COMPARISON OF $0 AND $1 ACCOUNT VERIFICATION

TRANSACTIONS

Background

Historically, merchants employing a recurring payment model have used a $1 authorization to verify that the
consumer's account is valid and in good standing before offering their service to consumers. Typically, merchants
do not capture or reverse this $1 authorization.

Visa announced the introduction of the Misuse of Authorization Fee, effective October 1, 2009, for authorizations
that were not reversed within 72 hours or captured within 10 days. This new fee has a direct financial impact on
merchants that use a $1 auth to verify card accounts. Visa has recommended that merchants instead use a $0 auth,
called a Visa Account Verification transaction, which carries an additional fee, to avoid the Misuse of
Authorization Fee.

To help merchants plan for this change, our earlier communication on this topic provided details about the extent
of support for $0 auth and auth reversal transactions across the four major card brands. We also recommended that
merchants begin using the $0 auth instead of the $1 auth.

Starting May 2009, some of our merchants updated their systems to use the $0 auth for account verification. There
is now adequate data in our platform to investigate how the $0 auth has been performing across all of our
merchants and gain insight into potential implications for other merchants considering moving to the $0 auth. This
document examines the approval rates for both types of transactions and provides recommendations for merchants
to consider.

Auth Approval Rates

We have analyzed the approval rates for the $0 and $1 authorization transactions across all of our merchants that
use either of these transactions for account verification. The following figure shows the incremental approval rate
of the $0 auth in comparison to the $1 auth on a monthly basis by method of payment. For example, in the month
of July, the approval rate for Visa $0 auths was 10% higher than that of $1 auths when we consider all the $0 and
$1 authorizations processed through our platform.

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FIGURE 1 Incremental Approval Rate for $0 over $1 Auths

We observe the following from the data in Figure 1:

The $0 auth has a higher chance of approval than the $1 auth for all methods of payments except Discover.
Discover has informed us that they have left it to the issuer to decide if they will process $0 auths. Lack of
support for the $0 auth from Discover issuers is apparent in the data.
As merchants ramped up their adoption of the $0 auth, the incremental approval rates (for Visa and
MasterCard) for the $0 auth over the $1 auth for the same time period is trending higher. We believe that this
upward trend for Visa and MasterCard will not continue forever and the incremental rates may eventually
stabilize at lower values.
For Amex, the approval rates of the $0 and $1 auths are rapidly converging to the same level. It remains to be
seen if this trend will continue.

In addition to a portfolio-wide analysis, we looked at the population of merchants using each of these transactions
and we observed that the approval rate at the 25th, 50th (median), and 75th percentiles for merchants using the $0
auth were all higher than the corresponding values for merchants using the $1 auth. There was also less variation
in the $0 auth approval rate across merchants compared to the $1 auth approval rate.

Authorization Decline Reasons

Given that the $0 approval rates were higher than the $1 approval rates, we considered why this was the case
when many of the merchants that used the $0 auth did not make any fundamental changes to their marketing or
business model when implementing the $0 auth.

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 Comparison of $0 and $1 Account Verification Transactions

We analyzed the decline reasons for $0 and $1 auths to examine why the $0 auths were getting approved at a
higher rate. Figure 2 compares the difference in the reject reason codes that contribute most to the difference in
approval rates between the $0 and $1 auths by brand for the full time period we analyzed. For example,
considering the distribution of reason codes across $0 and $1 auths, we observed that Insufficient Funds reason
code accounted for 5.97% less of total auth responses in the case of $0 auths versus the $1 auths. Similarly, in the
case of Amex, the Invalid Amount reason code accounted for 1.62% more of total auth responses for $0 auths
than $1 auths.

FIGURE 2 Reason Codes that Contribute Most to Differences in Approval Rates

We observe the following from the data in Figure 2:

The $0 auth is less likely to be declined for Insufficient Funds. Perhaps this is because the $0 auth may not
require the issuer to check the consumer's open to buy limit. It is likely that some of these transactions would
have been declined if the $1 auth had been used instead.
The $0 auth is more likely to be declined for Invalid Amount. These transactions likely imply that the issuer
or the issuer processor is unable to process the auth with $0 in the amount field. However, merchants should
note that $0 auth declines for Invalid Amount comprise a very small percentage for all brands except Amex.
There were a few cases reported to us by merchants that have seen Visa issuers decline a $0 auth but approve
an auth for a higher amount for the same card on the same day. We reported all those issuers and their
processors to Visa. Visa is currently working directly with these issuers to ensure that their systems comply
with the Visa mandate that all issuers support the $0 auth.
The $0 auth is less likely to be declined with a Do Not Honor reason code.

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Comparison of $0 and $1 Account Verification Transactions

Recommendations
1. It is worth considering moving to using the $0 auth for certain methods of payment and not for others. The
merchant community does not have to worry about lower approval rates with the $0 auths except for Discover
& Amex. For Discover, merchants should use the $1 auth. In the case of Amex, while the overall approval
rate with $0 auths is higher, a higher percentage of $0 auth transactions are being declined with Invalid
Amount. Additionally, Amex is not able to provide CID validation responses with the $0 auth, which may
make it advantageous to use the $1 auths with Amex.
2. Merchants should carefully examine the impact of higher Visa and MasterCard approval rates for the $0 auth
on their core business metrics. It is likely that the higher approvals artificially inflate new customer
conversion rates without any change to the underlying marketing or business model. This could have a
negative impact when significant cost is involved between the authorization and sale transaction for a given
customer.
3. Merchants that provide free trial offers should evaluate the cost of providing increased free trials to more
customers that may not be able to pay for the service after the free trial period. Therefore, merchants should
trade off the cost of this incremental free service against the Visa fees (or the cost of reversing the $1 auths) to
determine the better course of action.
4. Merchants planning to continue using $1 auths should evaluate the cost of reversing all unused Visa auths
within 72 hours. If the variable cost of reversal is less than the Visa Misuse of Auth Fee (currently 4.5 cents),
we recommend merchants reverse the $1 auth to save money on fees.
5. Merchants who use the $0 auth should consider re-authorizing at the $1 level upon receiving an Invalid
Amount decline reason. It may also be worth considering re-authorizing in the case of certain other generic
decline reasons (Generic Decline, Cardholder transaction not permitted, and Invalid Transaction).

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Calculator: Should You be Using $0 Auths?

Here we provide a simple calculation that you can use as a framework for determining whether your business
should be switching from $1 to $0 auths. The following (gross) assumptions are made:

An auth that would be approved at an amount of $0 but would not be approved at an amount of $1 will not
result in a paying customer. We refer to such auths as false positives. Additionally, we assume there is a
measurable loss with false positives.
No auths would be approved at $1 that would not be approved at $0. These are false negatives and represent
the possibility of lost revenue. (False negatives do occur but can be minimized using Recommendation 5
above.)
The calculation depends upon the following parameters:

TABLE 1 Calculator Parameter Values

Parameter Value
Vantiv Processing Fee (per auth/reversal) P
Visa Auth Processing Fee (per $1 auth) 0.0195
Visa Misuse of Auth Fee (per $1 auth not reversed/captured) 0.045
Visa Account Verification Fee (per $0 auth) 0.025
Loss on false positive auth (product plus overhead; per approved L
auth)
Est. approval rate on $1 auths A1

Est. approval rate on $0 auths A0

A merchant will accrue the following costs per authorization performed:

TABLE 2 Costs Accrued - $0 vs. $1 Auths

Cost Using $0 Auths Using $1 Auths

Initial Auth P + $0.025 P + $0.0195
Misuse fee/reversal $0 A1 * min(P,$0.045)

Loss on false positive (A0 - A1) * L $0

auths

While these are not all the costs involved in doing business, they represent the cost difference when $0 and $1
auths are used. Therefore, the per-auth benefit of using the $0 auth is:

B = A1 * min(P, $0.045) - $0.0055 - (A0 - A1) * L.

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You should only use $0 auths when B is greater than 0. If B is less than 0, you are likely to lose money by
performing $0 auths.

For example, if you currently perform 10,000 $1 auths per month with an 80% approval rate, expect a 90%
approval rate for $0 auths, pay 10 cents per auth, and stand to lose $3 from a false positive auth (your trial product
plus shipping and handling is $3), then your benefit from switching to $0 auths is:
B = 80% * $0.045 - $0.0055 - (90% - 80%) * $3 = $-0.2795

You would lose 27.95 cents per auth on average by performing $0 auths instead of $1 auths. At a monthly volume
of 10,000 auths, this translates to a loss of $2,795 per month.

NOTE: Please use the accompanying spreadsheet to calculate if $0 or $1 auth is

right for you. Input values in the shaded cells only.

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