Zero MDR: Impact on small businesses
Ahmedabad is an interesting city for many reasons. But on that day, I was destined to be at the prestigious Indian Institute of Management for interaction with the students perhaps for encouraging them to take up entrepreneurship. The hall was named after the founders of TaxiForSure (acquired by Ola) “Raghunandan and Aprameya”. Fabulous!
It was on the 5th of July. The Finance Minister was presenting the budget in the Parliament. While we know that Digital Payments is an agenda that is very close to this Government, what did come out of the budget was quite a surprise.
During my conversation with the students, someone pointed out the announcement of Zero MDR and asked what I thought of it.
For more than a year now, Govt has been subsidising MDR (Merchant Discount Rate — aggregate transaction fee paid by the merchant) for transactions less than 2000 rupees and paid with a Debit instrument such as Debit card or UPI. The new announcement extends this further and removes the MDR altogether for all band of transactions paid using debit instruments.
I couldn’t really wrap my head around this at that time. It took a while to think through the whole picture and the implications. It's a long one, so please bear with me and grab a cup of coffee!
Subsidy economics
The Law of Demand dictates that if the price of a product goes down, then the quantity demand of the product goes high. Mostly though!
The twin forces that drive an economy are the supply and demand. But we are operating in a regulated area, so this is as complicated as it can get!
We can remove most of the other variables, and make the argument simple: since we are reducing the pricing of digital payments acceptance, quantity demand should automatically go up.
If only things were very simple, life would be so easy! Digital Payments ecosystem is anything but simple. There are several forces acting in this ecosystem and any pricing distortions will change the dynamics significantly. A friend of mine who was a veteran banker once said that Visa / Mastercard networks employ well qualified (PhD) economists to simulate experiments, measure various outcomes, before arriving at any pricing related decision.
Understanding the market divisions
A fair share of my transactions is conducted online. Seeing the market cap of companies like Amazon, and the valuation of companies like Flipkart, I am fairly convinced that a lot of people are like me. They like to buy stuff online. And of course, we go to restaurants, movies and do a lot of stuff offline as well!
So the market can be broadly segmented as online & offline. Given the growth of the online economy such as e-commerce & sharing economy, it has become an essential part of our life. The online economy relies heavily on the digital payments infrastructure to grow their business. This is akin to having electricity and water. Hence, for all our further discussion, we can safely say that the online economy will be an all-weather ally for digital payments.
In the offline economy, we can broadly segment into two categories: large format vs single store. Large format constitutes stores operated by big businesses such as BigBazaar, Domino’s, DMart, Hotel Saravana Bhavan, Lifestyle, Titan, etc.. Whereas the small ones are typically your Mom & Pop stores operated in a single store format. All the neighbourhood convenience stores, medical shops, hardware shops, bakeries fall into this category.
Acceptance Matrix
It is almost impossible to find a DMart store or a BigBazaar store that doesn’t have a POS machine at the checkout counter. On the other hand, it is very difficult to find a neighbourhood convenience store that has a POS machine and accepts card transactions. This is very telling from the number of POS machines that are deployed in the country. And there are a variety of reasons as to why this is the situation today.
Large-format stores attract a lot of credit card users. And it's proven (at least not yet unproven) that credit card users spend more than they actually intend to spend (due to various behavioural reasons). And also, credit card users will insist on paying with cards only. Hence, large format stores have no choice but to support digital payments. There is yet another compelling reason. Cash handling is very expensive and mismanagement of cash is a real issue. For these reasons, they have become ardent supporters of digital payments.
On the other hand, the dynamics of a small store is very different. Cash handling is not a problem and too few users expect credit cards. Since these are convenience stores, there is no scope of doing additional business with credit card acceptance. There could be many other reasons. What is very clear is that small stores don’t have POS machines and don’t seem to want POS machines. But we are quite adamant that we want them also to have POS machines (or QR codes) and accept digital payments.
Now that we have established where the majority of the problem is, let us try and understand the pricing aspects of digital payments acceptance. This is crucial for finding out the reasons why the small-format stores are reluctant to accept digital payments.
Pricing aspects of digital payments acceptance
There are two key pricing aspects to digital payments acceptance: (1) cost of a typical Point of Sale device (2) transaction charges. The capex charges are frequently converted to opex and are charged as a monthly rental on the device. The argument here is that of buying vs renting (we are not going to delve deeper into that). Since rental is the most prevalent, we will assume that as the market choice.
To know the other costs associated with the POS machines, please proceed here. I am not singling out any bank here, most other banks have a similar schedule of charges. It is not a happy thought to imagine a small store owner trying to make sense of the schedule of charges. His experience will tell him that all the fine print is going to cost him a lot!
Banks make it incredibly difficult to understand the pricing. Also, charging for statements, dashboard, etc. are extremely annoying. These are expected to be free. Since Banks have the compulsion to make money (due to the org structure), they resort to such hidden charges. Market disruption will take care of these & so I am going to discount them altogether. (If anything, the Govt could have mandated banks to simplify pricing.)
For the purpose of analysis, we are going to make some broad assumptions. Most of the numbers are close approximate rather than being entirely accurate.
The device rental cost is incidental, in that the Banks or Companies selling the POS machines usually don’t make it themselves. They get it from vendors like Verifone or Ingenico. Hence, a substantial part of the money from that goes to the manufacturer of these machines.
The column “Debit MDR @ 0.5%” is the one that the Govt is planning to subsidise. A related point is that who is going to subsidise this. There is no clarity on that as of today, so we will leave it for another day...
The other column that you need to pay attention to is the one labelled “Acquirer Margin on Debit”. This is the money that the company (or Bank) which is selling POS to the merchant outlet makes from Debit transactions. The rest of the money from the Debit MDR goes to the ecosystem (card issuing bank and network like Visa/Mastercard/Rupay).
The sustainability question of serving Small MSME
From the numbers, it is evident why no one is interested in selling POS machines to small merchants. At 60 to 100 rupees a month, it is impossible to run a sustainable organization without a great level of automation. The POS business hasn’t reached that level of automation. Rajeev from Innoviti put this aptly in one of the conversations: “People are very comfortable unboxing their mobile phones and figuring their way out with setting it up. But most are scared to touch the POS machines. Without expert help, merchants are unwilling to set up POS machines”. Thus making the whole exercise very expensive. Companies like Square tackled this with innovative design. But it has remained a challenge in India.
Does Zero MDR really benefit small MSME
MDR charges increase linearly with the size of the store. Thus, it is far more beneficial for large format stores with a high number and/or value of transactions. The difference is in fact more telling at 10x for Large Format stores compared to small MSMEs. But these stores already accept digital payments.
The real problem is with the rental charges rather than the MDR itself. That fixed cost is far more stinging for a small MSME than the MDR charges. With the rental cost, a small MSME is being asked to take a big leap without any guarantee of returns. Paying 500 rupees for POS machine every month, can they generate a tangible increase in sales which makes them, say 600 rupees? Isn’t that how a businessman thinks? Unless we answer that question, we simply cannot demand the Mom & Pop stores to deploy POS machine.
Our excessive focus on cost & pricing has diverted our energy from seeking value creation. Look no further than JustDial and Zomato to understand this. Small business establishments pay as much as 6000 rupees per month for listing in these platforms. But they do so because they see tremendous value in these platforms. Instead of treating this as an expense, they treat it as an investment, because it generates additional revenue.
Subsidy as the cure for Market Failure?
Stores can pay, if they see the value. No one can refute that. In the case of POS machines, there is no tangible proof that stores will see increased sales by deploying POS. If this had been the case, they themselves would have done it. When we cannot bring creativity to the market, the subsidy is the answer to drive behavioural change. To that limited extent, the Govt’s move is welcome. Let us then establish very clearly that POS companies have so far failed to provide value additions over & beyond just acceptance.
Can POS companies provide additional value?
This is easier said than done. Hardware iterations take time & need patient capital. We do have favourable conditions though. As Kunal Shah likes to say, “we have a CTO in every household, who knows how to use a smartphone”, I say “we have a waiting-to-be CTO in every small MSME”. As younger people take over their parents’ business, they will be far more willing to embrace technology. They will be more tech-savvy and would even start directing the market. So, I am optimistic about the future & firmly believe that the market will itself move towards digital payments.
Companies like Square have given themselves tonnes of capital, manpower and time to solve the MSME POS problem. It is unrealistic to expect similar output with a very small fraction of the risk capital available with companies here. We try nonetheless.
I wish the Govt had more faith in us, the scrappy entrepreneurs, to provide a market-based solution within the current parameters, instead of rushing in with their own brush strokes, the contours of which are now difficult to fathom. There are now ripples in the water and the picture is distorted. Hope, clarity returns quickly and we can all go back to business.
