Is Dynamic Currency Conversion dead?

Many acquirers, merchants and even some cardholders will be well aware of Dynamic Currency Conversion or DCC as it's commonly referred to. DCC involves a cardholder being offered the choice to choose their own currency during an international Visa or MasterCard transaction at the point of sale, as opposed to the normal process which does not involve any exchange rate conversion. DCC doesn't add an exchange rate conversion. It simply transfers the point of currency conversion from the card issuer to the merchant or ATM acquirer. And in doing so, it transfers the margin revenue added to the foreign exchange conversion from the card issuer to the acquirer. This is why DCC is attractive to acquirers and detrimental to issuers.

DCC has been around since the late 1990s in one form or another. It's a well established practice, especially in Europe, but also elsewhere. Visa and MasterCard acknowledge its practice and have codified rules around its implementation and use. But DCC has also a certain reputation in some quarters as being a way to simply add cost to an international Visa or MasterCard transaction for the cardholder without necessarily providing any material benefits to the cardholder.

In more recent times, Visa and MasterCard have increased card scheme processing fees charged to acquirers for submitting DCC transactions, imposed more onerous compliance regimes and watched as card issuers have increased their communications to cardholders to be wary of accepting DCC offers on the basis that doing so would result in additional costs to the cardholders.

Let's dig deeper into this and see whether there is any substance to the suggestion that DCC adds cost for the cardholder.

Normal international card transaction (no DCC)

The first thing to consider is the transaction flow for a normal international transaction that occurs without DCC, and the cost impost on the cardholder. A normal international transaction occurs like this:

1. The cardholder will be presented with the opportunity to pay for their goods or services at the point of sale in the merchant's "home" currency. For example, if a US cardholder is buying something at a retail outlet in the UK, then the price of the goods will be quoted in UK pounds sterling.
2. The retailer will enter the price to be paid in local currency onto the payment terminal which will then prompt for the card to be swiped, inserted or "waved" (in the case of a contact-less compatible payment terminal).
3. Once the card has been processed, the payment terminal will process the transaction for the local currency amount (eg. pounds sterling).
4. The retailer's acquirer will forward the authorisation in local currency to Visa or MasterCard, and the card network will forward it onto the international card issuer. The card issuer will approve or decline the authorisation request based on converting the requested amount in the retailer's currency (pounds sterling) to the cardholder's billing currency (US dollars in this example).
5. The card issuer is likely to have added a margin to the conversion from pounds sterling to US dollars when determining whether or not to approve the amount by comparing it to the cardholder's available balance.
6. The acquirer will ultimately clear this transaction to the card network, and the card network will settle with both acquirer and issuer for the transaction.
7. The acquirer would also pay settlement in pounds sterling to the retailer who originated the original transaction for the original amount of the goods or services being purchased.

We can see that the card issuer has extracted and retained the margin added to the exchange rate during the conversion from the retailer's currency and the cardholder's currency. (For completeness, the card network may also have extracted a small margin too when it settles with the card issuer, but for the purposes of this example, we will assume that the significant part of the margin is extracted and retained by the card issuer.

So the bottom line is that the cardholder has effectively "paid for" the exchange rate conversion between the retailer's currency and the cardholder's currency. The actual cost was imposed when the card issuer settled with the cardholder for the transaction. Remember that issuer settlement occurred after the actual transaction itself and so the cardholder didn't have any visibility of the "cost" added by the issuer at the time of the actual transaction.

How does Dynamic Currency Conversion work?

How does a DCC transaction work in comparison?

International card transaction with DCC

1. The cardholder will be presented with the opportunity to pay for their goods or services at the point of sale in the merchant's "home" currency. For example, if a US cardholder is buying something at a retail outlet in the UK, then the price of the goods will be quoted in UK pounds sterling.
2. The retailer will enter the price to be paid in local currency onto the payment terminal which will then prompt for the card to be swiped, inserted or "waved" (in the case of a contact-less compatible payment terminal).
3. A DCC-enabled payment terminal would recognise that the card is eligible and offer the choice to pay either in local currency (pounds sterling) or the cardholder's billing currency (US dollars). (The eligibility determination logic can reside within the payment terminal, the acquirer's centrally located server/host or a combination of the two).
4. The cardholder will then choose either the local currency option (pounds sterling) or the cardholder billing currency option (US dollars). Just like in a normal transaction (without DCC), an exchange rate conversion has just occurred. This time, it has occurred at the point of sale and prior to the transaction authorisation being submitted from the payment terminal back to the acquirer's server/host. The big difference is that the margin has been added by the acquirer (effectively), rather than the issuer.
5. Let's assume that the cardholder has chose their own billing currency (ie. accepted the DCC offer). Once the card has been processed, the payment terminal will process the transaction in the billing currency amount (eg. US dollars).
6. The retailer's acquirer will forward the authorisation in foreign currency to Visa or MasterCard, and the card network will forward it onto the international card issuer. The card issuer will approve or decline the authorisation request based on receiving the requested amount in the cardholder's billing currency (US dollars).
7. Because the transaction has already been converted at the point of sale, there is no need for the issuer to perform any further conversion. There is no further opportunity to add a foreign exchange margin.
8. The card issuer will simply approve the amount by comparing it to the cardholder's available balance which is in the same currency.
9. The acquirer will ultimately clear this transaction to the card network in the foreign currency (US dollars), and the card network will settle with both acquirer and issuer for the transaction.
10. The acquirer would also pay settlement in pounds sterling to the retailer who originated the original transaction for the original amount of the goods or services being purchased.

The difference?

The difference is that the acquirer has extracted and retained the foreign exchange margin instead of the issuer. However, there is no additional conversion. There has been no fancy sleight of hand. There has simply been a transfer of foreign exchange margin from the issuer to the acquirer.

So has the transaction cost the cardholder any more than usual?

The answer to this depends on whether the margin added by the acquirer was greater than that which would have been added by the card issuer without DCC. If it was, then it will cost the cardholder more. If not, then it might even have even cost the cardholder less.

It depends entirely on the particular combination of retailer, acquirer, card network, issuer and cardholder involved during any eligible transaction. It's impossible to provide a definitive answer to the question without looking at the individual circumstances of the transaction.

But is that ignoring the fact that generally speaking, acquirers are typically adding at least 3% margin for DCC transactions compared to a figure added by issuers that is possibly less than 3%? Well, maybe it is.

If we accept that by and large, issuer margins are less than 3% and acquirer margins are at least 3%, then the cardholders would be incurring a greater cost ...in dollar terms.

But even if this is generally true, are cardholders prepared to pay a little more for the benefit of knowing precisely what exchange rate they are accepting at the point of sale at the time of the transaction. The ongoing viability of DCC suggests they that perhaps they are?

So is Dynamic Currency Conversion dead?

It may be obvious now that the answer to the question depends on whether you are a retailer, acquirer, card scheme, issuer or cardholder. The motivations and value perceptions of each participant in the transaction process are different, and their view of DCC will vary accordingly.

I am writing this post as a someone who has participated in the Dynamic Currency Conversion space for a long time, and from the perspective of the acquirer. And in doing so, I can say that Dynamic Currency Conversion is not dead. It's alive and well, and with years of active life left to enjoy. This is because there remain many drivers that will support DCC for some time, including:

1. Increasing volume of cross-border Visa and MasterCard transactions.
2. Many markets where DCC is not yet prevalent amongst retailers and acquirers.
3. Continuing pressure on traditional acquiring margins prompting acquirers to look for new sources of revenue.

Dynamic Currency Conversion remains a very effective way for acquirers to extract additional revenue from their merchant portfolios. In fact, with traditional acquiring net margins being squeezed on all sides and falling to below 0.10% of the transaction value (in some cases), the prospect of adding anywhere from 2-4% of the transaction value in gross DCC revenue terms is extremely attractive. In fact, it is so attractive that any acquirer exploring revenue opportunities should at least investigate the pros and cons of DCC in some detail.

It's also true that there are headwinds, not the least of which are Visa, and to a lesser extent MasterCard, who are very conscious of anything that might detract from their own revenue or dismay their issuer members.

The other major headwind is payments innovation which continues to reduce the "friction" of the transaction process. DCC does introduce an extra step in the transaction process, and so retailers and acquirers need to consider whether the benefit of adding DCC (from a revenue point of view) is negated by the extra step (which may or may not detract from the cardholder experience, depending on the circumstances).

Summary

1. Dynamic Currency Conversion adds revenue for acquirers by transferring it from issuers.
2. Cardholders pay either way. There are no free lunches.
3. There's plenty of growth potential for DCC for some time to come.
4. Retailers and acquirers must evaluate whether their merchant portfolios are suitable for DCC, the investment required and the impact on the cardholder experience.

If you're a major retailer, processor or acquiring institution and want to know more, please keep an eye out for more posts on this subject, or contact me directly here.