Stores May Soon Be Allowed to Charge Their Credit-Card Customers Even More

American businesses, especially small ones, pay more to process credit cards than those in other nations. Here’s what a $50 supermarket transaction costs with a Visa card cost in various countries, based on calculations of interchange fees based on October 2010 data available on Visa’s site

Tim Chen, CEO and chief credit card analyst at NerdWallet.com, a site that educates consumers about credit cards, in his article in Christian Science Monitor puts the focus on hidden credit-card “swipe fees,” which, in contrast to the very visible bank-imposed ATM fees, late fees and over-limit fees are invisible to consumers.

The two biggest players in the industry, Visa and MasterCard indirectly set the interchange fees charged to merchants. Around 2007 (roughly the time they became publicly traded companies), they began raising interchange fees on premium rewards cards at a rate that far exceeds increases on standard credit cards. A merchant’s swipe fee is based on a complex algorithm that accounts for multiple variables such as the type of the credit card, but the fee generally amounts to between 1.5% and 3% of a transaction.

Costly to Merchants: While consumers may not be aware of swipe fees, they are affected nonetheless, as it is reflected in the prices merchants charge them. And merchants say that credit-card swipe fees represent a big expense to them.

Credit-card swipe fees cost merchants and their customers about $30 billion a year, according to estimates by the National Retail Federation. The fees are meant to cover processing costs. But retailers and other businesses, small and large, are angry, in part because some of the fees may be used by issuers to also shoulder the cost of marketing campaigns about benefits programs for reward points and airline mileage.

.Emily Maltby  in her Wall Street Journal article, says that at least one business interviewed she interviewed indicates that costs associated with credit card swipes have sometimes amounted to more than the business profit, representing their third biggest overhead expense last year after rent and payroll. How does this affect merchants and consumers?

Raises Prices for All Consumers: Companies charge merchants “swipe” or interchange fees for every credit-card transaction. When those fees go up, then merchants raise prices for everyone – all people who use credit cards. Consumers who pay in cash or use plain-vanilla credit cards without rewards end up paying extra without getting the advantage of credit-card rewards.

Disproportionately Affects Small Businesses: Interchange fees are lowest for large merchants processing non reward credit cards, but highest for small merchants processing premium rewards cards, partly because big chains have the clout to negotiate lower fees from the credit-card companies, while small supermarkets and other small retailers don’t. According to NerdWallet’s calculations:

  • A small supermarket pays $1.15 to process a $50 credit-card transaction from a Visa Signature” customer.
  • A large supermarket pays $0.63 to process the same transaction from a basic or simple rewards customer.

Greater Impact on US Customers: In the United States, the level of “swipe” or interchange fees appears to be based on merchants’ ability to negotiate, while the regulated interchange fees in Europe seem to be based more on the costs of processing. Take a similar $50 Visa transaction at supermarkets around the world. According to NerdWallet’s calculations.

  • In the US, the maximum is 2.3%.
  • No. 2 – Canada, is below 2%.
  • All but 7 of 35 developed nations have a maximum interchange rate of under 1%.

The US rate also varies considerably. The difference between its maximum rate and the minimum rate is the highest of the 35 nations. For example: While Visa’s US interchange sheet has four separate classes of consumer credit cards, and 26 different types of merchant classifications, Visa France’s interchange sheet lists only one class of credit card and six types of payment technologies, each with varying fraud risk.

The Cost of Antiquated Technology

Visa France’s system is much simpler and far cheaper. Interchange rates range from as low as 0.22% plus €0.10 (14 cents) to 0.45% plus €0.15. Presumably, this difference is driven by fraud risk, which is a cost borne by the credit card companies. However, the cards that qualify for the lowest French rate are those with so-called “EMV” chips, computer chips that are far superior at minimizing fraud risk than normal magnetic-stripe encoding common in the US. United Nations Federal Credit Union and State Employees Credit Union have started to issue these cards domestically because their international member bases have started facing card rejections abroad.

Yet the US is still using technology from the 1960s. A payment system that is resistant to improvements that would lower fraud and reduce costs penalizes all consumers.

Walmart offers a logical explanation about why US issuers are dragging their feet on EMV. It says that banks want to continue collecting high interchange rates on signature based transactions rather than invest in switching to a technology with lower fraud risk, which would presumably justify lower interchange rates. If Walmart’s allegations are true, this lends further support to the argument for regulation.

Loss to Fraud: Substantial amounts are lost to fraud every year. American Express reported $120 million in provisions for unauthorized transactions over the first nine months of 2010. The loss would have been much lower with widespread use of EMV cards. According to Tim Chen:

It is highly unusual to encounter an industry where raising prices benefits your customers, and the costs are borne by people who do not consume your product. This is exactly the case with credit-card processing. When Visa and MasterCard raise the interchange fees they charge a merchant, the resulting revenues mostly accrue to their customers: the banks that issue the cards. As a result, the merchant raises her prices, consumers take the hit whether they pay cash or use a credit card. Which consumers are cushioned from that higher price? Only those with premium reward cards, who get cash or something else of value when they make transactions.

Further Fee Rise Expected

iscounts, declined to comment.

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Swipe Fees are Costly: Credit-card swipe fees cost merchants and their customers about $30 billion a year, according to estimates by the National Retail Federation. Interchange fees typically are one of the biggest expenses for merchants after labor.

The interchange-fee costs for Visa’s and MasterCard’s premium cards increased 24% between 2005 and 2009, according to a 2009 report from the Government Accountability Office, and cardholders with rewards cards are more likely to use their cards exclusively than those without rewards cards, according to a 2008 study from the Federal Reserve.

New Surcharge Fee Coming: Visa and MasterCard  have long banned surcharge fees in the U.S., but the no-surcharge rule is likely to be eliminated or altered, under a potential settlement of long-standing lawsuits retailers have brought against the card networks and numerous banks that issue their cards, over the setting of the fees. The settlement discussions have taken place over the past year, and some expect a deal to be reached before the September trial date for the litigation, which includes more than 50 lawsuits filed by merchants since 2005. A settlement could also include payments by the defendants ranging from $8 billion to $12 billion and a temporary reduction in interchange fees, according to analysts. Visa and MasterCard, which allow cash discounts, declined to comment.

The Downside of Surcharge Fees: Consumers may be turned off if they feel they’re being penalized for paying with plastic, especially if they don’t have a previously existing relationship with the merchant, according to Amar Cheema, associate professor of commerce at the University of Virginia, who has studied how consumers think about and respond to surcharges. Ken Manning, marketing professor at Colorado State University, points out that shoppers might be surprised if they see an item’s price tag only to find out later at the register that they’ll have to pay up to 3% more.

Retailers may be “better off incorporating the surcharge into the price of the product itself” and then giving a discount for paying cash, framing the price as an additional reward for a cash-toting customer rather than a penalty for those using plastic. Madeline Aufseeser, a payments-industry analyst at Aite Group LLC, a financial-services research firm, is skeptical many large merchants would try surcharging for fear of angering consumers. Surcharging “slows down what happens at the point of sale,” she adds, leaving them vulnerable to competition.

The payments companies and banks argue that surcharge fees are justified because they help pay for efforts to keep fraud costs down and costs associated with handling cash and checks. They say that card acceptance helps boost sales for merchants.

The Cash Discount Strategy:  Discounts for paying in cash are offered by gas stations in certain parts of the country. Nice N Easy Grocery Shoppes Inc., a chain of convenience stores in upstate New York, customers who pay cash can get a nickel discount off the listed per-gallon price of fuel, for instance. Still, while more people have paid in cash for gasoline since 2010, when the chain started offering the discounted cash price for fuel, about 80% of fuel sold at these stores are still paid for with plastic, and a major shift to cash purchases isn’t expected since younger generations don’t tend to carry cash. Since swipe fees can account for several thousand dollars a month at some of the chain’s locations, to deal with that cost, the chain may cut back on labor or hold off purchasing a new piece of machinery.

Any Relief in Sight?

Mallory Duncan, senior vice president and general counsel for the National Retail Federation in Washington, D.C., an organization not involved in the lawsuits, states:

All retailers pay too much, but small retailers pay much too much. Swipe fees are high for all merchants, but large merchants can sometimes use sophisticated techniques or their sheer buying power to help get relief from swipe fees.

Retail analysts who expect the settlement to lift the ban on surcharging caution that there could be requirements concerning how merchants can impose surcharges. Merchants may have to limit surcharges to the cost of card acceptance, for instance, or disclose surcharges to customers.

Financial reform legislation passed in 2010 offered some relief to merchants who have been struggling with rising swipe fees by allowing merchants to set a $10 minimum on credit-card purchases and reducing swipe fees on debit card transactions. However, it didn’t address swipe fees for credit cards.

In my view, the best form of relief would be provided by the adoptation of more state-of-the-art technology to reduce fraud risk, since there is no doubt that “EMV” chips are far superior at minimizing fraud risk.

As Tim Chen notes, these fees are discriminatory against small businesses and the only consumers cushioned from the higher prices are those with premium reward cards, who get cash or something else of value when they make transactions.

Although lawmakers and the Federal Reserve are well aware of these issues, and regulation seems likely at some point in the future, until then, he writes: “consumers who use cash and those “plain vanilla” credit-card holders will pay a price for a system seriously out of whack.”

It’s time the credit card companies fix the problem instead of passing it on to small businesses and consumers who are already hurting.

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