Payments in E-Commerce Presentation to Conference on Entrepreneurship and E-Commerce Oklahoma City, OK by Richard J. Sullivan Payments System Research Federal Reserve Bank of Kansas City May 18, 2005

Topics Retail payment systems: pipelines to settlement Current research focus of the Payments System Research Department Options for payments in E-Commerce –Advantages and disadvantages Micropayments

Payment Clearing and Settlement Payment messages: payments out of and deposits to bank accounts ClearingSettlement Federal Reserve Bank

Retail Payment Options OptionClearing and settlement processor(s) CashBanks and Federal Reserve ChecksFederal Reserve Private clearinghouses Automated Clearinghouse Federal Reserve Electronic Payments Network (EPN) Debit cardsElectronic Funds Transfer (EFT) Networks (Star, NYCE, Pulse, etc.) Visa, MasterCard Credit cardsVisa, MasterCard, American Express, Discover

Payments System Research Department Established in 1999 Overarching objective: –Develop a thorough understanding of payments system developments and related public policy implications Participate in System and Bank studies –Recent examples: nonbanks in the payments system and interchange fees

Trends in U.S. Noncash Retail Payments Compound Annual Growth to to 2003 CheckVolume (billions) %-4.4% Share of Total77.1%59.5%45.6% ElectronicVolume (billions) %12.4% Share of Total22.9%40.5%54.4% TotalVolume (billions) Electronic payments include debit card, credit card, and ACH.

What’s happening with interchange fees? May 2003: Merchants, led by WalMart, win a class-action lawsuit against Visa and MasterCard –Eliminated the “honor-all-cards” rule –Mandated a lower signature (offline) debit interchange fee charged by MC and Visa until the end of 2003

Interchange and Merchant Processing Fees Issuer Acquirer Merchant Customer Customer makes purchase and pays $100 with signature debit Acquirer processes payment Merchant sends charge information to acquirer Interchange: $1.50 Issuer sends $98.50 to acquirer Processing fee: $.50 Acquirer adds $98 to merchant account Total merchant discount: 2% Issuer obtains $100 from customer account

Source: Fumiko Hayashi, A Puzzle of Card Payment Pricing: Why Are Merchants Still Accepting Card Payments?, Payments System Research, Federal Reserve Bank of Kansas City Working Paper WP04-02 (December 28, 2004), p. 4.

Payment Market Share in E- Commerce 2001

Accepting Credit Cards in E- Commerce Transactions Advantages –Many people have credit cards –Credit cards facilitate impulse purchases –Consumer like to use credit cards online Protection against fraudulent merchants –Provides merchants with information useful to marketing Disadvantages –Costly set-up fees –Must qualify for merchant status –Not suitable for sales of downloadable soft goods –Some customers do not have credit cards –Some customers fear credit cards online –High interchange fees for “card not present” transactions –Chargebacks

E-Commerce Merchants as Victims of Fraud Costs in 2003 –Direct loss: 1% of orders –Suspicious orders rejected: 3-4% of orders –Manual review: 23% of orders Costs are declining –Fraud loss as percent of online revenues: 2000—3.6% 2003—1.7% Security options –Don’t accept cards –Use delivery tracking on shipments –Use security measures Address Verification Service (AVS) and Card Verification Number (CVN) “Verified by Visa”, MC “Secure Code”

Offering Multiple Options for Payments Can Improve Likelihood of a Sale CyberSource, “The Insider’s Guide to eCommerce Payment,” 2004.

Other Options for E-Commerce Payments PayPal –No set-up fee, easy to qualify –Easy to integrate in Web site –Chargeback protection program –Fee at most 2.9% of sale plus 30¢ –40 million users (good or bad?) –Requires customer registration at PayPal E-Check –Low fees: payments processed on ACH network –Settlement faster than a paper check –Can reduce merchant risk by guaranteeing payment (for a fee!) –Requires consumer to enter bank and account information online –Fewer consumer protections compared to credit cards –Potential for consumer repudiation (chargeback)

Other Options for E-Commerce Payments Bill Me Later –Instant “loan” invoicing –Can increase sales and average ticket –30-40% less expensive than credit cards Signature debit cards –Many consumers hold these cards –Processed similar to credit cards but can have somewhat lower fees PIN-less debit cards –Low fees –Useful only to certain industries Checks (personal, money orders, cashier’s) –Many consumers still prefer these options –Can slow completion of sale if shipment is delayed until check clears

Sales Volume and Options for Payments Source:

Other considerations Security and privacy –Policymakers are concerned over ID theft and security breeches that facilitate online fraud Micropayments –Single purchase sales for online content is becoming more popular (e.g., online music) –Processing fees for established payment options are prohibitive for small dollar purchases –Promising alternative: aggregation schemes

Questions? Contact information: Rick Sullivan Payments System Research Federal Reserve Bank of Kansas City 925 Grand Boulevard Kansas City, MO Web site: