The Evolution of Debit: Poised for Aggressive Growth

SUMMARY

VISA, MasterCard, Wal-Mart, First Data, and Concord, to name only a few, are playing hardball, as is evident in the Wal-Mart settlement, the FDC/VISA legal imbroglio, and VISA's loss of $1.3B. In its new report "The Evolution of Debit: Poised for Aggressive Growth" the Mercator Advisory Group reviews the issues that make the Debit Industry a legal and economic battleground and predicts how the industry will grow.

Tim Sloane, author of the report, says that, "the traditional credit card associations remain in a dominant position but are fighting hard to maintain control against significant new market entrants. The competition include the Online Debit Network suppliers who are stealing market share and large merchants that, through consolidation, now directly influence the spending habits of a large number of consumers using loyalty programs." According to this report, the associations still control the bulk of all transaction volume and are well positioned to influence consumers towards the debt instruments that favor consortia members, but the Wal-Mart settlement and other current litigation makes the future far from certain.

This report maps the flow of consumer spending and discovers that US Online and Offline Debit continue to evolve into a significant consumer option at the point-of-sale; primarily because of high merchant acceptance and an increasing number of issuer incentives that promote consumer adoption. It is becoming clear that merchants are a force this industry must reckon with, and by reviewing the post Wal-Mart fee structures and contractual relationships this report demonstrate the new found power of the merchant.

The EFT Networks are also flexing their muscles in this post Wal-Mart era. The report documents the increase in fees these networks charge and how the fees create new challenges for this historically merchant-favored online debit transaction settlement environment. The merchant influence through the Wal-Mart settlement on the offline fee structure, coupled with the responding rise in online debit, indicates the dynamic nature of this market and why it must be closely monitored.

The report goes on to predict growth that favors the associations. While the growth rate for Offline Debit declined recently and gives the appearance of leveling off at ~20%, but Mercator Advisory Group projects the growth rate will soon increase again. Association members have a powerful influence over consumer behavior through signature-only loyalty programs and can influence merchants through rate reductions like those just introduced. Mercator Advisory Group predicts growth of 19% (compounded annually) from 2002-2005 for debit in the US and provides a breakout of online vs. offline and POS payment percentages (see exhibits 16 & 17).

"The Evolution of Debit: Poised for Aggressive Growth" explains the industry battles taking place, reviews the history that brings the industry to this point, the fee structures that simultaneously create alliances and competitors out of participants, and presents current transaction volumes and forecasts. A related report, "The Battle for the US Consumer: FDC, Wal-Mart and the Future of The Payments Industry" drills down into the major legal battles impacting the Debt Industry, the events that lead up to the Wal-Mart decision, provides a concise review of how the Wal-Mart decision impacted industry fees and contracts, and analyses the potential long-term impact.

TABLE OF CONTENTS

Introduction 3

Background on Debit Infrastructure 3

Online and Offline Debit 5

• Figure 1: Online Debit Transaction Process 6
• Figure 2: Offline Debit Transaction Process 6
• Table 1: Online and Offline Debit Comparison 6
• VISA / MasterCard Current Debit Options 7

EFT Fee Structure Review 8

• Online Fees 8

U.S. Market Evolution 11

• Exhibit 1: ACH Total Volume 1995-2002 10
• Exhibit 2: Total EFT Volume, All Networks 11
• Exhibit 3: 2000 Federal Reserve System, Retail Non-Cash Payments, By Type 11
• Exhibit 4: 2003 Projected Non-Cash Payments by Type - Based on Federal Reserve Growth Rates 12
• Exhibit 5: VISA and MasterCard U.S. Debit Growth 1999-2002 13
• Exhibit 5b: Payments by Type in the UK (According to APACS Estimates) 13
• Exhibit 6: All Merchant Terminals Interlink & Maestro 14
• Exhibit 7: Pin-Based Merchant Terminals for Interlink & Maestro 14
• Exhibit 7b: Total POS Installations, All Device Manufacturers 15
• Exhibit 8: Checks Written Classified by Size 15
• Exhibit 9: POS Payments by Payment Method 16
• Exhibit 10: Average Transaction Size at the POS 16
• Exhibit 11: Average Transaction Value for Debit and Credit Card Transactions 17
• Exhibit 12: Switch Volume Leaders for All Transactions as of March 2002 17
• Exhibit 13: EFT Network Leaders By Monthly PIN-Based POS Volume (2002) 18
• Exhibit 14: Pin-Only vs. VISA/MasterCard Debit (at Top 10 Issuers by Total Debit Cards Issued) 18

Factors for Building an Estimated Debit Growth Rate 19

Mercator Projections 22

• Exhibit 15: MercatorProjection: Debit Card Growth for VISA and MasterCard 2003-2005 22
• Exhibit 16: MercatorProjection: Total Online/Offline/Credit Growth 22
• Exhibit 17: MercatorProjection: Type of Transaction at the POS 23

Conclustion 23