Nov 7, 2006

Why do merchants prefer credit card surcharges rather than cash discounts?

Adam Levitin raises an interesting issue in his excellent paper, “Payment Wars: The Merchant-Bank Struggle for Control of Payment Systems”. It has been a number of years since merchants have been able to steer customers away from cards toward cheaper payment methods by offering discounts for cash paying customers. The associations gave into this form of steering years ago, but retained the rules prohibiting merchants from applying a surcharge on card purchases. Mathematically, it sounds like the same thing, so why are merchants now fighting for the right to surcharge?

According to Levitin:

“(Some) merchants accept payment cards but attempt to steer customers toward cheaper payment methods by offering discounts for non-card payments or by asking customers for a specific payment type. Card network no-surcharge rules (and state law in eleven states) prevent merchants from imposing a surcharge on credit or debit cards, but, by federal law, the card associations may not prevent merchants from doing the mathematical equivalent by offering a cash discount. Merchants rarely use cash discounts because they are not particularly effective in affecting consumer behavior, unlike a surcharge for credit use, because of the well-documented cognitive bias of the framing effect. Although mathematically the same, consumers perceive surcharges and discounts differently, much like a bottle half-full or half-empty, and react much more strongly to a surcharge than to a discount.”

An earlier paper by Levitin (“The Antitrust Superbowl: America’s Payment Systems, No-Surcharge Rules, and the Hidden Costs of Credit”) provides more detail on how consumers perceive surcharges and discounts to be different.

“The different framing effects of a discount or a surcharge are powerful. It is a well-documented behavioral bias that people have stronger reactions to losses and penalties than to gains. For example, in a recent survey of Dutch consumers’ opinions on credit card surcharges and cash discounts, attitudes were substantially more negative towards surcharges than towards discounts, in spite
of the economic equivalence. Accordingly, although the credit card lobby has never embraced cash discounts, it has preferred them to credit surcharges, because consumers perceive a discount as a gain, but a surcharge as a penalty and will prefer to use another payment system rather than be penalized for using credit.”

This is of course a huge threat to card usage. It is also one of the biggest threats to interchange, if not the single most important one. Merchant coalitions appear to be shifting their strategy away from court mandated regulation of interchange fees, and appear to be moving instead toward greater transparency, making it clear to consumers how much merchants must spend on interchange, so as to set the platform for massive surcharging. See my prior blog post, "Radio ad attacks interchange fees, hints at possible shift in merchant coalition objectives".


Colin said...

If I follow the logic, as interchange becomes transparent, consumers will react.
Presumably the next step after transparency would be merchants directing customers to the lowest interchange card.
This could have enormous consequences, and will drive interchange fees down. I think I am finally getting it!

Aneace Haddad said...

Yes! Exactly! The strategy has a much greater chance of succeeding than the prior objective of getting the courts to regulate interchange fees. And it ends up accomplishing exactly the same thing. I am really surprised that the associations are doing absolutely nothing to protect interchange, other than responding to court battles to resist change as long as possible. You would think that Visa and MasterCard would finally wake up at some point. Maybe they're all too busy with their IPO's. The consequences are so huge though, that it is hard to imagine the associations not making some major moves once they truly focus on the problem.

CreditCustomer said...

It is a natural process when prices and different rates are becoming lower in consequence of market competition. Moreover everybody wants to know wherein his/her money goes.