Surcharge (payment systems)

Different payment methods such as cash, credit cards and debit cards have different costs and benefits to both the merchant and the consumer.

Under "uniform pricing" (pricing that does not reflect the payment method chosen by the individual), consumers do not consider the effect of their choice of payment on the seller. Using credit cards, which utilize a payment platform, will incur fees to the seller.[4] Additionally, the seller suffers from indirect costs such as missing interest payments on the balance of goods or services sold using credit.[5]

Thus, the cost of using payment systems like these are borne primarily by the merchant. For customers to internalize this negative externality, merchants can use pricing incentives, through surcharging, to direct their customers to paying in the most cost-effective manner for their business. Utilizing this practice, the merchants can capture more of the consumer surplus using price discrimination methods. These tactics have been stopped in many countries where regulatory requirements ban the practice from occurring. Additionally, many card companies have enforced requirements stopping merchants from surcharging card transactions, to maintain demand from consumers for their services.[4]

In the presence of surcharging, consumers are encouraged to make payments using a cheaper option. They will elect to use traditional methods, such as cash, to avoid the extra cost of acquiring a good or service. Consumers indirectly place competitive pressure on payment platform providers, which could indirectly lower the merchants' payment costs.[6] As consumers' indirectly lower the cost to sellers or selling, the right to apply a surcharge on expensive payment methods means the business can offer lower prices on goods and services to all potential customers.[6] This could generate an increase in demand and an overall increase in consumer welfare. In the absence of surcharging it is postulated that there are substantial negative social and economic welfare effects including inflation, a reduction in the purchasing power of consumers because of larger debt service, lower ravings rates and inequitable cross-subsidization between consumers paying with cards and those paying with cash.[7][8]

Countries including the United States, Australia, and Canada have sought to promote price competition among card brands to increase efficiency.[16] In the United States, consumer protection advocates have promoted for surcharging solutions as a mechanism to slow the rapidly increasing cost to businesses of card acceptance, including the 24% increase in interchange cost for Visa and Mastercard rewards cards since 2004.[25] The Boston Federal Reserve argues:

"Merchant fees and reward programs generate an implicit monetary transfer to credit card users from non-card (or “cash”) users because merchants generally do not set differential prices for card users to recoup the costs of fees and rewards. On average, [...] each card-using household receives $1,133 from cash users every year."[26]

Whereas businesses that pay for the cost of card acceptance have no mechanism of exerting price pressure on the card brands, businesses that require their customers to pay the fees associated with their card create price competition, as the customers choosing the form of payment will prefer to use lower-cost cards. By creating the incentive for customers to choose lower-cost cards, surcharging reduces transaction costs overall. For example, industry experts have shown that, on a $1,000 transaction, motivating a customer to choose a debit card (to which no surcharge is applied) instead of a premium rewards credit card reduces the interchange cost of the transaction by up to $23.38.[27]

In the absence of surcharging, a retailer will attempt to recover the cost of using their payment platform a uniform increase in the price of goods and services. They will include a margin on top of their products in order to cover the average cost to the business of using a payment system, such as a credit. This results in a cross-subsidization from consumers using different payment types. Those who pay with low-cost methods such as cash or direct debit pay the same amount as customer using credit cards.[28]

Additionally, in the absence of surcharging, the prices of different payment methods are masked to the consumer, harming consumer welfare. Using credit cards to pay for goods or services can distort consumer's cost-benefit analysis decisions and increase their willingness to pay for goods or services.[28] An MIT study found that students when bidding on sporting tickets were willing to place bids up to 64% higher when using credit compared to cash.[29] This underestimation bias the consumer is prone to because of increased credit card usage results in a reduction in their personal welfare.

Some merchants impose surcharges to make additional profit instead of to cover official credit card company charges, in violation of consumer protections.[30] A prominent example of this phenomenon occurred in Australia when surcharging was permitted. In December 2010, the average rates of surcharges for MasterCard, Visa and Diners Club credit cards were 1.8, 1.9 and 4%, respectively. The merchant fees for MasterCard and Visa cards were around 0.6% and the fees for Diners Club cards were around 2.2%.[31]

Additionally, many merchants seeking to reduce transaction costs have implemented non-compliant solutions that fail to meet price transparency and consumer friendliness standards imposed by the card brands' contract requirements.[32]

Wright investigated the welfare effect of removing a no-surcharge mandate in a model where a not-for-profit credit card provider gave payment facilities to consumers and a homogeneous monopoly merchant. When the rule is removed, welfare was decreased for society as the monopoly merchants placed fees on the use of credit cards which were higher than the merchant fees they were required to pay.[33]

Conversely, Schwartz and Vincent found that the implementation of a no-surcharge rule increases the profits for credit card companies but decreases the welfare of consumers choosing to pay by cash and the merchants themselves. The credit card in their model is provided by a for-profit company to heterogeneous consumers and monopolistic merchants in an open system.[34]

Schwartz and Vincent also analyzed the no-surcharge rule in a competing platform setting with cashback rebates. Their article does not analyse the welfare implication of the no-surcharge rule. However, they provide a framework on the competition between two platforms and how to understand the equilibrium in setting their fees. Their main finding is that there exists no pure Nash equilibrium in setting the fees under the NSR.[35]

• Cabcharge
• Interchange fee
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