The two-sided retail payment network ecosystem is undergoing a tectonic shift. Distinctions between e-commerce, mobile commerce and payments at the physical point of sale are starting to blur, and a range of digital wallet platforms are changing the way that customers make purchases and payments. It may therefore be time for interchange 2.0.
Interchange fees and the categories under which they are paid are updated at least annually. But the core two-stage structure—acquirers paying issuers—has not changed since 1971. Digital wallets may give the industry reason to rethink this structure.
Digital wallets provide bank issuers with a convenient way to engage customers and manage payment keys along with rewards, loyalty and promotional programs. While wallet platforms can be neutral with respect to issuers and networks, they also may have reason to tilt the field by offering consumers rewards and collecting rents from parties benefiting from platform access. For example, Apple extracted 15 basis points of interchange from U.S. credit-card issuers participating in Apple Pay. This was because Apple could credibly threaten to shift customers' payments habits. The Cupertino tech giant is now reportedly at loggerheads with Australia’s four big issuers over its demand for a comparable participation fee.
In payments, consumers and merchants are creatures of habit. Established payment systems such as cards, cash and even paper checks are hard to displace. Nevertheless, payment friction using cards in e-commerce and particularly mobile commerce has fueled the growth of wallets such as PayPal, Alipay, and Tenpay, and harbingers more wallet growth.
If one believes that PayPal, Apple, Google, Samsung, and niche wallet and marketing platforms like Modopayments can influence network visibility and use, then it makes sense for networks to pay them interchange on top of—or perhaps partially in lieu of—interchange paid to bank issuers. After all, rewards drive behavior.Three-stage interchange would give networks more direct influence over digital-wallet platforms.
If payment networks want open, single-stage digital wallets with network branding and rules at the retail point of service, it makes sense to offer an interchange carrot. MasterCard already has an approach along these lines: it imposes higher fees on payments from two-stage digital wallets such as PayPal, which relegates MasterCard's brand to the back end and makes it invisible to customers and merchants.
One doesn’t have to love interchange to benefit from and be guided by it. If MasterCard offered Google 20 basis points of interchange for its wallet transactions, the search giant would take it in order to capture transaction data, notwithstanding its antitrust interchange suit against MasterCard and Visa. There’s no more vocal interchange foe on the planet than Walmart, yet interchange incentivizes it to promote co-branded MasterCards. (Walmart could, of course, make a principled statement by donating its interchange proceeds to the Boy Scouts or Red Cross. But that wouldn’t help Walmart cardholders or shareholders.)
In a decade, it's likely large portions of retail e-commerce, mobile commerce and physical point-of-service payments will occur over digital wallets. Networks that move now to ensure visibility by giving digital wallets a cut of interchange fees will protect their value.
Eric Grover is principal at Intrepid Ventures, a corporate development and strategy consultancy advising payment issuers, networks and processors, and other payments companies.