Did coronavirus permanently increase merchants’ transaction costs?

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E-commerce sales boomed during the height of the coronavirus when consumers were stuck at home, and merchants had no choice but to accommodate the surge. But some retail industry observers are concerned about potential long-term costs from the pandemic.

When coronavirus forced consumers to stay home, the proportion of retailers' card-not-present transactions soared, increasing many merchants’ expenses because of the higher cost of handling fraud risks and declined transactions for online purchases.

In the U.S. in the apparel category alone, CNP transactions between February and April went from no more than 40% of transactions to virtually 100% of clothing sales, while restaurants saw CNP transactions rise from less than 20% of all sales to around 80%, according to CMSPI, a global consultancy focusing on merchant issues.

Some of the shift to CNP transactions is likely to be temporary — sales at clothing stores tripled in May from a month earlier, in part due to restrictions lifting in some markets, the U.S. Commerce Department recently reported.

But if consumer habits acquired during the pandemic stick permanently — such as routinely using grocery and food delivery — merchants will be worse off because of higher CNP costs, some retail industry advocates predict.

U.S. merchants are likely to incur an additional $1.6 billion in additional credit card interchange fees this year because of the rapid shift toward online spending, according to Callum Godwin, chief economist with CMSPI, which has offices in the U.K. and U.S.

One reason costs are going up for U.S. merchants is that consumers strapped for cash during the pandemic have shifted more household purchases like groceries from debit cards — which have lower transaction costs — to credit cards, Godwin said.

U.S. merchants negotiated lower per-transaction rates for card-present transactions because of debit routing options available through the Durbin Amendment, but those options become less available in the CNP environment, according to Godwin.

"PIN and PIN-less debit transactions are typically cheaper per transaction. However, it's not desirable to enter a PIN online and the lack of PIN-less routing options means that debit transactions tend to be more expensive in a CNP environment," Godwin said, adding that credit cards are almost always more expensive to process online than debit cards.

In the wake of coronavirus, retail industry leaders are privately discussing the need for some significant changes, said John Drechny, CEO of the Merchant Advisory Group, a nonprofit organization founded in 2008 representing 150 of the largest U.S. merchants.

“Merchants have done a lot of innovation to enable the recent surge in contactless payments and CNP shopping during coronavirus, but if you look at the industry rules around the way these transactions are handled, there’s room for improvement,” Drechny said.

For example, with a larger share of consumers shopping online in unfamiliar patterns, CNP transaction approval rates sank as low as 80% for some retailers versus the typical card-present approval rate of 95%, Drechny said.

“If there were a way to pass more of the information the merchant knows about each transaction to the issuer, there would be higher confidence in who that online shopper is, and approval rates would go up,” Drechny said.

MAG would like to see new models developed enabling merchants to share what they know about shoppers that are registered as members or guests through online apps. This could aid in generating a card-approval score so issuers would decline fewer transactions, he said.

“Right now we have two independent sets of data — what the issuers think and what the merchants know — and the two sides aren’t formally sharing information to improve card-approval decision-making,” Drechny said.

MAG ultimately wants merchants and issuers to work together to develop better data and scores that could lower all parties’ transaction costs by streamlining card approval rates, he said.

“If the only way we have to make standards is looking to EMVCo or the card network brands, we’re always going to miss the mark, because they don’t see how customers are interacting with merchants,” Drechny said.

But merchants remain the best custodians for controlling their own transaction fees, according to Jeffrey Ungerott, managing principal at Capco, a global consulting firm.

Post-coronavirus, merchants should expect their CNP approval rates to be significantly better than 85%, variable by merchant type, according to Ungerott.

There are many ways merchants can optimize credit and debit card fees through renegotiating processing relationships based on volume changes and complying with available card network programs to streamline transactions, he indicated.

“Merchants experiencing frequent declines should regularly monitor payment activity to identify trends associated with declines,” Undergott said, noting that expired cards are one of the highest causes of declines for in-app transactions, especially with recurring or subscription purchases.

Ungerott doubts whether a program where merchants and issuers share data in real time to “score” card approvals would benefit either side.

“The passing of more data from the merchant to the issuer would not necessarily improve overall approval rates, and in fact would significantly slow the response time, which could weaken the customer experience,” Ungerott said.

Merchants looking to cut credit card interchange and other fees could look at offering customers ACH debit options, which would help improve margins by reducing payment transaction expenses, he suggested.

Overall, banks have as much to gain by streamlining card approval rates as merchants do, Ungerott said. “The primary loser when a payment is declined often is the issuing bank, due the cardholder associating the decline with their issuing bank. Issuers always want their card to be top-of-wallet and a decline generally forces a consumer to replace that card with another payment vehicle, often a competing card.”

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