What the Discover Misclassification Issue Tells Us About Merchant Payments Costs
On July 19, Discover announced that it had been incorrectly classifying certain credit card accounts for years, leading to higher costs for some merchants and acquirers.¹ The news saw Discover’s stock fall by 16%² and its CEO subsequently resign.
With upcoming fee changes from the global card brands forecasted to add over half a billion dollars to merchants’ annual costs³, we ask what other surprises could be sitting in their invoices.
The misclassification
According to Discover’s Q2 earnings report, the error began around mid-2007, when Discover incorrectly classified certain credit card accounts into its highest-cost merchant and merchant acquirer pricing tier. The update, combined with news of a separate investigation from the Federal Deposit Insurance Corporation in connection with consumer compliance, saw Discover’s stock drop by 16% the day following the announcement.4 On August 15, CEO Roger Hochschild stepped down with immediate effect.5 Despite this, the earnings release states that the incremental revenue resulting from this card product misclassification amounts to less than 1% of Discover’s gross discount and interchange revenue since the error began.6
The road to compensation
Discover has now set aside a liability of $365 million to provide refunds to merchants and acquirers as a result of the misclassification. However, they note that “given differences in individual merchant agreements, changes in network terms, and availability of historical data, it is difficult to determine the final amount of potential refunds at this time.”7 Until specifics of the misclassification are communicated, merchants are in a holding pattern awaiting the opportunity to quantify their potential refund entitlement.
The other hidden costs merchants are paying
While an active press story, the misclassification of transactions resulting in higher costs for merchants is by no means exclusive to Discover – or to any payments partner for that matter. With interchange and network fees differing by sector, card type, issuer location, channel, fraud strategy and more, there are hundreds of unique fee combinations that could apply to any given transaction. Processors apply network-set rates – along with their own fees – across billions of transactions in their portfolios, typically updating this logic every 6 months when the global networks release new fee schedules.
It’s no wonder that CMSPI regularly observes mischarges – from incorrectly-keyed rates, to seemingly-small multiplication errors that regularly present six and seven-figure savings opportunities.
Some of the most
common sources of
errors include:
Misapplied rates
+Payments reporting is opaque. As a result, gaining true visibility into whether various rates are being charged to the correct transactions can be extremely difficult using monthly invoices alone. In the Discover case, merchants may not even be equipped with the data to identify an error if it happens at the customer account classification stage.
Variations in pass-through
+Factors such as exchange rate fluctuations, settlement timescale differences, and variations in pricing structures can mean that one merchant’s invoice is different from another’s – even when they are being charged the same underlying fees. These differences are some of the most challenging because they can’t be identified by reconciling transaction charges with your own contracts.
Rounding
+The rounding up of fractional fees, when applied across large transaction volumes, can amount to significant additional costs for a merchant.
Keying errors
+Human error, especially given the regularity of changes to card fees, can cause surprisingly substantial cost increases that can go unnoticed for years following a fee update.
Phantom fees
+The complexity of merchant invoices and naming conventions in payments can leave room for fees to go unnoticed that do not necessarily correspond to contracted costs.
Umbrella charges
+When smaller fees are blended together under an “umbrella charge” within a merchant’s invoices, making it challenging to reconcile each line item with the relevant fee.
Tackling the problem
Discover’s announcement caught merchants’ attention, but most will have had other errors sitting in their invoices already. To determine their true cost of card acceptance, then, merchants need to not only utilize transaction-level data to ensure that their rates are being charged accurately, but also access industry comparisons to determine whether those fees were ‘passed through’ correctly in the first place.
CMSPI’s specialists work on hundreds of projects each year with household merchant brands, utilizing sophisticated data tools to analyze trillions of dollars of consumer spend and identify overcharges. In the process, we typically observe an uptick in complexity – and therefore errors – when new or amended network fees are introduced. With October’s network and interchange fee updates estimated to add over $500 million to merchants’ annual costs 8, this visibility is more important than ever.
Sources
+1 https://s23.q4cdn.com/669804705/files/doc_financials/2023/q2/Second-Quarter-2023-Earnings-Press-Release.pdf
2 https://www.reuters.com/business/finance/discover-financial-shares-sink-regulatory-review-disclosure-buyback-pause-2023-07-20/
3 CMSPI estimates and analysis
4 https://www.reuters.com/business/finance/discover-financial-shares-sink-regulatory-review-disclosure-buyback-pause-2023-07-20/
5 https://www.finextra.com/newsarticle/42791/discover-ceo-hochschild-quits?utm_medium=newsflash&utm_source=2023-8-15&member=133211
6 https://s23.q4cdn.com/669804705/files/doc_financials/2
23/q2/Second-Quarter-2023-Earnings-Press-Release.pdf
7 https://s23.q4cdn.com/669804705/files/doc_financials/2023/q2/Second-Quarter-2023-Earnings-Press-Release.pdf
8 CMSPI estimates and analysis