What happens without “Honor all Cards”?
The biggest losers in a world without Honor all Cards are Fintechs monetizing by virtual card
We are all waiting for the next iteration of the interchange settlement between the merchants and the networks. The prior version offered modest interchange (IC) reduction along with other relief. However, the judge overseeing the case rejected those terms as insufficient.
One issue the judge focused on was the “honor all cards” rule. Honor All Cards (HAC) obligates any merchant who accepts Visa or MasterCard credit cards to accept all Visa or MasterCard credit cards. The rule says merchants cannot steer or reject high-IC cards or treat some issuers different from others.
In most cases, the merchant doesn’t even know at time of purchase whether a card is high-IC or low-IC. High-IC cards can be 100bps more expensive than low-IC cards. High-IC products include affluent consumer cards, small business cards, commercial cards, virtual cards and other products. In theory, IC is higher on these cards because cardholders are high spenders that merchants should value more. Over time, more cardholders have migrated into these High-IC products, driving average IC up.
But what would merchants do if the Honor All Cards rule was eliminated? Many observers are doubtful that it would change anything, but, I have not seen rigorous analysis of this question. So, I thought I would take a crack at it.
The key question is how merchants would use their new powers. To answer that, we need to understand the incentives to act and the available tactics.
Analysis framework
I view this problem along the dimensions of: Merchant size, Ticket size, Payments Venue (In-person, ecommerce, or recurring) and Alternative Payment Options
Merchants size matters because small merchants generally don’t have long lines to deal with and they increasingly have Tablet-based POS devices to implement any surcharging or cash discounting strategies. Larger merchants need to address multi-state legal environments and typically don’t have a customer-facing tablet interface. They also need to train hordes of cashiers in how to deal with any new policy.
Ticket size matters because the potential savings on low-ticket purchases may be too small to bother going after. A 1% surcharge on a $10 purchase is worth 10¢. You need a lot of 10¢ transactions to get material aggregate savings. Any lost sales due to a surcharge and any cash fumbling that slows a line may offset the benefit. On high-ticket purchases, 1% can be material provided it doesn’t turn off high-value customers.
Payments venue matters because friction has different costs in each venue:
For In-person, the issue is slowing the line
For eCommerce, the issue is reducing conversion
For Recurring, the issue is getting consumers to enroll in an alternate method
Alternative payment options matter because the customer must substitute the alternative in near real time. For in-person, that could be Cash or maybe, debit for credit. For eCommerce it could be BNPL, installment loans, A2A or Debit. For recurring, it will usually be ACH but, could also be debit for credit.
As I thought through this framework, I concluded that consumer Debit is largely unaffected by the HAC: Most debit-centric consumers have only one payment card and the price of that card is usually governed by regulation:
70% of the time Regulated debit IC is capped at 22¢ + 5bp, so ticket size doesn’t matter
30% if the time, Exempt debit IC is ~100bp, but the Durbin amendment makes it illegal to steer against these Exempt cards
Most debit transactions occur at big, everyday spend chains like Fueling, Supermarkets, Drug Stores, QSR, and Big Box merchants – all of whom never want to slow the line. The only cheaper in-person option is Cash – but cash has material indirect costs like shrinkage & security and it takes longer at the till.
Finally, the Durbin amendment already gives big merchants tools to pressure interchange down via routing competition. They can play the 5 major PIN networks against each other and they can trade-off Signature Debit for PIN debit.
For all these reasons it is unlikely that large merchants would steer against consumer debit without HAC.
What merchants could benefit from HAC sunsetting and in what circumstances?
I do not see many circumstances where a merchant will risk alienating customers to save ~100bp in interchange. However, there are some situations where it is already happening and could become more common.
Recurring payments has the most upside from HAC elimination. Recurring payments, regardless of size, have no line wait problem and generally aren’t subject to the same conversion pressures as eCommerce. Utilities and telcos already pass through many taxes and regulatory overheads and a surcharge would be just one more line item. Importantly, it is practical to steer consumers to ACH – at substantial savings. Further, in Recurring even small savings an be meaningful over the lifetime of an account. Many telcos are already mandating ACH or offering ACH discounts to reduce the cost of card acceptance.
Recurring payments also faces upward interchange pressure, not because interchange rates are rising, but because Fintechs are substituting high-cost virtual cards for lower-cost consumer cards in bill pay. Billers must accept Virtual Cards under HAC but could reject them or surcharge them without HAC. Or they can steer them to ACH. Open Banking has made it much easier to enroll by simply logging into a bank account. This is a vast improvement over reading MICR ink off a check or finding the information on a bank statement.
Small merchants. Smaller merchants already deploy surcharges or cash discounts. In my conversations with small merchants, they say these tactics face virtually no customer push back. They are helped by the proliferation of Tablet-based POS solutions (ISVs) that make the experience easy and compliant. The consumer-facing screen can calculate any surcharge or discount, display any disclosures, and post the results without any additional work by the merchant Small merchants generally don’t face long lines at checkout so taking cash isn’t as disruptive as it might be at a larger merchant. The only issue is that the aggregate savings are not particularly material.
Large in-person merchants for delivery company purchases. Large merchants likely won’t surcharge or offer cash discounts for general consumers. But, they might turn down card products that are largely used by Fintechs. Most delivery Fintechs arm their “shoppers” with high-IC Virtual Cards or Business Debit cards (often, in Apple Pay). These Fintechs are intermediaries for an end consumer that pays them with a standard credit or debit card – the delivery company arbitrages the IC difference between consumer cards and Virtual Cards.
It would be rare for an end consumer to use a virtual card, so blocking that product is low risk. Given the low margins in many everyday-spend verticals, any lost sales might have been at zero margin on a virtual card. By blocking such cards, the merchant might steer the delivery companies towards gross ACH settlement rather than individual card payments.
What merchants are unlikely to leverage an HAC-less world?
Most large merchants in both in-person and eCommerce venues likely won’t add friction to their checkout for the modest savings on offer. But there are different reasons each segment might avoid surcharges or discounts, let alone product-level bans:
Mega merchants. The top 10 or so merchants already have one-off deals with the networks that lower acceptance costs. The most famous is Costco. At the rates these merchants already pay, there is limited value in trying to go lower by surcharging or discounting. Their savings will be lower because their starting point is already lower. They can instead market against merchants who do surcharge or discount.
High-ticket eCommerce. These merchants have a financial incentive to surcharge or discount since the average ticket is high and the buyers are more likely to use high interchange cards – a double whammy. However, those same buyers may not be willing or able to fund a big purchase with debit or ACH as it might impact their DDA balance too much. The other alternative is online installment loans, but these carry a discount rate as high as affluent credit cards, so what is to be gained? The risk of lost sales is too high once the customer is already at checkout.
All other segments will play follow the leader. The remaining segments are more mid-sized, middle ticket, and in-person. I suspect that the bulk of these merchants will copy the strategies of their largest competitors. Given that large merchants will only act in rare circumstances, I suspect this group will not change much.
How does all this impact payments providers?
If the impact on most merchants is modest, so is the impact on payments providers. But a few payments specialists could see outsized impacts:
Fintechs that monetize via Virtual Cards will see the biggest impact. Virtual cards are not presented by the actual consumer, but by a Fintech intermediary – either a delivery company at the point of sale or a bill pay company for recurring payments. Merchants may block virtual cards outright (bill pay) or surcharge them (delivery) – eliminating the arbitrage opportunity
Bill Pay fintechs have no real fall back as they typically don’t charge consumers for their services. VCs account for most of their revenue
Delivery companies would have to raise delivery fees to consumers if they can’t monetize via Virtual Cards
Acquirers that specialize in recurring payments or subscription billing may see a reduction in volume as billers steer to ACH
Issuers may see a reduction in recurring payments as billers steer to ACH. The issue here is not the lost revenue so much as the habituating impact of card-on-file. But if billers actively steer to ACH, this habituation impact will go away. Card issuers will need to develop different tactics to build loyalty
Networks may see growth deceleration in virtual cards. VCs have been a fast growing product in the networks’ arsenals — partially due to their popularity with Fintechs. However, they are still a small share of total volume. Further, not all VC use cases would be impacted by a blocking trend. For example, VCs used for Accounts Payable would not see an impact.
This is a relatively modest impact across the ecosystem, with certain Fintechs being the biggest losers.
Key Insights
The impact of Honor all Cards will be modest across the broad ecosystem
For in person venues, I expect different responses for large and small merchants
Large merchants will likely not change much as they do not want to slow their lines or go back to managing cash
Small merchants will continue the trend towards cash discounting, aided by their tablet-based ISV providers
For eCommerce venues, I expect the response will be the status quo
No one wants to risk conversion by complicating checkout
ACH methods have not had traction historically
BNPL & Installment loans have discount rates as high or higher than cards
For Recurring venues, I expect active adoption to steer against virtual cards
The lifetime value of steering to ACH is significant
ACH enrolment friction has been reduced by Open Banking technology
Consumer might still directly enroll with cards, without Fintech intermediation
Large, in-person merchants may block or surcharge virtual cards
VCs are largely used by Delivery Company shoppers rather than end consumers
Blocking or surcharging VCs might push Delivery Companies to settle via ACH
No direct fee is imposed on consumers, but Delivery Companies may raise prices
Most payments providers are not impacted, with a few exceptions
Recurring payments/subscription billing specialists may see a shift to ACH, which is harder to monetize
Issuers may need another way to habituate their cardholders if recurring venues makes a big push to ACH
The networks may see a deceleration in VC growth