That extra 3% that cuts into retailers’ profits is called a merchant processing fee. Retailers know this fee too well because they have to make up for the loss by building it into the price of final goods.
11 states, including California, Texas and New York, have banned credit card surcharges. These states prohibit merchants from passing on the cost of processing fees to consumers. The reason for the ban? Merchants may hide other fees in the surcharge, an unfair business practice, as viewed by the court.
Why not ban surcharges only on charges that are more than the industry rate of 2.9% + 30c? It’s important to note that it was credit card companies that strongly lobbied for the ban. The explanation that makes the most sense here is that these credit card companies believe that they’d lose more of their “three-percents” if a credit card surcharge can be added to a basket price.
This belief is confirmed by an experiment done by scholars at the Harvard Kennedy School and Harvard Business School. They created two separate scenarios for 820 participants shown in the infographic below. The goal on both scenarios is to get people to switch to paying with cash, and you can see that the scenario on the right is more effective in achieving that goal.
Becker Gallagher, http://szl.io/2k8jWyZ
If there is a field that math can be applied to in order to help people make rational decisions, we’d think it would be in their finances. After all, in both situations, when a participant pays with a credit card, he always ends up paying $133.90. When he goes for cash, it’s always $130.
Yet, cognitive limitations, biases and heuristics considered, people can’t always be expected to make the rational decision when it comes to money. As Katy Osborn, a writer at Time.com pointed out, “money is an emotional topic, which partly explains why we all struggle to spend, save and negotiate in an optimally rational way.”
The Results Explained
According to the study, the participants who were lead to the discount scenario (left of the infographic) perceived the cash discount as a forgone opportunity, an irrelevant cost, and would rather use cards for convenience.
When the other half of the participants were asked to pay for the $3.90 surcharge (right of infographic), they viewed this charge as an out-of-pocket, relevant cost. The second scenario proved to discourage credit card usage more. The difference in how the charge is framed accounts for the increase in people paying with cash.