• Daniel Hough
  • George Simotas
  • Kim Allin
  • John Hansen
Oct 20, 2010

Shifting to Debit

Changes in consumer spending habits in response to the tough economy and the increasing reach of debit card technology have helped to shape the consumer payments landscape over the past two years.  As debit usage continued its explosive growth, consumers dialed down their use of credit and paper checks moved closer to extinction. Some trends were less clear, however. Despite a lot of industry publicity, the promise of contactless and mobile payments remains unfulfilled and still in flux.

These are some of the key findings from the 2010 Hitachi/BAI Consumer Payments Preference Study. Conducted jointly by BAI Research and Hitachi Consulting, this primary research study looked at the key trends in consumer payments, the underlying factors that impact consumer behaviors when it comes to paying for goods and services and the implications for financial services institutions that provide those payment options.

The 2010 study, sponsored by First Data Corp., Fidelity Information Services, MasterCard, PULSE, and U.S. Bancorp, built on previous waves of the same study conducted in 1999, 2001, 2003, 2005 and 2008 to track consumer payment behaviors over the past decade involving cash, checks, credit cards, debit cards and gift/prepaid cards. The research also explored consumer payment attitudes and behavior online.

Debit Surge

Since 1999, payment for purchases at retail sites and online has changed dramatically as consumers moved away from paper-based payments like checks and, to a lesser extent, cash. The majority of consumers over that time migrated to debit cards, whether that involved signatures, entering a Personal Identification Number (PIN) or simply swiping the card through a card reader. The shift to debit fundamentally changed the way consumers conducted point-of-purchase transactions in stores.

In 1999, only one out of five consumers used a debit card for in-store purchases. By 2005, the use of debit cards for such transactions equaled that of cash, with a third of consumers saying they preferred to use a debit card (PIN or signature) and the same proportion opting for cash. The rapid increase in debit card usage continued to be seen in the two waves of the study since then (2008 and 2010), with debit cards becoming the dominant payment option for consumers; 42% of whom say they would rather use debit than any other type of payment.

The drivers behind debit usage – which vary little across all age groups – are the consumer’s ability to control their expenses and perceived safety and security aspects compared to other payment products. Safety and security correlate to consumer preference of PIN over signature debit, 46% to 34%, with 20% having no preference between the two types. These preferences have changed little since 2005.

We suggest that banks use these perceptions in their marketing messages to encourage debit activation and utilization as PIN debit is a less costly transaction to process than signature. The pace of growth in debit usage has more than doubled since 2005, from 6% to 14% in 2010. In addition, consumers expect to increase their usage of debit for Internet purchases more than any other payment product.

Another long-standing trend that continued in 2010 is the decline of check usage, with only 5% of consumers identifying this as the payment choice used most often in a store or retail environment. This very low incidence of check usage in 2010 stands in stark contrast to 10 years ago, when 18% indicated this as their preferred payment option. The sharp decline in check usage should cause financial institutions to look at outsourcing opportunities to convert increasingly expensive in-house check processing fixed costs to a more flexible, variable cost model.

Layered on top of these long-term trends, the 2010 study also found some new trends suggesting unique circumstances at work in the current consumer payments landscape, notably a decline in credit card usage. While the drop in check usage has been a consistent pattern as people moved to debit cards, credit usage had stayed fairly steady over the last few waves of the study. In 2010, however, credit cards as the preferred payment option in stores fell below 20% for only the second time since 1999, suggesting that the pressures of a bad economy encouraged consumers to steer clear of credit and rely more on payment options that help them control spending levels, such as debit.

Additionally, “pay-in-full” consumers increased from 62% in 2008 to 68% in 2010, adding further evidence of consumer desire to manage to a budget (and causing additional deterioration in the ability of issuers to earn interest income). The biggest increase in “pay-in-full” consumers came from the 35- to 54-year old age group, which jumped from 51% in 2005 to 61% in 2010. This percentage is in line with the 18- to 34-year age group, which changed little since 2008. The over 55-year old age group is one that issuers may want to de-emphasize in their acquisition plans as their “pay-in-full” percentage is 77%, having risen from 73% in 2008.

All signs point to this trend continuing, not only because the economic recovery remains stuck in neutral and consumers are cautious about their personal finances, but also because of recent regulatory changes impacting credit cards. Starting with the Credit Card Reform Act of 2009, credit card issuers have faced a whole new set of rules restricting what they can charge customers for using their credit cards when it comes to establishing or changing interest rates, enrollment and annual fees and punitive charges such as late or over limit fees. The net result has been a sharp curtailment of revenue for issuers.

The likely result of these forces is a reduction in rewards and incentive programs as issuers cut back on what they spend to motivate card usage. Surprisingly, although 21% indicated that they receive rewards for debit usage, approximately 64% said their debit usage is not very influenced by the rewards they receive. This should cause banks to question the economic payback of debit rewards and assess whether to continue offering them in their current form, or, at all.

Changes to Regulation E will curtail opportunities for banks to assess overdraft fees and provide another driver for reduced revenue. This could, however, have a positive impact, as well, as it could encourage consumers to increase their debit usage. Consumers who are worried about overdraft fees can “opt out” of having them assessed and accept a decline at the point of sale. Although this has already caused an increase in debit authorization declines, consumers who wish to control their spending limits will have another mechanism to help them. 

Going Mobile? Not Yet

Notable in this year’s study is the absence of a break-through payment channel, which many thought would be mobile payments. Despite all the hype from network providers, banks and the media, we did not see the promise of mobile payments realized in any significant way. While 5% of consumers say they currently hold a mobile payment device, only 1% used it for an in-store purchase. Banks should exert caution and take a “wait and see” when introducing mobile into their payment channel mix as 88% of consumers indicate they have no intention of using mobile for payments in the next two years.

Contactless payment options – whether cards with chips embedded, using a keychain with Radio Frequency Identification (RFID), or having a chip in or attached to a mobile device – have likewise failed to gain wide acceptance. Only 11% of consumers said they own a contactless device and less than 1% actually use it to buy things.

Noteworthy, however, is the growth of person-to-person (P2P) payments and, to a lesser extent, prepaid cards, primarily when it comes to purchases over the Internet. On the strength of activity from PayPal, the use of P2P payment options among those who made at least one online purchase grew from 49% of online purchases in 2008 to 62% in just two years, placing second only to credit cards as the predominant online payment option. With the potential for PayPal making inroads into offering their payment products for in-store purchases, banks should be concerned about losing fee income and deposit balances. One way for banks to mitigate this threat is to further use relationship pricing schemes to incent businesses to drive more balances to them.

Prepaid cards, whether gift cards or pre-loaded debit cards, have also seen increased usage over the past two years for online payments, growing from 32% of consumers using them in 2008 to 45% by 2010. As we’ve seen for in-store purchases, credit card usage for online buying is starting to erode, from 84% in 2008 to 81% this year, a trend likely to continue for the same reasons in-store usage is dropping.

All in all, the driving force behind change in consumer payments for the last two years has been less about technology and more about economic forces and government regulation.

Mr. Hough is director of strategic research for BAI. He can be reached at dhough@bai.org. Mr. Simotas and Mr. Hansen are directors and Ms. Allin a senior manager for Hitachi Consulting’s national financial services practice. Simotas can be reached at GSimotas@hitachiconsulting.com, Hansen at JLHansen@hitachiconsulting.com, and Allin at KAllin@hitachiconsulting.com.

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