One of the most controversial fees within the four-party card system is the interchange fee.  In the next few paragraphs we will review what interchange fees are, why they are in place and ways in which they may evolve in the future.



Card Network Fees and Interchange Flow over a Four-Party System

The figure below illustrates a typical transaction over a four-party system.

Note to Illustration: There are other fees charged by the acquirer, issuer and network that are paid on a regular basis (monthly or yearly) not included in this illustration and not discussed in this blog.

Edit (06.10.2012) - Note II to Illustration:  Interchange fees flow from the Acquirer to the Issuer through the Network, without the Network keeping any part of it.

Focusing on the fees involved in every payment card transaction:  
1)  Interchange fee:  Interchange flows from the acquiring bank to the issuing bank on purchase transactions and is entirely covered by the merchant (main element of the merchant discount fee).  Interchange is applied on a transaction-by-transaction bases and depends on many variables including the purchase amount, card type and merchant type.  

The rationale for this fee rests on the concept that the merchant (and the acquiring bank) benefits from the use of the card; meanwhile the card issuer incurs costs in making this use possible.  With interchange, the merchant, as the beneficiary of the service, compensates the issuer for the costs and expenses it incurs to generate this benefit.  

2)  Switch (or assessment) fee:  Fees paid by the acquirer and issuer to the network on each transaction.  These fees will cover the real-time authorization and the end-of-day (or batch) clearing/settlement of the transaction.

3)  Card usage fee:  In some cases consumers pay fees in card transactions to receive rewards.

4)  Merchant discount fee:  Acquirers typically quote prices to merchants based on 'interchange plus' pricing.  This means that interchange fees, along with card network switch fees, are passed through to the merchant with the acquirer's additional fees priced on top.  Interchange fees can account for over 80% of the merchant discount fee.  

Why is Interchange controversial?

Although the arguments are complex, some of the key points to consider are:

1)  Interchange are non-negotiable fees paid by the acquirer to the issuer and set by the network.  Fees will vary based on a number of factors including type and size of merchant, size of purchase and type of card (refer to the graph below).  The fact that the fees are defined and enforced by a third-party raises pricing concerns.     

2)  Once a merchant agrees to accept cards from a certain network, it will need to accept all cards (honor-all-cards rule) and cannot surcharge (no-surcharge rule).  

This means the merchant will need to cover all levels of interchange fees (i.e. fees associated with premium and standard credit cards and also signature and PIN debit cards) and will not be able to use surcharge to modify customer behavior by directing them towards cheaper (and more efficient) methods of payment. 

Edit (06/10/2012):  This rule has been softened in recent years in some states across the US and some countries across the world (such as The Netherlands and Australia).  It is interesting to note that, in most countries where the rule has changed, few merchants have taken the opportunity to apply surcharges in an attempt to influence customer behavior. It may be that customers’ expectations with regards to card usage are so ingrained that retailers fear a backslash.  For example, if faced with higher prices at a store to use, for example, a MasterCard card, will the consumer just use a different card (if he does indeed have another card)?  Will he look for it at another store?  How many impulse purchases will be lost?  There may be too many unknowns for retailers to feel comfortable with experimentation, particularly within the current economic environment.

3)   Although interchange is independent of the issuer, it is meant to help issuer costs and expenses associated with the provision of the service that are difficult to measure and that will be different for each issuer.  Examples of the costs / expenses it is meant to cover:

a.  Cost of guarantee - Payment to the merchant is guaranteed.
b.  Cost of funds - The merchant receives payment before the issuer does.
c.  Operating expenses.
d.  Marketing:  Main costs relate to reward programs.

4)   Interchange should also be in-line with the benefit the merchant receives from the use of the cards (i.e. increased number of transactions and ticket size), which is also difficult to measure.

5)   The network competition for issuance leads to rising, rather than falling, interchange prices. 
Although for a network to be successful it needs to have consumers and merchants on board, it views the consumers as the key drivers in network expansion.  For this reason, it values issuers, with their distribution capabilities, as its key customers. 
With interchange, the network’s customers (the issuing banks that decide which network to use) receive the price that the network sets.  That is, the network's customer is paid, rather than pays, for the service. 
In order to attract more issuers, the network will raise interchange fees, so that banks can develop more attractive card programs.  This will immediately increase the cost for merchants.

Next week we will cover possible policy interventions for the payment cards industry to solve the issues surrounding interchange fees.  The list of options we will discuss include actions taken and / or discussed by authorities around the world.



Sources:
1)  'Payments Systems in the U.S. - A Guide for the Payments Professional' by C. Coye Benson and Scott Loftesness.  Glenbrook Payment Essentials.
2)  'Finance and Economics Discussion Series.  Division of Research & Statistics and Monetary Affairs.  Federal Reserve Board, Washington, D.C. - Interchange Fees and Payment Card Networks:  Economics, Industry Developments, and Policy Issues' by Robin A. Prager, Mark D. Manuszak, Elizabeth K. Kiser and Ron Borzekowski.
3)  'Theory of Credit Card Networks:  A Survey of the Literature' by Sujit Chakravorti from the Federal Reserve Bank of Chicago.
4)  'Working Paper 03-10.  An Introduction to the Economics of Payment card Networks' by Robert M. Hunt from the Federal Reserve Bank of Philadelphia.

Although I asked many questions and did on-line research before deciding to go ahead with surgery, I was utterly unprepared for the seriousness of some of the complications I suffered which, it must be said, are relatively common.  What should I have done to be better prepared?  How could I have been more thorough with my research?

I backtracked my steps and reviewed the websites I had used to help me learn more about pancreatic laparoscopy or distal pancreatectomy.   Some examples of pages I used are:

1)   eHealth Forum – This site, and other similar forums, give you a good sample of individual experiences.  Although you do learn about the types of possible complications and some specific treatments, it is difficult to get an idea of the probability, seriousness and most likely outcome of the possible complications.  

2)   Georgetown University – I found this site, and other university and hospital web pages, very helpful since the information is well organized and very structured.  At the same time, although there was a thorough list of possible complications, neither the probability nor the seriousness or the consequences, were specified.  

3)   Annals of Surgery – I have listed this website to represent the large number of medical papers available online.  I found this to be a good source of statistics regarding types of surgeries performed, types of complications and likely outcomes.  However, the intended audience for these papers is doctors and researchers, which makes it difficult for the average person to follow.

I had used all these different resources and then tried to piece all the bits of data together to make an informed decision.  I know that undergoing surgery was the right decision – there seems to be a general consensus regarding the importance of removing any pancreatic tumor, whether benign or malignant – but I had not managed to piece the information together to prepare me for what happened as a result of it.  Is there a website that could have helped me further?

While pondering this question, I stumbled upon PatientsLikeMe.  This company, (5) co-founded in 2004 by three MIT engineers (brothers Benjamin and James Heywood and longtime friend Jeff Cole).  It has been recognized in Fast Company’s 2010 50 Most Innovative Companies in the World and again featured as a new MIT Technology Review 50 Company in 2012,  only two of the many awards and mentions PatienstLikeMe has received since its inception.

It covers over 500 chronic conditions from depression and epilepsy to ALS and MS.    It does not cover the type of issue I was researching (i.e. surgery of a benign pancreatic tumor) since it is not a chronic condition but I wanted to test the concept.  What can you do in this website?

1)   Members report their personal experiences over time both from a qualitative and quantitative perspective.  For example, you can log your condition, when it developed, current and past symptoms and their evolution, medicines used (including amount and cost) and many other useful bits of info.  This allows for somebody with a similar condition and evolution to directly learn from another person’s experience over time and even contact him / her to exchange ideas. 

2)   Users are also asked to numerically describe the severity of their symptoms, along with the benefits and side-effects from the medicines they are taking.  This allows the website to build ‘statistics’ on symptoms, medicines and any other relevant piece of information.  This information is displayed in a very friendly, usable and easy to understand manner. 

As an example of the power of this information gathering process, PatientsLikeMe has published a patient driven study – based on data contributed by 596 patients it refuts a previous paper suggesting that lithium could help people with amyotrophic lateral sclerosis (also known as Lou Gehrig’s disease).  The findings, published online in the journal 'Nature Biotechnology', highlight how social networking could play a role in clinical trials and enable patients to explore medical questions most relevant to them.  Jamie Heywood the PatientsLikeMe Co-Founder Stated, “While not a replacement for the gold standard double bind clinical trial, the platform can provide supplementary data to support effective decision-making in medicine and discovery.  Patients win when reliable data is made available sooner.”  Many in the scientific community, such as Lee Hartwell (Nobel Prize in 'Physiology or Medicine' 2001), have praised this initiative and believe “the approach has tremendous potential.”

Just as impressive is the fact that the founders, as part of this study and using the wealth of information shared by the site’s members, have built models that predict disease progression in individuals with certain characteristics, incorporating variables like age, gender, disease severity and time since diagnosis.  Although this is still being debated, the company defends that these models allow researchers to predict the course of an individual’s disease more accurately than the standard prognostic tools.  “We can predict when a patient will die 16 months ahead of time, compared to the typical doctor report of ‘you have two to five years to live’”, stated Heywood.

Obviously, PatientsLikeMe is only possible because of user commitment to the site, which is likely to be highest among chronic patients who, over time, need to develop into expert patients to best manage their condition.  It will be difficult to motivate ‘transitory patients’ (i.e. those that, after a few months of convalescence, will make a full recovery) to become as involved in data gathering and analysis but, at the same time, it would be just as helpful and relevant.  

The next few posts will be focused on Health Information Technology (HIT), a newly found interest of mine brought on by a recent personal experience.

Two months ago I was admitted to hospital to have a small benign tumor removed from my pancreas. Due to a number of complications, what was supposed to be a 4-day hospital stay with a 2 to 4 week recovery time turned into a 5 week hospital stay with a 2- to 3-month recovery time.  Happily I am on my way to making a full recovery and that this experience will soon just be a distant memory.

I have found myself thinking about the role that technology played in my experience – before, during and after hospitalization – and how it could have been used better.  I started researching this topic with the objective of answering three main questions:

1) Before hospitalization, what resources should I have used to better understand and gauge the risks associated with pancreatic surgery?  Furthermore, could I build a list of reliable and thorough on-line resources that would help me make more informed decision in the future?

2) During and after hospitalization, how are hospitals, pharmaceutical and health-care companies using technology to improve the lives of patients?  And, just as importantly, how are the U.S. Federal Government and its Department of Health promoting innovation in this field?

3) Thinking specifically about pancreatic issues, what technologies are available to make everyday life easier for those with a non-fully-functional pancreas?

I will devote one blog to answer each of these questions and will post them in the coming days. This is the first time that I cover Health IT here but I believe it will not be the last!