Surcharging on credit cards


The Payments System Board (PSB) has just released a Consultation Document on Credit Card Surcharging. The impetus behind this is the increased rate and level of merchant surcharging for credit cards in recent years. However, the PSB risks ‘throwing the baby out with the bath water’ through some of the options it is canvassing. What it needs to do is two things:

  1. Work out if there really is a problem and, if there is, where that problem arises; and
  2. Consider if there is a simple approach to solve the problem rather than direct regulatory intervention.

Surcharging on credit cards has only been possible from 2003, when the PSB forced the credit card schemes to remove their ‘no surcharge’ rules. There were good reasons for this. By preventing surcharging, the credit card schemes prevented merchants from passing the true costs of different payment options through to the customers that choose the payment options. This led to a cross subsidy from those customers who did not use credit cards to those that do use these cards.

To see this, think about making a purchase in a shop. As a customer, you choose the payment instrument to complete the purchase. Broadly speaking there are three choices – cash, credit and EFTPOS/Debit (yes – there are others such as scheme debit and different credit cards have different costs to the merchant but the basic economics survives these complications unscathed). The customer will make the choice of payment instrument to maximize their own benefit. But, the choice of payment instrument has costs to the merchant. Cash has handling costs. Banks charge a fee to merchants for credit card transactions. But EFTPOS transactions often involve a zero or negative fee to the merchant. However, in the absence of surcharging, the merchant’s costs cannot be reflected in the price the customer pays. So the customer may make a choice that increases their benefit but, overall, has a larger negative effect on the merchant.

Surcharging helps to solve this problem. With surcharging, the merchant can set a price to the customer that depends on the payment instrument chosen. So the price can reflect the merchant’s relative costs. Of course, the customer may still choose to use the ‘expensive’ payment option if the benefits that she receives outweighs the costs to the merchant. And this is efficient.

Put simply, surcharging enables the merchant to make the costs of credit cards (relative to, say, EFTPOS) explicit so that the customer who makes the choice of payment instrument ‘internalises’ the costs and benefits of their choice to the merchant.

But the theory also notes another result of surcharging. To the degree that customers who place a high value on using credit also have higher valuations (or less elastic demand) for the relevant good or service being sold, a customer’s use of a credit card can be used as a means of price discriminating. Raising the credit card surcharge becomes a form of second degree price discrimination. Customers ‘self select’ through their choice of payment instrument. Work by Joshua and I (as well as others) showed this almost a decade ago. For an example, look at proposition 1 here.

Competition can moderate price discrimination (if you set a surcharge above cost then I will just go to your competitor and use my card there) but it should not be surprising that:

some merchants may be using surcharging as an additional means of generating revenue, rather than simply covering the costs of card acceptance

In other words, it is likely that there is some price discrimination going on.

The PSB notes that surcharging is most common for on-line transactions:

data from the 2010 Consumer Payments Use Study suggest that the incidence of surcharging is much higher for online purchases than those made in person


there may sometimes be a lack of genuine payment alternatives where credit card surcharges are applied to online payments.

The PSB canvasses two options to deal with this ‘problem’: capping the maximum surcharge fee that a merchant can impose or requiring that merchants can only surcharge up to the merchant’s actual cost of card acceptance. As the PSB recognises, this second option is a regulatory can of worms so it notes that:

Given the difficulties involved in determining the appropriate scope for other costs, a more transparent and consistent alternative is to define the cost of acceptance as, simply, the merchant service fee.

However, these solutions beg a question: is there a problem?

Price discrimination may not be a bad thing. To the degree that it puts a wedge between consumers’ marginal valuations for the same product (in other words, different consumers face different prices) price discrimination leads to a loss in economic surplus. But price discrimination also changes the quantity of product sold. To the degree that total sales rise with price discrimination, there may be an overall economic benefit.

Is this the case with credit cards? No idea. More importantly, as far as I can tell from the consultation document the PSB has no idea either. Indeed, they do not even raise the question. This is worrying. Before the PSB ‘caps’ or ‘regulates’ surcharging, it would be good to know if the current price discrimination through surcharging raises or lowers economic welfare. It would be a bit sad if it raised welfare and the PSB worked hard to stop it.

But, let’s assume there is a problem. Where is it most prevalent? The PSB hits the nail on the head with this one. The problem is on-line transactions. For on-line transactions there is often a surcharge for credit cards even though there is no other alternative payment option. In other words, the on-line merchant charges a surcharge on all (or virtually all) transactions.

However, I would have thought there was already a solution for this. If the merchant is charging the surcharge on all transactions then this has to be included in the price up-front. If not, the merchant is violating the Competition and Consumer Act. The Courts have made it clear that our competition rules mean that consumers need to be given a clear ‘single price’ for a transaction rather than a price with ‘hidden add ons’. So if on-line merchants are imposing a universal surcharge but are not including this in the advertised price, then the ACCC should look at prosecuting them.

If this is wrong (or there is some exception about payment instruments that I have missed) a simpler solution to regulation is to make sure consumers are aware of the surcharge well in advance of pulling out their credit card. Some merchants (e.g. the duty free as you come in to Melbourne airport) have a nasty habit of telling you about the surcharge just as they are about to swipe your credit card. With twenty people lining up behind you the natural reaction is “Bugger – OK just swipe the card”. A bit of signage would help and would be a lot easier and cheaper to enforce than a regulated surcharge level.

So while I am surprised that the PSB is surprised that credit card surcharges are being used to price discriminate, my response to their Consultation Document is simple:

  1. Are you sure there is an economic problem here? If so where is it?
  2. Make sure the current laws on a clear single price are being followed. If not (or if they are effectively not being followed by on-line merchants in particular) ask the ACCC to investigate; and
  3. If there is a problem where consumers have real ‘payment instrument’ choice, then make sure consumers receive the information they need to make informed choices well before they effectively commit to a decision to buy. Then let competition, either between retailers or between payments instruments work to reduce the problem.



2 Responses to "Surcharging on credit cards"
  1. I’m trying to reduce the usage of my credit card at least online. I prefer prepaid cards which are mostly more convenient comparing to credit cards. Moreover, there are no hidden charges when paying with a prepaid card online. My favorite is Paysafecard which is being accepted by many online services besides a huge number of online games.

  2. Surcharging (of any kind) can have price signalling properties. This could be one item for question 1?

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