Reserve Bank of Australia Confirms Least Cost Routing Could Reduce Merchant Debit Costs by 20%

Reserve Bank of Australia (RBA) analysis confirms that least cost routing (LCR) on average reduces merchant payment costs. In a study released this month, the regulator found that LCR enablement by merchants has the potential to lower debit transaction costs by nearly 20%.¹ Once LCR is more widely available for online and mobile transactions, that opportunity only gets bigger.

For now, however, there are three major findings for Australian merchants from the RBA’s analysis.

1. LCR Creates a More Competitive Environment for Network Choice

The RBA has over twenty-five years of experience with payment systems, embedded in authority granted by the 1998 Payments System Reserve Act.² Drawing from its industry oversight and knowledge, the RBA contends that greater uptake of LCR – a function that allows the merchant to choose the card network over which to process a debit card transaction – “should create greater competition between the networks and lead to savings for both merchants and consumers.”³

The latest findings suggest that this expectation holds true, and that LCR has resulted in more transaction volume for the eftpos domestic debit network. According to the report, on average, merchants with LCR enabled send 50% of their debit card transactions through eftpos, compared with only 14 % of those for whom LCR is not enabled.⁴ This indicates a more competitive environment for network choice when LCR is enabled, which could have positive outcomes, including:

1. Increased performance and viability of the Australian domestic eftpos network.

2. Network redundancy on debit transactions, meaning that consumers will still be able to use their cards in the event a network experiences an outage.

3. Long-term competitive efficiencies when merchants and consumers have network choice.

2. Merchants are Seeing Significant Savings

On top of increasing competition, the RBA also contends LCR can help reduce the cost of accepting payments.⁵ The latest cost of acceptance data reported by the RBA shows that, on average, the cost of the domestic debit eftpos scheme is half that of the average international debit schemes.⁶ This may make routing transactions to eftpos more attractive to some merchants from a debit cost savings perspective, and ongoing competition between schemes could also help to mitigate future network and interchange fee increases.

The RBA’s analysis confirms the theory that LCR can drive down merchant costs. The study focuses on a subset of data from approximately 525,000 merchants partnered with 8 PSPs who have LCR functionality available. Of the subset, approximately 29% of merchants had enabled LCR accounting for an estimated two-thirds of total Australian debit volume.⁸ According to the study, the cost differentials between networks mean that LCR is associated with nearly a 20% lower cost of acceptance for debit card transactions.

3. Outcomes Vary by Merchant

The RBA study goes a layer deeper than the impact of LCR enablement alone, also reviewing outcomes based on merchant size and pricing plan (i.e., fixed, blended, unblended). Most merchants above $10 million had blended or unblended rate plans, which were associated with a 32% and 8% lower cost of payments, respectively.⁹

The RBA postulates that LCR savings may be largest for mid-size merchants with blended rates. One explanation for this relates to the tendency for blended rates to include both debit and credit pricing; with credit rates being historically higher than debit (see chart 1), blended pricing is elevated, resulting in the potential for a greater reduction in overall rates when debit costs fall.

In contrast, most of Australia’s largest merchants are on unblended pass-through pricing plans. While they have an opportunity for savings with LCR, they may already have more efficient rates, making the opportunity for cost reduction smaller in percentage terms, but often much larger in terms of aggregate payments budgets. For those merchants, the business case is far more complex than merely ‘switching on’ LCR; direct negotiations, volume minimums required for strategic rates, and more, mean that the businesses with the most to gain from LCR also require the most detailed analysis to take advantage of it.

The Message for Merchants

The RBA study demonstrates the value for merchants enabling a least cost routing strategy. With observed savings of 20% on mostly in-store debit volume, and both online and mobile LCR enablement on the horizon, Australian merchants of all sizes have a tremendous opportunity to get ahead of the curve and build a data-driven least cost routing strategy. As the RBA study notes, even without the inclusion of online and mobile LCR opportunities, there is “room for further reductions in payment costs through higher LCR take-up among merchants on unblended and blended plans,”¹¹ and that opportunity will only become more commonplace as more payment service providers deploy the option for LCR enablement.

Australia is not alone in this journey. CMSPI’s global experts estimate that least cost routing opportunities in the U.S., for example, have opened up an estimated $1 billion in savings for in-store PIN-debit transactions. When fully enabled for online and mobile volume, this could increase by $3 billion in annual savings.

Global experience shows that it is never too early to start reviewing your data and exploring least cost routing opportunities to see if they’re part of the right acceptance strategy for your business. Lessons learned from the U.S. also make it important the RBA remain engaged – with subsequent reviews and analysis – to ensure LCR enablement remains uninhibited when it becomes more widely available for online and mobile.