From In-store to Online: Five Questions with Callum Godwin

Callum Godwin, CMSPI’s Chief Economist, offers insights into how the pandemic has shifted the payments mix; the cost of processing transactions online vs in-store; and what European merchants should be doing now to prepare for a new payments landscape.

How has the pandemic changed the way in which consumers spend? How has this affected the payments mix?

There are five main trends we’ve observed when it comes to the change in which consumers spend:

• The shift to online has been substantial, with the apparel industry having gone from 35% to 100% online. Even the grocery sector, which has historically been 3-4% online, has moved closer to 10-15%
• An increase in contactless spend, with Visa and Mastercard reporting an increase of 40% globally. Many merchants are encouraging contactless spend to prevent the spread of the virus
• A decline in cash spending – in Europe, we estimate cash volumes are down from 26% to 8% of consumer spending, potentially due to the growth of contactless and the perception handling cash will spread the virus.
• A decrease in international spend, due to travelling limitations. One positive for merchants is scheme fees and Card Not Present (CNP) interchange fees tend to be much higher for international transactions than domestic, and therefore decreased spend will provide merchants with cost savings. However, in addition to revenue generated from international spending, merchants also benefit from international traffic via Dynamic Currency Conversion (DCC), tax-free shopping and the Foreign Exchange market
• A change in the credit/debit cards mix. We’re seeing an increase in credit spend in many sectors, which is reducing debit card spend due to consumers wanting to improve cash flow during these uncertain economic times. Credit card transactions are more expensive in Europe and this shift could considerably impact merchants’ costs

What are the factors impacting the cost of processing payments?

The cost of cards is predominately the Merchant Service Charge (MSC), which is composed of interchange, scheme fees and the acquirer margin. Interchange fees in Europe, after being regulated in December 2015, are capped at 20 basis points (bps) for consumer debit cards and 30 bps for consumer credit cards. Following the regulation, which is a key issue for us in Europe and something we’re speaking to regulatory authorities about. In addition to the MSC, merchants also face card processing fees for terminal fees, gateway fees, and fraud prevention tools.

The cost of processing payments in the cash space is a lot more difficult to quantify, with intangible costs such as labour and manual cash handling coming into play. There are hard costs of cash acceptance which are easier to identify, such as Cash in Transit (CIT), banking fees and shrinkage. However, there is no formulaic cost to cash and some subjective measures must be used.

Interestingly, in Europe, the methodology used to determine interchange fees equated the cost of cards to the cost of cash. In theory, that means they should be very similar: but we’ve noticed that, with scheme fee increases, the cost of cards is increasing over time. The cost of cash is also increasing, as a lot of fees are fixed and cash volumes are falling. Unfortunately, for merchants, the cost of cash and card have both gone up.

What are the differences in cost when processing online and in-store transactions?

Processing transactions online is a lot more expensive than in-store. For cards in Europe, scheme fees are much higher, as are inter-regional CNP fees. In addition, in the online space, there is a higher risk of fraud due to verification being more difficult. Research suggests average Card Present (CP) fraud in Europe is 3bps, whereas CNP fraud is 14 bps, an 11bps difference. In addition, gateway fees in Europe have more stakeholders involved in the CNP supply chain – with fees totalling several basis points. Overall, we estimate CP fees are 47 bps and CNP fees are 71 bp – which is a huge difference.

Further, the main competitor to card transactions in the CP space is cash, and whilst cash is difficult to quantify, the overall cost of cash tends to be low. In the online space, the competition to cards are Alternative Payment Methods (APMs) – such as PayPal or Buy Now Pay Later methods – which tend to be more expensive to accept than cards.

As we move further into the online space, we’re naturally seeing higher volumes in digital payment methods. Therefore, merchants need to ensure they’re familiarising themselves with the methods available and accepting the right ones for the markets they’re in.

One area we’re concerned about is methods involving Buy Now Pay Later (BNPL) solutions, such as Klarna. Merchants can either pay huge upfront fees to have the payment immediately, or they can wait a long time to receive the payment – in some instances, consumers are not paying for several months. This creates an undesirable trade-off between cost and cash flow for the merchant.

What should merchants be doing now to reduce costs and future-proof their payments strategy?

It’s become more important than ever for merchants to optimise their payments costs, as they were already balancing on small margins pre-pandemic. This has now been heightened, and despite regulations, payment costs might be merchants’ second or third biggest cost after labour and rent.

• Negotiate scheme fees – many merchants don’t realise they are negotiable and it’s a commercial pass through to the acquirer
• Negotiate APM fees
• Routing down local debit schemes, if available, which tend to be cheaper
• Reducing fraud
• Improving online approvals – approval rates online are only 85% compared to 95% in a face-to-face environment
• Ensuring their Point of Sale offers a seamless customer experience