If the architects of the Durbin interchange amendment get their way, the whole business of routing transactions is about to get a lot more complex, and transparent. In fact, I could see a whole new business model emerging for merchant acquirers and network owners who embrace this change. I just returned from the ATM, Debit and Prepaid Forum in Phoenix, where Wal-Mart Stores' Vice President & Assistant Treasurer, Michael Cook captured the opportunity (and challenge) presented by the Durbin interchange amendment (paraphrased):
The Durbin amendment allows a merchant like us to route debit transactions to the network that provides the best Price, Availability, and Response time.
Today, the vast majority of debit transactions automatically route to the network they were issued on, regardless of the price, availability and response time of that network. Merchants have no real choice in the matter. That's all about to change, and here’s why.
One of the primary elements of Durbin is the requirement that a card support a minimum of two networks. In the words of the amendment: “This provision also provides additional competition to a previously non-competitive part of the market. It allows merchants to choose the debit network with the lowest cost – the opposite of the current system where merchants are forced to use a specific network with fixed prices”
But how does this create a new business model for an acquirer or network owner?
Well, let's assume major merchants, who connect directly to networks, start requesting availability and response time statistics, comparing this with the network’s price, and making the most beneficial routing decision (and why they not if the option was available?). In other words, every network gets a score based on their Price, Availability, and Response time. Let's call this a network's PAR. Those who score best based upon the merchant’s priorities, get more business and stand to process more revenue generating transactions on a given day. (It’s true merchants will need an accurate way of measuring this score, but more on that later.)
If you're an acquirer serving smaller merchants without direct network connections, there's an enhanced service opportunity here. You can route merchant transactions to the provider with the best PAR and help your customers drive down their cost per transaction. You could also measure the three PAR components separately and enable more complex routing (C-stores will always want lowest price, but will demand a certain response time threshold).Whether you provide this at standard rates as a competitive advantage, pass the savings along to the merchant, or uplift merchant service fees slightly to access this feature, you have a new service level offering in your stable.
If you're a network, you have perhaps the most interesting new business model opportunity. Assuming large merchants and acquirers have the infrastructure in place to route based on PAR, you could actually dynamically adjust your PAR to affect merchant and acquirer behavior. Temporary lull in transaction traffic volumes? Lower your price for that time block, and capture more transactions. Just completed an upgrade and have industry-leading transaction response times? Raise your price to take advantage of your unique value proposition – quick service restaurants would probably be interested, especially during the dinner hour.
There's precedent for this in the cloud computing world already. Amazon Web Services has spot instance pricing – the cost of an Amazon virtual machine instance actually changes based on load factors and the availability of that resource in the Amazon environment. Developers using the Amazon cloud service can take advantage of these opportunities to lower their costs. The only difference in the payment processing business is the need to measure (and route) based on transaction information.
Now, there are two major challenges in getting to a dynamic routing model. Firstly, most merchant contracts are multi-year, fixed price arrangements that don't allow the kind of flexibility I'm describing above. However, if Wal-Mart follows through on their statement above, the demand side of the equation will change quickly. When you consider the potential benefits for an acquirer in offering this kind of differentiated service, or a network in grabbing a greater share of traffic, there's incentive on the supply side too. It's only a matter of time before one party in the payments business blinks or sees a strategic opportunity and disrupts the existing contract model.
Secondly, the infrastructure to measure and route based on PAR doesn't yet exist. Pricing systems would have to move from the back office to the network – which cloud computing vendors like Amazon have already proved is possible. I'm not saying it's easy, but it's also not impossible. The infrastructure would also require a highly-reliable way to measure response time and availability in real-time and feed this back into both routing and pricing algorithms. Fortunately, this type of information is readily available from business transaction management software. More on that in a future post.
So, if you're a merchant, the Durbin amendment probably has you thinking about how to drive down acceptance costs through smarter routing. If you're an acquirer or network, you're probably looking for a business model that works in this brave new world. For all parties, sooner or later, someone's going to ask: what's your PAR?