Payments in E-Commerce
Presentation to Conference on
Entrepreneurship and E-Commerce
Oklahoma City, OK
by
Richard J. Sullivan
Payments 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
Federal Reserve Bank
Payment
messages:
payments
out of and
deposits to
bank
accounts
Clearing
Settlement
Retail Payment Options
Option
Clearing and settlement processor(s)
Cash
Banks and Federal Reserve
Checks
Federal Reserve
Private clearinghouses
Automated
Federal Reserve
Clearinghouse Electronic Payments Network (EPN)
Debit cards
Credit cards
Electronic Funds Transfer (EFT)
Networks (Star, NYCE, Pulse, etc.)
Visa, MasterCard
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 Payments
Compound
Annual Growth
1995
Check
2000
2003
Volume (billions)
49.5
41.9
36.7
Share of Total
77.1%
59.5%
45.6%
Electronic Volume (billions)
14.7
30.1
43.7
Share of Total
22.9%
40.5%
54.4%
Total Volume (billions)
64.2
72.0
80.4
1995 to
2000
2000 to
2003
-3.3%
-4.4%
14.3%
12.4%
Electronic payments include debit card, credit card, and ACH.
What’s happening
with 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
Acquirer processes payment
Issuer
Acquirer
Interchange: $1.50
Issuer sends $98.50 to acquirer
Issuer
obtains
$100 from
customer
account
Processing fee: $.50
Acquirer adds $98
to merchant account
Merchant
sends
charge
information
to acquirer
Total merchant
discount: 2%
Customer
Merchant
Customer makes purchase and
pays $100 with signature debit
POS Interchange Revenue Per $100 Transaction
Non-Supermarket, 1999-2004
180
160
Interchange Fee (cents)
140
MC Credit
120
Visa Credit
MC Debit
100
Visa Debit
Interlink
80
NYCE
60
Star
Pulse
40
20
0
1999
2000
2001
2002
2003
2004
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 ECommerce 2001
Discover
7%
Other
7%
American
Express
10%
Visa
50%
MasterCard
26%
Accepting Credit Cards in ECommerce 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 Merchants
as 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
80
60
60
65
71
72
3
4 or
more
Shopping
Carts
40
Converted
to Sales
20
0
1
2
Number of payment methods offered
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 Volume
and 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 Sullivan
Payments System Research
Federal Reserve Bank of Kansas City
925 Grand Boulevard
Kansas City, MO 64198
816-881-2372
Web site: http://www.kansascityfed.org/FRFS/PSRhome.htm
email: Rick.J.Sullivan@kc.frb.org