Monday, December 12, 2011

Will the Retailer Battle with Credit Card Companies Help Consumers?

Right now in Canada you usually pay the same price to a retailer for goods and services whether you pay by cash, debit, or credit. On the surface this seems like a good thing. However, when we scratch the surface, we see inefficiencies that boost prices. Planned changes to these price rules could create different pricing for different payment methods, but whether consumers will benefit is still unclear.

When you pay with a credit card, the retailer has to pay between 1.5% and 3% of the transaction amount to the credit card company. The cost of all the wonderful credit card reward schemes we enjoy comes out of these fees charged to retailers.

Retailers have to raise their prices to compensate for the fees they pay to credit card companies. The catch is that everyone has to pay these higher prices, even those who pay with cash. In effect, people who pay cash are subsidizing the credit card rewards and cash-back schemes. But only some of the retailer fees flow back to consumers as rewards; the rest goes to banks and credit card companies.

Retailers are upset about new credit cards that require them to pay ever-higher fees. These higher fees pay for the increasingly generous credit card rewards consumers enjoy. But more of these fees are kept by banks and credit card companies, which causes the prices of goods and services to rise.

So, there are two problems. One is cash-paying consumers unfairly having to subsidize credit card users. The other is the growing fraction of transactions that get retained by banks and credit card companies that must lead to higher prices for consumers.

Retailers argue that they should be able charge consumers extra for credit card purchases. On the surface this would seem to solve both problems. Retailers in competitive markets would advertise slightly lower prices. This would end the subsidy by cash-payers, and credit card users would pay for the credit card fees. The high-fee credit cards would suddenly be less desirable to consumers if they had to pay 3% extra for each transaction. Cash, debit, and lower-fee credit cards would suddenly look much better.

However, why should we think that retailers would pass on just their actual costs for credit card fees? Why wouldn’t they charge much higher fees if they could get away with it? Consumers are driven by advertised prices and may not be as sensitive to extra charges at the point of sale. In the absence of rules to prevent this kind of abuse, particularly by monopolies and near-monopolies, there is no reason to believe that consumers would be any better off if retailers could charge extra fees for credit card transactions.

The Competition Bureau is challenging the rules credit card companies impose on retailers preventing them from charging extra fees for using credit cards. There is a lot at stake and it isn’t clear how much freedom retailers might get to charge extra fees. If retailer freedom is limited, consumers are likely to benefit, but the situation is less clear if retailers are free to add surcharges as they please.


  1. The retailers are also conveniently neglecting the costs of handling cash such as point of sale errors, theft, and security. So I don't think it can unambiguously be stated that cash customers are subsidizing credit card users.

  2. Sorry, followup: Also it's well established that people who use credit cards spend more than people who physically have to pull cash out of their wallets. I bet that if you created two identical stores, one that's cash only and one that's credit only, the credit one would come ahead.

  3. If the retailers are raising prices across the board to account for processing fees, aren't they coming out ahead?

    The consumers should be the ones complaining, not the retailers.

    I get that it's Mom & Pop shops who are getting squeezed by reduced margins, but the alternative of not accepting credit card payments will do more harm than good.

  4. @Lewin: Handling cash has costs for retailers, but it is less than the costs associated with credit cards.

    I'm not claiming that retailers care about credit card costs being partially shifted to people who pay cash. But consumers should care.

    @Echo: The short answer to your first question is no. Even if retailers were to raise prices to completely account for their credit card processing costs, they would have lower sales due to the higher prices. In this situation it helps to refer back to the price-quantity curve from economics classes. When their costs rise, retailers have to choose between holding prices and having lower profits or raising prices and selling fewer items. In reality, economic theory would have them raise prices part way and sell somewhat fewer products.

    The debate isn't about whether to accept credit cards at all. The debate is whether retailers will be permitted to add an extra charge at the point of sale when the consumer uses a credit card.

  5. @Michael: I just meant that it's often claimed that, "credit cards cost retailers 1-3%" and the unstated premise is that cash costs nothing. So the proper comparison isn't 3% vs. 0%, but 3% vs. some non-zero amount.

    I accept that cash consumers would want two-tiered pricing because of this subsidy. But retailers? They're crazy to propose anything that cuts down on credit card use. People using cards spend more and feel better about it. In one study, people who were paying on credit were willing to pay 60-110% more for a product than people paying with cash. Those who don't like fees are always free to stop taking credit cards, and free to watch their sales drop precipitously.

  6. @Lewin: It's true that accepting cash has costs. But it's also true that accepting credit cards has costs beyond just the fees charged by the credit card companies. For example, they need equipment to handle the cards and credit card pruchaes take longer than cash purchases. So, instead of 3% vs 0, the real comparison is 3%+x vs. y, for some positive values of x and y.

    I agree with you that retailers need to keep accepting credit cards. However, their goal is not to eliminate credit cards. What they want is the freedom to charge consumers extra for using credit cards. Presumably, if they got this freedom, they would use it in whatever way is most profitable for them.

  7. @Michael James - You mentioned in your post that "Retailers have to raise their prices to compensate for the fees they pay to credit card companies." That implies that all retailers are raising their prices to keep their margins intact. Consumers won't buy less, especially if we're talking about staple items...they're simply paying more.

    The real problem that wasn't mentioned is that big box stores like Wal-Mart can absorb these transaction fees (they just hammer their suppliers to lower prices), so customers wanting a deal will shop there instead of at the local small business.

    There's no way retailers will be allowed to add an extra charge to credit card transactions.

  8. @Echo: How much retailers increases prices to compensate for credit card fees depends on the competitiveness of their market and the elasticity of demand. In general, prices rise by less than the amount of increased cost and both consumers and retailers lose out to some degree.

    If Walmart could "just hammer their suppliers to lower prices", they would do this anyway whether they faced credit card fees or not. Walmart already hammers their suppliers to the maximum degree they can. Credit card fees cost money for all 3 parties: Walmart, their suppliers, and their customers.

    You may think that "There's no way retailers will be allowed to add an extra charge to credit card transactions", but this is precisely what the Competition Bureau is trying to achieve. You may be right in the end, but that seems far from obvious to me right now.

  9. Fascinating problem. Like Lewin says, paying with a credit card is less psychologically painful than using cash. I'm not physically losing anything when I use a credit card. There's just the vague notion that I'll have to pay for this later, and I may also get a bit of a bonus reward. Also, there's no inconvenience of gathering handfuls of change.

    If retailers were allowed to charge less for cash purchases, I think it wouldn't take that much incentive to those who would be interested. Most rewards cards offer less than 1% cash back, so a 1.5% cash discount would sway some people. Perhaps 3.0% wouldn't sway many more people than 1.5%?

  10. @Gene: My understanding of the agreements credit card companies force on retailers is that retailers can offer a discount for using cash. But, they can't advertise the cash price and then charge more for using a credit card.

    If prices for paying cash were lower I would certainly pay cash more often. I don't know what others are likely to do, but it makes sense to me to push extra costs on those who use credit cards. But, I also don't want to see retailers use the extra credit card fee as a profit center.

  11. What I find interesting is that debit is the most common transaction type in Canada (3.5 billion transactions in 2008, according to Interac), and I've seen some retailers charge a fee for using debit in their store ($1 or less).

    I can't find any information as to why or how this happened. Perhaps the Competition Bureau went through this 10 years ago when debit became the preferred method of payment for shoppers?

  12. @Echo: I've also seen very small shops charge extra for small credit card payments, but I think they do this in violation of their agreement with the credit card companies. I don't know much about debit transactions. Perhaps the agreements retailers sign to be able to accept debit transactions don't prevent them from charging extra -- I'm not sure.