ho says retail payments is a business dominated by big household names? To be sure, Visa and MasterCard (and to a somewhat lesser extent, American Express and Discover) dominate the public mindshare. But among retailers there's a subtle shift taking place-a shift away from the thinking that they must accept every form of tender consumers want to use, to accepting a select few payment types and brands.

The impetus for this shouldn't come as a surprise. It's about costs. All businesses make decisions based on cost, paring back where they can. Now some businesses (especially large retail chains) are figuring they really don't need to play host to the multitude of payment options at their check out. And that could have implications for acquirers and the folks who sell card-acquiring services.

Wal-Mart started the ball rolling earlier this year, announcing it would not accept MasterCard-branded signature debit cards when the retailing giant failed to negotiate an interchange rate to its liking. MasterCard and Wal-Mart have since come to an agreement, and consumers can now use MasterCard debit cards at Wal-Mart stores in all 50 states.

The disagreement between Wal-Mart and MasterCard was the latest salvo in an ongoing battle over the cost of card acceptance. While the smallest merchants (especially mom-and-pop stores) don't heavily analyze card acceptance costs these days, there are role models out there that aren't as intimidating as Wal-Mart, yet just as savvy at challenging the POS status quo.

Take Costco Wholesale Corporation, for example. If you're shopping at Costco and you want to pay for your purchases using a card, your choices are limited: American Express, the company's private label credit card (issued by HSBC Holdings plc's Household International), or PIN-based debit cards. (AmEx signage was added to Costco's doors four years ago, replacing Discover, which until then had been the only credit card that could be used at Costco Stores.)

Rue Jenkins, Costco Assistant Treasurer, explained during a recent interview that limiting card acceptance is strictly a matter of cost. "Our strategy is to accept a limited number of payment alternatives that are priced the most efficiently for us, and ultimately for the member."

Costco is a warehouse chain with 438 store locations worldwide, including 324 outlets in 36 U.S. states and Puerto Rico. Its customers are 42 million cardholders representing 23 million households and 4.7 million businesses.

For the first 48 weeks of its fiscal year 2004 (which ended August 31) the company reported net sales of $43.51 billion, a 14% increase over the same 48-week period in fiscal 2003.

Apparently, customers don't mind that Costco has closed its checkouts to Visa, MasterCard and Discover, as long as they can use PIN debit. Jenkins said PIN debit numbers rise by at least a basis point or two each quarter. PIN-based debit cards typically process through ATM networks (such as Star and Pulse) and are priced on a fixed per-transaction basis. For the last several years these cards have played the ugly duckling to signature debit cards, which look like and sometimes act like credit cards.

Until legal settlements last year between Visa and the merchant community (led by Wal-Mart), and between MasterCard and that same group, the increasingly popular signature debit card was assessed the same interchange rates as MasterCard and Visa credit cards. Between 1998 and 2004, Costco experienced a 16% increase in the dollar value of PIN-based debit card payments, according to Jenkins. Credit card transactions rose 14% during that same period, while the value of cash and check payments fell by 19% and 10%, respectively.

Jenkins said it hasn't been tough getting customers used to not pulling out their MasterCard and Visa credit cards. "People are becoming more used to using debit cards as a means of getting to their checking accounts," he said. And that may bode well for new and emerging debit products including ACH check conversion, check truncation and even ACH-based debit cards, he added.

Jenkins said he's interested in exploring ACH payment options for less expensive ways to accept payments. To date, Costco has stayed clear of ACH check conversion, Jenkins said, because ACH rules restrict the check conversion process to consumer checks and 40% of Costco's customers are businesses. But Jenkins-who participated in a panel at NACHA's Payments 2004 conference in September-is keen to explore ways the ACH can help reduce costs. "The ACH is a reasonably priced channel," he insisted.

One possibility: a proprietary debit card that clears through the ACH against customer checking accounts. ACH debit cards aren't new. Mobil Oil experimented with the concept in the late 1980s, but it never gained traction. (In fact, I may have been the only consumer who possessed and used the card with any regularity.) And Safeway has tested a loyalty card with ACH debit functionality in some markets.

Over the years, bankcards have been positioned as cheaper alternatives to accepting cash and checks at the point of sale. However, recent and repeated increases in interchange fees-the main cost component in card processing-have skewed traditional analyses.

Interchange is the base fee set by card associations and debit card networks to cover the costs of processing payments. It flows from the merchant to the card-issuing bank by way of the merchant-acquiring bank, which typically adds a mark-up to cover its costs and related third-party processing fees. This final, marked-up price, known as the discount fee, is paid by merchants on a per-transaction basis to the acquiring banks that direct their payments processing work.

Historically, interchange fees have been differentiated by retail sector, a merchant's annual volumes, type of card used, transaction size, and the procedures used to authorize individual transactions. And the big retailers have always enjoyed better pricing than the small guys - after all, transaction processing is a scale business.

With Visa and MasterCard having to rethink debit card pricing (courtesy of the Wal-Mart settlement), bankcard acceptance could become a high-cost luxury for small stores and a loss leader for banks.

"The top 200 merchants have been granted lower interchange as a result of the Wal-Mart suit," said industry consultant Paul Martaus. "This puts earnings pressure on the acquirers as these merchants generate well over 80% of [card processing] volumes. This may lead to even higher interchange on the little guys, but it will take a huge increase to make up the shortfall."

The investment management firm of Morgan Stanley raised similar concerns in a recent report. "Remarkably, credit cards are today more expensive for merchants to process than cash or checks, despite considerable reductions in electronic processing costs in recent years," wrote Morgan Stanley analyst Kenneth Posner. "Also strange is the fact that U.S. interchange fees keep spiraling upwards" while other costs (such as float) keep falling.

Posner predicted there's a 20% risk that banks (and bankcard brands) would lose a legal challenge to interchange. It's a small, but very real risk, to be sure. Successful challenges to interchange in other areas of the world, including Australia and Europe, may be setting precedents.

In today's highly competitive marketplace, nothing should be taken for granted, especially interchange revenues.

Patti Murphy is Contributing Editor of The Green Sheet and President of The Takoma Group. Contact her at patti@greensheet.com .