Sig-Debit Card

Commoditization of Bank
Networks: Havoc or Hope?
NACHA Payments 2008
May 20, Las Vegas
Steve Mott, Principal— BetterBuyDesign
1

Key Takeaways
1. Networks have come to mean different things for
different generations of consumers
2. Mounting forces are turning once­sacrosanct bank
networks into open platforms for innovation
3. Examples of commoditization spring directly from
exploitation of common networks (especially the ACH)
4. Private network options lessen banks’degrees of
freedom and security
5. Decoupled Debit poses a paradigm shift
6. At the bottom of much of this change lies the ACH and
EFT networks, which ironically are working to increase
network value
7. Quandary is how/where FIs will benefit in the new
paradigm
2

1. Physical to Social Network Transition
3

Facebook: New Home for Digital Transacting
4

Second Life: Banks, Currency, even Scams
5

Social Networks Redefine Lending
6

2. Sweeping Forces Changing
Payments Network Marketplace
• Massive transition to electronic payments puts
everything into play
• Needs and ways to access DDAs proliferate
• Mounting challenges to credit cards
– Industry maturing
– Too many eating off the food chain
– Too few make the money
– Customer reach extends too far
– Card economics get out of whack
– Success in priming the pump lessens
– Emerging markets underserved
– Alternative solutions gain traction
• Redefinition of debit cards risks the ‘franchise’…
7

Major Shifts in Channels/Types Underway
250
Payment Volume by Product (Bil. Txns.)
200
150
Stored Value
PreAuth
ElectBenXfer
Remote/Internet
PIN­debit
100
Sig­debit
Credit Cards
50
Cash
0
Checks
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Sources: Nilson Report (2004­2010); BBD projections
8

The Consumer DDA: A Payments Portfolio
Methods of DDA Payments (Mil. Txns.)
90,000
80,000
70,000
60,000
50,000
40,000
30,000
20,000
10,000
Transfers
SV/Other
eDebit
POSDebit
Sig­Debit
PIN
Image Exchange
IRD
Paper
ACH
0
2003 2004 2005 2006 2007 2008 2009 2010
Sources: NACHA, JPMChase, WellsFargo, McKinsey & Co., Nilson Report; BBD Estimates
9

CapOne: The Industry is Maturing
10

Card Solicitations— Bottom Fishing?
.05/.06
11

The Expanded Credit Card Food Chain
Source: Georgetown Law Center
12

Too Few Participants Make the Money
Graphic provided by: Assoc. Prof. Adam Levitin, Georgetown Law Center
13

Charge­Offs: Reaching Too Far…
Visa/MasterCard Fraud vs. Non­fraud Charge­offs ($ mil.)
$40,000
$35,000
$30,000
$25,000
$20,000
$15,000
Non­fraud
Fraud
$10,000
$5,000
$0
1991 1993 1995 1997 1999 2001 2003 2005 2007e
Sources: Nilson Report, industry publications, BBD estimates
14

Economics of Bank Card Use
Credit $8.16
Sig­Debit $2.16
PIN­debit $.26
Sources: Cards & Payments Magazine, ATM Debit News, BBD estimates
15

Sources of Credit Card Revenue
Card Revenue per transaction
$9.00
$8.00
$7.00
$6.00
$5.00
Enhancements
Total: $8.16
Interchange
Annual fees
Cash­Advance
Penalty fees
$4.00
$3.00
$2.00
Interest
$1.00
$0.00
Credit Card
Source: Cards & Payments Magazine, 5/2007, plus BBD projections
16

Source of Sig­Debit Card Revenue
Card Revenue per transaction
$2.50
Total: $2.16
$2.00
Interchange
$1.50
Other fees
$1.00
NSFs/
Penalty
Fees
$0.50
$0.00
"Interest"
Sig­debit Card
Source: BBD client data
17

Source of PIN­Debit Card Revenue
Card Revenue per transaction
$0.30
$0.25
Total: $.258
$0.20
$0.15
Interchange
$0.10
$0.05
$0.00
Other fees
NSFs/Penalty
Fees
PIN­debit card
Sources: Nilson Reports, industry publications, plus BBD client data
18

Is the Bloom Off Rewards Cards?
•80% of credit card
offers today carry
rewards;
•71% of sig­debit
issuers offer rewards
•83% of consumers
who have them use
them as primary card
Sources: CardTrak, Edgar Dunn/TransUnion, Celent; Financial Insights
19

Emerging Needs Inexpertly Addressed
20

Alternative Payments Gain Traction
21

Consumers Shift to Debit, but at a cost…
A new study has found that more consumers prefer debit cards
than any other type of payment for point­of­sale purchases. This is
the first time in the study's history that debit cards exceeded all
other payment devices as the overall preferred payment product.
The "Payment Dynamics 2007 Preferred Payments Study" from
TransUnion and Edgar, Dunn & Company found that 29% of
respondents prefer debit cards versus 26% for credit cards. This
year's study shows fewer consumers are adding payment
products to their wallets and more consumers are eliminating
products from their wallets than in prior years' studies. Only
31% of respondents added a new payment device to their wallet
this past year versus 56% in 2004, while 20% of consumers said
they shed payment products compared to 16% in 2004. The study
also showed that rewards credit cards represent 50% of all
preferred credit cards with 83% of rewards card owners using their
reward credit card
Debit Card Overdraft Costs $2 for Every Dollar Borrowed; Banks Get $53B in Fees
•More banks are allowing customers to overdraw with debit card purchases and at ATMs, then hitting them with fees of up to $35,
according to the Center for Responsible Lending.
•The average fee for overdrawing your account, by check or debit, reached a record high of $27.40 last year, up 11% from five years
before, according to Bankrate.com, reports USA Today..
•In 2006, financial institutions earned $53 billion in overdraft fees, a 58% increase from 2001, estimates consultant Moebs Services.
•Consumers are not happy. In a survey conducted by the Center for Responsible Lending, 61% of consumers who had a preference
said they would want to have their bank deny a debit card transaction — rather than approve it and charge a fee — if it will overdraw the
account.
•Making an in­store debit card purchase is by far the most expensive way to overdraft, costing $2.17 for every dollar borrowed. By
comparison, check­triggered overdraft loans cost $0.86 per dollar borrowed, according to the report.
22

3. Commoditization from Within
• Added value for Merchants
dissolves value of network
• PayPal emerges as 800­lb.
gorilla in eCommerce
– Friendlier merchant proposition
– Friendlier consumer proposition
– Solves security issues easily
– Business model makes GOOD money!
23

PayPal: Adoption Exemplar
24

Lots of Ways to Transact
25

Merchant Adoption is Surging
26

Instant Credit and High Interest on Deposits
27

PayPal Plug­in: MC­level Acceptance
28

Redirection from Merchant to PayPal site
29

Instant Credit as Needed (with backup)
30

PayPal Plug­in Offers Universal Payment
31

A Separate Log­in is Required to PayPal
32

A One­time Number is Generated
33

It Works (and Generates Receipts)!
34

Business Model Arbitrages Bank Networks
35

Margins Continue to Grow
36

4. Merchant­Based Hybrid Networks
• Prepaid reload networks spawning
• Collaborating merchants experimenting
• Wal­Mart joins the fray
37

Reloadable Prepaid Card Market Grows
Source: Digital Transactions Magazine, 3/08
38

Restricted Authorization Networks Emerge
39

Wal­Mart Immersed in Card Business
40

Credit Card Uses Hybrid Networks
41

Prepaid ‘MoneyCard’Uses 3 Networks
42

Revolution Card Tries to Change Paradigm
43

New Value Proposition Leverages PIN
Consumer Value Proposition
The RevolutionCard is different than other
credit cards.
Not only is it designed to be flexible, but
we're constantly adding new features.
• Credit card with flexible features
• PIN­based for greater control and security
• Instant rewards through merchant partners
• Competitive APRs
RevolutionCard is a PIN­based credit card.
If your card is lost or stolen, any
unauthorized user must know your PIN to
make purchases. And you can change your
PIN as often as you like.
RevolutionCard is not embossed.
You won't find your name or account
number anywhere on it­­and neither will
anyone else.
• No physical data is stored on the card.
• Limits identity theft
• Reduces fraudulent charges
• Lowers risk if card is lost or stolen
Merchant Value Proposition
Welcome to RevolutionCard for Merchants
• The new direction of credit cards. And a whole new
payment platform designed for the way you do
business.
• RevolutionCard works just like the traditional credit
cards you're used to. With one big difference: No
interchange fees. Which means you keep more of
your profits with every sale.
RevolutionCard:
• Eliminates interchange fees.
– Save on every transaction.
– Increase your profit margins.
– Reduce your credit card fees by up to 80%.
• Maintains a more secure environment.
– A more reliable, faster, and highly secure environment
for transaction processing.
– Significantly reduces transaction disputes.
– PIN­based system virtually eliminates unauthorized
transactions.
• Amplifies marketing campaigns.
– Launch co­marketing programs.
– Enhance your existing rewards and loyalty programs.
– Lower your customer acquisition costs and boost
customer spend
Source: Revolution Card website
44

A Better Mousetrap for Digital Era?
45

HSBC’s Tempo (formerly Debitman) Grows
46

‘Network­in­a­Box’(via ACH) Arrives
47

5. Decoupled Debit: Eating from Within?
48

Decoupled Debit— An Overview
49

Decoupled Debit’s Impact on Rewards
• "Incumbent deposit institutions will need to react to the risk of
disintermediation as their business model, which is based on
punitive fees and interchange income, comes under pressure,"
says Gwenn Bézard, research director at Aite Group and author
of the report. "Decoupled debit cards will also expose Visa,
MasterCard, and incumbent EFT networks to new competition
from the likes of American Express and Discover in the debit
arena," predicts Bézard. Aite Group anticipates that competition
on rewards will force major financial institutions to accelerate
their shift to enterprise rewards to resist consumers' cherrypicking
of the debit card product.
• Paul Grill, a partner of First Annapolis Consulting in Linthicum,
Md., agrees. “Capital One is a great marketer, and this product
is going to put pressure on banks to offer much better debit card
rewards.”
Sources: Aite Group, Transaction Trends
50

CapOne Projected Rewards Level
Positioning
Source: Aite Group
51

Consumer Adoption Issues?
• “This is an industry shaker, but consumers are fickle and
it could be difficult for them to break out of the traditional
debit card model,”Pamela Hayward, Mercator
• “Will consumers go through the extra steps to enroll in
the program? Are merchant­oriented rewards enough to
drive sufficient transaction volume (or even initial uptake)
to make for a successful product? I think the immediate
success of the product is suspect, but I suppose it
depends on how Cap One is defining that success.”
Bruce Cundiff, Javelin
Sources: Mercator, Transaction Trends
52

Decoupled Debit: Posing Risks
• While decoupled debit offers monoline issuers another avenue
by which to gain customers, notes Dan Schutzer, executive director
of the Financial Services Technology Consortium (FSTC) in New
York, it could be a huge threat to banks' deposit business.
"Decoupled debit allows a bank or non­bank to issue a debit card
against a DDA the issuer of the card doesn't have," he explains.
• However, the risks are even greater for banks that are not involved
in the decoupled debit game, notes the FSTC's Schutzer. The DDA
bank is going to lose a source of revenue, he stresses. "Now you
have an ACH­based debit card and that fee income is taken away
from the DDA bank," Schutzer comments. "The DDA doesn't die,
but it loses its profitability."
• "The fear of the unknown is palpable in the financial services
industry with the uncertainty of how the decoupled debit platform will
affect the competitive balance of interchange and consumer loyalty
within today's traditional debit card model,”says Patty Hayward,
Senior Analyst of the Debit Advisory Service for Mercator Advisory
Group
Sources: Bank Systems & Technology, 9/2007; Mercator
53

PayPal’s Virtual Debit Card­Millions Tried it
54

HSBC’s OptiPay program via Tempo
Network Qualifies
55

6. Current Sources: ACH and the EFTs
56

ACH Already Dominates Bill Payment
ACH Debit Payment Types (Mil. Txns.)
14,000
12,000
10,000
8,000
6,000
4,000
2,000
PPD (auto­pay)
ARC (lockbox)
WEB (online)
TEL (phone)
BOC (retail)
POP (retail)
0
2004 2005 2006 2007 2008 2009 2010
Source: NACHA, BBD projections
57

BillPay Shifts Favor ACH/PINless Debit
Bill Payment Shifts by Payment Types
$.35­.50
Percent of total annual bill pay transactions
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
0.1% 0.3% 0.6%
2.7%
4.8%
20.6%
5.0%
1.7%
65.1%
3.3%
5.6%
22.7%
4.8%
1.6%
61.7%
4.1% 4.9% 5.9%
6.7%
7.6%
8.7%
24.9%
4.7%
1.5%
57.6%
1.2% 2.1% 3.3%
26.7%
4.6%
1.4%
53.5%
28.7%
4.4%
1.3%
48.9%
6.9%
9.9%
30.9%
4.3%
1.1%
43.6%
2005 2006 2007 2008 2009 2010
$.01­$.02
Paper Checks Money Orders Cash ACH Credit Card Debit Card PINless Debit
Source: TowerGroup, Celent, Aite Group, BBD projections 2006
58

PIN­debit Online: Issuers Can Profit!
Online
Bankcard
Payment Type
Credit Card
Sig­Debit Card
PIN­debit Card
@ 1.5%
PIN­debit Card
@ 1.25%
PIN­debit Card
@ 1.0%
PIN­debit Card
@ 0.75%
PIN­debit Card
@ 0.50%
Net Issuer
Profit
$.95
$.62
$.97
$.82
$.66
$.51
$.35
1,400
1,200
1,000
800
600
400
200
0
Real­time Debit (mil.txns.) (@PIN­debt @
75bps and 125bps vs. Other RTD @125 bps.)
2008 2009 2010 2011 2012 2013
PIN­debit @ 125 bps. Extra @ 75 bps. Other RTD @ 125 bps.
% of
Mkt.
6%
8%
10%
59

Remote Capture, from Anywhere!
Remote Capture Image Streams (Mil.Txns.)
6,000
5,000
4,000
3,000
2,000
1,000
Small Retailer
Large Retailer
ATM
Branch
Vault/Lockbox
Large Corp.
0
2004 2005 2006 2007 2008 2009 2010
Source: Mitek; BBD Research and Projections
60

SVP: Attempts to Recapture Network Value
61

7. Who Profits From Commoditization?
• Handicapping the product providers and markets, and
speculating on potential winners and losers
• Understanding the consequences of all the recent
financial restructuring on the industry
• Assessing the relative impact of all these changes on FI
bottom­lines
• Evaluating which strategic options offer their best
business prospects for the future
• Considering a quantitative framework for projecting
payment revenues and incomes over the next ten years
62

The Issuers Controlling the Card Business
Graphic provided by: Assoc. Prof. Adam Levitin, Georgetown Law Center
63

Impact of the MasterCard/Visa IPOs
• MC stakes early claim (PayPal, CapOne, etc.)
• Visa deals with big merchants
• Both focus on transaction growth (their
sustaining business model)
• Less need/pressure to prop up big­bank profits
(e.g., will Interlink permit PINless debit billpay?)
• Big question is which one will dominate debit
cards worldwide (and who gets STAR?)
• New tech (e.g., contactless) needs different
business model than sig­debit
64

Reconstitution of the Processor Business
• FD as a private company
• Paymentech split­up looming
• New, sleek niche­processors emerge
• Interchange balance likely to shift toward
processors’take as rates drop and products are
redefined
• Risk management is up­for­grabs
• Mag­stripe era coming to a close
65

How/Where do FIs Participate?
• Critical mass volume less critical as networks become
more commoditized
• Customer relationship value/requirements become
paramount (pricing premium based on value replaces
punitive fees and interest)
• Need to manage credit, risk and transaction movements
across a dozen points of access and multiple channels
• Cooperation with merchants/billers can make a
difference in bottom­lines
• DDAs are the best source of leverage now (but won’t
stay that way as the concept of debit cards and accounts
become commoditized)
66

FI Perspective: Prisoner’s Dilemma
67

Steve Mott’s Contact Coordinates
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Steve Mott
BetterBuyDesign
dba CSI Management Services, Inc.
1386 Long Ridge Road
Stamford, CT 06903
(o) 203.968.1967
(f) 203.322.1012
(c) 203­536.0588
email: stevemottusa@yahoo.com
website:www.betterbuydesign.com
68