Beginning in the May issue of Inside Self-Storage, Mr. Federgreen will host a monthly Q&A column titled “The Payment Advisor,” to which readers can submit questions about card transaction systems, electronic funds transfer, check acceptance and processing, wireless transactions, international funds transfer, and other payment-related issues. To participate, e-mail questions to firstname.lastname@example.org . Also watch for quarterly installments of detailed editorials such as this one.
What are “alternative payments,” and why should self-storage operators care? Simply put, the types of payments your business accepts vary in cost, security and levels of risk. The processing fee on a $1,000 transaction can cost between 15 cents and $30; but a higher fee does not buy greater safety, relief from fraud or reduction in liability—it simply costs more.
In December 2004, the Payment System Research Group of the Federal Reserve Bank of Kansas City published a working paper titled, “A Puzzle of Card Payment Pricing: Why Are Merchants Still Accepting Card Payments?” Its conclusion was: “A card network that wants all merchants in a given industry to accept cards sets a lower merchant fee initially, and then gradually increases it to the highest possible level, which may be higher than the sum of the merchant’s transactional benefit and the merchant’s initial margin without cards.”
When we talk about payments, we’re really talking about the form of payment delivery—in other words, the form in which currency is being presented: cash, check or some form of card. There are two guiding principles a merchant must employ to make the most of his payment-delivery options. The first is to always encourage some form of debit-card payment over a credit-card payment. The second is to always encourage an electronic-check payment over any form of card transaction.
Delivery of Funds
Excluding cash transactions, all forms of payment require electronic pathways. To maximize your payment options, you must understand the various processes in detail. There are three steps common to all payment transactions: authorization of payment, transit of financial electronic data interchange (FEDI), and receipt of payment.
It is at the point of receipt that we consider the delivery of funds complete. However, depending on the payment method and the specific rules involved, reversal of a payment may occur. This risk of “reversibility” is paid for through the cost of each specific transaction. The cost involved in payment processing is related to this risk of reversal and the number of intermediateries involved in the process of FEDI.
Traditional Credit Cards
Traditional credit-cards are the most expensive to process and, therefore, the riskiest form of payment to accept. In a traditional credit-card transaction, when a merchant receives authorization from the credit-card company, it simply means a series of steps have been accomplished that verify the authenticity of the card and the available balance to cover a specific payment, which allows the transaction to proceed. It does not mean payment is guaranteed, nor does it mean the transaction is not subject to reversal. In fact, it can be vulnerable for a period that can easily stretch to six months from the date of payment and, in some cases, much longer.
The reason for this is a traditional credit card represents an open line of credit granted by a financial institution to a cardholder. The majority of the processing cost goes toward covering the risk that the institution will be unable to collect on the debt. This burden is shared by the merchant each time he accepts a credit-card payment, which is why it is in his interest to explore other options.
There are several alternative delivery formats available in the United States, including Automated Clearing House (ACH, or electronic-check format), and debit cards. Additional formats used under very specific conditions include SWIFT (standard worldwide international funds transfer) and DCC (dynamic currency conversion).
Surveys conducted by The Federal Reserve revealed that electronic-payment transactions exceeded paper-check payments in the United States for the first time in 2003. Of the three forms of electronic payment—ACH, debit cards and credit cards—ACH represented 92 percent of all transactions by value. Why?
First, the cost of ACH is based on the number of transactions, not the size of each “ticket.” The cost averages between 20 cents and 30 cents per transaction, regardless if a ticket is worth $100 or $10,000. There are additional benefits, such as greater security and fraud control and reduced reversibility. Finally, ACH provides significant opportunity to share in the back-end revenue generated by electronic items that are returned or dishonored. In 2004, back-end penalty revenue was in the range of $30 billion.
When using ACH, you must determine which standard entrance class (SEC) to apply to each transaction. An SEC is a three-letter code that represents the transaction type. There are 23 primary SECs, most of which have modifiers that help describe a transaction in greater detail. It’s important to apply the best SEC for the business’ needs and, in many cases, a combination of classes is necessary to achieve maximum results. Examples of SECs that apply in the storage industry are PPD (prearranged payment – personal), CCD (cash concentration or disbursement – corporate), ARC (accounts receivable entry), POP (point of purchase), WEB (Internet) and TEL (telephone).
Debit cards are linked to a specific checking or savings account. Offline or signature-based debit cards work in the merchant environment the same as a credit card and are not required to be connected to the account balance. Online or PIN-based debit cards ride over the ATM network; they require a PIN and the ability to connect to the live balance of the account holder.
Debit vehicles also offer significant advantages. Since a debit transaction is tied to a specific account and does not require the financial institution to grant an open line of credit to the cardholder, the risk involved is dramatically reduced. With the online format, risk is further minimized due to the combined requirements of a PIN and a live connection to the cardholder’s account.
An off-line debit transaction—driven by the price of a ticket—is 15 percent to 50 percent cheaper than a credit-card transaction, depending on the interchange for which it qualifies. Interchange represents more than 100 different base-price levels driven by multiple factors including risk, card type, type of merchant, submission of sales drafts and more. All levels of interchange are also based on three categories of performance: transaction minimums, maximum chargeback ratio and maximum fraud ratio.
Since online debit transactions involve less risk, their costs are lower. Total cost is not based on the ticket amount but on the number of transactions—the greater the ticket price, the greater the relative savings. Per-transaction fees range from 40 cents to 65 cents. Within this fee structure is a very tiny interchange value. It is important to mention the difference between online and off-line debit costs is actually shrinking.
Assuming the average self-storage ticket is approximately $115, the methods of payment you accept can have a significant impact on your bottom line. Let’s take a look at what the various methods might cost you, the merchant, on a transaction of this size (depending on the network or financial institution):
- Credit card — $2.07
- Off-line debit — $1.56
- Online debit — 55 cents
- ACH — 20 cents
A detailed understanding of alternative payment-delivery systems can help you achieve a 90 percent reduction in costs, along with greater security, system compliance, liability reduction and fraud control. I strongly urge all self-storage operators to consider which payment method works best for their businesses, as direct cost reductions flow straight to the bottom line.
Ross Federgreen is a co-founder of CSRSI, which provides an integrated approach to the analysis, design, implementation, deployment and management of electronic transaction services and systems. Since 1999, the company has helped more than 350 public and private institutions reduce the cost of acquiring money and minimize the liability exposure related to payment transactions and customer data. For more information, call 866.462.7774, ext. 1; e-mail email@example.com; visit www.csrsi.com.