Debit Cards
Like the ATM, the debit card is a relatively recent development - though they were in use during the 1980s, transactions were negligible until nearly twenty years later, after which time consumer adoption exploded and the industry consolidated into a few large firms.
In a sense, the debit card functions like an ATM to the bearer, providing just-in-time supply of funds to make a purchase (rather than going to an ATM to get cash to pay at the register, the card is used at the register to transfer cash directly), which makes them a substitute for credit cards from the consumer's perspective, but the implementation differs significantly from the merchant's perspective.
Usage and growth
Growth in the use of debit cards has been aggressive, with less than a billion transactions per year until 1995, to over 10 billion transactions in 2000, and approaching 15 billion in 2002.
The number of cards in circulation has shown less dramatic growth - it remained at between 200 and 250 million from 1990 to 2000 - though this is less meaningful, as many consumers' ATM cards technically had the ability to be used as debit cards, but were not used as such: in 1996, there were fewer than 10 annual debit transactions per card in circulation.
Merchant adoption was the critical element in driving the use of debit cards: around 1990, there were fewer than 40,000 merchant locations where a customer could use a debit card to make payment, but this increased to 3.5 million over the course of about 10 years *an average of 35% annual growth rate).
To merchants, debit card transactions were attractive because the debit transaction is less costly than a credit card and the risk of fraud was lower. As consumer adoption increased, it became necessary for merchants to accommodate them as a payment method preferred by many customers.
Industry structure
There are fewer regional debit card networks (16) than ATM networks (39). While it was fairly simple for banks to establish proprietary networks to ATMs used by their own customers, building a debit card network also requires coordinating with merchants in significant numbers, especially given the number of small merchants who process few transactions per month. AS such, it was largely credit card companies (Visa and MasterCard) who sought to establish such networks, leveraging their existing equipment and business relationships with merchants.
As such, concentration remains heavy, with the top three networks servicing 80% of transactions - and the top network (Star) servicing quadruple the number even of the second-largest (Pluse). The growth rate of the networks is higher for networks that are already the largest, suggesting that the gap between the top three or four firms and the rest will only continue to widen in future.
At the time the book was being written, three of the smaller networks were proposing a merger, which would create a combined network that would be a significant challenger to the top four networks that currently dominate the industry.
Within the industry, the author defines three "competitive battlegrounds" among providers:
- The three largest regional networks (Star, Pulse, and Interlink) are in a fierce battle for size and market share, largely focusing on banks and POS systems providers.
- The national networks, operated by Visa (Interlink) and MasterCard (Maestro), are more aggressive in competing directly with regional networks. They are already the third and sixth largest, the latter because MasterCard is focused more on overseas than domestic markets, and both have a more commanding presence with merchants.
- There is also competition with "offline" debit card products - which also include prepaid cards and merchant-specific "gift" cards. While offline cards have higher processing fees, they are considered more convenient to consumers, as they are more widely accepted, no PIN is needed, and the "float" between the time of transaction and settlement works in the consumers' favor.
There have been some struggles between card issuers and merchants, namely in the antitrust lawsuit initiated by Walmart against Visa and MasterCard for the "honor all cards" policy that forced merchants to accept debit cards (or abandon credit cards), which was only recently settled in favor of the plaintiff: so in 2004, the "honor all cards" policy will be terminated and merchants will be free to accept or reject any form of payment individually.
Industry pricing
Retail charges to the cardholder are relatively rare. While a few banks charge fees for ATM cards (either periodic on or issuing a card) the notion of an additional charge for debit card functionality is largely unheard of. Additionally, some per-transaction fees are charged (a PIN fee of $0.25 to $1.00) to the cardholder - some banks are removing the fees, others adding them, and studies are inconclusive as to which way the trend is headed. However, it is more common for banks to "pay" customers to use debit cards via rewards programs, in which each purchase earns "points" that can be exchanged for merchandise or contribute to an airline frequent-flyer program.
Wholesale fees to issuing banks and accepting merchants are more complex, but largely follow a model that follows the credit card industry: the merchant pays a fee for the service (POS terminal and network connection), and then pays a transaction fee that is a percentage of the purchase amount.
Additionally, banks and the providers of POS solutions are charged by the networks, in a similar manner as the ATM network: a membership fee, a transaction fee, and a switching fee. Because these are based on the amount of purchase, the amounts vary - but it's noted that pricing is discriminatory, favoring supermarkets, to whom the industry catered to drive adoption. Interlink, for example, charges a fee of about 45c for a $50 transaction for non-supermarket purchases, but only about 22c for a supermarket purchase on the same amount.
There is also a disparity between online debit card transactions (where a PIN is entered and the payment is authorized and made immediately) and offline ones (no pin, and transactions are compiled and periodically processed). Naturally, the offline transactions, being batched, are at a lower cost to banks (and lower revenue to the networks), so there is some struggle, with banks using rewards programs and PIN fees to give customers incentive to choose the option more favorable to the banks and networks adjusting their fees to banks to recover their loss.
Emerging applications
In addition to traditional use (payment to merchants), debit cards are increasingly used for indirect payments, which are more common for utilities, in which a customer who receives a bill for service logs into the company's Web site to make payment via debit card.
Person-to-person payment via the Internet is also becoming common. Because it is far more common to make purchases in small amounts using debit cards, customers are more inclined to use debit cards for frequent small payments using them.
Also, the use of "check conversion" enables both merchants and depositors to scan a paper check for electronic processing, which is currently accomplished by handling the check in the same way that a debit card transaction is processed.
Authorization, fee, and settlement routing arrangements
As with ATM transactions, the route by which a debit card transaction will vary according to the merchant who accepts a debit card, the bank that has issued it, the relationship between the two, and the intermediaries that may be involved. The author defines four common categories:
- Native transactions. The debt terminal is operated by the same company that interfaces directly with the bank (or in rare cases, the bank itself) and the entire transaction can be done through a single payment processing system without switching to another network.
- Network on-us. The debt terminal and issuing bank are connected by the same regional network, and the transaction does not need to be bridged to another network at all.
- Reciprocal. Two regional networks are involved, but have an agreement in place to communicate directly with one another rather than bridging over a third network.
- National bridge. Two regional networks are involved that have no reciprocal agreement, and the transaction must be switched across a national network.
Also as with ATM transactions, the cost of a transaction increases with the number of networks involved, so companies seek to take the shortest route possible to save expense.
Offline debit card transactions are run over the Visa and MasterCard networks, and are processed differently than other debit card transactions. They are similar to a native or network-on-us transaction in that these the two major networks directly process payments, but they mov fees through the automated clearing house (ACH) rather than the electronic funds transfer (EFT) network.