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Retail Payment Systems and Payment Costs
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Retail Payment Systems and Payment Costs

What are Retail Payment Systems

Payments systems are the methods used by customers to pay. These include cash (notes and coins), cheques, debit cards, credit cards and charge cards, and subsidiary methods such as pre-paid oystercards (in London), shopping vouchers, pre-purchased gift cards, and loyalty cards credits (where permissible).

The big problem is that the easiest ones for the consumer (credit cards, one month free credit etc) are expensive for the retailer. A second problem is fraud.

In some types of retail business, where immediate payment is not always required such as antiques or kitchens, and the customer is fairly well known (or the delivery will be made long after the account is credited), payments by cheque or bank transfer are common.

History time: the Bad old 1950-early 60s

There was a time when retailers were very strict about payments. The name 'Boots Cash Chemists' gave the game away immediately, and the Co-op, Sainsbury's and Tesco sold at competitive prices and expected you to pay cash. If they knew you were good for the amount, they would probably accept a cheque. There is a quote somewhere from Sainsbury's in the 1960s that they weren't interested in the housewife who has run out of money by Thursday. You could normally get credit from department stores and independent stores ('Put it on the slate') but you would not get keen prices. You could also use 'hire purchase' (the 'never never') from the retailer to buy domestic goods (typically cars, TV sets and washing machines) involving strict monthly payments for between 12 months and 48 months plus interest.

Hurrah for Payment Systems Liberalisation: late 1970s-early 80s

Only since the late 1970s/early 80s has it been normal for multiple retailers such as supermarkets to accept payment by credit card and this has only been routine in smaller shops since around 1989. The only credit card M&S would allow until 10 years ago was their own. It was an offence to buy alcohol in a pub using a credit card and I am not sure you could use a cheque either. Originally designed to protect the working man, this law has now been changed. In the same period, visitors to France in the 1970s and 1980s were simply amazed at the number of cheques issued by customers in payment for goods and the fact that the Epos terminals would pre-print the details on the cheque.

Historical fact: in the 1980s postal strike in Ireland, rural communities ran out of cash and cheques were used as currency.

Conclusion No 1: No one has any rights.

The purpose of this historical digression is to point out that the current system is relatively recent. The only method of payment that a retailer is obliged to accept is cash and coin of the realm.

Why the Change in Approach?

Retailers have been keen to allow customers to use a variety of methods of payment, because they saw this as a way of increasing trade. The problem is that card-based systems incur additional costs. There has been a long debate about whether these costs are justified. It's a bearpit out there. On one side there are the banks, the card issuers, the payment bodies, and the technical innovators facing the retailers, the cash collection firms, the security companies, the cash intermediaries and the consumer advocates. One side claims to have the future of payments in its sights, the other bitterly criticises what it regards as overcharging and abandoning freedom of choice for the public.

Credit and Payment Cards

  • In 2009, there were 58.1 million credit cards out there in the UK and 79.3 million debit cards.
  • Credit cards: 20.2 million adults used their cards at least once per month
  • Credit/charge card users made 2 billion purchases in 2009 with a total value of 139 billion (this includes travel, hospitality, and services as well as retail).
  • Debit cards were used to make 5.9 billion purchases (264 billion) AND to acquire 171 billion of cash in the UK.

As a result (probably) of the recession, the number of credit card users has fallen 1.3 million (against 2005). Compared to May 2009, there were 34 million debit card transactions and 2 million fewer credit cards transactions. Credit cards were still responsible for 10.2% of total spending - and debit cards for more than twice that.

spending on plastic cards - annual growth rate(Source: UK Payments Administration)

Conclusion 2: Payment cards are now deep into the Psyche

With more cards than there are adults, payment cards are deep into the psyche. Many reckless consumers who over-used their credit cards in the 2004-07 period have radically changed their approach. They now favour debit cards and many use cash as much as possible as a budgeting method.

Card Fraud

Card fraud cost 440.3 million in 2009 (source: UK Payments Admin), made up mostly of card-not-present fraud 266.4 million, counterfeit 80.9 million, customer-present fraud 72.1 million and fraud abroad on UK-issued cards was 122.7 million.

Note that APACS is now called the UK Payments Administration.

Coin Fraud

News that one-in-36 of the 1 coins is counterfeit is further evidence of the prevalence of frauds in the UK. If you receive counterfeit cash, you are legally obliged to hand it in to the Bank of England. The retailer receives no credit for it. It is a dead loss.

Current Trends in Payment Systems

The big trends in payment systems in the last five years have been:

  • the fall in the use of cash and the growth in debit card use
  • the growth in credit card use (this has reduced somewhat since the recession)
  • the disappearance of cheques in retail transactions and the end of cheque card guarantees from July 2011
  • the growth of card-not-present transactions (CNP) (mostly credit cards) as a result of orders by phone and e-commerce.

Further trials on contactless electronic cards and mobile phones to make small payments (below 10) are not yet a trend but are interesting.

The Nordic countries have moved even faster than the UK. Electronic payments are now so important there that cheques have been abandoned and the future of cash itself is in question for buying everything except small value payments.

E-commerce payments

E-commerce retailers have faced particular problems. Credit and debit cards are not guaranteed where the PIN (personal identification number) is not used and the consumer/card is not physically present. Retailers want to service the customer as quickly as possible and make his or her online experience easy. Security questions and credit controls can simply lead to customers abandoning the transaction part way though.

At least one-third of card holders refuse to buy online using credit cards because they fear fraud. This is a serious problem affecting their freedom of choice. In some countries you are not allowed to use credit cards to buy goods online and in countries like Germany pre-pay and cash-on-delivery are very common ways of paying for online purchases. In Italy, high-street shopping vouchers are popular ways of buying goods online. It is all a bit mixed.

Conclusion 3: Retailers and Banks have to Nail E-commerce Fraud

Retailers and the Banks have broadly got payment card fraud under control. The major growth opportunity for crooks is E-commerce/card-not-present fraud. As online retailing in the UK is expected to grow from the current 9% to 10% of retail sales to 25% over the next few years, retailers and banks have to nail card-not-present fraud or else face mounting losses.

Payment Systems Economics

The British Retail Consortium (BRC) has estimated that card payments accounted for 76.7% of retail spending in 2009. Smaller stores and supermarkets have a much higher proportion of their sales made in cash, and the percentage has increased in the last two years.

This seems to show cash use has fallen since 2006 by 27%, presumably in favour of debit cards. However the change is unlikely to have been that large over this period (reason: sampling error). In 2007 we estimated that cash made up 32% of retail sales.

BRC figures (2009) showed that the average credit card transaction cost retailers 34p, compared with 8p for a debit card transaction and 2.1p for cash. Whether cash is as cheap as that is doubtful, because cash involves heavy count, error, and security costs that are probably not included in the cash figures. These figures are a bit of a swizz because the average size of cash transaction is obviously much lower than that for credit cards.

CRR Estimates from 2007

retail turnover by method of payment

Banks argue that they carry heavy administrative and anti-fraud costs plus the free-interest for a month. This justifies what might seem to be high fees. They do not argue that retailers complaining about heavy charges is a bit rich ('What with your gross margins!'), but they probably think it.

This is obviously a dilemma. Retailers are not allowed to discriminate in accepting credit cards. If you have a Visa sign up you are supposed to accept any legitimate Visa card.

Financial Innovation

But this is an important debate about what should be the costs of operating payment systems. Obviously it is open to retailers to drop the use of credit cards if they feel the costs are too high. One problem with financial payment systems is the nature of the market. If any financial institution makes a change/innovation which the rest of the industry refuses to accept, then it is pointless. If you make a change and all your competitors do it, then you have not gained much advantage. So there is no real point in being innovative: it will not work. This point is made more effectively by Dr Alistair Milne of City University Business School.

Conclusion 4: the Impossibility of Innovation

So retailers individually might work with a financial institution to develop a low-fraud, low-cost card system. It would need to be accepted by most retailers to make the development cost worthwhile. Retailers cannot work together in this way because of anti-trust laws. So what we get instead is a sort of 'beating at the air' where retailers complain about monopoly capitalists (banks) exploiting them, and banks find it hard to provide lower-cost options because of the way the market operates.