Reward System

With the recent ruling from the Federal Reserve regarding the implementation of the Durbin Amendment to the 2010 Dodd-Frank Act, many retailers will be paying banks less when a customer uses a bank-issued debit card. That could free up additional funding to support some type of merchant-funded reward program, making it to a retailer’s benefit to convince those customers who like to pay with plastic that debit is the way to go.

Additionally, since the Durbin Amendment passed, several banks have announced that they are dropping some reward programs on debit cards — and, in some cases, charging customers who use debit cards. These actions could present an opportunity for retailers to implement their own reward offerings or join networks that offer consumers rewards specifically when a retailer has a lift in sales.

“The Durbin amendment represents a great opportunity for merchant-funded reward initiatives,” says Bob Legters, vice president of loyalty services for Jacksonville, Fla.-based FIS. “Consumers are demanding extra value based on their card choice today. If they can get extra value by using a card at a particular retailer, that retailer will get additional business.”

There is evidence that consumers want to be rewarded for their card choice. Pat Morgan, director of marketing for Coconut Creek, Fla.-based National Payment Card Association (NPCA), says research shows that consumers are split as to whether they would change their shopping habits if rewards on bank debit cards went away. But, she points out, that also means there remains a group of consumers who are swayed by reward programs, and retailers that offer their own rewards could gain new customers and a higher share of individual consumers’ wallets.

“If the banks drop their reward programs, some will simply go to another bank,” Morgan says. “But it is difficult to change banks, and some consumers will look for other options. If there is a merchant-branded reward program available, it could attract those customers.”

Avoid reactionary rewards
While merchant-funded reward programs may be an effective way for retailers to increase sales, retailers should be cautious not to overreact to bank activities, says Mallory Duncan, NRF senior vice president and general counsel. “Merchants should not be driven by what the banks are doing, nor should they try to replicate what the banks are offering.”

Each retailer should examine their own situation and decide whether some type of reward program would benefit their operations, Duncan says, but a reward program should not be implemented purely in reaction to a void in bank offerings.

Duncan points out that most debit card rewards were “miniscule” compared with credit card rewards, and that a number of banks are testing their phase-out — dropping them in certain states or on certain types of bank accounts. It is not clear what the long-term strategy is yet, he says.

There are several ways in which retailers can reward consumers for using debit cards. In some cases, merchants issue their own proprietary debit cards and then reward customers who use those cards in the store. In other cases, merchants join coalitions where a bank signs up retailers for a large-scale reward program. Participating retailers’ names are posted on the bank’s website and in flyers; when a customer uses a debit card issued by that bank at a participating retailer, she receives a reward from the retailer. The retailers pay for the cost of the reward and share in the marketing expenses.

The logic behind these network programs is that the cost of the reward is funded by the savings incurred because the customer used debit instead of credit. But more importantly, it is expected that the program will drive additional business to participating retailers because customers can only receive rewards at those stores. That differs from previous bank programs where retailers ultimately were paying for the rewards, but there was no incentive for a customer to shop at their particular store.

FIS sponsors merchant reward programs that connect merchants and banks that includes more than five million cardholders and merchant offers at 10,000 retail locations or online shopping sites. And Legters says there has been a big uptick in interest in the program by both financial institutions and retailers since Durbin.

The program has appeal among both large and small retailers, he says, but those retailers whose programs have recurring transactions — gasoline stations, grocery stores, convenience stores and restaurants — see the greatest benefit.

An alternative to coalitions is developing a proprietary store-branded debit card, such as Target’s well-known program. Shoppers receive a 5 percent discount when they use their Target-branded debit card. NRF’s Duncan says that programs like Target’s may be effective for retailers that offer their own financial products, but it is not for everyone: Most retailers do not want — or have the resources — to offer their own financial product.

Cost vs. benefit
NPCA has come up with a proprietary debit card offering targeted to a wide range of retailers. It currently offers this program at more than 3,500 locations. Participating retailers are as small as 10-store chains; the largest participating retailer has more than 1,000 outlets, Morgan says.

Rewards can vary. Some gasoline chains offer a 10-cent-per-gallon discount when customers use their debit card. “This type of discount is really effective at getting people to turn their car around and head for the station that offers the discount,” she says.

The cost to enroll customers and process transactions comes out to about 15 cents per transaction — still less than the 21 cents (plus .05 percent transaction fee) that the Federal Reserve Board set as a cap for bank debit card interchange, and considerably less than the 2 percent or more of the purchase price that retailers pay for credit card transactions.

Duncan cautions retailers to examine closely the total cost of any reward program. “You have to make sure that the rewards do not raise the total cost of accepting the payment or encourage a more expensive payment option.”

Duncan points to the early 1990s, when most grocery stores did not accept credit card payments. Many were convinced by the card networks to begin accepting credit to accommodate those occasional customers who asked to pay with credit. In the end, a large number of consumers began paying for groceries with credit cards and the total cost of payment card acceptance escalated for retailers.

So rather than try to replicate what banks are offering or have to fund costly rewards, retailers should look at what they can offer that would have real benefit to customers, but not be overly expensive. An example, Duncan says, is discounted delivery: It is valuable to many customers, but may not be that costly for a retailer to offer.