It’s been a while since I’ve written about interchange fees.
I hear a lot about how the interchange fee is determined by market forces. When it comes to the market for pizza, I have a fairly good understanding of what should happen if a pizzeria raises its price. I’ll eat less pizza and another pizzeria may rush in for my business. But what happens if interchange fees go up? Does this two-sided market look like the market for pizza?
I decided to interview Bob Johnson, the President of Consumers for Competitive Choice who is overseeing the credit card con project, and ask him about this, as well as ask him directly the best arguments I’ve heard in favor of the interchange rate.
Michael Konczal: Hello. Could you identify yourself and the project you are working on.
Bob Johnson: I’m Bob Johnson, the President of Consumers for Competitive Choice, and our project, The Credit Card Con, is drawing attention to the unrealistically high swipe fees for credit cards transactions in the United States and the fact that they cause business and consumers to overpay for products and direct windfall earnings to Visa (NYSE:V) and Mastercard (NYSE:MA) as a result.
Can you describe the conclusions of the report for us?
The major conclusion of the report is that consumers and small businesses are paying too much in credit-card transaction fees. You can quantify that number in many ways, but Visa and Mastercard charge about $48 billion dollars in fees every year, that’s about 8 times more than the actual cost of the fees. That’s a windfall that could create a quarter of a million jobs in this country, or could be used to reduce prices for consumers across the board by billion of dollars. So it’s significant to call attention to the fact that credit card reform is not complete unless these transaction fees are also addressed by Congress.
I want to get a sense of how the market dynamics, the supply and demand, work here. Normally if the price of a good goes up, people demand less of it. What happens if the interchange fee goes up, as it has been doing?
Well, interchange fees go up, and typically they go up in lockstep between different providers, as they try to provide more benefits on the alleged consumer side of the card and rates for the banks. So there’s little downward pressure on the interchange rates for the cards. There’s very little competition for retail businesses through lower rates.
So that’s the perverse way in which this market is working, it’s not creating competition in a way one would typically think, competition meaning lower prices for consumers of a product, those who are swiping the card at the small business. Instead they are creating competition by raising fees on a captive market, which is typically mom-and-pop small businesses, which don’t have a way to compete without having credit cards to remain competitive. Since between 80 and 90% of all transactions at small diners and grocery stores and gas stations are made by credit cards, you have to have the product in order to stay competitive, and unfortunately the swipe fee will increase.
To give an example, one grocery store that we work with sat down and computed the increase in the swipe fee over the past decade, and he found that that rate of increase for his business in terms of paying the swipe fee was second only to the rate of increase in health insurance premiums. So it is a significantly increasing fee that is taking a bigger and bigger bite out of small business, and the consequence of that is that it is taking money that could be used to create jobs or lower prices.
In the same way that you can charge differently for goods that cost you different prices to produce, why can’t you charge different rates depending on the type of card a consumer is using?
A small business doesn’t have the means to determine the fee that is going to be associated with a particular card when it is going to be used. In fact, many don’t learn that until 15 or 30 days later when they receive the monthly invoice. And that is because, with the propagation of cards there are literally hundreds of different pricing schedules associated with different credit cards. One person may come in and use a credit card with a 1.8% swipe fee associated with it, and the next person may come in with a card that has a 4% swipe fee associated with it. Even if businesses wanted to pass along these costs to specific consumers they could not do so since there isn’t any transparency or visibility for the marketplace. They aren’t even sure of the fee that is with the card being used as it is being used.
One reason interchange fees might be going up so much is because merchants are getting a better deal in terms of services, fraud protection, credit card company customer support, etc.
You hear that with respect to the fees, but you also hear that with respect to the monthly merchant fees for offering a card. You hear it with respect to the annual fees, with the higher interest rates, with the extra fees consumers pay, and it can’t be all the way. It’s not necessarily that better services are being offered and that this justifies the charges. Indeed the GAO was asked to look at this very topic by Congress, and what the GAO said when it analyzed the data publicly available was that they couldn’t tell, that no one could tell, because there wasn’t any transparency. No one could tell what the cards are making over costs, what we guess is 800% over cost, can’t be tracked to a service. So it can be justified if they come clean and show transparency in the process. What are the add on servicers, and what are the true costs, and then what is a fair price to pay per swipe? Then we can get to somewhere. Until then we are left in the dark.
Another argument you hear is that though interchange is expensive, so is the cost of handling cash. Employees steal, it’s a physical thing to deal with, etc. So even if you are getting squeezed, it’s still a pretty good deal for you.
There are certainly advantages to using credit cards over cash for businesses. Accounting, fraud protections. There are also drawbacks, like the 48 hour hold put onto accounts where they don’t have access to that money as if they had cash, so there are pros and cons to both sides.
Though when I hear the cost of cash arguments, I tend to think that shouldn’t cause the interchange fees to go up while the technology has matured and the market saturation completed.
Exactly. And that goes to evidence that this market does not work, that it isn’t functioning properly, and it isn’t functioning properly because Visa and Mastercard have 85% of the market, and because the vast majority of transactions are made by credit cards now. That’s market leverage, and that’s market leverage that is unchecked, so that’s the difference. You normally would expect the costs per transaction to go down, but it’s not. Regardless of what arguments are made for transaction fees, you can’t get around an 3 fold increase in credit card receipts in 7 years.
Normally if a firm is overcharging for a good, Economics 101 teaches us that another firm will rush in and cut prices, still earning a profit. Competition leads to the price being equal to the marginal cost. Why aren’t firms rushing in to take out these high margins?
The market dominance makes it difficult for a new player to enter and gain widespread acceptance. You look at relative startups like Discover (NYSE:DFS) try and enter and are unable to penetrate the market effectively. Maybe it can happen over time, but given the dominance of Visa and Mastercard to squeeze out other players in the marketplace, given their relationships with the banks, that is wishing for something that is unlikely to happen in this economy. The better fix would be to deal with the lack of transparency in the marketplace.
And to deal with: yes credit cards are a fact of life, yes there is a cost associated with each transaction on the credit card, but that cost should be based on the service not on what can be extracted from a given store.
The last thing I’ve heard is “Yes, these merchants are almost certainly getting squeezed. But I don’t trust the government to do anything about it!” What are some solutions to this problem you’d like to see?
The first thing we need is transparency. Then players in the marketplace can get a sense of how much they are overcharging. Then they can go about private remedies. Ultimately as we have with every product that is provided by an oligarchy, there has got to be standards. Standards that give the public and consumers information to work on. Everyone is afraid of government action, but standards need to be in place so that consumers and business owners can take their own private action about these fees.