit primarily as a result of added indirect costs for managing the ACH-based debit card program. Adding ongoing consumer incentives makes these programs much more costly compared to debit. The additional transaction size required to break-even compared to debit will vary by merchant size and type. Sample POS Transaction Costs per transaction ($40 ATV) / Amounts are in USD ACH-Based Private Label Debit Debit (Grocery) Subtotals Subtotals Subtotals DIRECT COSTS PER TRANSACTION Processing Costs $0.040 $0.407 $0.279 NSF & Fraud Costs $0.378 $0.028 $0.028 Float Costs $0.005 $0.000 $0.000 Total Direct Cost Per Transaction ($) $0.423 $0.435 $0.307 Total Direct Cost Per Transaction (%) 1.06% 1.09% 0.77% INDIRECT COSTS PER TRANSACTION Indirect Staff Costs (POS Environment) $0.005 $0.002 $0.002 IT / Systems Costs $0.004 $0.001 $0.001 Private Label Card Management Costs $0.154 $0.000 $0.000 Bank Costs $0.004 $0.000 $0.000 Other Costs Per Transaction $0.001 $0.001 $0.001 Total Indirect Cost Per Transaction ($) $0.168 $0.004 $0.004 Total Indirect Cost Per Transaction (%) 0.42% 0.01% 0.01% Total Cost of Acceptance ($) $0.590 $0.440 $0.312 Total Cost of Acceptance (%) 1.48% 1.10% 0.78% Private Label Discount to Consumer (3%) $1.200 Total Cost of Program $1.790 $0.440 $0.312 Note: Numbers may not add up due to rounding. Costs that are identical across payment types (e.g. POS terminal costs, internal systems costs) offset each other and thus are not included in this analysis. Based on 300 MM transactions, ATV $40, 67% regulated debit and 45% PIN transactions; will vary based on category, merchant size, ATV, penetration of debit and % of regulated debit within these categories. Debit (Grocery) based on 300 MM transactions, ATV $40, 72% regulated debit and 79% PIN transactions; will vary based on category, merchant size, ATV, penetration of debit and % of regulated debit within these categories. 6
Edgar Dunn & Company The grocery vertical analysis in the chart (left) highlights the fact that merchants in debit-heavy categories could potentially see their acceptance costs increase with a private label ACH debit program. For some merchant categories, particularly for merchants with effective marketing programs to drive incrementally higher average sales and the ability to scale the size of the program, private label cards may provide a net benefit. However, this is not the case for all merchants or merchant categories, especially categories with heavy debit spend. The grocery vertical analysis in the chart (left) highlights the fact that merchants in debit-heavy categories could potentially see their acceptance costs increase with a private label ACH debit program. In the end, once all factors are considered, it is a matter for each merchant to decide on the cost model that works best for the business situation. List of References Edgar, Dunn & Company estimates and analysis Phoenix-Hecht, Blue Book of Bank Prices NACHA Federal Reserve Bank of Minneapolis Bottomline Technologies European Central Bank US Department of Labor Food Marketing Institute Reserve Bank of Australia Board of Governors of the Federal Reserve System MasterCard State of North Carolina Data included in this document was obtained through MasterCard-commissioned industry studies. 7
Edgar, Dunn & Company in Association with MasterCard. edgardunn.com mastercard.com Published August 2014. Copyright 2014 Edgar, Dunn & Company All rights reserved. Reproduction by any method or unauthorized circulation is strictly prohibited, and is a violation of international copyright law.