Do those who pay with cash subsidise credit card users?

At the Freakonomics blog Steve Levitt mentions how high credit card fees are for retailers.

Now as consumers when we make our purchases we only make a decision on whether to use a credit card or cash/eftpos based on the relative cost to us and the whether the option of different types of payment are avaliable. In fact, since I get charged to use an eftpos card I prefer to use my credit card when I’m in a shop.

For some reason firms do not charge a different price based on payment method – and as a result when setting prices they will treat credit card fees as part of the cost of production.

In order to figure out if this translates into higher prices than in the case of price discrimination (and ignoring entry and exit) we need to ask – are the credit card fees seen as a fixed cost, or a variable cost. Assuming for fun that firms believe that some proportion of total sales will involve credit cards, the credit card fee becomes a variable cost – and as a result the price charged will be higher.

This makes me wonder – why do firms not charge me extra for using a credit card? If it is a framing issue why don’t they provide a cash/eftpos discount?

Update A reader says it is because credit cards are a two-sided market. So credit card companies effectively “subsidise” consumers so that they can charge retailers more. When this is combined with Grant’s statement that it is a contractual obligation that firms cannot price discriminate based on payment method this all makes sense.

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  • Grant

    I believe that it is a license issue. As a condition of use the credit card companies do not permit retailers to advertise a price differential based on payment method. If you go to a shop and offer to pay cash or EFT/POS many are prepared to negotiate.

    However, many online sites advertise fees for credit card use so they must have different licenses.

  • insider

    This argument has been going on for years and has even gone to court. The level of fees charged to merchants was based on risk. I was told that taxis and massage parlours had the highest card fees at 7 to 10%. Supermarkets fought really hard to get fees below 1%.

    Visa and MC had it in their T&Cs that users could not charge more for goods than customers paying in other manners – ie CC payers couldn’t be disadvantaged. Their argument was that consumers get all sorts of different benefits that they never get charged for so why should CC payment be any different? One was free parking: its cost is built into prices yet that disadvantages those who walk, yet like CC it is a service that draws customers to a business.

    There have been various attempts by retailers to skirt it. LV Martin for years has given better price for cash. Taxis routinely added a surcharge as do travel agents.

    The bigger issue to me was the Visa/MC cartel. It used to be that all the people who sat on the NZ MC board setting fees were almost exactly the same people as on the Visa board. Remarkably their fees were almost exactly the same too! I mean, who’d have thought that would happen? Not sure if that still happens. There was a case in Australia a few years ago about fees on the back of class actions in the US, and the Retail Merchants Assn had one going here too but it appears to have lapsed.

    Basically the CC companies were fighting various brush fires in different countries to try and maintain their T&C’s but appear to have given up.

  • “I believe that it is a license issue. As a condition of use the credit card companies do not permit retailers to advertise a price differential based on payment method”

    Very interesting – it makes sense.

    “This argument has been going on for years and has even gone to court. The level of fees charged to merchants was based on risk. I was told that taxis and massage parlours had the highest card fees at 7 to 10%”

    Interesting fact.

    “There have been various attempts by retailers to skirt it. LV Martin for years has given better price for cash. Taxis routinely added a surcharge as do travel agents.”

    It makes sense for them to try and pass on the cost if they can – price discrimination is really in everyones interest here (except people that are using credit cards, and I guess the credit card companies 🙂 ).

    The fact that they make firms not price discriminate as much as possible is very telling …