his is the first serious research to report on the implications of the recent Visa/MasterCard settlement with Wal-Mart, et al. It is estimated that U.S. banks will lose at least $1 billion in interchange revenue during the last five months of 2003 after the court-adjusted interchange rate took effect on August 1.

Bank of America has informed its investors that it expects its earnings to be $60 million lower because of this settlement and another $200 million lower in 2004. To put the importance of retail payments into perspective, over the last decade the top 25 banks have seen their payment-related revenues grow from 35 to 45 percent of total revenues.

How will banks seek to recover or replace the losses in bankcard revenues in the face of so many other changes going on in the payment field? IBM has factored this development along with other changes going on in our society to create a model that would forecast three different futures of the possible mix of revenues from payments for U.S. financial institutions over the next decade.

One of these forecasts targets the scenario where retailers can decide if they accept credit cards or signature debit. This White Paper summarizes the findings from this research.

Executive Summary

Five major retail payment types are first defined in terms of their revenue share and revenue drivers. Then the retail market variables at play are identified. Finally, assumptions are used to project different strategies financial institutions might deploy to capture more retail payment revenue share.

With so many variables in play, the projections are sure to be off the mark, but the logic described in this document is certainly worth the investment of time it takes to read it. The five major payment categories that this report first benchmarks are:

1. PIN Debit
2. Debit/Credit Transfers (ACH)
3. Signature Debit
4. Checks
5. Credit Cards

Three different sets of assumptions are used to make these projections. The starting point is 2002, and $86 billion of revenue is distributed across five payment categories. The relative importance of credit cards may be overstated but nevertheless is impressive:

• PIN Debit--1.0%
• ACH--0.4%
• Signature Debit--2.9%
• Checks--13.9%
• Credit cards--81.8%

Clearly, the major assumption behind this report's projections is how the consumer will evolve from paper checks toward various electronic alternatives. The "drivers" that the authors focus on to build their projections are:

• Scenario 1: Effect of EBPP Adoption: This is the extent to which consumers adopt Electronic Bill Payment and Presentment (EBPP) or substitute ACH transactions for the traditional check/stub mail-in model. While check volume declines rapidly in this model, revenue doesn't increase proportionally because of the banking industries' inability to price the EBPP service close to what is currently realized on each check processed ($0.91).

• Scenario 2: Replacement of Paper Checks at POS: In this scenario, IBM likes the prospects for both debit and credit cards in replacing checks. This is based upon consumers' dependence on bankcards' convenience and cost. The report documents the fact that America exceeds all other nations in the value and number of credit card transactions.

  They also see credit cards being threatened by the fact that they are a mature product selling into a saturated market with alternative credit/lower cost alternatives - such as second mortgage financing - undermining future growth. IBM doesn't like the prospects for the NACHA POP transaction version of check conversion. It believes that the missing ingredient of real-time guarantee associated with ACH transactions is a major handicap relative to ATM/PIN debit.

• Scenario 3: PIN Debit Transactions Leave Signature Debit Behind: IBM published this report before the Visa/MasterCard settlement was announced, but it inserted this scenario knowing that it represented a realistic possibility. In fact, this scenario may turn out to be the most realistic of any contained in the White Paper. This next 10-year projection results in an annual 4.7% revenue reduction relative to the current revenue mix of retail payments.

An outcome not welcomed by bankers is that by 2012 PIN-based debit accounts for 24 percent of the number of retail payment transactions but only 1.3% of payment revenues. This result is made more realistic by merchant resentment toward credit card and signature debit card pricing of 1.5% of transaction value; the question remains whether this is sufficient to prompt rewards and penalties for making these types of transactions.

Two emerging technologies are described toward the end of the report as possible "disrupters" to the current five payment options: stored-value and wireless payments. IBM sees these as major opportunities to generate incremental revenue streams to replace the erosion in revenue from electronic payments compared to paper checks.

These are technologies that offer efficient means for banks to tap into the almost 800 billion coin and currency payments U.S. consumers transact each year. Not mentioned in the report, but a fact not to be forgotten, is that the Federal Reserve has made public a new cash services pricing schedule that will take effect on January 1, 2004.

These increased costs for accepting coin/currency and providing rolled coin and bundled currency are sure to be passed through to retailers. This in turn will make it easier to provide ROI justification for terminal upgrades that allow consumers to take change in the form of credits to their stored-value loyalty cards or key chain fobs/mobile phones that make parking meters and vending machines much easier devices to use. The recommendations IBM leaves with its audience at the end of this report include:

1. To boost long-term profitability from checks, banks should invest in check truncation technology. The near-term passage of the Check 21 Act makes this recommendation even more compelling than the run-off in traditional retail payment revenues expected over the next decade projected by these researchers.

2. Banks should refrain from making large investments in EBPP until the market achieves critical mass. The problem with this recommendation is obvious. By the time the market achieves critical mass, banks won't have an opportunity to make large investments - the market will be owned by private-sector innovators.

3. RFID payment devices can provide banks entry into the low-value transaction space currently dominated by cash. This also is easier said than done. Prior experience around the world has PDA, cellular and phone companies using their mobile devices to accumulate small-value transactions and aggregate them into the monthly bill the consumer pays - hopefully by EBPP.

A very noticeable gap in this analysis of future retail payments for the next decade is a total disregard of smart cards. Maybe IBM knows something the bankcard organizations don't? Excerpts from this White Paper

• "However, use of debit/credit (ACH) transfers at point-of-sale is largely unlikely to succeed. ACH transfers are not real-time transactions, unlike transactions on EFT and card networks and, hence, offer insufficient protection for retailers."

• "Credit card usage in the U.S. exceeds other nations by a significant margin in terms of both the value and number of transactions."

• "Credit card issuers face significant challenges. Growth in the U.S. is expected to slow over the next several years as substitutes threaten both the payment and credit components of credit card revenues."

• "Faced with slowing growth, card issuers and merchant banks are embracing three strategies: cost reductions through technology, international expansion and movement down market into low value transactions."

• "Lower value, frequent purchases currently dominated by cash represent a significant opportunity for credit card issuers as well - one worth as much as $740 billion."

• "In the current landscape, issuing banks are tilting the playing field by launching loyalty programs rewarding cardholders for signature-based debit card transactions but not PIN-based transactions and instituting fees for PIN-based transactions."

• "However, stored value cards seem only to work in certain environments. They have seen success in environments that meet two specific criteria: the existence of a vendor serving a uniform need across a significant population and a base of high frequency, low value transactions."
• "A 'wireless payment' is not a new type of payment, but a new front end for traditional payment types, and includes three type of players: customer, merchant and one or more intermediaries (financial services institution, wireless operator and solution provider)."

• www.eps.unisys.com/eprise/main/admin/micro/doc/retail_payments_white_paper.pdf

  New Directions in Retail Payments, White Paper, Unisys, Global Concepts and Talson Associates: Review of declining check volumes, debit card growth, channel competition from ACH and ATM networks, recurring payments and Electronic Bill Payment and Presentment, smart cards and RDIF contactless payment options are reviewed and survey findings are reported.

• www.smartcardalliance.org/pdf/alliance_activities/ Infrastructure_White_Paper.pdf

  Smart Cards and the Retail Payments Infrastructure: Status, Drivers, and Directions, A Smart Card Alliance White Paper, October 2002: This trade association report identifies the drivers within the issuing and acquiring payment processing infrastructure to deploy smart cards.

• http://www.aciworldwide.com/pdfs/aci_trends_atm.pdf

  This is Not Your Father's ATM: Today's ATMs Are More Intelligent, More Personal and More Useful, by ACI Worldwide, Inc.

• www.aciworldwide.com/pdfs/aci_trends_retailpay.pdf

  The Multi-Channel Challenge. Brief perspective on the converging retail payment components from a "behind the scenes" player in the payment processing world.

• www.comixpedia.com/html/modules.php?op=modload&name=News&file=article&sid=669&mode=thread&order=0&thold=0&POSTNUKESID=42e22e745e1fe55aad3fa3fd33c7d621

  Features: Micropayments - An Issue of MacroProportions? A recent overview of the Internet perspective of micropayments - its history and future potential.

Eric Thomson is Executive Vice President of Profit Source Advisors. He can be reached at eric.thompson@profitsource.us .