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What is Least Cost Routing of payments and its benefits to merchants?

Updated: Oct 18, 2023

Least-cost routing or merchant-choice routing as it is sometimes known is becoming increasingly attractive for businesses looking to reduce costs across their payment channels. It is an initiative that will provide merchants with the choice to determine how their debit transactions will be processed, allowing them to choose the cheapest option available (assuming they are technically enabled to leverage this emerging capability).

The push towards least-cost routing has gained increased focus in Australia with government reports calling on banks and payment providers to provide merchants with the service. In the House of Representatives Standing Committee on Economics Third Report on the Review of the Four Major Banks, it is recommended that “banks be required to give merchants the ability to send tap-and-go payments from dual-network debit cards through the channel of their choice. Merchants should be able to choose whether to route these transactions through eftpos or another channel”.

In the Productivity Commission Draft Report on Competition in the Australian Financial System, it is recommended that “to give merchants some control over their payments system costs, merchants should be given the capacity to select their own default route that is to be used for payments by dual network cards.”

What is least-cost routing exactly?

When a customer purchases from a merchant with a card payment, the customer has the choice of using either a debit card (from cheque and savings accounts via Eftpos) or a credit card (Visa and Mastercard). Merchants without least-cost routing are not able to choose how their debit transactions will be processed, in most cases, they are processed via the more expensive credit card processing network (Visa and Mastercard) instead of via Eftpos (via processing payment gateway channels such as IPSI).

Least-cost routing enabled payment services, allow merchants to choose which network is used to process their debit transactions, allowing them to select the network which costs them the least. When you are processing millions of dollars in sales, a small reduction in processing costs for each transaction can lead to significant savings for merchants, which is why least-cost routing is gaining attention in Australia.

Payment Networks and Service Fees

To further understand least-cost routing, it’s essential to look at the payment ecosystem in more detail and how payments flow within the system and which stakeholders are involved in the transaction.

There are roughly two sides to the payment flow. The merchant side that consists of the acquirer and the merchant and the cardholder (or consumer) side that represents the issuer and cardholder. Connecting these two is the payment provider networks and card schemes such as Visa and Mastercard.

Choosing the right payment network provider

Merchants are charged by the bank or the payment provider network for this service. These costs are often passed onto the customer in terms of higher prices for goods and services. Therefore, it is in both the merchants and the consumers’ interest to keep fees low. Merchant fees can vary depending on the type of network used and whether it was a credit or debit transaction. Merchant fees typically include service fees, POS terminal rentals, and fraud prevention-related costs.

Australia has three major payment card networks, namely Eftpos, and the Visa and Mastercard network. Many debit cards in Australia support dual payment networks such as Eftpos which is the local payment network and an international one such as Visa or Mastercard. The merchant fees vary on all three networks, and according to the RBA;

For many merchants, payments via the Eftpos network can be significantly less expensive than payments via the Debit Mastercard or Visa Debit networks.”

In the case of instore payments, many incumbent systems leave the choice of network to the consumer. When a card is inserted into the POS, the consumer can select the preferred network CHQ/SAV for Eftpos or credit for an international network. By default though the network is set to the payment network that issued the card.

In the case of online payment processing, most merchants do not have the ability to leverage least-cost routing.

The need for least-cost routing came to the fore with the introduction of contactless payment or what is known as ‘tap and go’. While it is seamless, smooth and convenient, most consumers don’t select or have access to the least-cost payment option. On top of that, many contactless cards are only supported by Visa and Mastercard networks, which are relatively more expensive.

Regulatory push for Least-Cost Routing

In keeping with open innovation objective and the rights of merchants, many government reports have pointed out the need to support least-cost routing for debit cards. Many big banks now provide a stop-gap arrangement. In this arrangement, during the initial setup of the terminal, the merchant can choose the default payment network. However, many merchants prefer Eftpos for amounts smaller than $25 and Visa or Mastercard for higher values as that is the most optimum cost for them (most online systems are not built to handle these dynamic business rules).

The RBA’s Payments System Board is charged with promoting competition and efficiency in the Australian payments system and is overseeing industry progress and support for least cost routing. According to the RBA, the four big banks have committed to completing the technical work required to make least-cost routing generally available (at the time of writing this is still some time away).

How can a merchant access least-cost routing?

Access to least-cost routing requires a flexible payment service that provides the merchant with the ability to select how transactions are processed. Unfortunately, many organisations have legacy payment systems that lack the capability to dynamically choose between payment networks and as such are unable to deliver the cost savings associated with least cost routing.

One of the main challenges for organisations is accessing online least-cost routing across multiple payment channels, which may include online, mobile, IVR and payment via call centres.

If you’re interested and would like to discuss online least-cost routing, and the technical options available please contact us at [email protected] or call 1300 975 630.


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