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Payments in E-CommercePresentation to Conference on
Entrepreneurship and E-CommerceOklahoma City, OK
by
Richard J. SullivanPayments System Research
Federal Reserve Bank of Kansas City
May 18, 2005
Topics
• Retail payment systems: pipelines to settlement
• Current research focus of the Payments System Research Department
• Options for payments in E-Commerce– Advantages and disadvantages
• Micropayments
Payment Clearing and Settlement
Payment messages: payments out of and deposits to bank accounts
Clearing Settlement
Federal Reserve Bank
Retail Payment OptionsOption Clearing and settlement processor(s)
Cash Banks and Federal Reserve
Checks Federal Reserve
Private clearinghouses
Automated Clearinghouse
Federal Reserve
Electronic Payments Network (EPN)
Debit cards Electronic Funds Transfer (EFT)
Networks (Star, NYCE, Pulse, etc.)
Visa, MasterCard
Credit cards Visa, MasterCard, American Express,
Discover
Payments System Research Department
• Established in 1999
• Overarching objective:– Develop a thorough understanding of
payments system developments and related public policy implications
• Participate in System and Bank studies– Recent examples: nonbanks in the payments
system and interchange fees
Trends in U.S. Noncash Retail PaymentsCompound
Annual Growth
1995 2000 20031995 to
20002000 to
2003
Check Volume (billions) 49.5 41.9 36.7 -3.3% -4.4%
Share of Total 77.1% 59.5% 45.6%
Electronic Volume (billions) 14.7 30.1 43.7 14.3% 12.4%
Share of Total 22.9% 40.5% 54.4%
Total Volume (billions) 64.2 72.0 80.4
Electronic payments include debit card, credit card, and ACH.
What’s happeningwith interchange fees?
• May 2003: Merchants, led by WalMart, win a class-action lawsuit against Visa and MasterCard– Eliminated the “honor-all-cards” rule
– Mandated a lower signature (offline) debit interchange fee charged by MC and Visa until the end of 2003
Interchange and Merchant Processing Fees
Issuer Acquirer
MerchantCustomer
Customer makes purchase and pays $100 with signature debit
Acquirer processes payment
Merchant sends charge information to acquirer
Interchange: $1.50Issuer sends $98.50 to acquirer
Processing fee: $.50
Acquirer adds $98 to merchant account
Total merchant discount: 2%
Issuer obtains $100 from customer account
POS Interchange Revenue Per $100 TransactionNon-Supermarket, 1999-2004
0
20
40
60
80
100
120
140
160
180
1999 2000 2001 2002 2003 2004
Inte
rch
ang
e F
ee (
cen
ts) MC Credit
Visa Credit
MC Debit
Visa Debit
Interlink
NYCE
Star
Pulse
Source: Fumiko Hayashi, A Puzzle of Card Payment Pricing: Why Are Merchants Still Accepting Card Payments?, Payments System Research, Federal Reserve Bank of Kansas City Working Paper WP04-02 (December 28, 2004), p. 4.
Payment Market Share in E-Commerce 2001
Visa50%
MasterCard26%
American Express
10%
Discover7%
Other7%
Accepting Credit Cards in E-Commerce Transactions
• Advantages– Many people have credit cards– Credit cards facilitate impulse purchases– Consumer like to use credit cards online
• Protection against fraudulent merchants– Provides merchants with information useful to marketing
• Disadvantages– Costly set-up fees– Must qualify for merchant status– Not suitable for sales of downloadable soft goods– Some customers do not have credit cards– Some customers fear credit cards online – High interchange fees for “card not present” transactions– Chargebacks
E-Commerce Merchantsas Victims of Fraud
• Costs in 2003– Direct loss: 1% of orders– Suspicious orders rejected: 3-4% of orders– Manual review: 23% of orders
• Costs are declining– Fraud loss as percent of online revenues: 2000—3.6% 2003—1.7%
• Security options– Don’t accept cards– Use delivery tracking on shipments– Use security measures
• Address Verification Service (AVS) and Card Verification Number (CVN)• “Verified by Visa”, MC “Secure Code”
Offering Multiple Options for Payments Can Improve Likelihood of a Sale
6065
71 72
0
20
40
60
80
1 2 3 4 ormore
Number of payment methods offered
Shopping Carts
Converted to Sales
CyberSource, “The Insider’s Guide to eCommerce Payment,” 2004.
Other Options for E-Commerce Payments
• PayPal– No set-up fee, easy to qualify– Easy to integrate in Web site– Chargeback protection program– Fee at most 2.9% of sale plus 30¢– 40 million users (good or bad?)– Requires customer registration at PayPal
• E-Check– Low fees: payments processed on ACH network– Settlement faster than a paper check– Can reduce merchant risk by guaranteeing payment (for a fee!)– Requires consumer to enter bank and account information online– Fewer consumer protections compared to credit cards– Potential for consumer repudiation (chargeback)
Other Options for E-Commerce Payments
• Bill Me Later– Instant “loan” invoicing– Can increase sales and average ticket– 30-40% less expensive than credit cards
• Signature debit cards– Many consumers hold these cards– Processed similar to credit cards but can have somewhat lower fees
• PIN-less debit cards– Low fees– Useful only to certain industries
• Checks (personal, money orders, cashier’s)– Many consumers still prefer these options– Can slow completion of sale if shipment is delayed until check
clears
Sales Volumeand Options for Payments
Source: www.wilsonweb.com/wct4/pg-merchacct.htm
Other considerations
• Security and privacy– Policymakers are concerned over ID theft and
security breeches that facilitate online fraud
• Micropayments– Single purchase sales for online content is
becoming more popular (e.g., online music)– Processing fees for established payment
options are prohibitive for small dollar purchases
– Promising alternative: aggregation schemes
Questions?
Contact information:
Rick SullivanPayments System ResearchFederal Reserve Bank of Kansas City925 Grand BoulevardKansas City, MO 64198
816-881-2372
Web site: http://www.kansascityfed.org/FRFS/PSRhome.htmemail: [email protected]