The Rise of Credit and Debit

Greg Blackman / The Rise of Credit and Debit

Last week in a meeting with a prospect that is a non-acceptor, at the closing of the meeting the prospect said “Most Businesses are not accepting credit cards any way so, why should I?” Hence, this blog post.

The Rise of Credit and Debit
Credit and debit cards have increasingly become the preferred methods for consumers to pay for goods and services, making these forms of electronic payments an indispensable way for merchants big and small to conduct business. The trend of rising usage is predicted to continue for some time. Credit and debit card transactions surpassed more than 50% of all non-cash transactions by 2006, up from 42% in 2003, according to a tri-annual study by the Federal Reserve.

Thus, as time passes, it’s no surprise cash has lost out to almost every form of electronic payments in stores. Cash transactions, at 10 per month in 2010, represented 26% of a customer’s in-store purchases, down from 39% in 1999, according to a 2008 study by Hitachi Consulting and BAI. Credit cards decreased over the time period, from 22% to 19% transactions per month — while debit cards continued their rise, accounting for 14 transactions per month in 2010, or 42% of all purchases, up from 21% in 1999.

On the Internet, it’s a similar story of dominance. Credit and debit cards made up 74% of all purchases in 2008 (Internet payment services – mainly PayPal – accounted for another 19%). And it’s just the beginning for growth in the category: e-commerce comprised just 3.3% of total retail sales in 2008, up from 2% in 2004.

Credit Cards
The concept of a charge card dates back to the 1920s in the United States, when it was used to sell fuel to the nascent market of automobile owners. In 1938, companies started to accept each other’s cards. Yet it wasn’t until Bank of America Corp. launched “BankAmericard” in 1958 did the modern day concept of the credit card exist. This was the first product of revolving credit that was issued by a third-party bank and accepted by a large number of merchants.
Until then, cards tended to be issued by merchants and were accepted by only a handful of other retailers. Later, a group of banks in 1966 issued Master Charge to compete with BankAmericard, the precursor to the Visa® system. MasterCharge evolved into MasterCard®.

Visa and MasterCard were originally owned by groups of banks; they now have been spun off as separate, publicly-traded companies. Risk, from a cardholder perspective, is borne by the banks that use the brands on the cards they issue. In the credit card world, there are also card brands that act as issuers themselves – American Express® and Discover® – and those companies assume the risk of extending credit to their cardholders. However, since a 2004 Supreme Court ruling in Discover’s favor upheld a lower court’s ruling that Visa and MasterCard could not prevent their issuing banks from also issuing a Discover card, Discover and American Express have moved to create open loop environments where banks can issue their cards.

Credit cards are accepted by most merchant types; historically, they were most frequently used for discretionary and luxury purchases such as travel and entertainment, department stores, and restaurants. They were also commonly used to purchase gasoline. In the 1980s and 1990s, they became a popular option for customers at discount stores, grocery stores and drug stores.
Credit cardholders carry an average of four credit cards in their wallet, but use just 2.2 of them in a given month. Visa represents 43% of all general purpose cards carried, while MasterCard holds 36% of the market share. About 54% of cardholders pay their balances in full, versus 46% who carry a balance (these are also known as “revolvers”).

Rewards have also become a popular feature. About 76% of credit cardholders receive rewards on at least one card, with 51% saying the rewards have a strong impact on usage. All told, 58% of all credit cards
earn rewards.

Debit Cards
Debit now ranks as consumers’ favorite way to pay, with 38% saying they prefer the method for in-store transactions, followed by cash and credit cards at 28%. Debit remains most popular in its traditional venues: grocery stores, drug stores, and discount stores, yet it is also a popular choice at department stores, gas/convenience stores and restaurants.

In fact, debit cards have become so popular they have begun to overtake credit in the United States in terms of dollar volume. For example, Visa debit cards generated $1.09 billion in volume in the fourth quarter 2008, compared with $952 million for the network’s credit cards, according to a Mercator study.
This dovetails with the first year-over-year decline on record of consumer revolving credit, which fell to $931 billion in 2009, down from $963 billion in 2008. Time will tell if this is due to the recent recession or a sign of a more permanent trend.

Signature Debit vs. PIN Debit
Debit cards, which are linked to customers’ checking accounts at banks, come in two forms:
signature-based and PIN-based. Both capabilities typically reside on the same card. Signature-based debit
transactions (also known as “offline debit”) tend to be routed through either MasterCard or Visa, much like a credit card transaction. These transactions are debited from a customer’s account about two days after the purchase – similar to credit transactions. The process uses two separate messages for authorization, clearing and settlement. Consumers typically do not pay a fee for signature-based transactions, and the logo for the association is on the front of the card.

PIN-based debit (also known as “online debit”) requires the consumer to enter a personal identification number – four to 12 digits long – at the point of sale (POS); the transaction is then routed through electronic-funds-transfer (EFT) networks such as STAR®, Pulse®, NYCE®, MAC®, and SHAZAM®. These all require users to enter a PIN for both ATM and POS transactions. PIN transactions also can be run through EFT networks at MasterCard (Maestro®) and Visa (Interlink®). The PIN-based format uses a single message for authorization, clearing and settlement. Unlike signature debit, the customer’s checking account is debited immediately, much like an ATM withdrawal. And also similar to an ATM withdrawal, the issuing bank may charge the customer a fee to make a POS purchase.

Yet for merchants, fees for accepting PIN-based debit transactions have historically been lower than those for the signature-based option – the need for a valid PIN combined with the immediate debiting of funds makes them less risky, thereby translating to a lower cost. Signature-based debit cards, on the other hand, come with higher fees to account for their greater risk, in part due to the chance that the user might be forging a signature.

And that’s why Merchants are accepting Credit and Debit Cards more and more today.

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