Payments Intelligence extract: scheme fee increases, another uphill battle for merchants

The latest scheme fee increases announced by Visa are not unexpected; such increases have been anticipated by CMSPI since then Visa Inc. CEO, Charles Scharf, publicly told investors in November 2015 (just prior to the Visa Europe takeover) that there was ‘…an opportunity to expand yields in Europe as we align the economic model with the value we bring and genuinely evaluate pricing from the perspective of a commercial enterprise rather than a member-owned association.’

Visa already increased scheme fees in January 2017, in particular raising costs for cross-border and high-value transactions. Merchants in sectors such as hotel and car rental were worst affected.

From April 2018, Visa will introduce another change in the structure of scheme fees, moving more towards the U.S. model. The schemes have removed acquirer volume tiers in Europe (resulting in significant increases for larger acquirers) and will also introduce new fees, poised to increase costs for all merchants. A consequence of this new charging structure is that intra-European Economic Area (EEA) fees – previously the same as domestic transactions for many acquirers – are increasing in April 2018. It will be interesting to see how the European Commission responds to this as it is committed to removing barriers to cross-border business. The net result of both rounds of increases is that scheme fees across Europe will have roughly doubled from €2.3 billion in 2016 to €4.6 billion in 2018.

Figure 1 : Typical MSC breakdown pre-IFR (CMSPI estimates)

Figure 2 : MSC breakdown post April 2018 (CMSPI estimates)

Though this is significant, it still means that Visa’s average scheme fees per transaction in Europe are only around half their U.S. equivalents (Fig. 3). However, it still absorbs nearly half of the estimated €5 billion annual savings merchants generated from interchange fee regulation (IFR) caps that came into force in December 2015.

This all means that the composition of the merchant service charge (MSC) has changed significantly for merchants in the past few years. Before the IFR, a large merchant could expect interchange to comprise 80-95% of their total MSC, with scheme fees totalling 10% or lower (Fig 1). However, after interchange regulation and scheme fee increases, a typical large merchant MSC may now be made up of 30% scheme fees (Fig. 2). It should be noted that the actual split depends on several factors including:

• Size: the size of merchant often reflects bargaining power with acquirers
• ATV: average transaction value affects the credit vs debit split
• Volume: volume of international transactions will affect both interchange and scheme fees
• Location: country or acquirer used may affect scheme fee tiers
• Sector: some sectors are riskier and have higher acquiring margins than others

Who will be most affected?

The latest scheme fee increases are on a per-item basis, which is different to the fees introduced in January 2017. This, of course, means that merchants with low ATVs will be worst hit. This can be seen in Fig. 4, where CMSPI calculates that merchants in the quick service restaurant (QSR) sector will see Visa scheme fees roughly double, while merchants in the hotel sector might only see single-digit fee increases.

Figure 3: Visa Europe vs Visa Inc. revenue and profit per transaction

Figure 4: Visa scheme fee increases, April 2018

Why have these fees been allowed?

Ultimately, the scheme fee increases have been allowed because the European Commission has excluded scheme fees from interchange fee regulation (IFR). Although the IFR did include an anti-circumvention clause (Article 5), it only included compensation received by issuers (i.e. the definition of interchange) and did not extend to other fees such as scheme fees. However, there is a compelling theory that these new scheme fees are in fact a form of interchange in disguise. This is because increased scheme fees are being used to fund the very high premium of 70-times earnings that Visa Inc. paid to acquire Visa Europe in 2016. Of course, Visa Europe was member-owned by the issuers and acquirers that used the network, so issuers were essentially the ultimate beneficiaries of the Visa Europe premium and, therefore, recent scheme fee increases.

What can merchants do?

The first thing merchants must do is ensure that the acquiring industry is passing on increases fairly. To do this, merchants need to understand the underlying scheme fees charged to their acquirer by Visa. This can be difficult because the underlying fees are opaque; what is required is a thorough financial analysis of both the schemes and acquirers, plus benchmarking against peers.

Merchants may also wish to use local debit schemes in Europe, where possible. Compared to Visa and Mastercard, local debit schemes typically operate on a cost-recovery basis. This means that Visa and Mastercard scheme fee increases will hinder the attractiveness of multinational acquiring solutions, which typically can’t accommodate local schemes. Many large acquirers are keen to develop multinational acquiring and may find this a significant barrier.

More fundamentally, merchants may begin to consider a radical movement away from card payments altogether. As discussed in the previous edition of Payments Intelligence (Autumn 2017), the Payment Initiation Service Provider (PISP) model being introduced as part of the Payment Services Directive II (PSD2) from January 2018 opens the door for initiation of non-card payment to new providers such as banks, mobile providers (including WeChat and Alipay – see page 8), FinTech companies, and large merchants themselves.

Estimates suggest that non-card payments may cannabalise up to 30% of debit card transactions and 10% of credit card transactions by 2020, which would remove fixed interchange fees associated with card transactions and replace them with a structure whereby merchants can directly negotiate fees with PISPs and issuers. More fundamentally, though, it would decrease merchants’ dependency on card payments, thereby increasing bargaining power with the card schemes and diluting the schemes’ economic incentive to use their dominant market position to maximise fees.