What’s the Cost of Open Payment Systems?

During the past five years, there has been considerable buzz about open payment systems. In short, this means using contactless bank cards such as MasterCard PayPass, VISA Wave and American ExpressPay to pay for transit fare in addition to using these cards at retail establishments. These smart cards will be used with a swift tap at the turnstile or on the bus farebox to process fare payments. The main attraction has been to re-think traditional fare collection processes with coins, bills and magnetic stripe credit/debit cards, and to migrate to contactless bank cards. Transit then becomes one of several merchants in open payment system architecture. In a parallel move, the mobile phone/smart phone industry is also vying for a crossover entry into the transit payment space — albeit in its early developmental stages.

Today’s electronic payments solutions offer many new methods to improve customer convenience and introduce new service businesses to provide better customer convenience. But what are the tough questions related to cost issues and risk? Is there a strong business case to migrate to open payment systems?

This article highlights some of the considerations in adapting such technologies as applications for transit. The concept of operation is easy to grasp. It has created excitement in the transit, banking and related service sector industries. But its implementation is complex with new stakeholders — and there are technical, cultural and financial issues to address. Some of these matters are outlined in this article. In closing, some points are noted with the expectation that it may invite further discussion.

Why Change the Current Payment Structure?

Credit/debit cards are commonly used account-based paymentinstruments. We use them for grocery purchases and other items at retail stores. The process is well understood, including how to use it to buy a transit pass. So why not extend this payment method using contactless bank cards to pay for all transit trips? Is it viable to replace the traditional transit “house” smart cards?

This convenience could also be extended to regional transit agencies that may opt to participate as separate “accounts” but as partners in a larger electronic payment scheme.

Key Issues in Introducing Change in Payment System

Some of the issues and structural changes have to be addressed. At the user level, clearly there is simplicity. But that is the tip of the iceberg. Below that — the submerged two-thirds level — there are many issues to address. Some of these are:

  • Revenue Collection PrincipleIt will be a change from today’s pay first/then ride method to a predominantly ride first/pay later method; it will become a billing system. The benefit of the “float” — that unused portion of a pre-paid payment — will disappear with a post-payment scheme.
  • Technical and Institutional Factors Infrastructure changes, addressing rider demographic issues, and developing new public/private partnership will be required.
  • Societal Issues How to meet the needs of at least 26 percent of U.S. population at large that is unbanked and underbanked (FDIC’s 2009 Report). Also how to comply with local, state and federal subsidy mandates such as providing reduced fares to seniors/disabled and free fares or a complementary “ticket” for eligible persons who have to use transit to seek a job or to visit health care center.
  • Cash Payments Retaining it for those who prefer to use it and for those who have no choice and have to use cash or a government script — these payment methods have to be addressed.
  • Integrating Legacy SystemsIntegrating a current data system usually requires multi-generation “stove pipe” systems — for fare system, security, sales and revenue accountability, banking needs and so on. Migrating this information to a newly introduced data system involves software, intellectual property (IP) and other issues. It becomes a vital and pivotal need for success.
  • Managing Expectations Technology is a moving target. This often brings into play political (ribbon-cutting) schedules and deliverables schedules. Often GM and board membership changes add to the complexity of service delivery for staff and the selected contractor.

In summary, this process is not just a technical matter. It is about people, policies and politics. It requires considerable due diligence in developing the business rules, establishing the deliverables and the contractual agreement – a marriage with a pre-nuptial agreement.

Where Are We Today?

New York Metropolitan Transportation Authority (MTA)/Port Authority Trans-Hudson (Path): New York’s recent pilot ended in November 2010. The MTA and its regional partners expect to release a specification later this year. Knowing the scope and scale of its multi-modal/multi-agency operation, one can only guess that it will be at least three to five years before any significant starts occur.

Chicago Transit Authority (CTA): Chicago is in the process of evaluating the proposals it received. Perhaps we will hear about its next step — selection of their contractor — by end of 2011.

The Washington Metropolitan Area Transit Authority (Metro): Washington, D.C., started its procurement process in January 2011 and has shortlisted candidate teams. It now proceeds to the next stage —and perhaps it will be one to two years before the contract award, followed by the design phase.

Southeastern Pennsylvania Trans-portation Authority (SEPTA): Philadelphia is expected to announce its selection of the contractor in mid-September 2011. It is expected to be about two to three years before the start of any noticeable transition changes.

Dallas Area Rapid Transit (DART): Is also reported to be assessing its options.

There is a lot of work in progress, but soon we should see the results of SEPTA’s approximately three-year process culminating in the selection of the contractor in fall 2011. In a separate move, PATCO, in Lindenwold, N.J., announced it expects to start its open payment system pilot in fall of 2011. That will serve as another guiding point for others.

The Smart Card Alliance (SCA) is addressing many details about this subject and it will include information about the pilot tests and other technology matters in a whitepaper titled Transit and Contactless Open Payments: An Emerging Approach for Fare Collection, expected to be released in fall 2011.

It should be noted that Utah Transit Authority (UTA) has done considerable pioneering work in this arena. UTA took many bold and innovative steps with its procurement process. Its experience is serving as an operational test bed for many people. It has helped transit agencies and bank card industry to work toward open payment systems implementation.

Understanding Transit Market for Fare Products — An Affordability Issue

There is big difference between the use of bank cards at retail stores and payment made to obtain a transit farecard. Consider the realities of the following characteristics of transit payments. One should not be left with the impression that ALL transit transactions will be in the form of open payment method.

Transit systems invariably have three distinct market tiers. They are based upon what the riders can budget. Riders typically buy a monthly pass, a weekly pass, 10-trip tickets or pay on a daily basis using a bank card to pay their daily ride ticket or they pay cash.

The purchases made by the same people at Wal-Mart, Best Buy or other retail stores are generally based on seasonal and discretionary spending habits. But with transit, payments are budget-minded spending necessities — to buy monthly/weekly/daily spending. It is a necessity.

Across the nation, over many decades policies have been crafted to offer different fare products with varied pricing schemes. Overall the choices fit into roughly three payment tiers.

They are:

Tier 1 — The Pay in Advance for Monthly Pass

This market suits persons who budget to buy monthly passes. Many pay in advance by using a subscription service or their company corporate pass program. Alternatively, they go to a ticket window, retail sales outlet or a vending machine at a station to purchase a monthly pass.

Subscription service enrollment often uses ACH or direct debit from a customer’s account to a transit agency’s account. This approach is popular as witnessed by its success in Washington, Chicago, Boston and Seattle. Typically this involves only 10 to 11 electronic payment transactions — per annum for each enrollee.

Washington’s Metro, for instance, has about 220,000 persons in its SmartBenefits programs and the Massachusetts Bay Transportation Authority (MBTA) has more than 112,000 in its corporate pass program. The Chicago Transit Authority has about 273,000 U-Pass enrollees. Seattle, too, is heading in that direction with advance payments.

At these agencies this represents between 20 to 30 percent of the total rider base. All this is money banked in advance of using the transit service — this is often referred to as the “float.” It can be an appreciable amount.

Tier 2 – The Pay in Advance for Weekly Passes & 10-Trip Tickets

This market suits those who can afford to budget for a weekly pass or buy a 10-trip commuter ticket. They typically may not be daily riders but ride frequently and wish to get a deal. This fare product typically results in two to four “buy” transactions per month.

Commuter rail 10-trip ticket purchases at two major agencies in the Northeast indicate that about 15 to 20 percent of riders select this fare product.

Tier 3 – The Pay As You Go Riders

The remainder of the population is split into two components:

  • Those who continue to pay cash on a daily basis — two times a day with cash drop in the farebox. Recent surveys indicate that cash is used on the buses for 20 to 35 percent of boardings.
  • The remaining riders use their credit/debit cards at a station vending machine to buy a ticket.

The overall financial operating principle is pay before you ride.

Moving Targets and Technical Issues

At the heart of this open payment system matter is the desire to minimize cash collection and to improve customer convenience with acceptance of contactless bank cards for transit payments. Making this work requires a sound business plan with estimates of the risk and rewards for all parties. Additionally, there is an increase in complexity with scope creep if management starts adding new technologies and/or applications. Some of the considerations are:

NFC/smart phones: In the near future, it appears many smart phones will be equipped with a variant of contactless smart card technology known as near field communication (NFC). It would allow payment with the wave of the handset. But many details remain to be addressed as that industry is in a flux with huge buyout/dropout and intellectual property rights challenges. Within the past six months, Microsoft bought Nokia’s rights and Google is working toward new IP arrangements with Motorola. It indeed is a moving target with blazing shifts in business partnerships. Technical and pricing factors are moving targets.

Getting Out of the Cash Handling Business: This matter is often debated in transit circles — Should transit get out of the cash handling and fare media sales business? Perhaps so, but it may take a long time — maybe decades? Cash is here to stay, but it can be encouraged to be reduced with pricing disincentives as in Boston, London and recently proposed toll hikes for New York.

Bus Data System Issue: The bus system brings a big challenge. It is not connected “live” and it requires an associated backend transaction aggregating system with an account-based system. It has to manage the business rules to process transit vagaries such as timed transfers, stop-and-go privileges, round-tripping rules and so on.

Additionally, most city routes operate with “canyon” effects due to tall buildings. Even with 3G/4G wireless connections, there are technical/reliability issues for near-live checks.

Finally, there are other cost drivers such as the backend data sorting/parsing engine. This becomes expensive, particularly in the context of processing say $3 to $4 fare transactions. Some clever approaches have been proposed — but their merit remains to be assessed in full revenue operation — tested under daily stress conditions.

Legacy System Integration: Finally, if a bank card-based open payment system is to be considered, it is not just the transaction cost. One needs to address the cost associated with migration of the old system to a new system. There are many information technology (IT) related issues for the path forward. At the same time, one must allow for backward compatibility, letting the system operate with the old method of fare payment in tandem with the new method over a fairly long transition period.

These new partnerships call for many change, such as management efforts related to customer service, staff re-training, public education and other related business issues. All this has to be done to ensure that success can be measured in terms of increased revenue with reduced operating cost while providing better convenience to the customers.

In Closing

The open payment system solution started with an easy-to-understand notion — use your contactless bank card everywhere. People grasp the concept; it is easy to understand. It is just like the ATM card and customers like that simplicity. But then complexities begin to add as people ask “Why not add in use of the NFC/smart phone?” Also keep in mind, the bank card/ATM system matured over about a 25- to 30-year period. It too had its growing pains with technical aspects and business ecosystem development.

A lot of progress has been made with the New York and Salt Lake City experiences on smaller scale of operation. Further work was done by SEPTA in addressing business case propositions; we will know the results by this fall. In parallel development, everyone will be watching what the PATCO pilot brings to the Philadelphia/New Jersey region. These are all work-in-progress initiatives.

It will be a trade-off every financial manager has to make: What is best for customer convenience, what is going to cost the least money, and what will be my payback period for the investment? One question to ask is: What will be my long-term cost for ongoing transactions — every time a customer uses a bank card or a smart phone? How does this compare with an in-house smart card system?

A final personal thought: If we shift too heavily from a buy now/ride later approach, are we not encouraging a deficit-driven model — spend first/pay later? One needs to be aware of that fact every time the financial people formulate their guiding principles. Remember the old adage: No ticket, no ride!