Transparent Pricing of Payment Services?

Bernardo recently sent me a link to a blog post that advocated for transparent pricing of payment services. The post is a bit of a rant about unnecessarily high interchange fees, which is the fee the merchant’s bank pays to the card-issuing bank for a credit or debit card transaction. These fees are set by the system as a whole, and they naturally set the floor for what a merchant pays to accept credit or debit cards. The trouble, the author argues, is that these fees are much higher than they need to be, and because consumers are generally unaware of these fees, they continue to use the most expensive, least efficient payment instruments, ultimately resulting in higher prices for goods and services.

The solution, the author contends, is to make these fees transparent and visible to the consumer. The author reasons that if the fees charged by the payment networks are passed on explicitly to consumers, they will naturally choose less expensive payment instruments, and probably exert pressure on the payment networks to lower their fees across the board.

VISA and Mastercard have traditionally prohibited such surcharges via their merchant agreements, but various lawsuits might soon give merchants in the USA the right to pass on their merchant discounts more explicitly (merchants in Australia and New Zealand have been able to do this for a while now). Although very focused merchants such as gasoline stations are allowed to offer a “discount” for cash transactions, they are not allowed to impose any kind of “surcharge” for transactions involving cards. In real terms, these are just two different ways of looking at the same thing, but the card networks, which have always been very savvy at marketing, know that consumers don’t see these as equivalent. A “discount” is a reward, something you might want to take advantage of, but not something that will really hurt you if you pass it up; a “surcharge” is a penalty, something you should do everything you can to avoid.

Psychologists refer to this phenomenon as “loss aversion,” noting that most people are motivated more by the threat of a potential loss than the promise of a potential gain, even if the net result is the same. Thus, if you were offered a discount to pay in cash, you might take advantage of it, but wouldn’t be as motivated to do so as you would if you were told that you would have to pay a surcharge if you wanted to use your credit card. Theoretically, a surcharge would motivate more people to choose less expensive payment instruments, forcing the card networks to lower their fees.

All of this sounds great in theory, but the trouble is that surcharges would be only one of many considerations that ultimately influences a consumer’s choice of payment instruments. Human beings are complex creatures; we are motivated not only by prices, but also by convenience, the status something might afford us, the extrinsic rewards it might provide us, the desire to be treated fairly and with respect, and expectations formed by years of prior experience.

Imagine if the next time you went to the grocery store, you were told at the checkout that you could pay one of four different amounts depending on which kind of payment instrument you used. Would you be happy that transaction pricing was finally transparent, or would you just be confused and angry that you had to pay 3-4% more because you wanted to use your air miles credit card? If you are reading this blog, you are probably already more aware of these issues than others, so imagine how someone who has no idea these fees even exist would feel.

Historically, consumers have tended to react very negatively to this kind of unbundling and pass-through of fees, especially when they’ve been conditioned for many years to assume that the service should be provided for free. For example, when most of the airlines in the USA started charging for checked bags a few years ago, consumers responded with outrage, and tried to carry on enormous bags, delaying boarding, which made everyone even more frustrated. In Seattle (my hometown), the city council just passed a law requiring stores to charge their customer 5 cents for a paper bag; the intent was to incentivize consumers to bring reusable bags for environmental reasons, but it has resulted mostly in anger towards the city council.

Although these kinds of moves are intended to draw consumer’s attention to the real costs of providing a good or service, they instead tend to focus consumer’s dissatisfaction and anger towards the organizations imposing the change. This provides a good opportunity for competitors to jump in and steal customers, as Southwest Airlines is attempting to do with their “bags fly free” policy.

Banks in the USA have been playing this game of chicken for many years with regards to checking and debit/ATM card fees. Traditionally, American banks have offered checking, ATM, and debit card services for free in order to lure more and more consumer deposits. These services, of course, have real costs that are not being passed on transparently to consumers. At various points in history, a few banks have tried to unbundle these costs and pass them on explicitly to their customers, but they have almost always reversed their course in response to customer backlash. The most recent example was Bank of America’s attempt to impose a $5 fee to use their debit cards; after a large number of customers left the bank, they were forced to abandon their plans.

My point is that imposing surcharges might not achieve the results the blog author expects. As opposed to directing attention and indignation to the card networks and their interchange fee, it may instead direct that anger towards the merchants themselves, especially if their competition starts advertising a “no surcharges” policy. In that scenario, consumers may see the surcharge as something capriciously imposed by the merchant, and not something that is being passed on from the card networks.

The larger question here, however, is how we should think about transaction pricing in general. How much “should” it cost to process an electronic transaction, and how much of that should be paid by the merchant vs the consumer? That depends in many ways on what you think a payment card network like VISA or MasterCard actually is. Are they like public utilities, whose fees should closely resemble their underlying costs, or are they for-profit businesses, whose fees should be set according to market conditions? Many people seem to think of them as the former, but the card networks are neither structured nor financed as public utilities, and they certainly don’t think of themselves as such.

But we are now heading into another, very complicated topic, so I will leave that to another post. For now, what do you think about the idea of making card transaction pricing transparent via surcharges? Do you live in a country where this is already happening, and if so, what has been the general reaction?