Commentary

How Lucrative Is LevelUp For Merchants?

LevelUp made news about a week ago when it announced that it was eliminating interchange fees for its merchant customers. Instead, LevelUp said it would assess a fee based on the value of the promotions redeemed by the customers of its merchants. This move was touted by many as a game-changer that would force downward pressure on processing fees charged to small merchants. But, that’s not what’s interesting about what LevelUp is doing — and may even miss the bigger point. What makes LevelUp’s announcement interesting is how it has managed to use the interchange “hot button” to breathe new life into the merchant-funded rewards category at the same time it makes payment invisible to the consumer.

For those of you who haven’t tried it, LevelUp is a mobile app that enables two things – easy payment at the point of sale via a QR code that is linked to a consumer’s card account, and an email notification, post purchase, of an offer to visit that same merchant again and receive a discount on a subsequent purchase. The discount is automatically applied to that purchase at that next visit. LevelUp also does something that a lot of new mobile apps also do – it rides the existing card rails. That makes it easy for both merchants and consumers to adopt.

LevelUp used to charge its merchants a straight 2% “processing” fee for each transaction made when someone paid for stuff using the LevelUp mobile app. It probably initially sounded good to merchants who might have even paid more and who got the added bonus of being able to offer a cool new mobile payments application to its customers that wasn’t too complicated to implement. Someone at LevelUp though must have realized that its business model pigeonholed them as a mobile “payments” application (a) subject to all of the price/fee comparisons of every other mobile payments app to come along and (b) failed to monetize the stated value of the LevelUp platform for small merchants: the ability to link a mobile payments app with a loyalty scheme designed to acquire new customers and keep existing ones coming back.

The result is a new business proposition for LevelUp merchants: say goodbye to interchange fees and say hello to a 35% flat fee on each dollar redeemed by consumers from merchant promotional campaigns. Yep – 35%, which is a lot cheaper than Groupon but a lot higher than interchange fees! But, the difference between it and other similar schemes is that it used its mobile payments “coolness” to get people to try it, and then hooked them to use it more via ongoing rewards in the form of discounts to be redeemed the next time they visit that merchant. That transformed LevelUp from just another mobile payments app to a merchant-funded loyalty scheme pulled thru by a mobile payments application.

The lunch spot around the corner from my Boston office is a LevelUp merchant. I was curious to know how the program economics work today, how they worked under the “old” LevelUp fee structure, and what it might look like sans LevelUp. This little table below tells the story: basically, merchants have to agree to a promotional scheme to both attract users and to keep them in order to play with LevelUp. My lunch guys says that they give a customer $5.00 for every $50.00 they spend and offer 50% off their first order.

Here’s how the math looks when calculating the all-in cost to the merchant: the 35% fee paid to LevelUp plus the cost of the discount given to the customer.

So, what do we conclude from this? Well, at first blush, LevelUp’s new fee structure appears to be a whole lot more expensive than the status quo (like by about 66%) and even more expensive (roughly 12% more) than its old pricing scheme. But here’s where things get a little tricky.

Absent any sort of trackable rewards or loyalty program, it is really hard for most merchants, especially small ones, to solidly differentiate new customers from existing ones. It’s then hard to really measure the real cost of LevelUp versus the status quo. LevelUp’s promise is that it will deliver new, incremental customers. But in the case of my lunch guy, I was already a loyal customer and didn’t (and don’t) have to be rewarded to eat there. Convenience (mostly) and quality is what keeps me coming back. Now, as LevelUp customer, I have the further advantage of being subsidized! The problem for my little lunch guy is that he is now paying more to have me as a customer. I don’t spend any more when I visit – I still order the same old grilled chicken caesar, extra parm (and every now and then go all out throw in a banana) but now get $5.00 off after about every 6th time I do. When I asked my lunch guy whether he thinks that LevelUp has brought him more new customers or gotten them to spend more, he wasn’t really sure. His answer back to me was, “well it hasn’t hurt me so far that I can tell.”

Of course, incremental sales are the two most coveted words in retail. And, these days, it is pretty much what all loyalty programs promise. The problem is that there aren’t enough human beings on the planet to produce all of the incremental customers that all of these schemes promise! But blending an easy way to pay for lunch (via a mobile app linked to card account) with rewards to be redeemed the next time a customer visits, may, in fact, get a lot of people into the habit of visiting that merchant over another – until, they of course implement LevelUp and then the battle for consumer preference heats up. Once LevelUp becomes more widely adopted, merchants may likely have to spend more to keep their establishment top of mind.

The LevelUp CEO says that merchants “typically bring in $18 for every dollar spent on a campaign.” The math didn’t really work using my lunch guy example ($5.00 back on a $50.00 spend) since he would have needed me to spend $90 to get that kind of return from my $5.00 reward ($18 x $5.00 promotion). As long as my lunch guy is doling out $5.00 every time I spend $50 I don’t see how he ever gets that sort of return, at least from me. The glass half empty side of me says that what he is actually getting is an increase in his cost to service me (since I am an existing customer) by about $5.00 every 6th visit. Over the course of a year, that could amount to a couple of hundred bucks.

LevelUp also says that 64% of new customers who come in to a merchant through LevelUp come back within 30 days and 40% of all new customers complete a loyalty progression with 30 days. Sure, they are all new to LevelUp, but the big question, is whether these are, in actuality, new customers for that merchant. As I mentioned earlier, most of the LevelUp customers are too small to have systems in place to track its customers systematically and to make those distinctions on any kind of scale. As more merchants sign on and more consumers who download the LevelUp app get visibility into what other merchants accept the application, that could, of course, change.

All of this isn’t to say that LevelUp isn’t powerful or effective or helpful for merchants. LevelUp has done a pretty impressive job of designing a product that has made mobile payments less important than the loyalty proposition it helps its merchants deliver. Once a merchant implements LevelUp, it is basically an autopilot mobile loyalty scheme with mobile payments as almost a gift with purchase. It is building out its network of merchants around a business model and proposition that is tied to the one thing that merchants value – incremental customers and sales – rather than the stuff they hate to pay for – implementing a new payments application.

The yet to be determined part of LevelUp is how much of what it delivers is truly incremental (spend + customers). How merchants answer that question will determine whether they stick around over the long run.

On that note, LevelUp’s “hook” of consumer convenience and incrementality is not unlike the early roots of payments when Frank McNamara (the founder of Diners Club) “hooked” consumers by giving them a convenient way to pay and merchants an immediate way to be paid in exchange for a 7% fee. Merchants willingly accepted those terms since general purpose credit cards were new and helped differentiate their establishment from the rest. More consumers with cards drove the interest in more restaurants wanting to accept them – the ignition that platforms dream and hope for. Novelty and differentiation soon became a “standard” way to pay at merchants. Diners Club paved the way for others (AmEx, Visa, MasterCard) to follow its model very soon thereafter. Those later cards offered payment convenience plus credit and rewards for using the card. And as more and more merchants accepted these cards, and payment via card became a “standard,” the distinction between incremental customers and spend as a result of accepting those cards became tougher for merchants to prove. Merchant complaints over fees charged to them to accept cards followed, fueled by their inability to directly link payment acceptance to “incremental value” and ignoring the other benefits of card acceptance (e.g. consumers like using cards to pay). That’s the risk for LevelUp (and the others that follow them). Today, mobile payments is a novelty and the differentiated business model pegged to customer promotions seem like a decent deal for merchants. But, if LevelUp can’t prove incrementality, which strikes me as a really tough thing for small merchants, then there is a strong possibility that merchants may decide, ironically, that the good old days of interchange may not look so bad after all.

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