Jun 12, 2006

Has interchange hype brought us to the brink of a surcharging sea change?

If you were a merchant, would you seriously consider adding a surcharge on credit card sales or giving a discount for cash? Probably not, if you felt that your customers would get angry and take their business somewhere else. But what if customers understood that you had no choice? What if they didn’t get angry with you, but with banks instead?

What if your customers kept seeing news reports like this one on Good Morning America about a gas station owner that can hardly make a profit but is paying $1600 a week in credit card fees? How many people have not heard the theme, "gas station owners make less money, or even lose money, when customers pay with plastic"?

What if customers were aware of how much money banks make on a gallon of gasoline? Local papers like this one in New Jersey break apart the cost of gasoline to demonstrate the impact of interchange. "The Legislature needs to pass a law requiring that all credit card fees for gasoline purchases be added to a bill rather than included in the price," says the writer. "This lets New Jersey residents cut out the costs of the middle man. For those who want their air miles, let them pay for the air miles separately.”

Air miles? What’s that got to do with the cost of credit card payments? More and more people now know that credit card companies fund their loyalty programs entirely out of the interchange revenue they receive from merchants. Maybe the general public doesn’t have a sense of this practice yet, but people in our industry are certainly starting to understand it. Some banks even report interchange revenue as a net figure after deducting the cost of their rewards programs! Some nerve, right? Why should merchants be financing the bank's loyalty program? This practice can’t last. It’s so lame that it has to fall apart. If and when that happens, what will happen with traditional rewards programs? Will they go out the door, like they did in Australia?

What if you knew that many of your customers had heard about MasterCard’s IPO; billed as the biggest since Google, in articles (here is one) and on mainstream TV news? Anybody who heard about the IPO definitely heard about MasterCard’s "ongoing legal battles over what are known as interchange fees", with "dozens of lawsuits across the nation", many of which specifically demand the right for merchants to surcharge credit card payments.

What if you saw the ABC News TV segment on how some merchants are already offering discounts for cash payments? The reporter concludes with the line, “Paying in cash instead of credit cards could lead to more money saved for everyone.”

What if you read a similar article in USA Today? The newspaper reports that cash discounts at US gas stations are causing card usage to plummet in some stores. One retailer explains how only 18% of customers are now paying with credit cards, down from 60% to 70% before he started offering a cash discount. Plus, high margin sales inside the store of chips, candy, soft drinks and other items have risen as more people are coming into the store to pay rather than inserting credit cards at the pump and driving off. What a fantastic added benefit! Every convenience store owner is dying to get people to buy more stuff in the store!

What if you were convinced that more and more people were angry with bank fees anyway? Fees for using an ATM, fees for late payments, fees for using their card overseas, and on and on and on. There didn't seem to be so much talk about all of these fees a few years ago. But today, wouldn't people understand your desire to avoid paying fees as well?

What if adding a surcharge was easy to do? Say you had a key on your cash register that calculates a 2% surcharge, so clerks don’t have to fumble with a calculator and the fee is automatically added to the customer’s receipt, like this restaurant in Sydney. Why wouldn’t you have your clerks press that key? Of course, this is allowed in Australia, but more and more countries are also forcing Visa and MasterCard to allow merchants to surcharge.

The Sydney Morning Herald reports that 19.4% of Australia’s top retailers plan to add credit card surcharges within the next six months. In 2003, Australia’s Reserve Bank removed restrictions on surcharging but few merchants followed. Conditions now seem to be changing, with both of Australia’s major newspapers talking of a “surcharging sea change”.

In fact, the term “sea change” was used in this exact context in Australia in 2002, before the reform, in a document commenting on the Reserve Bank's proposals: “The Financial Services Consumer Policy Centre supports the RBA’s principle of allowing surcharging. The Centre takes the view that this new policy would have slow take up rates by merchants who for so long have been accustomed to embedding the cost of merchant fees. However, the Centre also takes the view that in due course a cultural sea change will develop whereby merchants begin to feel more comfortable with the surcharge.”

Thanks to lots of press coverage on rising gasoline prices, increased card usage and even MasterCard’s IPO, interchange fees are no longer a “hidden tax” that people are unaware of. For the first time in credit card history, the general public now has some idea of the fact that merchants have to pay a lot of money to accept cards. This is new. We have never been here before. Then there are all the reports on "fee gouging" by banks, a topic which has gone mainstream in a big way in just the past couple of years. This is all very new. Put it all together, and it makes sense for merchants to be seriously looking at credit card surcharges. The public could be on their side.

Merchants in the US have been allowed to offer a discount for cash purchases since 1975, yet by the early 1980s, less than 10 percent of retailers did so and the practice became even less common after that. Merchants in the UK, Sweden and the Netherlands have been able to surcharge credit card payments since the 1990s, but few chose to do so. Central bankers and economists have assumed that merchants simply don’t want to risk a negative reaction from customers. Some studies point to another reason.

A study on surcharging in the Netherlands found that only 10 percent of merchants surcharge (Vis and Toth, 2000). However, only 28 percent of merchants interviewed were aware of a court decision which allowed them to surcharge. There clearly wasn't the same amount of interchange hype six years ago. The study also found that of the firms that did not surcharge, 60 percent stated that they did not surcharge because they felt that acceptance of credit cards was a service provided as part of the shopping experience and charging for it was viewed as being “unfriendly.”

But what if most merchants interviewed in the study were aware they could now surcharge? What if merchants felt confident that customers understood that banks were making too much money on credit card transactions, and would not see the merchant as being “unfriendly” for surcharging? How would merchants have answered the survey under such radically different market conditions?

In the past, banks could focus on getting cards out and encouraging usage. Interchange revenue seemed to come by itself, almost by magic, with little thought about merchants. That model doesn’t work anymore. The engine is broken. Merchants are gaining increased control and relevance in the payments world. They are angry about card fees and want to stop interchange. Encourage cash over cards? Very few would hesitate if they knew they could get away with it. And why blame them?

How will banks end up responding? The easy way out is to give up on fixing the source of the problem, concentrate everything on litigation to try to keep things as they are for as long as possible, and get ready for a world with no interchange fees. I've heard payment association executives suggest that this was the probable outcome. The idea of giving up like that makes my blood boil. The hard way is to fight and create much more valuable payment products and services that solve major problems for merchants, problems which merchants would have lots of difficulty solving without a general purpose payment card. That's hard, but immensely more satisfying. Our industry has tremendous energy. But it's not channelled right. It would be more effective for banks to shift their frustration with merchants away from litigation and channel it into making payment cards more valuable for merchants.


Citizen Dave said...

I wonder if surchaging might work through loyalty points. Differential pricing is a hassle and might cause problems at POS, but someone like Tesco could easily give bonus clubcard points for paying by cash or ACH rather than card.

Bob S said...

This needed to be said ... and you've said it very well! Back in the "old" days, we had to provide real value to justify the price of our products ... and we accomplished that through providing the merchants with services, information, and marketing/advertising that could generally be quantified as an offset to the fees. Now, everyone points the finger of blame at the other guy(bogey-man), those "miles/points-crazy" users, and those "horribly greedy" banks/card companies/associations. The longer we continue to let the merchants frame the argument in economic terms vs. value for benefits received, the more we risk the cardholders taking their side and forgetting why they have embraced the convenience of plastic in the first place.

John Januszczak said...

About 10 years ago, when I was working at an insurance company, we did a customer study on our products and services. Payment flexibility (in terms of the number of methods of payment available to them) was one of the highest priority items to our customers.

My point is that one of the values that cards provide merchants is simply providing convenience for the merchant's customers - at minimum, equal convenience to one's competitors who accept cards. Is it worth the fees? I don't know, but I suspect it must be otherwise it would be an easy decision for merchants to stop accepting this payment option. It goes without saying that it is in the merchant's interest to argue that the value provided by cards should be available to them at lower cost.

Also, my two cents: cash discount over surcharge. I think it is easier to "sell".

Michael Imbleau said...

It seems we’ve come full circle. The evolution of money started with barter and precious metals. Then we moved to hard currency. Then we moved to card payments with credit and debit. Now we’re moving backwards to cash. Strange!

Banks no longer worry about cost when pricing their products. Recently I was told to setup a standing order for paying my rent out of my bank account would cost me $5/month…but I could write a physical check for free. Banks know what we prefer, and it’s a case of supply and demand. We want electronic products, and they’ll charge more for them even if they are cheaper to operate than the alternative.

Consumers don't have choice...but the second they do, they will migrate on mass. Look at the success of ING Direct.

John Januszczak said...

Further to my comments that "...it is in the merchant's interest to argue that the value provided by cards should be available to them at lower cost", I have been reading Adam Levitin's The Merchant-Bank Struggle for Control of Payment Systems where he echoes my sentiments:

"Merchant-initiated payment card litigation is ultimately a business strategy to reduce payment acceptance costs."

However, Mr. Levitin does a nice job explaining the other side of this - the merchant side of the struggle - and why the fees might legitimately be viewed as unfair. I highly recommend reading his paper.

Aneace Haddad said...

Adam's paper really is excellent. I have just finished reading it and will prepare a blog post with several of his comments which I found especially insightful.

Rosie said...

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