Once upon a time, there were four payments networks that ruled the land called Payments in the United States. They created rules and regulations that every merchant in the land had to abide by – and even imposed fees that those merchants had to pay if they wanted to accept cards bearing the network’s logo.
These fees, so say these big networks, are necessary to operate the very complex payments ecosystem that supports nearly $4 trillion in consumer spending each and every year in the U.S. – and to enable the safe and efficient transacting of merchants and consumers. In exchange for those fees, these payments networks promised that transactions would be processed in a matter of nanoseconds. They invest heavily in security and fraud applications in order to make good on that promise and in marketing and branding so that consumers would want to have and use their payments products.
These networks depend on a gaggle of humble serfs, Financial Institutions, to issue cards bearing the name of the Financial Institution and their network logos. These cards get into the hands of consumers in one of several ways. Debit cards are given to consumers, for free, who hold a checking account at their bank so that they can access those funds from ATMs and use them to pay at those merchants. Credit cards are given to consumers, also for free in many cases, who are credit worthy and can repay what they buy using those cards either in full at the end of the month or with interest later on.
There are many such humble serfs in the U.S. and they work very hard. In fact, there are ~15,000 Financial Institutions in the land called Payments in the United States, and they have collectively issued some 560 million debit cards and 536 million credit cards as of 2012. Of course, since these humble serfs have been so successful at getting cards in the hands of consumers, the merchants in the land called Payments want to accept those cards; the citizens of the land like using them to pay for goods and services at those merchants.
The fees set by the giant networks and paid by these merchants to these humble serfs (yes, reader, I do know it is a bit more complicated then this but look, this is a fairy tale after all so give me a break) is a business model that has been in place in the land called Payments for nearly 50 years. It’s a model that gives issuers an incentive – paid by the merchant – to issue cards that consumers can use, for free, at those merchants in exchange for operating the payments network. In reality, consumers get an even better deal than free since they often get rewards for using those cards, and those who pay their balances in full each month get the benefit of using the issuers’ money for free for that period of time.
This two-sided business model enables payments throughout the land to operate efficiently and effectively and securely.
But, this model has made merchants angrier and angrier as the years and decades have passed. As more citizens of the land use more cards, the fees paid by merchants to those issuers have increased. Some merchants say that these fees are greater than expenses like rent and payroll and object mightily.
These merchants began to put pressure on the giant networks to lower those fees, and some merchants, those that were big and mighty themselves, were even successful at doing so. Some of these merchants now even pay less than half, on a per transaction basis, than what average merchants with less bargaining power pay because of the volume of business they drive to those networks.
So why, some ask, are these big merchants still so angry? There are several reasons.
Once upon a time, card acceptance was a novel way to attract new, incremental customers – it made it easier for consumers to pay for things at merchants. In exchange, card-accepting merchants got paid faster and were able to transfer the risk of bad debt to the issuer. It was magical. But, now that all merchants accept most cards, they feel that the advantage of acceptance no longer exists and minimizes the value of the network’s other benefits.
As card acceptance became more ubiquitous, issuers began to use the fees paid to them by merchants to fund rewards programs. These programs helped create consumer preference to their cards and to that issuer so that consumers would use their cards more. But merchants objected since these programs did little to benefit individual merchants directly. Merchants began to feel resentful because they believed that these programs only raised their cost of sales and no longer carried a direct advantage for them, and it became harder and harder to make the connection between card acceptance and incremental sales.
Merchants also watched as third parties, increasingly enabled by new technologies and mobile devices, captured data about what customers bought in their stores and began to use it for their own purposes, oftentimes making it available to competitors. This made merchants even angrier, since it was very hard for any merchant to access all of the data about what their consumers were doing in their own stores.
Over time, merchants became more and more frustrated.
Then, one day, someone at the land’s largest merchant had an idea.
Why don’t we organize ourselves into our own card network? If enough merchants in the land came together and established their own network, then merchants could make the rules that would benefit their interests and they would no longer be beholden to the giant networks who operate the payments networks in the land called Payments in the United States.
Convinced that this was a stroke of genius, this large and learned merchant began to take this story to other large merchants. A few immediately agreed that creating its own network was sheer brilliance. They together contributed the funds to establish a small operation in Dallas to further develop this idea in August of 2012. It was to be called MCX – for Merchant Customer Exchange – symbolizing the two primary stakeholders in payments for whom the payments system is intended to benefit – merchants and consumers.
An interim President was appointed and other merchants began to express interest. Some also signed on. This interim President issued many proclamations that would govern MCX:
– MCX would be its own card network – and its payment method would be accepted at all merchants that joined the MCX coalition;
– MCX customer and transaction data would be sacred – and the property of each merchant. It would never be comingled and used in marketing efforts to attract one merchant’s customers to another;
– MCX would operate a very low cost acceptance network – the cost of processing payments would be low – in fact, much lower than merchants pay today to participate in the payments system;
– MCX would be a mobile network only – they would banish plastic cards or other physical artifacts that would only add cost of operating the network;
– MCX would issue its own accounts – it would not rely on third parties to acquire customers – it would acquire customers by simply converting the customers that it already has to MCX customers. They believe that since so many merchants would be signing up customers at the same time, MCX as a network would scale more easily;
– MCX would provide its customers with more than just another way to pay – it would provide offers and promotions, with some of those promotions benefiting other MCX merchants who complemented each other;
– MCX would be exclusive – MCX merchants would agree not accept any other third party mobile payments schemes, such as PayPal.
Today, a little more than one year since its official formation, more than 44 merchants, with over 90,000 stores representing more than $1 trillion in purchasing volume, have joined MCX.
And even more decisions have been made about how it will operate:
– MCX will launch with a cloud-based solution – its payment platform is a bespoke solution leveraging Gemalto’s technology for its digital wallet and the FIS processing platform. This decision will allow merchants with existing terminals and consumers with existing phones to use the MCX payment method right away. The NFC advocates across the land called Payments were very sad to learn of this news.
– After a long and arduous search, a CEO was appointed — Dekkers Davidson, the former head of mobile at Barclaycard US and a well respected mobile authority, was brought on to ignite MCX in August of 2013. The merchant village cheered that such an experienced person would take their vision and make it a reality.
But, some in the payments industry began to raise red flags about MCX’s ability to achieve its goal and free itself from the grip of the giant networks who ruled the land called Payments in the U.S.
There are five big areas of concern:
1. The costs to MCX of building and operating a network. It is well known that building a new payments network is very expensive and starting one from scratch is very difficult. MCX believes that it has a big advantage since it does not have the “chicken and egg” problems that other new networks have – it already has important merchants “on board.” Further, each merchant can leverage its own customer base with customers from other MCX merchants. Being able to simultaneously sign up consumers, they believe, will help scale its network faster.
But signing up customers implies that MCX has a value proposition to offer them – and strong economics in place to fund its operation until it ignites. The last card network to enter Payments Land may hold some clues to the MCX future.
Discover, too started with consumers – some 25 million Sears’ consumers – and it invested in cash-back programs to attract consumers to its brand. Still, it has taken Discover 27-plus years to capture a small fraction of the market. Today, it’s a very profitable card issuer, but it’s a dwarf compared to the giants that rule the land called Payments in the U.S.
The big question for MCX, then, becomes how much it will invest in order to move consumers away, permanently, from the method of payment they like to use today to an MCX payment method. It could be the case that the answer is not enough, especially since consumers will be given many incentives from incumbent providers to remain a loyal customer – and even in the best of situations, it will take a long time for MCX to acquire a critical mass of customers. It could also be the case that consumers are happy to take the MCX incentive opportunistically, but that the MCX business model is inadequate to support its operating costs, including that subsidy.
The important implication is that until MCX achieves a critical mass of consumers, it will have to support all of the existing payments methods that consumers use today, including the MCX payments method. That can only mean that the cost to merchants of supporting payments will be much higher than it is today for a very long time to come.
Additionally, from the standpoint of operating a network, it’s hard to understand how MCX could, as a fledgling network starting from scratch, operate at a lower cost than the big networks who have been doing it for more than 50 years and have the kind of massive global scale that is essential to keeping the costs of running the network in check. MCX has said publicly that its transaction costs would be “pennies,” which plays off one of the primary reasons for MCX existence: lowering the cost of acceptance. That assumes some magic formula exists to enable it to operate more efficiently (better, faster, cheaper) than the existing networks and that it has robust revenue sources to fund its operating costs. Others have tried to find that magic formula over the last 50 years and have been unsuccessful.
2. The time to scale the MCX network. The costs of building and running the MCX network are a function of the time it will take to scale – to achieve a critical mass of customers. Scale, in this case, is a function of how quickly enough consumers shift enough of their spending to the MCX payments method. And that is all related to the value that consumers will gain from moving away from their existing payments methods to something new.
There are a few relevant points to consider.
At the end of the day, consumers don’t care how much it costs merchants to accept the cards they want to use in the stores they frequent. In fact, they don’t even understand how the system works and who pays whom for what and why. All they know (and care about) is that their card works, that it’s free and they get offers and other benefits for using those cards. So, getting them to switch away from what they know and like to something new (and mobile) will require an incentive – and a pretty big one, probably delivered over a long period of time.
Even with incentives, all of the existing empirical evidence in payments suggests that it won’t be easy to convince consumers to move away from the payment methods that they use today to something entirely new. In fact, recent evidence from a Federal Reserve Board study supports this, saying that consumers are creatures of habit – and once they pick a payments’ method, they don’t often switch away. Consumers may add payments methods to the mix and adjust their usage mix, but they don’t often abandon products entirely. Cash is still used after 3,000 years and is actually increasing in overall use in the land called Payments in the U.S.!
Consumers haven’t exactly fallen in love and lived happily ever after with store card credit products either. There are 335 million store cards in circulation (versus more than 1 billion credit and debit cards in circulation) and the growth in the purchase volume on those cards lags behind general purpose card spending. These cards often come with high fees and low credit limits – even though those cards are highly profitable for merchants (and despite efforts by merchants to sign up consumers at check out). Unless MCX credit products are better/different, it seems like a hard sell, not to mention needing to support the risk associated with offering such a product that could significantly add to the cost of operating its network.
The MCX white knight, many think, is store-branded debit products, also known as decoupled debit. The Target REDcard, introduced in 2010, is the model cited for how MCX might approach its product design. It offers consumers 5 percent cash back on purchases made at Target and now accounts for 14 percent of in-store sales. The benefit cited for Target is a reduction in interchange on those sales. More importantly, the REDcard helps Target capture customer data that enables them to more effectively market to those customers. Target’s cash back proposition has been successful at overcoming the consumer inertia of ditching existing debit products for merchant issued ones. But, it isn’t entirely clear that it has helped drive incremental spend at Target – unless REDcard can drive up basket size, it’s hard to understand how the economics work.
Target REDcard is also a closed-loop product – it can only be used at Target. The open question for MCX, if this does become the product proposition, is how such a program would be deployed. Would it be a store-branded, interoperable product capable of being used at all participating merchants, like its failed predecessor Tempo was envisioned? Or would it be a network-branded product bearing the MCX logo that can be used at all participating merchants? And, what incentive would be offered to consumers to create either of these accounts? If interoperable store-branded, would there be a requirement at the MCX network level that promotions/incentives be the same across all merchants? If so, would that disadvantage those merchants who were not in a position (or were not interested) to participate at that level? If not, then is the value of merchant participation in the network?
And, perhaps most obviously, if decoupled debit is the white knight of retail payments, why haven’t more merchants ridden this horse into the land called Payments already? Does mobile really make it that much easier for a decoupled debit product to be offered to consumers? Decoupled debit isn’t without its risk, either. Since merchants don’t have real-time access to bank balances, they would have to be prepared to absorb potential losses as part of their cost of doing business.
3. The business model that supports the MCX network. It’s a fact in payments that funding comes from one of two stakeholders – merchants or consumers. MCX, today, assesses merchants a relatively modest fee, based on volume, to maintain its membership in MCX. It has promised that its processing costs will be “pennies.” It seems unlikely that the sum of membership fees plus processing costs will support the cost to operate the MCX network.
So, how could MCX be thinking about funding its operation?
It could charge the consumer but consumers would likely revolt in the land called Payments because consumers get their payments products for free today. They would have very little incentive to try a new product that could only be used at 44 merchants and that they would have to pay for. Consumers would simply continue to use the payments methods they have always used at MCX merchants – who of course would continue to accept them for fear of losing sales.
It could charge each other through the creation of an MCX “offers” platform that assesses merchants a “redemption” fee based on spend and conversion related to those offers at participating merchants. That could get very tricky especially since MCX has said that merchant data will never be comingled. And, depending on how such a platform is implemented, it could end up creating exactly the same kind of “rewards” scheme that merchants object to today – one that is funded by all merchants but actually benefits only a few – the “earn” merchants could end up subsidizing the “burn” merchants, creating both imbalance and frustration over time.
It could charge other third parties, for instance, loyalty providers, or brands/manufacturers that want to reach their consumers. But these third parties probably won’t be interested in paying MCX for access unless they can be sure that they will receive an ROI – which is about proving that there are MCX customers – which MCX would need to have – and access to data – which isn’t something that MCX has said they will share. MCX will then have to sort out what their value proposition is for third parties apart from what these service providers can get independent of working through MCX.
4. The impact of Judge Leon’s Ruling and MCX merchant value proposition. The recent ruling by Judge Leon in the debit fee interchange challenge mounted by merchants caused the issuing community to shudder but merchants to cheer. This Judge made a mockery of the Fed’s Durbin Amendment ruling and insisted that current debit fee be lowered to its original range of $.07 – $.12 per transaction. One wise economist and at least one legal scholar suggest that the range might even go even lower.
This dilemma presented to MCX is this one.
Many MCX merchants today serve customers that use debit almost exclusively in their stores – grocery, discount retailers, QSRs. It’s a very cheap way for merchants to accept payments and if the Judge’s ruling is upheld, debit could become even cheaper. The incentive for merchants to incur more cost to build and operate a network that might not deliver a big cost advantage no longer seems as compelling. The differential between ACH (what everyone assumed would be the rails to power MCX) and debit is not as great – and debit as an underlying payment method comes with greater benefits to the merchant, e.g. real-time access to bank balances and security.
Further, if decoupled debit is, in fact, the white knight that MCX decides to ride throughout Payments land, the gaggle of humble serfs who control the checking accounts that these accounts will access will likely rise up and revolt. They will soon see how valuable their funding assets are and will be forced to take action. That action could include raising fees to consumers who chose those products (thereby discouraging them from switching). It could also include making their own debit products more attractive in other ways. MCX could, therefore, face additional costs to operate its products or be forced to use ACH rails – which comes with the risk of potential losses or other costs that the ACH network operator may wish to impose for the use of its rails over time.
Ironically, Judge Leon’s ruling that was intended to benefit merchants may end up disadvantaging the future of its proprietary payments network.
5. The wisdom of the MCX exclusions provision. One of the MCX proclamations states that MCX merchants have to agree not to accept other emerging third-party mobile payments methods. Part of this rationale is that these service providers don’t actually bring incremental customers into their stores but simply force existing consumers to use a different (and more expensive) method of payment. Regardless of whether you believe this to be true, excluding other emerging service providers seems very shortsighted. It will produce one of two outcomes: It will force consumers to switch to MCX entirely (very unlikely) or force them to shop at stores that accept the method of payment they like to use (very likely). Further, and also ironically, forcing MCX as an exclusive payment will also stifle the innovation that has given rise to so many new ideas in payments and commerce and that are stimulating many of the great ideas that are at work in merchant locations today. Insisting on exclusivity could have the unintended consequence over time of eliminating the incentive for innovators to emerge and ceding control of the land called Payments to the dominant network incumbents.
It’s also possible that if MCX holds tight and fast to its exclusivity provisions, it could have trouble recruiting merchants and/or retaining the ones it has. It’s simply too early in the mobile payments game for any merchant to agree never to accept any other third-party player’s mobile payments scheme. Now, many of these providers have too few customers to matter today, but many others do. There isn’t a merchant in the land who will risk turning away a customer who wants to use the method of payment that they want to use – it’s why most merchants still accept cash and checks, alongside credit and debit cards, and will entertain the notion of acceptance by anyone that can deliver consumers to them. Making a sale trumps all, in spite of what Treasury executives operating at merchants may say.
So, will this MCX story have a happy ending and will everyone living in the land called Payments live happily ever after?
Well, that depends.
It’s entirely possible that as MCX pursues its payments network ambition, that it has the ability to exert pressure on the giant networks that could stop or delay big network imperatives like EMV and NFC by simply saying that they won’t play along. MCX merchants today represent 25 percent of total non-cash purchasing volume in the U.S. and could wield enough power to jeopardize those initiatives entirely – especially since their stated payment ambitions are mobile: a method of payment which EMV does nothing to solve for. If these large merchants push back, other smaller merchants may feel as though they have the latitude to push back too. Yes, it’s a fact that the U.S. is the biggest land called Payments not to adopt EMV, but the merchants in this land are the only ones with enough power to push back and make an impact. If this were to happen, it would make many cloud-based players happy, and issuers happy too, who wouldn’t have to worry with issuing EMV cards and adapting their payments spec to NFC. The giant networks would be very sad since the land called Payments that they had hoped to control through the deployment of these standards would be at risk.
It’s also possible that as the MCX network vision evolves, these merchants will collectively act to affect other things as well, including the cost of accepting other mobile payments solutions should they relax their exclusivity proclamation. Consumers will, over time, be presented with options by third parties to use their mobile phones to pay for things at merchants throughout the land, including MCX merchants. Today, these transactions are considered card-not-present transactions and are very costly. It could be the case that MCX merchants use their collective position to persuade the big networks to lower the cost of acceptance of these transactions at the physical point of sale. That would make merchants happy and third parties whose business models are linked to registered credit card accounts happy, but issuers sad.
Issuers will need to watch how MCX goes to market. If it is successful at taking share from traditional debit products by offering decoupled debit products that leverage their checking account assets and issuers do nothing to monetize that access, then they will be sad, very sad, especially if MCX offers enough of an incentive to get consumers to sign up.
If you are a merchant, then it depends on how the MCX business and operating model is designed. There is talk throughout the land called Payments that given the land’s largest merchant’s position as MCX founder and visionary, and its sheer size, that they could benefit disproportionately from anything that MCX does – and maybe even to the disadvantage of other merchants in the network. As a network, MCX will have to work hard to balance the needs of its largest merchant member with everyone else so that the network provides demonstrable value to all participants.
And then there’s the consumer. Will consumers switch exclusively to a brand new method of payment that’s entirely mobile? That will depend on many things that are within MCX’s ability to control – incentives, usability, freedom of choice to use whatever payment method they want, including MCX, at MCX merchants. But, it may also be the case that MCX consumers – Middle America – are the least comfortable with a mobile-only payments solution and will resist a move to a new payments method that is entirely mobile. And, affluent consumers, for whom mobile solutions are more accepted, may not be as interested since they have their own portfolio of payment options and strong preferences for usage and use MCX products opportunistically, if at all.
But, since this is a fairy tale, there might be another scenario about the future of MCX that could be worth considering.
Perhaps, MCX isn’t about operating as a payments network in the true sense of the word, but is rather to “organize” merchants and control access to merchant members (and their consumers) by those who wish to deploy payments and commerce innovation at those merchants. Perhaps the future view of MCX is something more like a “farmer’s cooperative” model that operates for the benefit of its members, and is in the business of correcting “market failures” incurred when services have to be acquired by others at costs that are considered too high.
Hypothetically speaking, in such a model, MCX would ensure that all members have access to a standard set of services at competitive prices. Any service provider wishing access would have to agree to its terms and operating procedures and standards and would pay for such access. The cooperative would not necessarily be driven by a profit motive, but by collectively helping individual members compete with the giant networks in the land called Payments, and their suppliers. MCX, in this scenario, evolves to become a “network” that decides how and what innovation will be deployed collectively to its members, but outsources the development and delivery of that innovation to others, including the operation of a payments system to those who do it now, but at much lower costs.
After all MCX stands for the Merchant Customer Exchange, not the Merchant Customer Network.
But even if that is a glimmer of an idea, it won’t surface for several years to come.
MCX has hired a serious and capable CEO and spoken quite publicly for over a year about its intention to launch a mobile payments network in the classic sense of the term. It has secured technology partners and is building a team. It recognizes the value of customer data and the challenges that merchants face today in the land called Payments to easily access the data on what their customers are doing in their stores. MCX will continue to recruit merchants and will work diligently to get more of the big ones to sign on. It’s a real entity. Whatever its longer term ambitions may be, it will look like, smell like and operate like a payments network in order to have the necessary credibility and respect throughout the land called Payments.
However, that’s a much different point than whether it can or will be a viable payments network over the long term.
In the land called Payments in the U.S., MCX has many battles over many years to fight before it could ever unseat the giant networks. It has to decide what it is and how it will operate. It actually has several creative and even disruptive options available to it that could surprise many in the land of Payments – but this storyteller will keep those secrets locked away and guarded by lock and key.
So, for a very long time to come, MCX doesn’t seem like it’s ready to scale the walls and slay the giant networks. The question, however, is whether the repeated and relentless attacks on the networks’ castles by MCX and others, who wield mobile and connected devices powered by software platforms, could topple the giants to the ground, or at least, and in perhaps less of a fairy tale, put a crimp in the giants’ style.
As we become a Payments Land that has its citizens embracing mobile commerce solutions that offer new ways for consumers and merchants across that land to transact, it’s possible that we may one day crown a new King and Queen and Princess.