Pricing Increases
It is our expectation that a perceived or real increase in risk exposure will dramatically increase pricing to
all merchants (and merchants will pass that increased pricing on to consumers). We believe the increase
in pricing will come from three main sources: increase in risk exposure, the incremental operational
support, and insurance premiums.
1. Pricing Increases Due to Increase in Risk Exposure
Acquirers expect a certain average losses-to-exposure ratio under the current risk environment.
Assuming that ratio would stay roughly the same in an environment of increased exposure to risk,
acquirers would have no choice but to increase pricing to cover the increased exposure (and, therefore,
increased losses). These price increases from acquirers to merchants would most certainly be passed on
to consumers in order to cover the increased cost of card acceptance. While it is impossible to predict
exactly how this would be implemented, it may come in the form of surcharging for payments made with
cards or an overall increase in a merchant’s price of goods.
First Annapolis looked at four potential scenarios of increased exposure. As a baseline case, we applied 2013 industry bankcard volumes to a standard exposure model in order to assess how much exposure is in the market today, resulting in a calculation of 86 bps of exposure compared to an average loss rate of about 1.5 bps (approximately a 57 to 1 ratio). The second scenario looks at what pricing impact would result from the most conservative application of the FTC’s proposal (i.e., an acquirer is now exposed to the entire volume of telemarketing transactions, not just chargeback volume). In this scenario, an acquirer would be potentially liable for the face value of all transaction volume, past and future, for an individual merchant in the telemarketing industry. If exposure were calculated based on 2013 industry volume, then total exposure increases by $1.4 billion, resulting in a pricing increase of 0.1 bps. Applying that increase in pricing across the entire industry (and assuming the increase is directly passed on to consumers), consumers would pay an additional $26 million annually for products and services.
If, however, there are more significant risk exposure changes in the industry (as we expect) and acquirers
adjust their models to calculate exposure for all MO/TO or all card-not-present transactions, pricing could
increase to an average of 44 bps or 54 bps, respectively, which would result in merchants (and
consumers) paying an extra annual amount of $1.5 billion or $4.1 billion, respectively, for goods and
services.
Finally, we contemplated a scenario in which acquirers would face exposure for 100% of all volume processed for all merchants, or 10,000 bps of exposure, meaning acquirers have a contingent liability equal to all card sales for all merchants in their portfolios. While this is not contemplated by the industry today as a realistic risk, the FTC’s actions set a precedent for any other government agency of any form to hold acquirers liable for the actions of its merchants. This exposure translates into aggregate pricing increases of almost $43 billion annually for consumers.
2. Increase in Pricing Due to Required Operational Changes
Changes to the acquirer’s liability and risk exposure will result in incremental infrastructure over what is in
place today. This will increase the cost of providing processing services. First Annapolis estimates that
the change in risk exposure will double to triple the cost of on-boarding and monitoring each merchant
account. That translates to 3 to 6 bps of additional cost for each merchant.
3. Increase in Pricing Due to Additional Insurance Requirements
Acquirers will consider purchasing insurance to offset the additional risk of loss. This cost would ultimately
be passed on to merchants and consumers. We estimate this could increase pricing 0.5 to 1 bps.
4. Total Pricing Increase
Merchants are likely to see pricing increases of between 9% and 61%. As discussed previously, these
pricing increases will be passed on to the consumer, which will see collective pricing increases of
$900 million to $5.9 billion annually.
Small Merchant Pricing Increases
An increase in acquirer pricing will not be felt equally by all businesses, and it is almost guaranteed that small merchants will be disproportionately impacted by pricing increases. Net Spread by Merchant Size, merchant pricing and average merchant size have an inverse relationship, with small merchants paying much higher acquirer fees in terms of bps on volume than large merchants.
According to the Small Business Administration, small businesses account for nearly half of U.S. economic output. Additionally, according to U.S. Census data, nearly half of Americans are employed by small businesses, and small businesses represent 99.7% of all businesses. This data does not include non-employer businesses, which would add another 22 million employees to the “small business” pool. It is likely that this disproportionate pricing increase on small merchants will have far reaching negative consequences to a substantial part of the U.S. economy. While the average industry net spread is 38 bps,
merchants that have less than $10 million in annual volume contribute 70.1% of that net spread.
Due to the contractual and other pricing vagaries within the industry, we expect that small merchants
(merchants with less than $10 million in annual Visa/MasterCard volume) will bear most, if not all, of the
increase in pricing.
In response, merchants may re-evaluate the extent to which they accept cards as a form of payment.
Currently, just under 50% of consumer spend is on credit and debit cards, and the FTC’s proposed
changes could result in an unknown impact on tender mix at individual merchants as well as in the
economy at large.
The FTC’s Potential Impact on the Merchant Acquiring Industry Prepared for the Electronic Transactions Association
First Annapolis Consulting, Inc.
July 15, 2014
