Mark Hudson was all ready to launch an online dating site two weeks ago when he abruptly pulled the plug: He found the business was considered "high risk" by Visa USA and MasterCard International and could open him up to potentially huge fines.
Hudson, the chief executive of Atlanta-based Ascent who runs a site called American Preferred Jobs, is just one of many online merchants smarting under new guidelines passed by Visa and MasterCard that tag certain businesses as risky. Those riskier businesses face tougher conditions and limits on the amount of credit they can use. In particular, they face sizable fines - from $25,000 to $100,000 per month - if their total number of repudiated customer purchases exceeds the new limits.
While Visa and MasterCard officials said the guidelines are strictly targeted at problem merchants such as online pornographers, who can generate charge-back rates of up to 30 percent. Online business owners, merchant bankers and credit-card processors complain that the new regulations - which cover everything from online travel to mail order - are too broad and could cripple e-commerce for many small and medium-sized players.
Hudson insisted his dating site, which he spent $10,000 developing, was not pornography.
But the credit-card issuers didn't see it that way. To get and maintain a merchant account in good standing, Hudson would have to keep his chargeback rates to 1 percent of transactions or 2.5 percent of monthly revenue. Unsure of his ability to comply, he didn't want to risk Visa and MasterCard fines of what he said could be up to $75,000 per month.
"If we were to accrue this kind of penalty, it would bankrupt us," Hudson said.
Tony Berkman felt the same way. His online vacation lodging company, Goin2Travel.com, received a letter from his processor, Cardservice International, telling him that his business was now considered high-risk and would be held to the new 1 percent charge-back rule. He was told he was in a new program for "merchants who engage in electronic commerce transactions." Berkman's charge-backs often exceed 1 percent monthly.
"From the way I read this letter, all e-commerce businesses are subject to the rules," said Berkman.
Some executives in the credit-card industry think he may be right. According to Visa's rules, travel agencies, airlines, limo services, direct marketing, computer programming and membership clubs are all deemed high risk, together with a catch-all called "computer programming, data processing and integrated systems design."
Backlash From Issuers
"It's a broad categorization," said Bob Aguirre, manager of the special investigations unit at Cardservice. "It's a backlash" by the card issuers against rising chargeback rates from some Net businesses.
Critics said the new policy is a classic case of using a sledgehammer to kill a fly: A lot of businesses are falling into the resulting hole. Visa and MasterCard officials said their sole aim is to reduce charge-backs and protect their brands.
"The intent was to identify organizations that bring excessive risk into the entire system," said Mike Smith, vice president of corporate risk management at Visa. "Just because a merchant falls into one of the categories doesn't mean it is going to be high risk [if he or she keeps the charge-backs down]."
While that may be so, there is general agreement in the credit industry that online merchants generate a higher rate of charge-backs than brick-and-mortar companies - 0.25 percent to 2 percent of transactions, enough to fall afoul of the new rules. Non-Net companies generate very low charge-back rates, often less than one-tenth of 1 percent.
The rules don't appear to be applied evenly. Amazon.com (Nasdaq: AMZN), for example, is categorized by Visa as a book retailer, not a catalog order business, and is exempt. There are whispers among card processors that large companies get treated with deference by card issuers because they generate huge volumes. Visa officials denied this.
One Alabama-based online bookseller, who received the high-risk letter from his bank even though he keeps his charge-backs below 1 percent, felt there is something larger going on.
"It worried me a good deal," said the merchant, who wished to remain anonymous. "There is a thinning of the crop [going on] - the big dogs from the little dogs."
For example, the Internet access company EarthLink (Nasdaq: ELNK) falls into the high risk computer network/information services category, but hasn't received any notification from its merchant bank about high-risk categorization, company officials said.
The card issuers are reserving the right to target and prosecute merchants as they see fit: Visa and MasterCard state clearly that the new regulations will be enforced at their own discretion.
Behind The Scenes
In a separate but related move, Visa has informed its affiliate banks, known as acquirers, that it will change the rules regarding the amount of capital they must keep on hand to cover card transactions. Currently, banks can transact up to 100 percent of their own net worth each week. As of March 2001, that will drop to 20 percent, a move that could force smaller acquirers to give up most of their merchant credit customers.
Ken Musante, manager at Humboldt Bank in Eureka, Calif., said the policy will chase local merchant customers, many of which are small and midsized businesses, to larger banks.
First Annapolis banking consultant Marc Abbey agreed. "The effect could be to move market share toward the larger players, but the smaller players have been the most innovative," he said.
And they're the ones currently catering to many smaller Internet companies. Large banks have historically spurned smaller shops and have done little to cater to fledgling e-commerce merchants, said Michael Butts, president of Creditcards.com.
But that's where transaction growth is booming - and some suspect the new capital rule is a tool being used by large banks on Visa's board to steal that business back.
"This is really a wealth transfer from little banks back to the [large ones]," said Roger Baer, president of Transmark, a California-based third-party card processor.
"The whole picture of what we're looking at is having 80 percent fewer [acquiring banks] who do mom and pop and high-risk businesses," Baer said. "The one who is going to get hurt is the merchant, because he's going to have to pay more because there will be less competition.">