LevelUp declares payment war, kills interchange fee for merchants

Every month, it seems players in the mobile payment market try to outdo each other, offering merchants a slightly lower transaction fee in a game of one-upmanship. LevelUp, a Boston-based loyalty and payment startup, has played that game to some extent, pushing down its fee to 2 percent. But now, it’s laying down the gauntlet to competitors by doing away with processing fees forever in what it calls a bid to achieve “Interchange Zero.”
LevelUp said it will not charge its 3,000 merchants interchange fees to process credit card payments and will swallow the cost. The company said instead of passing on interchange fees to move money over existing payment networks, it will look to make its money from merchants by helping them bring in new and existing customers. In essence, LevelUp feels like it can make more money by providing offers, loyalty and analytics than by facilitating pure payments.
It’s a big move that could shake up the emerging mobile payments market. Competitors such as PayPal (s ebay), Square, Google (s goog) and Isis are adding more value-added services themselves but they’re still looking to profit from the payment transaction itself. But Seth Priebatsch, LevelUp’s chief ninja, said transactions are a commodity that won’t hold up over time.

“The fact that we can move money, that’s not interesting. The fact that we can drive new customers and track them when they come back, that’s real value,” said  Priebatsch. “The amount of money we’re making on our campaigns is trending up and we stepped back and said if it’s stable right now we should just skip the middle part of this game and stop charging.”
For the last couple months, LevelUp has charged its merchants 35 cents on every dollar of credit provided to consumers during a campaign. So for instance, in a campaign to bring in 500 new customers, a merchant may offer $2 free credit for a first-time visitor. LevelUp will earn 70 cents for that transaction. Priebatsch said merchants typically bring in $18 for every dollar spent on a campaign. And of new customers who come in through LevelUp, 64 percent come back within 30 days and 40 percent of all new customers complete a loyalty progression with 30 days.
That’s how LevelUp believes it can be valuable enough to charge for these services. By letting merchants push offers to specific sets of customers and providing analytics that track how well the offer does and how often the user comes back, LevelUp is making enough money to support this new Interchange Zero approach. LevelUp, again, is paying the interchange fee but it’s acting like Google, which offers free search because it can make it up on advertising. For merchants, the removal of interchange fees means an average of $500 in savings a month, said Priebatsch.
But how can LevelUp afford to pay the existing interchange fee? Priebatsch said it is able to move money through interchange networks more efficiently using special algorithms and it has less fraud than competitors because of its barcode scanning and token payment system. The company is building out special relationships with banks to further decrease the cost of fees. Over time, Priebatsch said the cost of moving money over the interchange fees has also gone down, but the fees haven’t.
It will be interesting to see how competitors react. It’s still early in the race but merchants are hearing all kinds of pitches on payments, offers and loyalty programs. A service that does away with processing fees and only charges based on real business performance could stand out in the market. Merchants may feel more confident about trying LevelUp because they will only be paying to drive in customers and sales.
This fits into the larger discussion about mobile payment business, which many are realizing is much about about the services around payments than the action itself. Providing an alternative to credit cards or cash has limited appeal to consumers and merchants because the current methods of paying aren’t terribly broken. It’s really in the extra features where payment systems are able to sell themselves.
This will have an impact on not just payment providers, but also new offers and loyalty-focused startups. The reality is that these businesses are all coming together and competitors will need to be able to offer all these elements plus analytics, customer relationship management and other business services as well. LevelUp is showing that in this local scrum, the real value proposition may be in leading first with offers and loyalty and just throwing in payments for free.