Every day, millions of Americans stand at store checkout counters and make a seemingly random decision: after swiping their debit card, they choose whether to punch in a code, or to sign their name.
It is a pointless distinction to most consumers, since the price is the same either way. But behind the scenes, billions of dollars are at stake.
When you sign a debit card receipt at a large retailer, the store pays your bank an average of 75 cents for every $100 spent, more than twice as much as when you punch in a four-digit code.
The difference is so large that Costco will not allow you to sign for your debit purchase in its checkout lines. Wal-Mart and Home Depot steer customers to use a PIN, the debit card norm outside the United States.
Despite all this, signature debit cards dominate debit use in this country, accounting for 61 percent of all such transactions, even though PIN debit cards are less expensive and less vulnerable to fraud.
How this came to be is largely a result of a successful if controversial strategy hatched decades ago by Visa , the dominant payment network for credit and debit cards. It is an approach that has benefited Visa and the nation’s banks at the expense of merchants and, some argue, consumers.
Competition, of course, usually forces prices lower. But for payment networks like Visa and MasterCard , competition in the card business is more about winning over banks that actually issue the cards than consumers who use them. Visa and MasterCard set the fees that merchants must pay the cardholder’s bank. And higher fees mean higher profits for banks, even if it means that merchants shift the cost to consumers.
Seizing on this odd twist, Visa enticed banks to embrace signature debit — the higher-priced method of handling debit cards — and turned over the fees to banks as an incentive to issue more Visa cards. At least initially, MasterCard and other rivals promoted PIN debit instead.
As debit cards became the preferred plastic in American wallets, Visa has turned its attention to PIN debit too and increased its market share even more. And it has succeeded — not by lowering the fees that merchants pay, but often by pushing them up, making its bank customers happier.
In an effort to catch up, MasterCard and other rivals eventually raised fees on debit cards too, sometimes higher than Visa, to try to woo bank customers back.
“What we witnessed was truly a perverse form of competition,” said Ronald Congemi, the former chief executive of Star Systems, one of the regional PIN-based networks that has struggled to compete with Visa. “They competed on the basis of raising prices. What other industry do you know that gets away with that?”
Visa has managed to dominate the debit landscape despite more than a decade of litigation and antitrust investigations into high fees and anticompetitive behavior, including a settlement in 2003 in which Visa paid $2 billion that some predicted would inject more competition into the debit industry.
Yet today, Visa has a commanding lead in signature debit in the United States, with a 73 percent share. Its share of the domestic PIN debit market is smaller but growing, at 42 percent, making Visa the biggest PIN network, according to The Nilson Report, an industry newsletter.
The Risk of Refusing
Critics complain that Visa does not fight fair, and that it used its market power to force merchants to accept higher costs for debit cards. Merchants say they cannot refuse Visa cards because it would result in lower sales.
“A dollar is no longer a dollar in this country,” said Mallory Duncan, senior vice president of the National Retail Federation, a trade association. “It’s a Visa dollar. It’s only worth 99 cents because they take a piece of every one.”
Visa officials say its critics are griping about debit products that have transformed the nation’s payment system, adding convenience for consumers and higher sales for merchants, while cutting the hassle and expense of dealing with cash and checks. In recent years, New York cabbies and McDonald’s restaurants are among those reporting higher sales as a result of accepting plastic.
“At times we have a perspective problem,” said William M. Sheedy, Visa’s president for the Americas. “Debit has become so mainstream, some of the people who have benefited have lost sight of what their business model was, what their cost structure was.”
Visa officials said the costs of debit for merchants had not gone down because the cards now provided greater value than they did five or 10 years ago. The costs must not be too onerous, they say, because merchant acceptance has doubled in the last decade.
The fees are “not a cost-based calculation, but a value-based calculation,” said Elizabeth Buse, Visa’s global head of product.
As for Visa’s market share, company officials maintain that it is rather small when considered within the larger context of all payments, where, for now at least, cash remains king.
While Visa may be among the best-known brands in the world, how it operates is a mystery to many consumers.
Visa does not distribute credit or debit cards, nor does it provide credit so consumers can buy flat-screen televisions or a Starbucks latte. Those tasks are left to the banks, which owned Visa until it went public in 2008.
Instead, Visa provides an electronic network that acts like a tollbooth, processing the transaction between merchants and banks and collecting a fee that averages 5 or 6 cents every time. For the financial year ended in June, Visa handled 40 billion transactions. Banks that issue Visa cards also pay a separate licensing fee, based on payment volume. MasterCard, which is roughly half the size of Visa, uses a similar model.
“It’s a penny here or there,” said Moshe Katri, an analyst who tracks the payments industry for Cowen and Company. “But when you have a billion transactions or more, it adds up.”
With debit transactions forecast to overtake cash purchases by 2012, the model has investors swooning: Visa’s stock traded at $88.14 on Monday, near a 52-week high, while shares of MasterCard, at $256.84 each, have soared by more than 450 percent since the company went public in 2006.
While there is little controversy about the fees that Visa collects, some merchants are infuriated by a separate, larger fee, called interchange, that Visa makes them pay each time a debit or credit card is swiped. The fees, roughly 1 to 3 percent of each purchase, are forwarded to the cardholder’s bank to cover costs and promote the issuance of more Visa cards.
The banks have used interchange fees as a growing profit center and to pay for cardholder perks like rewards programs. Interchange revenue has increased to $45 billion today, from $20 billion in 2002, driven in part by the surge in debit card use.
Some merchants say there should be no interchange fees on debit purchases, because the money comes directly out of a checking account and does not include the risks and losses associated with credit cards. Regardless, merchants say they inevitably pass on that cost to consumers; the National Retail Federation says the interchange fees cost households an average of $427 in 2008.
While the cost per transaction may seem small, at Best Buy, the biggest stand-alone electronics chain, “these skyrocketing fees add up to hundreds of millions of dollars every year,” said Dee O’Malley, director of financial services. “Every additional dollar we are forced to pay credit card companies is another dollar we can’t use to hire employees, or pass along to our customers in the form of savings.”
Weighing Rules on Merchants
The Justice Department is investigating if rules imposed by payment networks, including Visa, on merchants regarding “various payment forms” are anticompetitive, a spokeswoman said. Several bills have been introduced in Congress seeking to give merchants more ability to negotiate interchange, which is largely unregulated.
While interchange remains legal despite repeated challenges, a group of merchants is pursuing yet another class-action suit, this time in federal court in Brooklyn, against Visa and MasterCard that seeks to upend the system for setting fees.
“Visa and MasterCard have morphed into a giant cookie jar for banks at the expense of consumers,” said Mitch Goldstone, a plaintiff in the case.
Fees were not an issue when debit cards first gained traction in the 1980s. The small networks that operated automated teller machines, like STAR, Pulse, MAC and NYCE, issued debit cards that required a PIN. MasterCard had its own PIN debit network, called Maestro.
Merchants were not charged a fee for accepting PIN debit cards, and sometimes they even got a small payment because it saved banks the cost of processing a paper check.
That changed after Visa entered the debit market. In the 1990s, Visa promoted a debit card that let consumers access their checking account on the same network that processed its credit cards, which required a signature.
To persuade the banks to issue more of its debit cards, Visa charged merchants for these transactions and passed the money to the issuing banks. By 1999, Visa was setting fees of $1.35 on a $100 purchase, while Maestro and other regional PIN networks charged less than a dime, Federal Reserve data shows. Visa says the fee was justified because signature debit was so much more useful than PIN debit; at the time, roughly 15 percent of merchants had keypads for entering a PIN.
Merchants said they had no choice but to continue taking the debit cards, despite the higher fees, because Visa’s rules required them to honor its debit cards if they chose to accept Visa’s credit cards.
A Seven-Year Battle
Wal-Mart, Circuit City, Sears and a number of major merchants eventually sued. After seven years of litigation, Visa and MasterCard agreed to end the “honor all cards” rule between credit and debit and to pay the retailers a settlement of around $3 billion, one of the largest in American corporate history. Visa paid $2 billion, and MasterCard the remainder.
Since then, only a handful of retailers have stopped accepting Visa debit cards, an indication that the crux of the lawsuit was “much ado about nothing,” Mr. Sheedy says.
And while some merchants said they thought the lawsuit would pave the way to a new era of competition, a curious thing happened instead: while Visa temporarily lowered its fees for signature debit, it raised the price on PIN debit transactions and passed the funds on to card-issuing banks, and its competitors soon followed.
The current class-action lawsuit joined by Mr. Goldstone contends that Visa’s PIN debit network, called Interlink, is offering banks higher fees as an incentive to issue debit cards that are exclusively routed over this network. Interlink, which has raised its PIN debit fees for small merchants to 90 cents for each $100 transaction, from 20 cents in 2002, is often the most expensive, especially for small merchants, Fed data shows.
One large retailer, who requested anonymity to preserve its relationship with Visa, provided data that showed Interlink’s share of PIN purchases rose to 47 percent in 2009, from 20 percent in 2002, even as its fees steadily increased ahead of most other networks — to 49 cents per $100 transaction in 2009, from 38 cents in 2006.
Visa officials say its PIN debit network is taking off despite rising costs because it offers merchants, banks and consumers a level of efficiency and security that regional networks cannot match. “We are motivated as a company to try to drive value to each one of those participants so that they accept the card, issue more cards, use the card,” Mr. Sheedy said.
At checkout counters, meanwhile, consumers are quietly tugged in one direction or the other.
Safeway, 7-Eleven and CVS drugstores automatically prompt consumers to do a less costly PIN debit transaction. The banks, however, still steer consumers toward the more expensive form of signature debit. Wells Fargo and Chase are among those that offer bonus points only on debit purchases completed with a signature.
Visa says it does not care how consumers use their debit card, as long as it is a Visa. But for now at least, the company says the only way to ensure that a purchase is routed over the Visa network is to sign.
“When you use your Visa card, you have a chance to win a trip to the Olympic Winter Games,” a new Visa commercial promises.
The commercial does not explain the rules, but the fine print on Visa’s Web site does: nearly all Visa purchases are eligible — as long as the cardholder does not enter a PIN.