Are Open Loop Payments worth the investment for public transit agencies?
Spoiler alert: There are few things that can do more for transit agencies today than investing in open loop payments solution. We will take a closer look at where the costs that have traditionally burdened open loop systems came from, and how the new generation changes the math.
Open loop payments, sometimes referred to as “Pay as You Go” or “Tap to Pay,” are simple and fast transactions enabled by the implementation of Contactless EMV standards and technologies.
For a refresher see What are Open Loop Payments in Transit
Transit agencies everywhere are taking a fresh look at open loop payments.
However, that simple transaction is supported by a complex network of payment industry participants, each with their own capabilities, business interests, and regulatory compliance and business rules, that converge to ensure that every transaction is successful, secure, and payment transparency is maintained for the customer and transit agency alike.
Who is involved in public transit open loop payments?
To simplify this discussion, we should consider the three primary objectives of any automated fare collection system; Ride, Manage, and Settle. Payment system integrators must unify an array of participants to deliver an effective solution for the transit agency.
Ride
Ride describes the parties involved in physical interactions that take place to access a transit system. Think of the physical devices and interactions that can be seen or felt.
Card Holder
Generally, a bank will issue a card to an account holder. This card can be used to make payments on its own or transferred to some other contactless media like a mobile device. In transit we see that most card holders use debit, followed by credit accounts.
Often contactless credit and debit cards used by card holders are “free” from the issuing bank. Some cards are associated to unique banking products that can contain reload or other usage fees that are generally paid by the card holder.
Validator
When contactless media is tapped to a validator, the validator uses certified hardware to communicate wirelessly with the card. Validator vendors may have a proprietary reader or procure one from any number of reader manufacturers. The Validator has a payment application that authenticates the card offline.
Cost Input: When procured independently, the Validator vendor may include transaction fees in their pricing model. These fees are sometimes passed through the Transaction Processor or other integrator depending on the contract structure.
Manage
Transit agencies require systems that can manage the business rules that support.
Back Office / Transaction Processor
The Transaction Processor can be viewed as a central hub, that manages all of the business rules for a Public Transit Agency. The platform handles every transaction, and the newer generation of these platforms including Bytemark Connect, provide additional features to increase the value of the solution to the transit agency. Benefits include aggregating multiple tap transactions into a single payment transaction to reduce interchange fees that are not under its direct control and automatically find the best pricing by linking special fare policies and calculation based on fare capping rules. The central role of the transaction processor makes it an obvious choice for agencies looking for a system integrator.
Cost Input: The Transaction Processor typically includes a nominal service or transactional fee.
Financial institutions round out the third part of the equation to Settle funds. Ultimately any transit agency needs to be paid so that it can continue to provide the benefits of things like daily maintenance and infrastructure reinvestment.
Acquirer / Payment Processor
The Payment Processor is most often considered to be the Acquirer and is required to lead the effort to ensure security compliance of the end to end open loop payments solution. They can be viewed as a sort of switchboard that looks at all of the payment requests coming in from the Transaction Processor and routes them to the appropriate networks for repayment. These networks can be quite complex, with rules and interchange fees that vary considerably – but the Payment Processor simplifies all involved.
Brand network
The brand networks such as Visa, Mastercard, Discover, Amex establish the compliance guidelines for the end-to-end open loop payments solution. They work to rally all the participants in a direction that brings consistency across widely ranging payment landscape.
Cost Input: Card brands set boundaries for interchange fees – subject to governmental caps. In the USA, these fees generally include a percentage of the transaction plus a fixed fee. These fees can vary based on the type of card account and the supporting card brand.
Account Issuer
Account Issuers are generally recognized as banks and can include traditional checking account providers like your local Credit Union, J.P. Morgan Chase, or Credit Card providers like Capital One or Citi.
Cost Input: Issuers are paid with a portion of the interchange fees established by the Brand network and assessed by the Acquirer.
How open loop payment costs stack up
For small transactions, like those used in public transit, the fees identified above can become a large percentage of the revenue from a transaction, leaving agencies with very low margins to contribute to operating costs. Luckily for you, with the new generation of open loop payment systems, we are able to reduce the number of financial transactions that take place thereby increasing the revenue transit agencies recover.
Interchange Fees
Interchange fees are the portion of transaction fees that are determined by card brand schemes like Visa and Mastercard.
In 2015, the EU established Interchange Fee Regulations that cap interchange fees at 0.2% of the transaction value for debit and 0.3% for credit charges with a goal to ensure that retailer’s average costs are not higher than cash. These are great for small dollar transaction like those in the public transit space. Reference: European Commission
However, the USA has not established the same level of regulatory guidance for small dollar transactions. Instead, for most debit cards, the interchange fee is capped at $0.22 plus 0.05% of the value of the transaction Reference: Federal Reserve
Credit cards caps are applied by the card brands, and fees range from 2.5 to 3.5% of the transaction amount plus up to $0.10.
For larger purchases these fees are often overlooked because they account for a small percentage of the transaction. However, public transit is typically a small dollar transaction.
Let’s look at a how interchange fees break down for a single trip in public transit that costs $2.50.
EU: $0.01 for credit and debit
US: $0.19 for credit and $0.23 for debit
That means interchange fees alone for US-based debit transactions account for up to 10% of the total. That can have a significant impact on a public transit agency’s revenue, especially when a legacy open loop payment platform assesses these fees for every tap.
Payment aggregation to the rescue
The new generation of open loop payments systems, like Bytemark Transact, address this issue directly by aggregating multiple taps into a single transaction. This serves to lower interchange fees to a level that is more consistent with reloading closed-loop account or purchasing a pass.
Transactions are generated every time a validator is tapped. The number of transactions can grow quickly when as a traveler commutes regularly, changes vehicles on a single route, or just visiting multiple places. The first tap generates a pre-authorization request for a nominal amount, but all the rest of the tap transactions are withheld, until the final tap is recorded. At the end of the day, all of the transactions are swept up into a single settlement request and interchange fees are assessed.
You can see how quickly the fees can add up in a legacy open loop payment system compared to newer systems that aggregate payments.
What Contributed to High Implementation Costs?
Before an agency is even faced with transaction fees, they may become dissuaded by implementation costs. Megacities have the budget to spend the tens of millions of dollars that have traditionally been required to enable open loop payments on their system, but most transit agencies have budgetary constraints that has made adoption slow.
Certification
All cEMV based transaction open loop payments systems must be certified to meet three levels of EMV and PCI industry requirements:
Level One EMV Certification of the reader device that communicates with EMV media. This can be a proprietary reader or hardware procured from a company like Feig that supplies readers to various Validator vendors.
Level Two EMV Certification of the Validator device – a payment terminal with an enclosure for the reader, a User Interface, and firmware that manages the overall behavior of the device. Card brand Kernels are included on the Validator which allow the reader to securely read and encrypt data provided by the EMV media.
Level 3 EMV Certification of the open loop payment system. This certification is led by the Acquirer and proves that the entire system securely manages card data and meets the requirements of each card brand that is supported by the system.
Both Levels Two and Three certifications must be performed once for each card brand supported. For example, if Visa, Mastercard, American Express, and Discover are supported, a combined total of nine separate certifications take place. Testing teams often spend months working on a single certification, and this process alone contributes a significant amount to implementation costs. Thousands of hours means that certification costs alone can reach mid 6-figure range and higher.
Bespoke Designs
Legacy open loop payment systems are often controlled end-to-end by a single entity. One company builds the Payment Terminal, or Validator, the back-office transaction processing system, and integrates directly with an Acquirer using complicated ISO 8583 specifications. A single entity can be responsible for management and implementation of all Level one and two certifications, and for implementation of Level three certification. Supporting infrastructure is deployed separately for each Agency.
The problem with these systems is that they are not flexible and require a large up-front commitment. Additionally, as the hardware ages the agency is generally required to upgrade everything along with the back-office system. The result has been that open loop payments have been largely relegated to Megacities with enormous Public Transit program – and budgets.
Bytemark approaches things differently.
Bytemark is recognized as an innovator in Public Transit Payment Systems that are available to any Agency, large and small. Continuing in that tradition we built our open loop payment solution to be a modular part of our product portfolio.
Offering open loop payments as a feature of our configurable off-the-shelf account-based product, Connect, rather than as part of a custom implementation, means that Agencies of any size can benefit from a cost competitive solution. Implementation cost is orders of magnitude lower than legacy systems, with operational expenses that are efficient and transparently managed via Payments as a Service (PaaS).
Some of the benefits transit agencies find when selecting a Bytemark open loop payments solution include:
Modular offering with multiple combinations pre-certified. Choose your favorite Validator, choose your preferred Acquirer, we make it work.
Product-based off-the-shelf design reduces up-front engineering costs.
Multitenant platform reduces operational overheads
Enhanced account-based back-office features benefit travelers and transit agencies alike.
Choose your preferred Validator
More and more, Validators are becoming a commoditized product, and vendors have been enhancing their offerings to include specialized services to stand out. Vendors offer products that range from low cost but reliable hardware, to higher cost hardware with more modular upgrade capabilities.
Bytemark can provide guidance to help transit agencies select the best candidate, but by using our Universal Validator API (UVAPI), we support any validator that has, or can obtain, Level Two EMV certification.
Choose your preferred Acquirer
Bytemark has established multiple Acquirer relationships to support Agencies in the USA and Canada.
Your choice in Validator and Acquirer combination may impact the implementation cost, but we are actively certifying combinations that we believe provide the greatest value. This means that you can choose from your favored providers or save by selecting an acquirer that we have already integrated with.
Open loop payments are worth the investment
With the latest generation of open loop payment solutions the costs to implement and operate are lower than ever before. However, the loss in ridership growth that open loop payments create combined with the missed opportunity to capitalize on reduced operational costs to maintain the system make it abundantly clear why transit agencies across the globe are implementing open loop payment systems today.
About Kevin Burgess
Kevin Burgess has spent over 10 years delivering solutions for public transportation agencies around the world, primarily focused on innovative payment systems with a fintech approach.