Will fees for processing online payments disappear completely?

For many years now, banks and other financial intuitions have been generating revenue from transactional fees of one kind or another. In fact, these fees can make up a large proportion of overall revenues and corresponding profits (in some cases constituting up to 50% of all profits in some banks). 

In general, fees fall into two categories-those that are charged to the end customer or the consumer and those that are charged to an organisation or merchant, when it wants to allow payment services to its customers.

Direct Customer fees

Transactional fees categories typically apply only to the customers of a given bank (as the bank has no direct relationship with other consumers) and even then, only when a customer has gone beyond what is deemed to be the core commercial relationship that the bank is prepared to offer at no direct cost. Hence, fees are typically charged to customers when they have overdrawn an account, written a cheque in circumstances where they are insufficient funds to cover it, or perhaps used an Automated teller machine or ATM in another banks’s network.. However, even here, a bank will allow many transactions without fees, if a customer maintains a positive balance (sometimes with a minimum threshold) or commits to regular income being paid in or saved every month. This is because banks worry a lot about customer “churn” and know that fees can often be a “switching factor” if they become too much of an irritant to an account holder (especially now that opening another bank account can be done online very easily in many cases).  The simple logic here is that it is more cost effective and profitable to keep good customers who transact regularly with a bank (and for the most part in the black) for what might be many years, than to risk losing them completely over a fair but nonetheless irritating fee that “pushes them over the edge”.  Even though this results in what might be seen as a better deal for the end consumer, banks still have to find ways to recover their internal transactional costs in some way. For some transactions, such as  bank cheques, wire transfers and transactions involving foreign exchange a customer will be relatively happy to pay (as these are often one off instances). However, these fees will not always cover the costs involved completely and it therefore often falls to the other major category to provide other fees that can cover costs and the bank’s overhead-the merchant.

Merchant fees

Although every individual commercial merchant relationship will be different, depending on a given organisation’s size, type of business, types of services offered etc, banks will typically charge a very wide variety of fees to most merchants.

The most obvious fees charged to merchants (because they have been around for a long time) are for cash and cheque handling. In both cases, these payment transactions are expensive for any financial institution because they involve human intervention and data entry (sometimes carried out multiple times). As with an end consumer, a merchant may be able to bring about lower fees by maintaining a positive balance or “float”. However, it is rare for any merchant these days to be able to operate without an overdraft at least some of the time, so fees in this area need to be monitored carefully.

Outside cash and cheque payments, the majority of fees that are charged by a bank a credit and debit card use fees. Cards are typically issued to a consumer without charge, and with no transaction fees when they are paid off regularly. However, the merchant will be charged for every transaction that a customer makes with a credit and/pr debit card and this may be a very complex affair. In some cases, the fee charged will be a single “aggregate rate” for say credit card use, such as 2.5% of the transaction size. Hence for a £100 consumer purchase, a charge of £2.50 will be made. However, this rate may vary from one transaction to another and this is because the aggregate rate is made up of many sub fees that every merchant needs to know about. Here are just some of the fee types that are typically charged:

The Discount Fee Rate

Credit and debit card companies (Visa and MasterCard being by far the largest of these) have what is called “interchange” rates. They range in price- so in order to make it easier, the merchant providers created three categories.

Qualified Discount Rate – a pre-set or agreed percentage is paid for each pound charged.

Non-Qualified Rate – a fee added to the qualified discount rate in certain transactions. For example, if a merchant does not use an address verification service (AVS) when they manually enter  or take a transaction.

Transaction Fees

This is a specific, flat rate that is paid on every sale processed through the credit card processor. (Sometimes the transaction fee is called the interchange fee, authorization fee, or per inquiry fee).

Address Verification Service (AVS)

Merchant banks charge a small fee for the validation service to ensure that the billing address provided in the online checkout process matches the issuing bank’s records. Not using this service will result in hefty charges on the processing of the card for that sale.

Batch Fees

Merchant banks require that customers close out their transactions a minimum of one time each day. The batch fee pays for expenses for the gateway or software that accesses the credit card processing network. If you don’t have transactions to process, there is no batch fee to pay.

Monthly Statement or Customer Service Fee

Most merchant banks charge a monthly fee in order to cover their monthly costs of operation (paying their customer service team for example).

Monthly Minimum Fee

Many merchant banks providers require a given organisation to process a minimum amounts of sales per month, or they pay a monthly minimum. Monthly minimums tend to range between £15 and £50 per month.

Gateway Fees

There are fees for internet and mail order merchants to use an internet gateway service such as Authorize.net, although some merchant providers will cover this fee on their customer’s behalf as part of the package deal. If you are solely an internet business, you’ll want to look for an internet merchant account that includes the gateway service as part of the package.

Annual Fees

These are often charged by Merchant banks  when free terminal equipment to take payment is offered. There are numerous merchant account providers that do not charge an annual fee, so you may want to shop around if the first few you look at require an annual fee. Sometimes it would be cheaper to purchase the equipment than to pay an ongoing annual fee.

Cancellation/Termination Fees

Most merchant accounts require a contract agreement of one or two years and if you cancel early, you are likely to be charged a termination fee.

Chargeback/Retrieval Fees

When a customer requests a refund (or the customer’s credit card issuer requests a refund), merchant account providers typically charge a “chargeback” fee.

What will happen to bank fees in the future?

In my last blog article I stated that Merchant Banks are now making a large proportion of their profits by charging fees to both end consumers or account holders (although they worry about overdoing this to prevent customer “churn”) and to merchants who want to offer payment services to their customers. In the latter, I also suggested, there are many direct and indirect fees in the mix that need to be closely scrutinised. In this follow-on article I want to look take a more philosophical perspective and gaze into the crystal ball a little. I am therefore going to look at what the future might hold for merchant bank fees of all kinds.

The future of Direct Customer fees
Banks tend to charge transactional fees only when a customer has gone beyond what is deemed to be the core commercial relationship. Hence, fees are typically charged to customers when they have overdrawn an account, written a cheque in circumstances where they are insufficient funds to cover it, written a banker’s draft, made a wire transfer or carried out a foreign exchange transaction etc.

Although different banks are likely to try different approaches, most of them will want to move to a more transparent business model with customers. This will involve no fees whatsoever for customers that maintain a minimum positive balance and are willing to tie inward payments to their checking account (such as regular salary payments for example). It may also be that the bank will require some other accounts to be maintained to keep fees at zero (such as having a separate savings account or buying insurance through the bank etc). However, the model here will typically be not to charge fees for normal everyday transactions, and this will include items such as electronic bill pay, peer-to-peer payments online or via a smart phone app and even account balance enquiries online or at an ATM.

Of course, while this free service approach may work well for customers who can maintain a minimum float in a checking account (and also meet the other standards that may be required), many customers will not be able to do this and may actually pay more than they are charged today. As this encompasses many customers who are potentially still very valuable to a bank in the long term, another strategy here (and one that has been adopted already in several banks) is to charge a single standard account management fee (such as £20 or £30 per month perhaps-often also involving some rewards or loyalty benefits being offered too). This would either render all transactional fees at zero (or at least all but the ones that involve a customer going into debt).

Merchant fees
There has been much controversy about merchant bank fees in recent years. This controversy arises mainly from two factors: The first is the scale of these fees (both fixed and variable). And the second is the number of different fees that are levied (leading to much complexity and frustration on the part of a given merchant, much of the time). As we saw in the last article, there are often many separate charges rendered by merchant banks including: Cash processing fees, Cheque processing fees, Discount Fee Rates, Inter-change Transaction Fees, Address Verification Service (AVS) fees, Batch Fees, Monthly Statement or Customer Service Fees, Monthly Minimum Fees, Gateway Fees, Annual Fees, Chargeback/Retrieval Fees, and even Cancellation/ Termination Fees (not to mention other administrative fees relating to copy statements or reminder letters etc). The shear volumes of these different and often layered fees make not only for extra hidden costs but often considerable internal merchant time and effort to check that they are accurately applied.

While it is highly unlikely that merchant side fees will disappear completely, we are already seeing a shift to fees that fall into two categories. Those fees that are seen by a merchant as relatively arbitrary and unrelated to any real cost or contribution (let’s call them bank overhead recovery fees) and fees that are seen by a merchant to relate directly to a particular service or tangibly valuable outcome (let’s call them convenience fees). The future of these two fee categories will be very different.

Overhead Recovery Fees
Overhead recovery fees (rightly or wrongly in reality) are seen to be things like Discount fee rates, Bank Interchange rates, Gateway Fees, Batch Fees, Monthly minimum fees, Annual fees, Cancellation/Termination fees and any fees related to administration (such as charging for an email being sent) etc. What these fees have in common is that most merchants see these costs as having no direct benefit to their business or add little value as far as they are concerned. In fact, most merchants take the view that many of these tasks and processes have been automated or made very simple and cheap in the advent of modern software and/or Internet based technology, and yet fees have remained broadly the same or in some cases gone up. Debit cards in the US, provide a particular example where fees which often average 75 cents or higher were known to be costing a bank 70-80% less than this.

All Merchant banks will continue to compete aggressively with one another to win new customers or to retain existing ones, and price will be their primary tool. This is likely to drive these perceived to be low valued-added overhead recovery fees down strikingly in the next few years. Furthermore, as more and more mainly internet-based payment providers come to the market (with far less overhead to have to recover of course) there is every chance that all of these fees will evaporate completely-very good news for merchants of all sizes and types.

Convenience fees
Convenience fees (again rightly or wrongly in reality) are seen to be things like Cash and Cheque processing fees, Monthly Statement fees, Chargeback/ Retrieval fees etc. Not only do most merchants appreciate that these services have more easily seen effort and cost associated with rendering them but can more readily appreciate the value that they add to them. In other words, these activities would be as costly or even more expensive if they were to be performed by the merchants themselves or some other third-party organisation. In addition, these activities are perceived to add value in many cases by providing efficiency, or even a direct customer service benefit (which either increases satisfaction or can justify a particular pricing position on goods and services). You’ll notice that Address verification fees or Customer Service fees are not automatically listed here as convenience fees. These qualify to be included but merchant banks need to work hard to explain why and how this is the case (whether it is describing the benefit of having a real live person available in a call-centre to help with an unusual transactional event or bring about better credit card security by using look-up database services etc).

For all of these fees, if well-presented and explained, there is every opportunity to continue to charge for the service offered. However, the real opportunity here (to both retain fee income and then to grow it) lies in really getting alongside merchants in helping them to reduce their costs or to increase their revenue (in tangible ways). In this respect the opportunity is to help the merchant get bills/invoices seen more quickly and in digital form, to set up calendarised and recurrent type payments when they want them, the offer aggregate bulk payments (especially in the B2B space), to offering currency exchange service options, to offer greater payment type ubiquity and to offer better analysis and reporting on progressive transactional activity. In addition to this, merchant banks can offer modern internet-based technology to store invoice and payment data, offer alerts and reminders when wanted and even to provide links to better goods and services pricing and payment options in the future. Simply put, fee income in this convenience category can grow, and do so substantially, but only when there is a true partnership and the bank and merchant can both gain from the relationship in real and visible ways.

Summary
The merchant bank fee scene will change dramatically in the next few years. Overhead recovery type fees will reduce dramatically and ultimately disappear altogether in the competitive landscape ahead. However, convenience type fees, or those that can be seen by a merchant to add-value will continue to exist and can grow. This growth however, will be heavily dependent upon each bank’s ability to work in partnership with their merchants and offer technology and services that tangibly lead to lower costs or higher revenues. This will therefore be the big challenge for merchant banks in the next few years.