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Ripped off or not?

Anyone who’s ever felt ripped off when a major hotel or airline adds a surcharge for simply paying the bill – technically, for using a credit card (but really, who uses cash to pay for an air ticket online?) – well, the British government agrees. You’re being gouged.

The UK – ironically drawing on new European Union regulation – will ban all consumer-facing card fees, for both credit and debit purchases, from next year. Merchant fines will apply.

The Economic Secretary to the Treasury, Stephen Barclay, said “rip off charges have no place in a modern Britain….This is about fairness and transparency, and so from next year there will be no more nasty surprises for people at the check-out just for using a card”.

"In the real world, the economics which drives merchant decision making can be social and ethical as well as economic.” - Andrew Cornell

Surcharging is a vexed issue globally. The cost of taking a payment for a good or service is a cost of doing business – like wages, rent, power and myriad other expenses. Yet regulators around the world have taken different attitudes.

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Where in the UK the government has decided surcharging is a rort – “so you want to buy my product? I’m going to charge you extra for making the purchase!” – other jurisdictions have decided credit card payments are different in kind to other payment methods.

For example, under payment-system reforms instituted by the Reserve Bank of Australia in 2003, merchants were given permission to surcharge at will. Since then, the incidence of surcharging has steadily risen.

Trending down

According to East & Partners, a consultancy which has monitored surcharging since the reforms, an increasing number of businesses have surcharged although the size of the surcharge is trending down.

“The proportion of surcharging merchants levelled out slightly over 2016 following several of years of rapid growth,” East said. “Just under half of all Australian merchants now apply a surcharge (49.8 per cent) with a further 15.5 per cent intending to do so.”

The RBA’s intention when the reforms were introduced was to make the cost of payment systems – credit, debit, cash, cheque – transparent to consumers which, in the rational universe beloved of economists, would see them favour cheaper systems and so drive down costs to the economy.

However, the real world can be messy. East notes “a significantly higher number of Institutional enterprises surcharge compared to other segments (77.9 per cent), on average 1.42 percent of transaction values and jumping by 8 per cent since 2014”.

“What is even more concerning is that Institutional enterprises are also charged the lowest fees by (card) issuers at an average of 0.92 percent, almost half the level of Micro businesses (1.61 per cent),” East said – which distorts the intention of surcharging properly representing costs.

Interactive: Tom Hounslow

Moreover, in the real world, the economics which drives merchant decision making can be social and ethical as well as economic.

Former KPMG chairman Michael Andrew is chairing the Australian Federal Government’s task force investigating the ‘black economy’ – the unofficial, overwhelmingly cash-based shadow system which facilitates tax avoidance, employment exploitation and criminal activity.

He has been unequivocal about the need to adopt technologically advanced, non-cash payments.

“We have to seriously reconsider our payments system,” Andrew said. “Cash is convenient but it’s also untraceable, which makes it ideal for dishonest people to abuse. Every business should accept electronic payment. Anything else is shonky.”

Allowing merchants to surcharge, even to ‘recover’ a cost of payment, runs counter to that argument.

The logic behind making the cost of taking a payment an extraordinary business cost is not without precedent: for several years airlines (which coincidentally are also among the industries demanding the highest payment surcharges in percentage terms) charged a ‘fuel levy’ – yet it is difficult to conceive of a more fundamental cost of doing business for a transport industry than fuel.

It would be like banks levying a ‘cost-of-debt’ surcharge: “the interest rate on our liabilities has gone up so we’re adding a ‘cost of funds surcharge’ for all bank customers”. Good luck…

The cap fits

In the UK, the ban on surcharges follows a cap under EU law on the amount merchants can be charged for processing transactions by banks and payment companies, so there is regulation on both sides.

In Australia too, the RBA has put downward pressure on wholesale ‘interchange’ fees. Since the reforms a decade and a half ago, the average fee merchants pay – the ‘merchant-service fee’ – has trended consistently downwards.

Interactive: Tom Hounslow

Moreover, while the Andrew task force has been looking at the broader cost to society of the cash economy, all forms of payment have a ‘cost’. Old-fashioned paper cheques cost by far the most to process but cash, often perceived as ‘free’ by merchants, is not free.

Cash ‘shrinks’ – that is it may be pilfered, it is only valuable when it goes into an account, it has transport costs and security risks and – not insignificantly – it places a limit on purchasing power.

The original ‘Diners’ Club Card’ was conceived in the 50s when a regular lunch crowd ran out of money but were keen to keep their lunch going – so a ‘card’ was created which allowed them to order more food and beverage (probably beverage) and pay later. Maybe not great for their own budgets and waist lines but good business for the merchant.

That remains the case today: it makes sense to take the pain and physical barriers out of paying. Thus merchants who annoy customers by surcharging or refusing non-cash payments discourage business.

There are other hidden affects: informal surveys show where restaurants surcharge for payment at the end of the meal, diners tip less. This costs the service staff - the tip pool is smaller - while benefitting the restaurant owner. So as well as annoying customers it transfers income from staff to owners.

Given the well-documented rorts in Australia after surcharging was allowed, the RBA and the Australian Competition and Consumer Commission set up rules around what can be charged.

In the latest RBA ‘How Australians Pay: Evidence from the 2016 Consumer Payments Survey’, the bank noted the new rules which came in May 2016 as part of its Review of Card Payments Regulation.

“Under the new rules, surcharges cannot be more than the average amount that it costs a merchant to accept a particular type of card for a given transaction,” the bank said.

“The aim of the new standard was to improve price signals to consumers about the relative costs of different payment methods, and to eliminate instances of excessive surcharging (including in particular industries where this practice had emerged in recent years).

“These changes led to reductions in the value of surcharges levied by some large merchants – particularly domestic airlines – on some lower-value transactions.”

A challenge

The payments industry has long argued enforcement of these rules will be a challenge. While the major volume and value of surcharging is via larger merchants who are perhaps easier to monitor, for consumers some of the more annoying incidences are where smaller merchants place ad hoc minimums on payment or levy flat rate surcharges such as 30c or 50c – which for a cup of coffee or newspaper (an ancient form of pulp-based communication) –equates to 10 to 20 per cent.

The UK’s answer is to ban the lot - effectively acknowledging accepting a payment is a cost of doing business. The rules also “tackle surcharging by local councils and government agencies”.

“In 2010, the total value of surcharges for debit and credit cards was an estimated £473 million,” the UK Treasury found.

Here at ANZ, the view is the relatively new surcharging regime needs time.

“Surcharging can add friction and frustration to the customer payment experience,” the bank’s head of products Bob Belan says. “In 2016 the RBA, in consultation with Banks and other payment industry participants, made regulatory changes that now prevent the excessive surcharging of customers while still allowing merchants to recoup their payment processing costs.”

There’s no doubt the payments ecosystem is incredibly complex – even for network economists who make a living from dissecting the entrails of costs and benefits.

Who benefits from an electronic transaction? The bank, yes. But also the merchant. And the consumer who has the convenience and maybe loyalty points. So who should pay for it?

Those parties all also incur costs. How do you allocate them? The RBA has long argued there is market failure in the setting of wholesale interchange rates – they only ever seemed to rise and that rise was all too even. But it now also accepts its solution – surcharging – is open to rorting.

In a paper for Monash University and the Australian Centre for Financial Studies, two economists, Stephen King and Rodney Maddock, argue in fact the complexity is insoluble.

They argue for what they call “direct charging”: “Under this model, each merchant sets prices for goods and services that do not depend on the payment instrument proffered by the customer. There is no surcharging (so we can eliminate one level of regulation)”.

“The customer will be (or may be) charged a fee directly by her financial institution,” they posit. “As with automatic teller machine (ATM) withdrawals, this will be presented as an electronic message and give the customer the option of aborting the payment. The essential point of the direct charging concept is that the customer can see the fee that she will be charged for using that particular payment method.”

It’s a different approach to the UK and the RBA but it does have the benefit of being simple. And it doesn’t require a value judgement on whether surcharging is a rip off.

Andrew Cornell is managing editor at bluenotes

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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