Interchange and the major factors that can influence it

Have you ever wondered why some merchants enforce an additional fee when customers pay with credit cards? Or why do some merchants politely request customers to pay by cash when a purchase is less than $5? Or why can some fintech startups offer debit cards with rewards when big banks don’t seem to bother?

The answer is Interchange. Cash has been the medium of transactions for centuries. When a shopper hands cash to a merchant in exchange for goods or services, the merchant takes 100% the amount of such exchange and deals with taxes when the time comes. The problem with cash is that 1/ storing a large amount of cash requires a lot of effort for merchants and 2/ not many customers find it convenient to carry cash around, especially for large transactions. Card transactions bring convenience. Merchants get paid in the form of increased balance in a bank account while consumers can spend without carrying a thick purse or wallet. With credit cards, consumers can transact on the credit line extended by a financial institution. But as the old saying “there is no free lunch” goes, such convenience comes at a cost and that cost is Interchange.

Interchange is a small fee that merchants have to pay on every card transaction. The recipient of interchange is financial institutions (FIs) that issue debit or credit cards to shoppers. These FIs use this revenue stream to either pay for their operational expenses or fund rewards that are promised to consumers. Since doing business nowadays always involves card payments, interchange is one of the expenses that merchants can’t avoid.

How much do merchants have to pay on every transaction? The amount of interchange is determined by interchange rates mandated by networks such as Visa, Mastercard, Discover or American Express. There are a lot of factors that can influence these rates and below is a list of factors that I know (by no means, it’s an exhaustive list):

Merchant Category Code

Merchant Category Code (MCC) is a 4-digit code that represents the type of business area in which a merchant operates. For instance, 5411 refers to grocery stores while 5300 represents wholesale clubs. Some companies such as Walmart or Amazon can span across multiple MCCs because of the breadth of their offerings while others like mom-and-pop restaurants have only one MCC. In some industries, including airlines or hotels, a merchant can have its own code. For instance, 3000 and 3001 are assigned to United Airlines and American Airlines respectively.

High frequency categories such as Gas and Grocery carry low interchange rates while others such as Dining or Travel fetch higher rates. Whenever there is a push to promote a specific area, networks raise the interchange rates as an incentive for card issuers. Take Electric Vehicle Charging 5552 as an example. Its rate for consumer cards is 3%+ which is much higher than the average 1.7% across other categories.

Sometimes, it’s easy for consumers to guess MCCs of their purchases. However, it’s much trickier when it comes to big merchants such as Walmart or Amazon. The only way to know is to wait for the transaction to be posted.

Merchant

Giant merchants such as Costco, Walmart or Amazon command great bargaining power and can negotiate a special low rate with the networks. Think about it this way. The rates that I have seen for these companies are around 0.7%. At $500 billion in annual revenue that the likes of Amazon or Walmart generate, interchange expense amounts to $35 million a year. If they had to pay 1.4% in interchange, the expense would double to $70 million. Their retail business margin is not big enough for them to ignore that difference.

Card-Present or Card-Not-Present

A transaction is considered as “card present” only if a card is swiped or tapped or if an EMV chip is processed. A transaction by fax, Internet, mail or over the phone is considered “card not present”. Since card-not-present transactions do not require a cardholder or a physical card to be present at the time of the transactions, the risk of fraud is higher. Hence, issuers receive higher interchange rates on CNP transactions for taking on additional risks.

Networks

There are a few major networks such as Visa, Mastercard, Discover, American Express and JCB. Each has its own pricing schemes and that can affect the rates that merchants have to pay.

Plastic Type

The type of your card also influences interchange rates significantly. On the Visa Consumer side, there are usually three types of cards: Visa Classic, Visa Signature and its highest tier, Visa Signature Preferred. Visa Signature Preferred comes with much higher rates than Classic or Signature. Normally, if your credit limit is above $5,000, your card is qualified for Signature. To qualify for Signature Preferred, a cardholder typically needs to meet a certain spend threshold. To my knowledge, an issuer sends a list of cardholders that meet certain criteria to Visa so that they can flagged as Signature Preferred. If successful, the issuer can earn a decent amount of additional interchange revenue. On the Mastercard, there are also similar schemes and tiers.

Consumer or Commercial

The rule of thumb is that commercial credit cards have higher interchange rates than consumer cards.

Credit or Debit

Credit cards command higher interchange rates than debit cards, simply because credit cards are much riskier as a product than debit cards.

Purchase Volume

Sometimes, the size of a transaction can affect how much merchants have to pay. For instance, American Express has different rates for different ticket size tiers across key categories. Typically, the bigger a transaction, the higher the interchange rates.

Point of Entry

If you shop in store, whether you use an EMV chip, swipe your card, tap your plastic on the card reader or pay with a mobile wallet can affect the interchange rate of that transaction. To make it more complex, the type of mobile wallet that consumers use is also a factor. For instance, staged wallets (PayPal, Cash App) which break down a transaction into funding and payment stages command slightly higher rates than pass-through wallets (Apple Pay, Samsung Pay) that pass payment details directly to merchants. The alleged reason why there is such a difference is that staged wallet providers do not provide as much information regarding payments as the networks would like and that could make the verification task a tad more challenging.

Regulations

To help smaller banks compete, the US government allows debit card issuers with less than $10 billion in assets to charge significantly higher interchange rates than bigger issuers. That’s usually known as the Durbin Amendment. Fintech companies use this loophole to partner with small less known banks to offer debit cards with rewards. In many countries, including the European Union, interchange rates are capped by laws and much lower than what we see here in the US.

Weekly reading – 21st May 2022

What I wrote last week

Want to do something? Do it right away!

Business

What Happened When a Wall Street Investment Giant Moved to Nashville. AllianceBerstein uprooted its headquarters from New York to Nashville, Tennessee to save $80 million a year. The move has been smooth so far, but the interesting thing here is how some large corporations, once exclusive to mega cities on the coasts, are open to moving to smaller towns. My colleague mentioned his college mates got great job offers from an investment firm in Arkansas. Boise in Idaho attracts interest from tech workers too. Snowflake already moved its headquarters to Montana. It’ll be interesting to watch what this trend will do to real estate.

A great podcast with Ted Weschler, a lieutenant of Warren Buffett. Listening to him bolsters my belief that to even have a chance at being good in investing, you need to read a lot, especially what other folks don’t, to create and connect the dots.

Marriott Rolls Out Media Network That Lets Brands Reach Travelers on Its Apps and TV Screens. I really wonder how this will actually work. The first requirement is that Marriott needs to profile and segment customers such as travel enthusiasts, cooking lovers or pet owners, so that their ads can be targeted. Then, it’s a matter of scale. In a 500-room hotel or resort, how many are actually pet owners at the same time? This makes me think that at least in the beginning, the ads won’t be targeted. Also, how would Marriott measure the effectiveness of the ads? Guests will likely just look at the screens and…move on. This service will aid brand awareness, but tracking conversion will be tricky.

Mastercard launches tech that lets you pay with your face or hand in stores. We’re still a long way from having this sort of technology ubiquitous. What intrigues me when I think about this is when governments around the world can have a unified database that recognizes folks based on biometrics. The amount of red tape and administrative work can be reduced significantly.

There’s a New Media Mogul Tearing Up Hollywood: ‘Zas Is Not Particularly Patient’. The new boss at Warner Media is bringing discipline, work ethic and a new culture to the company. A pretty interesting read on Zas.

The Algorithm is a Lie. A very smart take on Netflix and the long-standing assumption that Netflix is great at mining data for actionable insights.

Other stuff I find interesting

Innovative Fish Farms Aim to Feed the Planet, Save Jobs and Clean Up an Industry’s Dirty Reputation. A super interesting read on what is being done to protect the fishing industry in Maine.

Germany Declares Crypto Gains Tax-Free After 1 Year — Even if Used for Staking, Lending. Other securities can still be taxed after one year of holding, but crypto currencies aren’t in Germany. I wonder how Germans think about this since I assume stock holders outnumber crypto investors.

Take a look inside the Finnish bunkers capable of withstanding a nuclear attack. Today, the Finnish Parliament approved the application to join NATO. Putin threatened to retaliate, but seriously, what did he expect the people of Finland to do after watching what he did to Ukraine?

An interesting read on MOBI and EPUB book format. I love Kindle, but their previous requirement that users must use MOBI format was super annoying. So I am glad that they accept Epub now.

Stats

“The median pay package for chief executives of the biggest U.S. companies reached $14.7 million in 2021”

Pollutions accounted for one out of every six deaths globally in 2019

11.3 million guns were manufactured in the US in 2020. I had to look at the figure one more time to actually believe it. 11.3 million, I mean why do you need that many?

Grab has 30.9 million monthly users as of May 2022

65% of Disney+ subscribers said Movies were the top reason to subscribe

Weekly reading – 12th March 2022

What I wrote last week

Cuisine in Saigon (Ho Chi Minh), Vietnam

Business

‘Batman’ and the Movie Pricing Predicament. A good article on AMC’s move to charge one more dollar to every ticket for the upcoming Batman movie. Yield management by theaters often involves higher ticket prices in the evening or on Fridays and weekends. Charging more for a specific movie is rare. I look forward to seeing how this will benefit or harm the theaters.

Metaverse is all…hype? Google introduced Google Glass years ago. Today, you’ll have the same odds of seeing that Glass on the streets as finding Nokia’s iconic flip phones. I don’t know what these tech visionaries see, but I won’t bet my money on seeing metaverse or whatever the hell it is in the next 10 years.

Moving money internationally. A fantastic read on SWIFT.

Visa, Mastercard Prepare to Raise Credit-Card Fees. Visa and Mastercard are going to charge higher interchange fees to big merchants while lowering the fees for small merchants whose annual revenue is less than $250,000. Visa said merchants could avoid paying more by offering more transaction data and using its tokenization services. I look forward to seeing how this increase will harm consumers as merchants are likely to pass on the higher expense. It’s no wonder why lawmakers want to look into this sort of duopoly enjoyed by Visa and Mastercard. They simply have too much power

The Three Sides of Risk. “You realize that the tail-end consequences – the low-probability, high-impact events – are all that matter. In investing, the average consequences of risk make up most of the daily news headlines. But the tail-end consequences of risk – like pandemics, and depressions – are what make the pages of history books. They’re all that matter. They’re all you should focus on. Once you experience it, you’ll never think otherwise.”

Fraud Is Flourishing on Zelle. The Banks Say It’s Not Their Problem. “Nearly 18 million Americans were defrauded through scams involving digital wallets and person-to-person payment apps in 2020, according to Javelin Strategy & Research, an industry consultant. When swindled customers, already upset to find themselves on the hook, search for other means of redress, many are enraged to find out that Zelle is owned and operated by banks. Banks say they take fraud seriously and are constantly making adjustments to improve security. But police reports and dispatches from industry analysts make it clear that the network has become a preferred tool for grifters like romance scammers, cryptocurrency con artists and those who prowl social media sites advertising concert tickets and purebred puppies — only to disappear with buyers’ cash after they pay.”

Why Commercials Are Coming to the Biggest Streamers. A good piece on streamers weighing on offering ads.

Other stuff I find interesting

Unleash collaboration with new experiences in Google Workspace. The new features look very sweet. If you are a Google Drive/Docs/Workspace user, check this out!

How U.S. Visa Delays Are Taking a Costly Toll on Frustrated Workers. I can tell you from personal experience that these delays add unnecessary stress to immigrants’ life. My colleague’s PERM application in 2019 took 52 days to get adjudicated. Mine is expected to take 6-8 months.

The story of how Swahili became Africa’s most spoken language. “During the decades leading up to the independence of Kenya, Uganda and Tanzania in the early 1960s, Swahili functioned as an international means of political collaboration. It enabled freedom fighters throughout the region to communicate their common aspirations even though their native languages varied widely. Swahili lacks the numbers of speakers, the wealth, and the political power associated with global languages such as Mandarin, English or Spanish. But Swahili appears to be the only language boasting more than 200 million speakers that has more second-language speakers than native ones.”

The Magic of the Japanese Convenience Store Sandwich

Stats

Hertz had more than 3,300 cars stolen each year

“Just one pint of beer or average glass of wine a day may begin to shrink the overall volume of the brain”

Solar power and batteries account for 60% of planned new U.S. electric generation capacity

US merchants paid more than $55 billion in interchange fees to Visa and Mastercard in 2021

Tap-to-pay penetration in the US as of March 2022 is 20%, according to Visa (from KBW Fintech Payments Conference)

Weekly reading – 30th October 2021

What I wrote last week

My own thoughts and commentary from several companies on App Tracking Transparency

Good reads on business

Intel slipped—and its future now depends on making everyone else’s chips. If the future of Intel depends on making chips for everybody else, then it’s a bleak future. They fall so far behind others, especially TSMC, in this game.

L1 Capital International Fund Q3 Shareholder Letter. It discusses Texas Instruments. So if you are looking for a new idea for your portfolio, it may be an interesting read

Buy Now, Pay Later & Payment Ramifications. If you are looking for a primer on BNPL, this one should do. Follow the author too for payments and fintech content

China is pushing to develop its own chips — but the country can’t do without foreign tech. One thing that I have learned so far is: never underestimate the Chinese. They may be behind in chip design and production, but they have every intention of integrating Taiwan, the hometown of TSMC, into the mainland and they have the will and resources to catch up and surpass the Western world

Mastercard Partners With Bakkt to Bring Cryptocurrency Payments to the Masses. This will definitely increase the usability of Bitcoin in ordinary circumstances. The problem, I think, is who will convince the masses that it’s ok to pay in Bitcoin. The cryptocurrency’s price has gone up by $20,000 in the last 30 days. This fluctuation makes me wonder why I should pay with something that can be 50% more valuable in 30 days.

Image
Source: Simon Moores

Stuff I find interesting

The Unlikely Outsiders Who Won the Race for a Covid-19 Vaccine. The two companies that helped the world get out of the once-in-a-lifetime pandemic were close to financial ruins. Just think about that for a second. On a side note, while I appreciate the dedication of BionTech’s founder, I wouldn’t want to be as extreme as he is.

Lewis Hamilton’s Plan to Revolutionize Formula 1. “The final report, published in July, confirmed what Hamilton had felt in his bones: Less than 1 percent of people working in Formula 1 are Black. The reasons, laid out across 184 pages, ranged from teams’ hiring practices (which tap the same universities year after year) to major fault lines within British education, as Black students are funneled into the lowest-achieving tracks and expelled at much higher rates. That began to change inside his own garage. Mercedes committed to making sure that 25 percent of new hires come from underrepresented backgrounds. The team, which has raced cars under the nickname Silver Arrows since the 1930s, also made a radical statement in paint. For the first time in its F1 history, the team changed its livery from silver to black last summer. The cars haven’t returned to the old colors. Not only did Hamilton’s latest contract, signed during the 2021 season, include stipulations for increasing diversity within the team—Hamilton also spoke directly with the team’s sponsors asking them to do the same. “Where are you guys at?” he remembers asking the CEO of the Monster energy drink company, which has backed him since 2013. “How are you guys holding yourself accountable? How can we work together?”

Female African Elephants Are Evolving Without Tusks Due to Ivory Poaching. The thing about this trophy hunting that bugs me a lot is that it’s not critical to our survival. We just do it for fun, for ego and because we can. These elephants do us no harm. They just mind their own business and we are the thugs that come in, hurt and kill them for what doesn’t belong to us. Some people say that outrage for trophy hunting is hypocritical because we kill chickens and fish and other animals too. Well, there is a big distinction here. We and our societies have evolved in a way that we look to these animals for protein and survival. I mean we could have been eating grass for dinner too if our ancestors had done it millions of years ago. But here we are through no fault of our own. Why do we commit more sins for absolutely no necessary reasons?

The $3.50 go-anywhere ticket to fight climate change. I am no expert, but I really believe that the U.S has to significantly upgrade its public transportation infrastructure to catch up with other countries and contribute to the climate change fight.

Stats

There were more than 500,000 U.S sellers on Amazon between 1st September 2020 and 31 August 2021. Almost 4,000 sellers surpassed $1 million in sales for the first time

There were 203.7 billion cigarettes sold in the U.S in 2020. A mind-blowing figure

Source: Fox

Weekly reading – 30th January 2021

What I wrote last week

What I like about Apple Fitness+

Business

An excellent write-up on the state of news outlets or local journalism in America. It’s astounding that half of the local news outlets are now owned by private equity, hedge funds or other investment firms

SoftBank’s plan to sell Arm to NVIDIA is hitting antitrust wall around the world

Brexit has major implications. Whether the net benefits are positive or not remains to be seen, but this new development doesn’t seem to benefit consumers: Mastercard is hiking fees

AirBnb conducted a new survey that said: One in five want their destination to be within driving distance of home. Not a very good sign for airlines

N26 got 7 million customers

Apple published a document that outlines its imminent privacy policies

Some notable data from a letter from YouTube CEO

Over the last three years, we’ve paid more than $30 billion to creators, artists, and media companies.

YouTube Gaming had 100 billion hours of content in 2020

Our Music and Premium Subscriptions have been growing quickly, reaching more than 30 million paid Members in the third quarter of last year.

Source: YouTube

Technology

A glimpse into JPMorgan Chase’s $12 billion annual tech budget. There are quite some interesting features that the interviewee shared

CB Insights has a write-up on 40 companies that are working on autonomous vehicles

A long but great list of big ideas from ARK

What I found interesting

How homogeneous is Japan

What does the night sky look like on Mars?

A French-Vietnamese woman is fighting for justice for victims of war crimes. It’s crazy that US and Korean veterans received compensations from chemical companies because their products which were used in the Vietnam War had life-altering effects. Yet, Vietnamese victims have not received any.

What I find is that it is often these kinds of multiple small mispriced insights that overtime compound to form a business which is very defensible and very difficult to replicate. The discovery of those multiple small insights really requires a bottom-up organic idiosyncratic investment process.

Source: Interview with Mark Walker from Tollymore Investment Partners

Today I learned – 30th Jan 2020

Rise of contactless payment reported by Visa and Mastercard

It is so much faster and easier to just tap your card or phone on a reader than to use the chip or swipe. The frictionlessness of this payment method has clearly wowed users enough that it is on a rise, especially in the US.

In the card-present environment, we continue to see meaningful momentum in tap to pay, what we consider to be the most friction-free way to pay in person. We have reached a point where 1 in every 3 card-present transactions that runs over our network is [tax] versus 1 in 4 a year ago this quarter. This past year, we’ve doubled the number of countries whose face-to-face transactions are at least 2/3 contactless.

Transit continues to be a key user case and an important way to habituate tapping behavior. In New York City, on the NPA, Visa crossed 2 million taps in November from the beginning of the pilot and 3 million in January. The FDA recently announced the tap-to-pay expansion to their entire system by the end of 2020, and we are currently pacing a 350,000 Visa taps a week on the MTA and nearly 1 in every 10 transactions in the New York Metro area is a tap-to-pay on a Visa card.

Source: Visa in its Q1 2020 Earnings Call Transcript, provided by Atom Finance

Echoing the sentiment was Mastercard in its Q4 2019 Earnings Call

..On to contactless, where as I said, we’re making real progress. This quarter, contactless made up over 30% of global card-present purchased (inaudible). Contactless provides a frictionless and fast payment experience, which is opening new categories of spend, including displacing cash on small-ticket purchases. The U.S. point for growth on this front and the New York City MTA is a good example of the potential for rapid adoption by consumers. In fact, they surpassed 5 million taps since the launch in May. And the MTA has planned to roll out contactless acceptance system-wide by the end of 2020.

I’m pretty certain that U.S. contactless will keep growing throughout 2020 quite attractively. Because if you look at the numbers of the number of bank partners that have committed to issue contactless cards for a [minute], let’s even forget Apple Pay and Samsung Pay that enable every card through their archive to be used. If you just look at the number of cards, we are talking about 70% of our total cards in the U.S. market will be reissued over this 12-month to 14-month period. My own personal cards are already contactless from Citi.

On the acceptance side, kind of all new terminals going on are embedded with contactless. So (inaudible) large retailers Target and 7-Eleven and CVS have announced that they will accept contactless payments. And in fact, over half of U.S. card-present transactions are now happening at contactless-enabled merchant locations. And when the MT rolls in on system-wide in New York City, and there are other transit systems beginning to do the same in their cities, I think you will get the impetus.

Source: Atom Finance

Vietnam as an important emerging market for Apple

My country was mentioned repeatedly in the latest earnings call of Apple. In a positive light that makes me think that we are going to be, if we are not already, an important emerging market for the Cupertino-based company

Geographically, we established all-time revenue records in many major developed and emerging markets including, among others, the U.S., Canada, Mexico, Brazil, the UK, Germany, France, Italy, Spain, Poland, Thailand, Malaysia and Vietnam.

Source: Seeking Alpha

For iPad, we saw growth in key emerging markets like Mexico, India, Turkey, Poland, Thailand, Malaysia, the Philippines and Vietnam

Source: Seeking Alpha

Phone revenue of $56 billion grew 8% year-over-year, as we saw a great customer response to the launch of our newest iPhones. We set all-time revenue records in several countries, including the U.S. Mexico, the UK, France, Spain, Poland, Thailand, Malaysia and Vietnam.

Source: Seeking Alpha

Productivity and Business Processes keeps leading the margin game for Microsoft

Microsoft has three main business lines:

  • Productivity & Business Processes that includes Office 365 Commercial and Consumer, LinkedIn and Dynamics
  • Intelligent Cloud that includes server products and cloud services led by Azure, and Enterprise service
  • More Personal Computing that includes Gaming, Search, Windows and Surface

Azure likely receives the most attention, yet it is Productivity & Business Processes (PBP) that consistently took the crown in the margin game at Microsoft. In the latest earnings report, Microsoft reported almost 44% margin for PBP

Source: Microsoft
Source: Microsoft

Even though there have been only 2 quarters so far in 2020, the segment has generated more revenue and operating income than the full year 2019

Source: Microsoft

Today I learned – 1st Jan 2020

US lags behind the world in tap-to-pay

The latest annual report by Visa wrote:

Contactless payments—or when a consumer taps to pay at checkout with a contactless card or mobile phone—continues to see strong adoption around the world. In 2019, excluding the United States (“U.S.”), tap to pay had surpassed 50 percent of face-to-face transactions that ran over the Visa network. This is up from less than 30 percent just two years ago. There are now more than 50 countries where tapping to pay represents at least a third of all domestic face-to-face transactions processed on our network, up from 35 countries at the end of last fiscal year.

The U.S. is starting to catch up to this global adoption rate. In 2019, U.S. financial institutions began issuing contactless cards to customers nationwide. There are now more than 100 million Visa contactless cards in the U.S., and we expect that number to grow to 300 million by the end of 2020

Contactless payments can also open up new payment experiences, such as transit. Transit continues to be an important use case for introducing consumers to the benefits of tapping to pay. In 2019, Visa helped launch contactless transit solutions in cities around the world, including Belarus, Edinburgh, Florence, Manchester, Miami, Milan, New York, Rio de Janeiro, Singapore, São Paulo and more—making it easier for people to get around while reducing operating costs for private and public transport operators.

Visa’s 2019 Annual Report

In July, Apple CEO Tim Cook said the following in its earnings call

In the United States, in addition to a successful integration into Portland’s transit system in May, we’re beginning to rollout of New York City transit and will launch in Chicago later this year. In China, Apple Pay launched the payment card for Didi the world’s largest ride hailing provider.

As I’ve said before, transit integration is a major driver of a broader digital wallet adoption, and we’re going to keep up this push to help users leave their wallet at home in more and more instances.

Source: Seeking Alpha

While iPhone and Apple devices are wildly popular in the US, a recent study reported a low adoption rate of 9% of Apple Pay among Apple-device owners. It’ll be interesting to see how transit helps with the adoption of Apple Pay and, as a result, contactless payment in the US. In Omaha, to the best of my knowledge, there is no contactless payment at Walmart. Adoption at such a chain that attracts traffic like Walmart will definitely increase the use of tap-to-pay.

US seemed to have a bigger cash transaction on credit card than the rest of the world

While studying the reports from Visa and Mastercard, I noticed something quite interesting. The US seems to withdraw more cash from credit card each time than the rest of the world. The figures from Visa and Mastercard are pretty similar, signaling a true pattern. The following data is from Visa and Mastercard in the quarter ended Jun 30, 2019.

 Cash Volume ($ billions)Cash Transactions (millions)Average Cash Ticket
US1415$933.33
International49223$219.73
Source: Visa
 Cash Volume ($ billions)Cash Transactions (millions)Average Cash Ticket
US1010$1000.00
International41190$215.79
Source: Mastercard