Payment Pulse – Ep. 49

Understand how least cost routing works, why debit transaction mix matters, and how SaaS platforms can identify opportunities to optimize payment processing costs.

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Episode Transcript

Shannon:  Welcome to Payment Pulse, the podcast where we talk with payments and SaaS leaders about the trends and strategies shaping the future of embedded payments. Today, we’re talking about least cost routing, also known as LCR. If that’s a term that you’ve heard but never really understood, we’re going to break it down.

But we’re also going to go a step further and talk about why routing and payments optimization start to matter more as a SaaS platform’s payments program grows. A lot of embedded payments programs start with a very clear goal, which is launch payments, get merchants activated, and grow transaction volume.

Once meaningful volume is there, another question becomes important: How effectively are we managing the economics and performance of the payments volume we already have? So joining me today is Mark Passifione. He is our Senior Vice President of Integrated Payments at Xplor Pay. Mark, thanks for joining me today.

Mark: Hi, Shannon. Great to see you. Great to be with you today. Excited!

Shannon: So let’s start with the basics. What is least cost routing and what problem is it designed to address?

Mark: Well, at a real basic level, the idea is that all eligible debit transactions can actually be processed on more than one available network. It’s actually part of the Durbin Amendment. Most of the people, when you think of the Durbin Act, they think of the idea that we regulated debit at a standard rate across the normal regulated banks in terms of the five basis points and the 21 cents. But the other part of the act was the idea that processors like us have to have the ability to process and product a debit transaction in more than one way. So, the interesting thing that it does is it opens up this opportunity behind the scenes where the cardholder does the same thing.

They make a payment. They don’t have to choose the network. They don’t have to decide that during checkout. The platforms on the back end, they go in and they route the transaction to various debit processors to get improved economics on the transaction, and then we have the ability to pass those economics to our customers, in our case, embedded software players, vertical SaaS companies that are using our embedded payment stack.

So it’s a nice feature because it allows us to create a cost savings without affecting price.

Shannon: Yeah, great! So to help understand why that matters, it’s helpful to understand what’s happening behind a debit transaction in the first place. But before we go deeper into that, can you explain what debit routing actually means?

Mark: Sure. It’s almost in its term, right? The idea is that we can determine to send specific debit cards to certain networks where they process at a much better rate. So an example, if you had a customer making a $50 debit purchase, and the cardholder does the same exact thing, but behind the scenes, we could send that to different debit networks that charge different costs for that transaction. Now, this really has to do with the idea of what we refer to as regulated and unregulated debit transactions. So we’ll get into a little bit later, like, what does that mean? But essentially, what we’re talking about is the size of the bank that actually issues the debit card, whether that be a regulated or unregulated debit card that’s issued.

Shannon: Okay, gotcha. So where does the least cost part come in, and why doesn’t LCR simply mean choosing the one network that’s always the cheapest?

Mark: Yeah. So least cost doesn’t mean one debit network that’s always cheaper, right? The economics vary really from transaction to transaction based on the available debit networks that we can send to, the pricing, the characteristics of the transaction, such as “Is it a card present, card not present?”

Is it for a certain niche industry that allows for a better debit option? What LCR uses is a routing strategy, right? So on the back end, what our platform would do is actually look at transactions that are eligible to route it to a different processor, and then do so based on the characteristics that I just explained: the type of transaction, the networks that’s available.

It can even come down to geography in some cases. It’s not always just about cost, because you can look at things like performance, reliability, the customer experience. There’s a lot of other factors that go into it. But the real ultimate goal is to improve the economics of the transaction, to reduce the overall interchange costs associated with an unregulated debit transaction.

Shannon: Yeah, that makes sense. So what doesn’t qualify for least cost routing and what should SaaS platforms understand about eligibility?

Mark: So this is really where the concept of regulated and unregulated comes in. The large banks that you’re all familiar with would be considered a regulated type of bank. And so there you have assets above a certain amount. They have the ability to send their cards through, and we’re gonna process those cards at five basis points and twenty-one cents. Pretty common across the entire payment, network and domain.

When you have an LCR system, it’s those other transactions that come through as debit. So these would typically be issued by a regional bank, a credit union. Those cards can then be sent to different processing networks.

So if you were to flip your card over and you see things like Cirrus and NICE and Star, those are all other networks.

Shannon: Mm hmm.

Mark: In addition to- Visa owns Interlink Network, which is the traditional way that people would put these kinda transactions through. So you could have two SaaS platforms that take the identical payment, but when you have LCR, you have the opportunity to process that at a cheaper rate for certain cards.

Not all cards are eligible, but there’s a good amount, and that’s one of the first things that we do when we talk to somebody, is we look at how much of their eligible card volume comes from these unregulated debit cards.

Shannon: So that leads to the question that most people are probably waiting for, which is: what could this actually mean economically? Let’s talk about the savings. Where can LCR create an economic opportunity, and why isn’t there one savings percentage that would apply to every payments program?

Mark: Well, simply put, LCR savings is not universal. There’s no universal way of doing it. The potential opportunity really depends on the individual payments portfolio, and again, taking into characteristics of the type of cards, how the cards are taken, the industry that they’re for, the geography that they’re in.

Savings can be influenced by all of these things: eligible debit volume, transaction mix, pricing, available networks, transaction, the characteristics of the actual customer that’s processing the transactions.

A simple way to think about it is if you had two SaaS platforms, and they’re each processing five hundred million annually, one has a much higher concentration of eligible debit transactions and more available routing options than the other. Even though the total payment volume is identical, their potential LCR opportunities could look very different just based on that mix of cards.

Before estimating the savings, you need to understand how much of the payment volume is actually eligible. So that’s really the route you have to take first to determine, okay, this is how much is debit, how much of it is eligible debit for LCR. And then, then from there you can kind of contract what you think would be the actual savings based on the routing opportunities. We also have to look at who you route that to to see what exactly those savings are. But you can, with that information, come up with a projected savings for that customer in pretty exact science.

Shannon: Mm-hmm. Okay, great. So we’ve established what LCR is and why the economics can vary. But least cost routing, it’s really only one piece of a much larger payments optimization conversation. So as payments programs mature, where does LCR fit within the larger payments optimization picture?

Mark: So typically, when a lot of new embedded partners come to us, they’re really just looking for integration. One of the big concerns they have is how quickly and how little friction can I have to get a new merchant on board and boarding. Because they just sold their software to them, in most cases, unless they’re working in their back book, and they want to get that customer into the payment rails as quickly as possible with the least amount of friction as possible.

So that’s usually the early concerns, right? Things like, I wanna have the ability to show white label concepts. I want it to be a quick and easy integration. All of those things are the early indicators when a new company comes to us. But over time, as they develop a base, it’s not just the number of attached customers they get, but it’s how much value can they extract from the attached customer without incurring price changes, right? You know, you see this in our industry all the time.The easy thing to do is just raise prices. But the reality of it is, if you can lower cost, it’s another tool that you can use in your overall strategy to drive a better mix of payments. And ultimately, as you optimize transactions, you become a much more mature player in the business.

Because what you’re doing is you’re not affecting your customer’s cost in any way. You’re just lowering the overall cost of the transaction, which in most cases you benefit from because most companies and the most vertical SaaS players these days go to market with flat rate models, meaning they’re going to market at something like, two point nine and thirty cents or two point nine and twenty-five cents.

And the idea is, if you can lower that overall cost from ninety-five cents to forty cents, you’re saving the fifty-five cents, and it’s coming to you, right? And so it’s a boon to the vertical SaaS player. In the instances where they’re selling interchange plus to their customers, you still have the benefit where you’re saving the merchant a significant amount of money.

So it’s not always just about lowering costs. The other thing is performance, reliability, the customer experience. But lower processing cost is really the outcome that most people are looking for in terms of all of the trade-offs in terms of payments.

And, this is a tool. It’s a tool similar to CEDP, which is now what we use to replace level two and level three processing. But this one is unique in that the consumer experience doesn’t change. The software partner doesn’t have to do anything different. This is all stuff that we handle on the back-end from a processing partner standpoint, because this is all done based on our back-end routing transactions to the least cost available network.

Shannon: Okay. Gotcha. So, let’s say I’m leading a SaaS platform that has meaningful payments volume. What should I be looking at, and what questions should I be asking my payments provider to make sure that we identify those optimization opportunities?

Mark: Well, I think the very first thing is you have to understand your mix, right? Like, do you take debit? Typically, we see debit used in any size transaction. I think historically people looked at this and said, “Well, the lower the average transaction cost, the more debit.”

And that’s probably still the case that you see a lot of that. There’s a lot of people who use their rewards card for everything and then pay it off at the end of the month. So there’s a lot of different scenarios. But as the actual merchant, the idea would be to look at your payments mix.

Determine how much of it is debit, first of all, and then how much of that debit qualifies for alternative routing. That’s the very first step, and like I said, things that you would think of in consideration of that kinda give you some early indicators, I think of like average transaction size, the type of transaction.

If you’re going out to a restaurant, like a quick-serve restaurant where you may be buying Mexican food and it’s forty bucks, you’re gonna see a lot more debit traffic typically in that world. And then once you determine how much eligible transactions you have in your card mix, then you can start doing some math to determine, based on the providers and the options that we have to send it to, what the economics are gonna look like. And you will get a reduction in cost. There’s no question this will turn into some sort of savings. But the other side of that is, it also depends on how you go to market.

Whether you preserve that savings or you pass that on to your merchant, there will be a savings. It’s just how does that get put in market? There’s a lot of ways to do it, but it’s not a one-and-done thing. Your transaction mix will continually change, but you do see trends by industries without question.

Like, I was saying earlier, you look at a quick-service restaurant where an average ticket might be forty dollars and below, you’re gonna see a lot of debit transactions. And the more debit transactions you see, the more likely you’re gonna have a bunch of unregulated debit transactions that we can account for.

That’s really the best steps and then you can get down to the savings to see where that’s gonna apply.

Shannon: Yeah. Okay, great! Well, to close us out, what’s one thing a SaaS platform with meaningful payments volume should look at that they’re probably not looking at today?

Mark: I would start by asking your payment provider, “What is my mix? Can you give me a report of what my mix looks like? What kind of programs do you have?” Ask them what kind of improved economic plan they have.

Do they have LCR? Do they have CEDP? Do they have the kind of things that can help save you money on these types of transactions? I like ’em both. CEDP obviously in a B2B type of world is very helpful in terms of overall reduction. But when you move into the B2C space, you tend to see in certain industries more and more debit traffic, and so LCR, least cost routing, becomes one of the valuable tools.

But you know, you start with really understanding your card mix, I think is the very first thing that you need to do, and you can do that often by getting reports from your processing partner. You might even have it in the portal that they provide you. There’s probably a lot of ways that you can get that data. You should be able to understand that mix fairly well. On all your statements they should have that kind of visibility, where you can see it’s a debit versus a credit. And that’s an important aspect of this. That’s always the first step.

Shannon: Yeah. Well, awesome. Well, I think that’s a great place to leave it today. Least cost routing is just really one example of how the payments conversation evolves as a program matures. And once you have meaningful volume, the opportunity isn’t just to keep adding more.

You really wanna understand how effectively that volume that you already have is being managed. If you’d like to learn more about least cost routing, check out our blog post at xplorpay.com, and we’ll include the link in the show notes. Well, Mark, thank you so much for joining me today. It was great having you.

Mark: Yeah, it was great being with you. I mean, even if LCR is a very technical thing, it was still fun. Shannon: Yeah! And thanks everyone for listening, and we’ll see you next time on Payment Pulse.

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