Inside the Black Hole

Suddenly it looks like the owner of the cupcake store of TechCrunch Jay Donovan’s story hasn’t made such a clever business decision by selecting Square as her credit card processing provider after all. It turns out that a Square competitor could be processing her cupcake payments at a rate that is lower by more than one percent, losing even more money than Jack Dorsey’s start-up in the process.

Intuit GoPayment, the Square competitor in question which has just partnered up with Verizon, has also dropped the fixed per-transaction component of its processing fee, which seems to be the current fad in the mobile payments world, even though that makes no sense at all.

What GoPayment / Verizon Customers Get

Here is what GoPayment’s blog tells us about the pricing details of their Verizon offer:

For Verizon Wireless customers, the GoPayment credit card reader is free after you’re approved for a GoPayment account and you file the mail-in rebate, which refunds to you the $29.97 purchase price. We’re also making it easier for Verizon Wireless customers to get started with a discounted service plan for the first two months. This is a great deal for those of you who expect to process a higher number of credit card payments. Under this offer, you’ll spend just $12.95 a month and pay the low rate of 1.7 percent for swiped transactions.

Of course, we’re still offering our basic service plan as well, which has no monthly or cancellation fees and offers a 2.7 percent discount rate for swiped transactions.

Intuit tells us that GoPayment is available to “everyone,” even as their Terms & Agreement explicitly states that the “use of the Services is subject to your being affiliated with a merchant that has an active Intuit Payment Solutions merchant account.” So GoPayment is not exactly available to individuals, as Square is, but the lack of fixed monthly service and cancellation fees, combined with the lower processing fees, makes it the better choice for small businesses.

Why Is the Per-Transaction Fee a Big Deal?

Now back to the per-transaction component of the processing fee. As I’ve pointed out in my cupcake post and before that, Square is losing money on transactions below a certain threshold that varies by card type. For regular Visa and MasterCard credit cards, the threshold is about $8.50, give or take, and it is higher for special card types, such as rewards, commercial, business-to-business, etc. Square’s break-even threshold is lower for debit card transactions, but once the interchange limit goes into effect in October, that one too will rise above the one for regular credit cards.

The break-even threshold is much higher for GoPayment’s “High-Volume Plan,” as high as $60 or so for regular Visa credit cards and even higher for MasterCard. Now, this plan does come with a monthly fee, which will protect them from losing money from low-volume accounts, but our cupcake store would certainly be a money-loser, even though their transactions will be processed at a lower interchange and the break-even threshold will also be lower.

The Takeaway

I really have no idea why Square, GoPayment and their competitors are falling over one another in their rush to dispose of the fixed transaction fees. I understand that their overarching priority right now is to grow as quickly as they possibly can, but this is a strategy that will inevitably need to be adjusted at some future point or other. If their plan is to reintroduce the fixed fee or to set a minimum transaction fee later, I think they will discover that the merchants that will be affected by such a change will not like it and push back hard against it.

The issue will become even more acute in October when the per-transaction component of the debit interchange fees will rise to $0.22 and the break-even threshold for small-ticket debit transactions will rise quite substantially. Perhaps Square and GoPayment will be forced to redo their pricing models sooner than they would like.

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It’s been quite some time since we’ve written anything about Square, Jack Dorsey’s mobile payments project, but I read something interesting this morning that simply had to be commented on.

The story in question involves a sleepy Midwestern suburb, cupcakes (fantastic ones at that), the biggest U.S. payment processor, credit card fees and, of course, Square. It’s a great story and I had a lot of fun reading it, as I’m sure many others did too. However, I suspect that I had so much fun for a reason that completely escaped the author’s notice.

The Cupcake Story

So TechCrunch’s Jay Donovan tells us about Fantasy Cupcake’s search for the best credit card processing provider. This aptly-named killer cupcake maker (take Donovan’s word for it, not mine) is located in Canal Winchester, a suburb of Columbus, Ohio.

The fun began shortly after Leah Dotson, the owner, chose Square as Fantasy Cupcake’s processor. A procession of smug bank representatives beat a path to Fantasy’s door, armed with flyers and credit card processing proposals that were sure to be far better than Square’s. “We’ll give you 300 bucks if we can’t beat your current merchant rate plus give you $100 to switch to our service,” one of them tells Dotson, only to make an ignominious retreat shortly after she sees Square’s pricing sheet (and keep her $300 in the process!).

Having fun yet? Wait, it gets better. Donovan has actually posted the pricing proposal submitted by a Huntington Bank / First Data representative. Here it is:

By comparison, Square charges a qualified rate of 2.75 percent, with no other fees. Donovan has excluded both Huntington’s and Square’s non-qualified rates, I guess for the sake of simplicity, which is fine, as I don’t think it takes anything away from the point he’s making, which is as follows:

In the end, a First Data merchant agreement would have amounted to almost $800 per year in additional fees for Leah vs. Square’s simple 2.75% rate structure and no additional fees. Forget the POS hardware purchases and statement fees and just think about that $.15 transaction fee. That’s 1.2% plus $.15 on every single transaction vs. Squares flat rate of 2.7%. When you think about the fact that the majority of Leah’s sales are under $3.00, it really adds up. That’s roughly $.21 in fees for that $3.00 order vs. $.08 using Square.

Then there are the PCI, service and terminal fees. By the way, the type of terminal this merchant needs costs $100 – $200, depending on the make and model, and $32 per month for two or three years is way over the top.

So yes, Square is indeed the better option for Fantasy Cupcake and Dotson has made the right decision. But what makes me smile is that Donovan is unwittingly making fun of the wrong payment processor here.

A Few More Successes Like This One…

When Square dropped the per-transaction component of its qualified rate back in February, we analyzed its fee structure and concluded that:

[F]or regular credit cards, Square’s break-even threshold would be at about $8.50. In other words, the start-up would be making money from processing larger transaction amounts, but losing money on lower transaction amounts.

For rewards and other special credit card types the threshold is higher, while for debit cards it is lower. What that means in our cupcake story is that Square is losing money on the majority of Fantasy’s transactions (which Donovan tells us average $3 per sale).

So I’m not sure if the Square guys are having as much fun as Donovan and Dotson understandably are.

The Takeaway

The point is that Square’s decision to drop its per-transaction fee places it in a very vulnerable position. The start-up is already losing money on most small-ticket transactions, as seen above, even as it charges a very high percentage rate on both qualified and non-qualified transactions.

At the same time, as the number of Square’s competitors is rapidly increasing, so is the downward pressure on the percentage component of the processing fee. For example, just today we learn that ERPLY is now offering a Square-like service that charges 1.9 percent per transaction. Even though the ERPLY card reader costs $50 to buy, that would be a price well worth paying for merchants with a sufficiently high average ticket (the higher the ticket amount, the higher the weight of the percentage component and the lower the weight of the fixed per-transaction component of the processing fee).

So Square will eventually have to adjust its pricing structure in some way. I wouldn’t be surprised at all if the per-transaction fee makes a reappearance or a minimum fee is introduced, specifically to counter losses from processing small ticket transactions. Whatever their form, any future changes may not be as amusing to owners of cupcake bakeries or indeed, bloggers.

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Just a month or two ago Capital One was the only major U.S. issuer who offered credit cards with no foreign transaction fees. Its rivals charged, and most of them still do, on average 3 percent of the transaction amount every time you made a purchase with your card outside of the U.S. That is, provided your card was accepted in the first place, but that is a different issue.

Suddenly several large U.S. issuers have launched cards with no foreign transaction fees, even as a new Federal Reserve rule is about to be enacted in July that will cut a large chunk off the revenues they collect from debit card transactions. What are we to make of that? After all, issuers were supposed to start jacking up fees elsewhere to make up for lost debit revenues. Well, they are and the no-foreign-transaction-fee thing seems to be more of a marketing ploy than anything else.

Who is doing it?

Cardhub.com has compiled a list of the no-foreign-transaction-fee credit cards currently being offered in the U.S. Capital One dominates it, issuing all but three of the listed cards. Let’s take a brief look at the new entrants.

I should first note that American Express‘ entry is a charge card, not a credit one. The difference is that users of charge cards are required to pay off the entire balance at the end of each monthly cycle. This is why there are no interest rates applicable to these cards. You may ask how AmEx is making money from cards with no interest rates. Well, beside the hefty $450 annual fee, AmEx is making money from the processing fees it charges merchants accepting its cards. Visa and MasterCard issuers don’t have this option, as the processor of a transaction involving their cards may be any other Visa or MasterCard member. So this is a special case.

Then we have two entries from Chase and one from Citi. These are very similar offerings. All come with no promotional interest rates on either purchases or balance transfers and all charge an annual fee, two of them after the first year.

A Marketing Ploy

The new crop of cards with no foreign transaction fees are all targeting high-spending consumers with very high credit scores. I am pretty certain that Chase and Citi have looked at the average amount of foreign transaction fees generated by the prospective holders of the new cards and have compared it to the average per-account fees generated from the promotional interest rates.

The issuers have probably calculated that the extra fees they will generate in the absence of promotional interest rates will make up for the lost revenues from foreign transaction fees for a few years ahead. But then, they can change the terms of these cards at any time they want, which just happened to my Chase Rewards card, making it much less attractive in the process.

The Takeaway

When it’s all added up, the new Citi and Chase offers are not nearly as competitive as the lack of foreign transaction fees may make them seem at a first glance. Quite apart from my hypothetical calculation above, none of these three cards has a particularly good rewards program. True, two of them offer a great initial bonus if you spent a certain amount within a specified time-frame. But many other new cards offer similarly attractive bonuses. And, while the no-foreign-fee cards’ rewards max out at three points for a spent dollar, many other new cards do so at a ratio of 5 / 1.

So what I will keep doing is using my best rewards card when shopping at home and take my Capital One when traveling abroad.

Get a personalized credit card rate for each of your transactions!

Get the lowest possible credit card processing rate for each individual transaction! Our interchange-plus pricing model gives you:

• Processing rates calculated separately for each transaction to ensure that not a single one of them is overcharged.
• No more mid-qualified and non-qualified fees.
• No fixed monthly fees.

The Nevada Senate is well on its way to passing a bill that would be collecting $400,000 from taxi companies operating in Clark County, which includes Las Vegas, every six months, Las Vegas Sun’s Cy Ryan tells us. Clark County cab companies are being penalized for charging a $3 fee to customers who pay their fare by a credit or debit card.

The Nevada cab industry is only the latest one to stir a credit card trouble. What is with cabbies and credit cards?

Cab Drivers Hate Credit Cards

That much we do know. Here in Boston taxi owners sued the city last year for $1 million over the rules regulating the operational status of point-of-sale (POS) terminals inside the cabs. Drivers were not allowed to operate their cabs when the credit card machine was down.

In fact, cabbies have long resisted having to take credit cards in the first place. Amazingly, it was not until three years ago when New York taxis were ordered to place credit card terminals in their cabs. I don’t think legislators should have involved themselves, but think about that for a second; well into the 21^st century you could only pay cash for your cab ride!

Anyway, later there were reports that credit card payments actually led to higher tips for cab drivers, however that did not put a stop to their constant grumbles. In fact, quite apart from the constant grumbling, NYC cabbies resorted to “adjusting” the tip option on the terminal’s screen to show the 20 percent as the lowest available choice and the 30 percent one listed as a “reasonable” one.

Why Do Cab Drivers Hate Credit Cards?

This is all a bit bemusing. After all, all other consumer-oriented industries have long ago accepted credit card fees as cost of doing business and moved on. Or at least I cannot think of another one. What makes taxis any different?

I asked a cab driver some time ago what he thought about credit card payments, even though I knew perfectly well how he felt about them. Still, his answer did offer an insight. He said that the main issue was that he had to pay the cab owner at the end of each day, whereas he had to wait a few days to collect his credit card receivables.

Of course, processing fees are an often-cited issue as well. San Francisco taxi drivers, for example, protested earlier this month against a 5 percent fee they were being charged for accepting credit cards. The issue in this case, however, lies with the cab companies, not with the payment processors who charge much less than 2 percent for credit cards and even less for debit. So to a large degree this is a case of self-inflicted pain.

The Takeaway

The way I see it, taxi companies are just stuck in the past, stubbornly refusing to enter the present. Credit cards are here to stay and now, with all of the new mobile payments technologies being rolled out left and right, card acceptance is becoming easier than ever. Moreover, customers demand it. I, for one, use my card everywhere I can, because it is convenient, pays me back and because I don’t have to deal with cash and especially coins. I have no intention to quit paying my cab fares by card anytime soon.

That said, what Nevada’s Senate is doing is wrong. Private businesses should be allowed to charge whatever they please for the services they provide and it should be up to consumers to accept it or not.

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Wells Fargo, U.S. Bancorp, Bank of America and most other major American banks may soon enter the prepaid card market, according to WSJ’s Robin Sidel and Aparajita Saha-Bubna. The two reporters are actually pretty much stating the obvious, as credit card companies are feeling increasingly pressured to go outside of their comfort zone to make up for lost revenues from traditional operations.

Already suffering from lower profits from their credit card operations, due to poor economic conditions and tighter regulations in the wake of the implementation of the CARD Act’s provisions earlier this year, issuers are now also faced with the prospect of reduced revenue from debit card fees, expected to result from the enactment of the Dodd-Frank Act’s provision limiting debit card interchange fees. Prepaid cards are exempt from the new restrictions imposed by both Acts.

Prepaid cards can be described as a hybrid between credit and debit cards. Used as debit cards, prepaid cards draw funds not from the cardholder’s checking account, but from an account with the issuer that is funded by the cardholder. Once the funds are used up, the cardholder has the option of re-loading the account.

As the WSJ piece points out, big issuers have so far stayed clear of prepaid cards, “because they are usually sold as an alternative to a checking account and are mostly aimed at low-income consumers who don’t have bank accounts.”

Smaller and largely unknown competitors have meanwhile stepped in and filled the niche. Some of them have been quite successful at that. The biggest prepaid card company, Green Dot Corp., raised $160 million in its IPO this past July and has seen its stock rise by more than 74 percent since then. The second-biggest company in the industry, NetSpend Holdings Inc., did even better, raising $204 million in its own IPO in October.

There is a very good reason for all this activity. Prepaid card use has been growing rapidly and is projected to explode in the coming years. The Network Branded Prepaid Card Association projects that the amount loaded on prepaid cards will reach $118.5 billion in 2012, up from $1.8 billion in 2006. According to the Nelson Report, a payment card industry newsletter, the prepaid card market will reach $200 billion in revenue by 2013.

So it is not surprising that the big issuers are finally warming up to prepaid cards. What is surprising is that it took them so long to even consider them as a viable alternative to their traditional offerings. Hopefully the increased competition will help bring down the various fees, associated with prepaid cards. But then, aren’t the big guys entering the market precisely because it offers opportunities for higher profits?

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