Monday, January 26, 2009

Interchange fees, innovation & disintermediation

There has been a lot of debate on the level of interchange fees (aka merchant discount rates - the fees paid by the merchant for accepting an open loop network card), and the role it plays in fostering commerce.

Supporters, typically issuers, says it fosters innovation, increases sales at stores... Opponents, typically merchants, says that the fees paid by merchants are subsidizing issuers marketing programs. Interchange fees were not particularly controversial until the proliferation of reward cards. The interchange rates for reward cards are at least 20 basis points higher than for the basic card, and are therefore balked at by the merchants especially those that have slim margins.

In a world where intense competition is getting organizations to review every single expense, merchant's focus on interchange rates is not misplaced. In the 'old' days, merchants did not have much of a choice and came to terms with the world dictated by Visa/MasterCard.

However, new entrants are changing the landscape. Paypal, Amazon and Apple have tremendous market reach. They have the ability to be an alternative to the payment networks. This is already true for Paypal in the US ecommerce world. Amazon is well on its way as well.

It is not obvious to me that focus (or limits) on interchange rates implies reduced innovation. There is plenty of innovation taking place in the payments industry, outside of the realm of the traditional payment networks. This innovation is not being funded by interchange fees. Innovation will continue

Having said that, I agree that Congress must not try to mandate interchange rates and stifle the competitive nature of the payments industry.

Do you support limits on interchange rates? How does the disintermediation of payment networks in the online world extrapolate to the offline/retail world? Is iPhone providing a glimpse of what may be looming on the horizon?

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