Credit Card Reform: Interchange Fees

Also, while I’m ranting, interchange fees! Rawr!

Credit Card Industry:  Rawr!

Credit Card Industry: Rawr!

The fact that interchange fees, the fees that businesses get hit by that get passed onto consumers, have risen over the past two decades, while, as far as I understand, protection to businesses has decreased and services to consumers has stayed the same while the volume of the market has increased and the technology has also increased strikes me as de facto price fixing.

Crowd-sourcing request: Why don’t businesses, in general, offer cash discounts? Let’s assume that the interchange fee is 2% to the business. If I buy a $100 stereo from a store, they only make ~$98 if you pay with a credit card, but they make $100 if you pay with cash. Now if I pay with a credit card, I get about 1/3rd of that interchange fee in some sort of credit card payment reward. Frequent flyer miles, an inflatable grill, whatever. Let’s say that I end up with a $1 if I use my credit card in this case.

Now I have to decide whether or not to use my credit card, and the business has to decide whether or not to charge $100 or $102, the $102 reflecting a break-even from a customer using their credit card. The stereo costs the business $100 and is worth $100 to me. What’s the payouts?

Note that the consumer always using a credit card, and the business charging the fee is the Nash equilibrium. (Also strongly dominated equilibrium at that.) Even though I’d be better off if I paid cash and they didn’t pass along the interchange fee.

This isn’t an academic exercise. A small business I was at had a sign noting that they get charged over 2% every time a customer used a credit card, so why don’t you pay cash or with a check? But as I was about to pay cash, I wondered: “Don’t the prices already reflect that I will use a credit card? I might as well get points towards my plane ticket or whatever comes with the card.” In other words, my only choice was to go from (-1,0) to (-2,2), since I know what is rational for the business to charge. I do this even though I am indifferent on how much convenience I save with credit cards. Since most stores only charge one price, this cuts the legs out of prices doing their information work. I don’t know what credit card fees are being charged with my prices.

So my question: Why don’t more businesses offer a cash discount? It would move us to the optimal (0,0) space above. Do they get such a sweet deal with how much consumers spend when they have a card they don’t want to draw attention to anything going on behind the curtain? Am I just a weirdo, and this is a weirdo line of reasoning? I know credit card fees are illegal in many places, though I don’t think cash discounts are. Is there something about how people perceive people with cash getting a ‘special deal’ that makes them upset with the business? I have no idea.

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15 Responses to Credit Card Reform: Interchange Fees

  1. stefan says:

    Hm, don’t the card agreements forbid cash discounts? If the business takes the card, it has to offer the best price to the card user.

  2. Joe says:

    Cash discounts are against most credit card merchant agreements – which is why they’re rare.

    Of course, there are monopoly issues with the whole concept, but it seems noone cares about that.

  3. Mike says:

    Thanks for the responses. Is this true that cash discounts are outlawed by the merchant contract? I tried figuring this out earlier – According to the Mastercard “Interchange Myths And Facts”:

    === http://www.mastercard.com/us/merchant/pdf/021208MythsFacts.pdf ===
    Myth:  Card company  rules prohibit merchants from offering 
    discounts for cash and check. 

    Fact:  MasterCard has always allowed  merchants to offer discounts  for 
    cash and check.  Gas stations,  for example, used to regularly offer 
    cash discounts, but the majorit y  independent ly ceased this pract ice. 
    These t ypes of businesses came to recognize that payment cards, 
    such as MasterCard, offered them significant benefits over cash or 
    check transactions. 
    ==

    Now granted, I don’t know if that has been lawyered in such a way that it means the opposite of what it says, or if there’s another layer in the merchant contract that forces a merchant to discount that. I could easily see the merchant contract essentially requiring them to be removed even though they are a ‘possibility.’ But I’ve seen this language elsewhere.

    In general, I don’t trust much information vis-a-vie credit cards online, since they have a small industry in information-distribution-favorable to them. I tell people in trouble with credit cards to get advice and credit counseling from Churches – it’s one of the few places you can trust not to be run by a VISA subsidiary.

  4. willdearman says:

    As a small business owner, I can confirm that part of the merchant agreements with Visa/Mastercard/Discover/Amex all specify that we are not allowed to offer any sort of cash discount or give any appearance of a “surcharge” on credit card transactions. If the merchant association receives complaints about your discount/surcharge policies you can be barred from ever accepting that type of card again.

    [As a side note: Mike, I love Rortybomb; have been following since your Gaming PPIP post. Thanks for the great work]

  5. Sue says:

    Bricks’n’mortar locations esp gas stations and grocery stores – Security – they don’t want more than minimal cash on the premises. They don’t want their employees robbed nor a lawsuit if one gets shot.

  6. racerx says:

    We made a trip to Highpoint NC recently to buy some furniture from one of the many outlet stores. A lot of the smaller stores do not take charge cards.

  7. Alex R says:

    Where I live in New Jersey, almost all of the local gas stations I go to — mostly of the cheap, not-a-national-chain variety — post both a “cash price” and a “credit price”. The cash price is typically 5 to 10 cents a gallon below the credit price. Interestingly, this wasn’t the case two or three years ago — the practice of posting two prices seemed to arise spontaneously when gas prices got up around $4/gallon, and remains even though they’re back around $2 again.

    I hypothesize that when gas got expensive, people were more inclined to save every penny they could on filling up, and some stations realized they could pull in extra business by posting lower cash prices. Now that the system is in place, they are keeping it to keep the benefits of advertising a lower price than they could otherwise.

  8. pebird says:

    The interchange fee on debit cards with PIN is much less than credit – can cost the retailer about .50 instead of 2.00. The .50 is probably a good fee for the savings of having to handle cash (count, deposit, theft). This is why most grocery stores present you with a PIN option by default – if you use the PIN for debit, the grocer gets the lowest charge.

    I have not seen any retailer offer the discount for debit to the consumer – I think there would be too much confusion with clerks able to differentiate. Its also problematic trying to process an automatic discount via the register – until the transaction is completed you don’t know what method(s) was used, so how do you tender the discount – retailers don’t want to issue cash out. Also, people pay with multiple tenders (it happens more than you would think).

    The only electronic method is the stored-value card (like a Starbucks) – where the transaction can be issued and a discount put back on. But other than loyalty and rebate cards, you don’t see those much.

  9. Mike says:

    Thanks for all the clarifying comments. The confusion issue makes a lot of sense as does the not keeping cash on premises. I actually thought using my PIN would be a headache for most businesses, and have usually rang through as credit. I’ll change that practice.

    How do people familiar with this, especially small business owners, feel about the statement: “Services provided by the credit card companies to businesses, especially in the form of protection, have declined in the past several years.” ?

    How do you even define services broadly? Someone argued with me recently that, even though interchange fees have increased instead of decreased though the technology is maturing and the scale is increasing isn’t evidence of de facto price fixing if the services are increasing – kind of like how like an average computer hasn’t gone down in price though they are much faster.

    I’m under the impression that the cc companies are shoving more risk away from them and to buisnesses, though I’d like to hear more.

    Also, “Mastercard: Myths and Facts” how could you mislead me! RAWR!

  10. pebird says:

    I think the confusion about not being able to offer cash discounts might come from the card agreements that don’t allow a retailer to show financial preference for one electronic payment form over another.

    So, for a retailer that accepted VISA, MC and AMEX, even though AMEX charged (used to be much higher than it is now) a higher rate (because of supposedly higher income card holders who would spend more) than VISA or MC, the retailer could not offer a “VISA” discount or an AMEX surcharge (some tried).

    So that was in place a long time ago. Then with the advent of debit (which with PIN is basically electronic cash), the vagueness in the card agreement led some to the belief that there could be no “cash” discounts – at least no stated policy that debit should be given an explicit preference. The card associations didn’t really do much to dispel that notion.

    If you frequent independent gas stations, you can get a lower price for using debit, but they charge a debit fee – so you have do the math to figure out if your discount is worth the .50 – .75 debit fee. The reason for this is that for a ticket of $10.00, a debit fee of .75 is 8% vs. the 2-3% credit card fee on a higher price.

  11. Felix Salmon says:

    I think the only thing rising faster than interchange fees is cash-handling fees charged by banks. Cash involves at the minimum a lot of employee time collecting banknotes, putting them all face-up, taking them to the bank, etc etc, even if the bank charges nothing — and most banks charge quite a lot. So it’s not really true that the shop makes $100 if you pay with cash.

  12. James Durand says:

    I’m in the business of advising stores about cards. The credit card company rules look simple, but are so lawyered up in practice that its almost impossible to offer discounts for cash – outside of gas stations – and even they get hassled by the card companies.

    As for debit cards – the credit card companies have rules that prohibit stores (including even gas stations) from giving discounts for debit – including PIN debit – even though many merchants would jump at the chance to do so.

    Congress recently tried to pass a bill that would have let stores give discounts for debit cards and the banks and credit unions cried bloody murder.

  13. Sam says:

    I am surprised that gas stations and other businesses simply do not pass these costs to the consumer. Simply inform the consumer that the cost of doing business has increased and is a result of credit card companies and their “convenience” thus associated fees will be past onto the consumer. The businesses could then state, “If you have concerns or comments please contact your local congress person and complain about Interchange Fees.” It amazes me that these fees have not been passed on to the consumer, especially with gas stations. This is not a fee for use of a credit card on the consumer, but passing the cost of using a credit card to the card holder.

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