The Future of Online Payments - Part One
By Dalip Mahal, PayCash.us
Got Cash? Payment providers in the Adult Industry are becoming rare[1]; American Express and PayPal have turned their backs entirely, Visa and MasterCard are becoming increasingly strict (and expensive), and banks are closing their doors, with HSBC (www.hsbc.co.uk) doing so in August[2]. The love affair between the credit card and the Adult Industry is clearly coming to an end. The ease of access for credit in the US coupled with the ability to supply instantaneous gratification was a winning combination - but as they say everything has advantages and disadvantages.
Why is Credit Drying Up?
Banks are withdrawing credit card services from the adult industry because they can no longer make reasonable profits in this industry. This withdrawal has nothing to do with morality, the banking industry is conservative, but they are the first in line when it comes to making money legally. Consumer and merchant behavior have lead to a situation where dropping the adult industry leads to greater profits, despite the drop in volume of payments collected.
Credit has been part of human history for 3000 years; the modern credit card infrastructure was inaugurated by Diner's Club when they issued 200 cards in 1950 to New York millionaires, so they might dine at 27 restaurants without carrying cash. The idea was to allow consumers to spend based on their ability to pay rather than on what they were carrying. Inherent to the concept of credit cards is that the merchant can trust that a card is as good as cash. While that may have been true in 1950, it is not entirely true today.
With respect to credit cards, the banks have always put the consumers' interests first.
Federal laws covering usury prevent the credit card industry from charging consumers interest over the grace period. In fact, banks don't make money on consumers who pay off their balances in each period; therefore the cost of offering credit cards is borne by the merchant. The merchant inevitably faces some kind of set-up, monthly, and per-transaction fee to cover the costs of the system.
The Achilles heel of the credit card infrastructure is chargebacks. Convenience was the goal of credit cards, and therefore there needed to be a mechanism to handle mistakes made in applying credit charges to a consumer. Chargebacks are a hassle to a merchant with electronic content, and are deadly to merchants who ship tangible goods. But the cost of the chargeback is not only limited to the loss of revenue by the merchant; the chargeback is also extremely expensive to the banks.
The end to end cost of handling a chargeback in the US is about $50 USD, in the UK it is estimated to be about £60 pounds Sterling (the average transaction size is £50). The number of chargebacks is increasing at a rapid rate for Internet transactions, and the banks have to pay the costs. In 1996 the 40 largest banks had about 84% of their assets in credit card debt; however, they were also earning much less than 2% ROA[3].
ABOUT CYPHERMINT
Headquartered in Marlborough, Mass., Cyphermint is a provider of Global Electronic Cash Payment and e-commerce infrastructure/integration solutions. Our core technology, Pay Cash is used in three major areas: (1) Internet Cash Payment Systems, for B2C e-commerce via the Cyphermint Pay Cash System, (2) Kiosk Solutions - delivering Web-enabled self-service B2C merchandising systems, and (3) The Pay Cash Now Debit Visa Stored Value Card. Cyphermint's Kiosk Integration Division provides solutions to online retailers enabling full integration with kiosk networks and also sets up existing kiosk networks with e-Commerce capabilities. Cyphermint's core technology, the Pay Cash System provides businesses complete turnkey solutions.
Visit the corporate website at: www.cyphermint.com and tour the Pay Cash operations website at: www.paycash.us.
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The increase in chargebacks is driving down these meager earnings, so despite the sheer volume of payments collected by the adult industry, the banks are losing money due to the proportionally higher level of chargebacks. By dropping the adult industry, a bank can remove their principal source of chargebacks and dramatically improve their ROA. It is no wonder that American Express pulled out first, given that their members generally don't carry balances, which made the cost of chargebacks a losing proposition.
Sources of Chargebacks
We should take a closer look at the source of chargebacks and determine whether they will decrease over time. If not, the adult industry needs to search for an alternative payment system. Chargebacks come from different sources, but regardless of the source, the cost to the credit card industry is the same!
The legitimate source of chargebacks is in the case of identity theft. Identity theft is definitely on the upswing. Fully 6% of Americans surveyed in 2003 reported credit card misuse[4]. Identity theft is not likely to decrease any time soon; you can actually find articles on the Internet explaining how to perpetrate identity fraud.
Another source of chargebacks is the adult industry itself. Some subscription sites have offered a low introductory rate for a short period of time, but then commit the user to an ongoing subscription in the fine print. This looks interesting in theory, but customers are motivated to remove subscriptions they feel they did not sign up for. If the merchant makes it difficult to unsubscribe, the consumer can go to his credit card company and cancel the charge. Not only was it a questionable business practice to force a subscription on a consumer, but the adult industry trained the consumer on how easy it is to reverse a charge. Two facts emerge from this: (1) the consumer wants absolute control of his spending, and (2) merchants must compete on the basis of superior products, not fine print.
Another cause of illegal chargebacks is the dreaded gak factor. It is illegal for a consumer who intentionally signs up for your service to then back out due to embarrassment (generally when the spouse finds the credit card charge). However, the adult industry has decided not to fight these consumers, and assumes this loss as a cost of doing business. Once again, the consumer learns the ease of retracting a payment from the merchant.
The bottom line is that the source of a chargeback does not matter, what is important is that chargebacks are expensive and show no indication of decreasing in the future. The credit card infrastructure was designed to handle impulse buying when both consumer and merchant were acting in good faith; the adult industry has enough people acting with questionable faith that that this payment method will either become extinct or extremely expensive.
If we can agree that payment processing is broken, what can be done to fix the problem? In the December Issue I will discuss all the available alternatives for guaranteeing that you are able to process secure transactions on any type of e-commerce site regardless of the status of credit cards online, and do so well into the future. Don't miss it.
REFERENCES
1 Optimal Billing Options: The Visa Situation By Cynthina "Cyndalie" Ashlock, Klixxx Magazine
2 http://www.avn.com/index.php?Primary_Navigation=Articles&Action=View_Article&Content_ID=187410
3 Bank Management: Text and Cases, George Hempel and Donal Simpson, 5th Ed.
4 http://www.ftc.gov/os/2003/09/synovatereport.pdf
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