Payments in E-CommercePresentation to Conference on

Entrepreneurship and E-CommerceOklahoma City, OK

by

Richard J. SullivanPayments System Research

Federal Reserve Bank of Kansas City

May 18, 2005

Topics

• Retail payment systems: pipelines to settlement

• Current research focus of the Payments System Research Department

• Options for payments in E-Commerce– Advantages and disadvantages

• Micropayments

Payment Clearing and Settlement

Payment messages: payments out of and deposits to bank accounts

Clearing Settlement

Federal Reserve Bank

Retail Payment OptionsOption Clearing and settlement processor(s)

Cash Banks and Federal Reserve

Checks Federal Reserve

Private clearinghouses

Automated Clearinghouse

Federal Reserve

Electronic Payments Network (EPN)

Debit cards Electronic Funds Transfer (EFT)

Networks (Star, NYCE, Pulse, etc.)

Visa, MasterCard

Credit cards Visa, MasterCard, American Express,

Discover

Payments System Research Department

• Established in 1999

• Overarching objective:– Develop a thorough understanding of

payments system developments and related public policy implications

• Participate in System and Bank studies– Recent examples: nonbanks in the payments

system and interchange fees

Trends in U.S. Noncash Retail PaymentsCompound

Annual Growth

1995 2000 20031995 to

20002000 to

2003

Check Volume (billions) 49.5 41.9 36.7 -3.3% -4.4%

Share of Total 77.1% 59.5% 45.6%

Electronic Volume (billions) 14.7 30.1 43.7 14.3% 12.4%

Share of Total 22.9% 40.5% 54.4%

Total Volume (billions) 64.2 72.0 80.4

Electronic payments include debit card, credit card, and ACH.

What’s happeningwith interchange fees?

• May 2003: Merchants, led by WalMart, win a class-action lawsuit against Visa and MasterCard– Eliminated the “honor-all-cards” rule

– Mandated a lower signature (offline) debit interchange fee charged by MC and Visa until the end of 2003

Interchange and Merchant Processing Fees

Issuer Acquirer

MerchantCustomer

Customer makes purchase and pays $100 with signature debit

Acquirer processes payment

Merchant sends charge information to acquirer

Interchange: $1.50Issuer sends $98.50 to acquirer

Processing fee: $.50

Acquirer adds $98 to merchant account

Total merchant discount: 2%

Issuer obtains $100 from customer account

POS Interchange Revenue Per $100 TransactionNon-Supermarket, 1999-2004

0

20

40

60

80

100

120

140

160

180

1999 2000 2001 2002 2003 2004

Inte

rch

ang

e F

ee (

cen

ts) MC Credit

Visa Credit

MC Debit

Visa Debit

Interlink

NYCE

Star

Pulse

Source: Fumiko Hayashi, A Puzzle of Card Payment Pricing: Why Are Merchants Still Accepting Card Payments?, Payments System Research, Federal Reserve Bank of Kansas City Working Paper WP04-02 (December 28, 2004), p. 4.

Payment Market Share in E-Commerce 2001

Visa50%

MasterCard26%

American Express

10%

Discover7%

Other7%

Accepting Credit Cards in E-Commerce Transactions

• Advantages– Many people have credit cards– Credit cards facilitate impulse purchases– Consumer like to use credit cards online

• Protection against fraudulent merchants– Provides merchants with information useful to marketing

• Disadvantages– Costly set-up fees– Must qualify for merchant status– Not suitable for sales of downloadable soft goods– Some customers do not have credit cards– Some customers fear credit cards online – High interchange fees for “card not present” transactions– Chargebacks

E-Commerce Merchantsas Victims of Fraud

• Costs in 2003– Direct loss: 1% of orders– Suspicious orders rejected: 3-4% of orders– Manual review: 23% of orders

• Costs are declining– Fraud loss as percent of online revenues: 2000—3.6% 2003—1.7%

• Security options– Don’t accept cards– Use delivery tracking on shipments– Use security measures

• Address Verification Service (AVS) and Card Verification Number (CVN)• “Verified by Visa”, MC “Secure Code”

Offering Multiple Options for Payments Can Improve Likelihood of a Sale

6065

71 72

0

20

40

60

80

1 2 3 4 ormore

Number of payment methods offered

Shopping Carts

Converted to Sales

CyberSource, “The Insider’s Guide to eCommerce Payment,” 2004.

Other Options for E-Commerce Payments

• PayPal– No set-up fee, easy to qualify– Easy to integrate in Web site– Chargeback protection program– Fee at most 2.9% of sale plus 30¢– 40 million users (good or bad?)– Requires customer registration at PayPal

• E-Check– Low fees: payments processed on ACH network– Settlement faster than a paper check– Can reduce merchant risk by guaranteeing payment (for a fee!)– Requires consumer to enter bank and account information online– Fewer consumer protections compared to credit cards– Potential for consumer repudiation (chargeback)

Other Options for E-Commerce Payments

• Bill Me Later– Instant “loan” invoicing– Can increase sales and average ticket– 30-40% less expensive than credit cards

• Signature debit cards– Many consumers hold these cards– Processed similar to credit cards but can have somewhat lower fees

• PIN-less debit cards– Low fees– Useful only to certain industries

• Checks (personal, money orders, cashier’s)– Many consumers still prefer these options– Can slow completion of sale if shipment is delayed until check

clears

Sales Volumeand Options for Payments

Source: www.wilsonweb.com/wct4/pg-merchacct.htm

Other considerations

• Security and privacy– Policymakers are concerned over ID theft and

security breeches that facilitate online fraud

• Micropayments– Single purchase sales for online content is

becoming more popular (e.g., online music)– Processing fees for established payment

options are prohibitive for small dollar purchases

– Promising alternative: aggregation schemes

Questions?

Contact information:

Rick SullivanPayments System ResearchFederal Reserve Bank of Kansas City925 Grand BoulevardKansas City, MO 64198

816-881-2372

Web site: http://www.kansascityfed.org/FRFS/PSRhome.htmemail: Rick.J.Sullivan@kc.frb.org