Mercator Blog

The Buy Now Pay Later Merchant Proposition: Credit Card Interchange Is Cheaper
Date: March 26, 2021
Brian Riley
Director, Credit Advisory Service

This blog focuses on the merchant side of the BNPL transaction. Our next blog will cover the consumer side of the equation.

Credit card interchange, the price merchants pay for accessing the payment networks, is a constant cause of friction. Even when payment networks back off on increasing the merchant expense component, the regulators and merchants still complain.

Interchange varies by product, brand, card type, and merchant vertical. It ranges globally from zero to 4 percent, according to the Federal Reserve. The fact is that Mastercard and Visa do not earn revenue from the interchange proper. Instead, Mastercard and Visa generate revenue from their member banks through a line-item known as Assessments.

Using Australia as a Straw Man (or Straw Person)

Buy Now Pay Later (BNPL) lending promises that merchants can benefit from using this fledgling consumer payment option. Merchant fees appear more transparent in comparison to credit cards. With that in mind, consider Australia's highly mature BNPL business.

As new Aussie banks try to protect their lending market with bank-driven variations of the fintech product, top digital banks such as Commonwealth Bank of Australia (CommBank/CBA) hedge their bets.

  • Commonwealth Bank of Australia revealed plans to begin rolling out its own new BNPL offering to eligible CBA customers in mid-2021.
  • Available to eligible CBA customers, the new BNPL links to a CBA bank account, with no ongoing fees and at no additional cost to businesses. It is, however, subject to regular Mastercard and account fees, as the fine print reveals.
  • CBA is an investor in Klarna, the Swedish BNPL service provider which launched in Australia last year and has more than half a million local customers already.
  • "Customer needs are evolving, and this new BNPL offering is about giving customers more choice around how they choose to pay and when, depending on the option which suits them best," said CBA's Group Executive.


Power Retail, another AU news source, has a more aggressive view on the BNPL discount fee:

  • In terms of challenges, with BNPL the merchant fees tend to be very high—in some cases, as much as six percent.
  • They can be up to three times the processing fees of payment modes such as PayPal and credit cards.
  • The high processing fees of BNPL are affecting many merchants, especially in low margin sectors such as electronics, as these fees are eating into their profits.


The BNPL Cost

Let's stipulate that the BNPL merchant fee in a typical consumer transaction is 4% to 6%. Simply put, when a consumer makes a $100 purchase, the merchant (and ultimately the consumer) pays the BNPL business between $4 and $6.

Without getting into the politics or friction around the interchange, we should agree that merchants complain about interchange costs. Ironically, the fact is, "The U.S. credit interchange structure has been largely unchanged for the past 10 years," Bloomberg quotes from an internal Visa memo. In the U.S., the average debit card interchange is minute. According to the Federal Reserve, "The average interchange fee per covered transaction processed over dual-message, and single-message networks was $0.22 and $0.24." For Visa dual message transactions, the effective rate amounted to 1.44%. The rule of thumb is that U.S. credit interchange is about 2.25%.

Remember, even though regulators rarely consider this fact, on top of the interchange, there are often merchant bank or acquirer costs for statements, servicing, and ancillary functions. For the sake of simplicity, assume that is an additional 1%, so that merchants effectively pay between 2.44% and 3.25%. Using PayPal's concise merchant fee disclosure policy, for commercial online transactions, the fully loaded cost is 2.9% plus a U.S. dollar fee priced at $0.30.

 
Where's the Beef?

Using the Australian market merchant costs and the U.S. pricing model (which is one of the world's highest set of interchange rates), there is no compelling reason to use the BNPL process if transaction cost management is the objective. In fact, this benefit of using BNPL merchant pricing gets less pronounced when you consider markets that have credit card interchange mandates, such as the European market. In Europe, Mastercard disclosures indicate that Mastercard Consumer Credit transactions are a mere 0.30%, or as we say in the trade, 30 basis points.

The Merchant Needs to Do the Math

Stack up that 4% to 6% fintech BNPL merchant fee against credit card interchange. In the U.S., the credit card interchange would be about half the cost, and if it were a debit card, the cost difference would be even more pronounced.

Remember also that credit card networks have high standards for chargeback and disputes. Since many BNPL platforms do not generate revenue from credit card interest, they are frequently not covered by regulatory entities. In sophisticated markets such as the United States, the Federal Reserve and other entities have no control over fintech BNPL firms, though consumer protection agencies, such as the CFPB, may address consumer complaints through their broader authority.

The short story: If the merchant is looking to shift business to BNPL simply to save money on a given transaction, the math does not work. Both models would have arguments for the pursuit of a higher rate of sales, repeat business, increased ticket size, better traffic, or reduced basket abandonment. But if the goal is to save money directly, BNPL is not the answer. Net transaction cost is what matters, and simple math does not support the business model.