Least Cost Routing Explained (and When It Makes Sense)
Australian businesses could be leaving tens of thousands of dollars on the table through a simple oversight in their payment terminals. While executive teams rightfully focus on growing revenue and managing major expenses, the hidden costs of payment processing continue to erode profit margins unnecessarily. For CFOs and operations leaders seeking tangible cost reductions without compromising customer experience, understanding Least Cost Routing could deliver immediate financial benefits with minimal operational change.
Demystifying Least Cost Routing: The Strategic Payment Processing Opportunity
In the complex world of payment processing, few strategies offer as clear an opportunity for cost reduction as Least Cost Routing (LCR). Despite its significant potential to improve bottom line performance, many Australian businesses remain unfamiliar with this approach or uncertain about when to implement it. This guide aims to demystify Least Cost Routing, explain its mechanics, and help you determine when it makes strategic sense for your business.
The Australian payments landscape has evolved significantly over the past decade, with the proliferation of Multi Network Debit Cards (MNDCs) creating both opportunities and challenges for merchants. These dual network cards, commonly issued by major banks, can process transactions through either the domestic eftpos network or the international Visa and Mastercard networks. The network choice for each transaction directly impacts the fees merchants pay, making it a critical consideration for cost conscious businesses.
Understanding Least Cost Routing Mechanics for Business Optimisation
At its core, Least Cost Routing is remarkably straightforward: it is a system that automatically directs debit card transactions through the payment network that incurs the lowest cost for the merchant. In Australia, this typically means routing contactless debit transactions through the eftpos network rather than the Visa or Mastercard networks when the card supports multiple networks.
The concept gained significant traction following the Reserve Bank of Australia's intervention in the payments market. Recognising that many merchants were paying unnecessarily high fees for debit transactions, the RBA encouraged payment processors to offer LCR as an option. While initially meeting resistance from some quarters of the payments industry, competitive pressures and regulatory nudging have made LCR increasingly available to Australian merchants.
The mechanics behind LCR involve sophisticated payment terminal programming that recognises dual network cards and makes routing decisions based on pre configured rules. These rules consider factors such as transaction value, card type, and the specific fee arrangements negotiated between the merchant and their payment processor.
Card Transaction Fee Structure Fundamentals
To appreciate the value of Least Cost Routing, it is essential to understand the three tiered fee structure that applies to card transactions in Australia:
Interchange fees flow from the merchant's bank (acquiring bank) to the cardholder's bank (issuing bank). In Australia, the RBA has capped these fees at 0.50% for credit cards and 8 cents for debit cards. However, the actual rates vary based on multiple factors, including card type, transaction environment, and merchant category.
Scheme fees are paid to card networks like Visa, Mastercard, and eftpos for using their infrastructure. These fees have been rising steadily in recent years and now represent a significant portion of processing costs. Importantly, unlike interchange fees, scheme fees are not regulated by the RBA.
Acquirer margin is the markup your payment processor adds for their services. This may be presented as a single blended rate or broken down into components in an interchange plus pricing model.
The key insight for merchants is that eftpos typically charges lower scheme fees than the international card schemes. By routing debit transactions through eftpos instead of Visa or Mastercard, merchants can often reduce their overall payment acceptance costs by 20 40% for these transactions.
When Least Cost Routing Implementation Makes Strategic Business Sense
While the potential savings from LCR are compelling, it is not universally advantageous for all business models. Let us examine scenarios where implementing Least Cost Routing makes particular sense:
High Volume, Low Margin Business Operations
Retail operations, supermarkets, fuel retailers, and quick service restaurants typically operate on thin margins where every cost reduction directly improves profitability. These businesses also tend to process a high volume of debit card transactions, magnifying the potential savings from LCR. For a supermarket processing millions of transactions annually, even a few cents saved per transaction can translate to six figure annual savings.
Businesses with Significant Debit Card Transaction Volume
The value of LCR is directly proportional to the volume of debit card transactions your business processes. In sectors where debit cards are the predominant payment method, such as everyday retail, convenience stores, and public transport, the case for implementing LCR becomes particularly compelling. Australian consumer preference for debit over credit has been growing steadily, making this consideration increasingly relevant across sectors.
Transaction Value Optimisation Considerations
The economics of LCR vary based on transaction value. For very small transactions (typically under $15), the per transaction component of fees becomes relatively more significant than the percentage component. For larger transactions, the percentage based fees take precedence. Understanding your average transaction value helps determine the potential benefit of LCR for your specific business model.
Global Payment Routing Strategy Perspectives
The concept of transaction routing optimisation is not unique to Australia. Similar approaches exist in other markets, though with important distinctions reflecting different regulatory environments:
The European Union's Interchange Fee Regulation established caps similar to Australia's but went further by requiring that all cards issued within the EU be capable of processing transactions through multiple networks. Additionally, merchants must be given the choice of which network to use. This regulatory environment has created even stronger incentives for European merchants to implement routing optimisation strategies.
The Durbin Amendment to the Dodd Frank Act introduced routing requirements for debit cards in the US, mandating that issuers provide at least two unaffiliated network options. However, these requirements initially applied only to chip and PIN transactions, not contactless payments. Recent regulatory updates are extending these requirements to contactless and digital wallet transactions, creating new opportunities for US merchants to optimise routing.
Least Cost Routing Implementation Considerations
While the concept of Least Cost Routing is straightforward, implementation involves several technical and strategic considerations:
Payment Terminal Compatibility Requirements
Not all payment terminals support LCR functionality. Older terminals may require software updates or replacement to enable this feature. When evaluating new terminal solutions, merchants should explicitly confirm LCR compatibility and understand any associated costs or limitations.
Some payment processors have been more proactive than others in supporting LCR. When selecting a processor or renegotiating existing arrangements, merchants should inquire specifically about LCR offerings, including customisation options and reporting capabilities to track the resulting savings.
Customer Experience and Online Transaction Limitations
While LCR is largely invisible to customers, it can affect certain aspects of the payment experience. For instance, some eftpos transactions may require PIN entry even for contactless payments above certain thresholds, whereas Visa and Mastercard typically allow PIN less transactions up to $200. Merchants should consider whether such differences align with their customer experience priorities.
Currently, LCR is primarily relevant for in store transactions. The eftpos network has historically had limited presence in the online environment, though this is changing with the introduction of eftpos online capabilities. Merchants with substantial e commerce operations should monitor these developments closely.
Industry Specific Payment Routing Implications
Public Transit Payment Cost Optimisation
For public transit operators, LCR presents particularly compelling opportunities. Transit transactions are typically high volume but low value, meaning per transaction fees can significantly impact profitability. With Multi Network Debit Cards becoming standard, implementing Merchant Choice Routing to process transactions through the eftpos network rather than Visa or Mastercard can yield substantial savings.
Additionally, transit operators should analyse the cost implications of implementing account based ticketing systems alongside LCR. These systems can reduce per transaction fees by consolidating multiple trips into single daily or weekly charges, working synergistically with routing optimisation to minimise payment costs.
Measuring Least Cost Routing Financial Impact
Implementing LCR is only the first step; measuring its impact is equally important for ongoing optimisation. Calculate your effective rate before and after implementation by dividing total processing fees by total processing volume. This provides a quick benchmark for evaluating the overall impact. Most Australian retail merchants should see their effective rate for debit transactions fall from approximately 0.6 0.8% to 0.3 0.5% after implementing LCR.
Analyse routing effectiveness by reviewing the percentage of eligible transactions successfully routed through the lower cost network. Not all dual network cards will be identified and routed optimally, so monitoring this metric helps identify opportunities for further optimisation.
Track savings over time and against transaction volume fluctuations to ensure the benefits remain consistent. Some processors provide detailed reporting on LCR savings, while others require merchants to perform their own analysis based on statement data.
The Future of Australian Payment Routing Optimisation
Australia's payment landscape continues to evolve, with several trends likely to impact routing strategies in the coming years. The New Payments Platform (NPP) and PayTo services are creating alternatives to traditional card payments for certain use cases. These account to account transfer mechanisms bypass card networks entirely, potentially offering even lower costs than optimised card routing for some transaction types.
Mobile wallet transactions add complexity to routing decisions, as the tokenisation processes used by Apple Pay, Google Pay, and similar services can affect network identification and routing capabilities. Payment processors are developing more sophisticated approaches to maintain routing optimisation for wallet transactions.
Regulatory attention to payment competition remains high, with the RBA continuing to monitor merchant access to least cost routing options. Future regulatory interventions could strengthen requirements for processors to offer and support LCR.
Conclusion: Least Cost Routing as a Strategic Financial Imperative
Least Cost Routing represents more than a tactical cost reduction measure; it reflects a strategic approach to payment acceptance that recognises the competitive advantage of optimised operations. In Australia's evolving payment landscape, the businesses that thrive will be those that understand not just what they are paying for payment processing, but why they are paying it and how they can optimise it.
The savings potential, often 20 40% on debit transaction fees, directly impacts bottom line performance without requiring changes to pricing, product offerings, or customer experience. Few other operational optimisations offer such clear cut financial benefits with minimal downside risk.
In an era where margins face constant pressure and operational efficiency is paramount, payment routing optimisation is not merely an option for forward thinking businesses. It is becoming an essential component of financial management best practice. The question is no longer whether Least Cost Routing makes sense, but rather how quickly and effectively your organisation can implement it to secure the competitive advantages it offers.
Ready to optimise your payment routing strategy? Payment Matters specialises in helping businesses implement effective Least Cost Routing solutions tailored to their specific transaction profiles and operational requirements. Our team of payment specialists works with CFOs, operations leaders, and executives across all sectors to reduce processing costs while maintaining seamless customer experiences. Contact us at info@paymentmatters.com.au or visit paymentmatters.com.au to arrange a comprehensive payment strategy review and discover your potential savings.
Enjoyed this article?
We regularly publish insights on payment strategy, risk, and governance.
You will find more articles here.
Let’s talk if you think Payment Matters could be the right fit for your needs. Reach out to discuss how we can support your organisation.
paymentmatters.com.au
Fantastic in-depth dive into LCR David, great read. 👍