Laying The Foundation For Innovation In Payments

And so you’re a retailer looking for new ways to reduce operational costs, improve the shopping experience, enhance customer loyalty, and ultimately increase sales.  At the heart of all of these objectives is a payment transaction  – and the retail world is buzzing as never before with the promise of new technologies that will revolutionize the way consumers make payments. 

Isis, Google, PayPal, Square and many other companies have introduced new payment technologies in just the past few years.  For retailers, the complexity and pace of change can be daunting.  After all, retailers are already faced with a dizzying array of payment options to manage and each with its own unique value proposition, risk profile, and cost/benefits to carefully consider.  And now we add a tidal wave of innovation to the mix.

The changing regulatory environment is also an important factor.  On July 6, 2011, the Federal Reserve Board issued final rules of the Durbin Amendment, part of the Dodd-Frank Act signed into law in July 2010 by President Obama.  While this is good news for retailers, greatly reducing payment processing cost for most debit card transactions, it also represents another complicating factor in the consideration of new payment approaches and technologies.


Building Skyscrapers
In our consulting work, we have found that developing a payments innovation strategy is much like building a skyscraper.  Before you can erect a 50-story tower that stretches for the clouds, there is a significant amount of engineering and construction that has to be completed on the ground level and below.  Laying the foundation is the most important part of the process.

We have dubbed this process ‘Payments Optimization and Innovation.’  The optimization aspect is like the foundation for the skyscraper.  The focus of ‘payments optimization’ is to understand and maximize the value that the retailer receives from its current payment environment.  Once this has been established, then we are in a much better position to develop and implement an appropriate ‘payments innovation’ strategy, including but not limited to mobile payments.

Payments Optimization – The Foundation
Our payment optimization process begins with analysis of payment data from the retailer, including the processing agreement and monthly merchant statements from their acquirer.  We also carefully consider other factors such as the retailer’s primary banking relationships and point of sale environment.  The objective is to identify opportunities within the three primary aspects of the retailer’s payments environment: Pricing, Processes, and Products.

  1. Pricing Optimization involves negotiating the best possible terms with acquirer processors and receiving the fastest access to funds.  The interchange rates for debit and credit card transactions are set by the payment networks and the rules are uniform for all merchants, but all other components of pricing are negotiable, including fees for processing, chargebacks, statements, etc.  With over 2,000 payment processors and resellers pitching merchant services with various pricing configurations, it is easy for even a sophisticated treasury manager to get confused.  In general, retailers should always favor interchange pass-through pricing and consolidate all payments under a single acquiring contract for better pricing and simpler compliance management. 
  2. Process Optimization refers to managing Interchange fees, which can represent 70% to 95% the total cost of processing card payments.  Interchange is the wholesale price charged by Visa, MasterCard and Discover for settling a payment card transaction and is not negotiable.  However, the retailer can optimize internal processes to obtain the lowest rate available for each transaction.  A best practice for retailers is to import monthly interchange data into Business Intelligence (BI) software to create dashboards that identify issues and potential savings opportunities.

    The application of a specific Interchange category from among the more than 400 such card network categories depends upon a number of variables.  Retailers cannot control many of these variables but they do have control over adherence to compliance standards.  For instance, if a Visa transaction is key-entered, it should always be accompanied by a customer’s billing ZIP code for Address Verification System (AVS).  Based on current published rates, if a standard Visa card transaction is keyed with AVS, the Interchange rate is 1.85% + $0.10.  If the customer’s billing ZIP code is not sent, the Interchange rate is 2.30% + $0.10, a differential of 0.45%, a significant and unnecessary added expense.

  3. Product Optimization represents the bridge between the ‘optimization’ and ‘innovation’ aspects of our work with retail clients.  Here we consider how introducing new payment types, such as proprietary retailer-branded payment account, might allow the retailer to reduce their payment processing costs while also enhancing sales revenues.  This analysis also includes consideration of least cost routing for debit cards, alternative payment types like PayPal, and niche products like Dynamic Currency Conversion.

Through careful analysis of these three aspects, we often uncover significant cost savings opportunities and improve bottom line financial results that can potentially be used to fund payments innovation initiatives.  We also evaluate how important regulatory changes, such as the Durbin Amendment, will impact the retailer’s payments strategy decisions.  The overall exercise helps retailers to gain greater control and understanding of their current environment while also informing the proper consideration of new technologies. 

Payments Innovation – The Tower
And so now we’ve built the foundation and it’s time to build our tower of innovation.  There are almost an infinite number of possibilities for innovation in the retail payment environment but let’s describe them in terms of three primary categories, as follows:

  1. Mobile Payments – Here we will use this term to mean new payment technologies, including but not limited to Near-Field Communications (NFC), that enable consumers to use their mobile phones as a payment token to make purchases at a retail point of sale.  Some examples of new providers in this space include the Isis Mobile Commerce Network, Google Wallet, and the Starbucks Card Mobile App.
  2. Mobile POS – A consumer mobile device, such as a smartphone or tablet, can also be enabled as a mobile point of sale terminal to accept credit card payments.  Apple retail stores are among the first to deploy this technology and startup company Square has also raised awareness of the potential for mobile devices used as portable POS terminals.
  3. Loyalty Innovation – This is a fairly broad category but is perhaps the home of some of the most important opportunities with respect to payments innovation.  New innovations in loyalty marketing allow retailers to deliver real-time marketing messages and offers to consumers before, during, and after the payment transaction.  Google Offers is a loyalty innovation example that complements the Google Wallet mobile payments capability.

Development of a payments innovation strategy begins with establishing the retailer’s goals and objectives for the effort.  These goals should be based on the findings from the payments optimization analysis and guided by the retailer’s overall marketing and business strategy.

For example, we find that most retailers’ goals for mobile payments innovation include securely processing payment transactions at reduced cost and with value-added marketing programs that will help them better engage with the customers and increase sales.  In fact, if a mobile payments program does not help the retailer achieve all of these objectives, then we generally recommend exploring other options.  These are all achievable goals for a mobile payments program.

And by having first completing a thorough analysis of the retailer’s current payments environment, it’s much easier to see how to establish and achieve these goals using new technology.  For example, if our optimization analysis reveals that adding a retailer-branded credit account is an important opportunity, then the retailer knows to evaluate mobile payments options and providers with respect to their ability to support this type of payment program. 

Putting it All Together
Once the retailer’s payments innovation goals have been established, they can efficiently work through the process of evaluating potential customer use cases for each new payment technology and developing a roadmap for achieving their payment innovation objectives.  The payment optimization process has built the foundation for the skyscraper.  With payment innovation goals establishing the design for the tower, the retailer can begin to build it in phases, floor by floor.

With such a flurry of activity in mobile payments and other technologies, there is a tendency by retailers to either move too quickly without first understanding their starting point or to remain inactive due to concerns over the investment risk.  By following the ‘Payments Optimization and Innovation’ approach, retailers can more confidently move toward achieving their goals.

Andrew Morris is CEO of Morris Advisors, Inc. His recent consulting work has focused on alternative payments, mobile financial services, mobile retailing, and the role of CRM and loyalty marketing in emerging payments trends.

Anand Goel is CEO of Optimized Payments Consulting, Inc.  His firm works with its large merchant clients to ‘optimize’ their payments processing environment and reduce payment processing and other operational costs.

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