Allan L. Shampine is a Vice President at Compass Lexecon in Chicago
While the GAO report provides a useful summary of many of the issues being debated within the credit card community, the GAO’s mandate was, in some ways, rather narrow. The GAO was asked to “review (1) how the fees merchants pay have changed over time and the factors affecting the competitiveness of the credit card market, (2) how credit card competition has affected consumers, (3) the benefits and costs to merchants of accepting cards and their ability to negotiate those costs, and (4) the potential impact of various options intended to lower merchant costs.” We will be talking a lot about their conclusions on these issues, but first I would like to set the stage by talking about where credit cards fit in the economy as a whole.
Credit cards are a way of buying things, but they are only one of many. Other common methods include cash, checks and debit cards. Each payment method touches different groups, directly and indirectly. Academics, central banks and regulators around the world have debated for many years as to which payment methods are best for society as a whole. The research into this question suggests that there is no simple answer. Indeed, researchers have not even agreed on how to ask the question. Some researchers say that trying to figure out all the costs and benefits is just too hard and we should concentrate on the overall costs of the system. In particular, electronic payment methods are often regarded as less costly than paper payment methods. Other researchers (including myself) point out that consumers stubbornly continue using paper payment methods even as they become more expensive (relative to other payment methods), showing that there must be benefits to doing so, and that those benefits are important enough to influence people’s choices. Most researchers agree, though, that different payment methods are better in different circumstances. For example, for a small transaction at a garage sale, cash is very efficient. You don’t need any terminals, electricity or approvals. You hand over the cash and you’re done. If you’re buying a house, though, cash is not a good choice. You’re almost certainly going to use a wire transfer. If you’re at Starbucks getting a cup of coffee, you might use cash or credit, although the cashier and the other people in line are likely to grind their teeth if you choose credit.
That examples brings up another problem that regulators wrestle with. When you pull out your wallet to pay for something, you ask yourself questions like “Do I have enough cash? Should I use my credit card for the rewards? Should I use my debit card to stick to my budget?” You do not ask yourself, “How much will this cost the merchant? How much will this cost the bank? Are other people going to pay a higher or lower price because of this? Am I going to slow down the line?” (Well, most people don’t. If you’re reading this blog, you may be the exception that proves the rule). That is, you choose how to pay for things, but the “price” you face for using whatever payment method you choose may not reflect all of the costs and benefits to everyone else.
This distinction is important because whether something is good for an individual does not necessarily mean that it is good for society. If networks take money from some merchants and give it to people using credit cards, at first blush, those merchants are worse off while credit card users are better off. But what does that mean for society? Do prices go up? How does that affect consumers? How does that affect merchants? How are the owners of the networks affected? These are not simple questions. Hopefully this overview will provide something of a framework to discuss them in.
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That’s an excellent question, and I’m impressed with your knowledge of up and coming payment methods. These technologies are not only not outside the scope of analysis on interchange fees, but are right at the center.
I’m pasting in a small piece from Revolution Money’s web site answering the question of why merchants would want to accept RevolutionCard:
RevolutionCard Saves Merchants Money
Lower Card Acceptance Costs By Up To 80%
With no interchange payments between banks and a cost of only 0.50% for transaction processing and settlement, RevolutionCard saves merchants up to 80% per transaction compared to other card brands.
Reduce Fraud And Costly Transaction Disputes By Up To 90%
RevolutionCards are non-embossed, PIN-based cards that contain no consumer identifying information. This helps protect both consumers and merchants from unauthorized disclosure of cardholder information, and reduces unauthorized transactions, chargebacks and costly transaction disputes by up to 90% compared to traditional signature-based cards.
As you can see, one of the selling points of the RevolutionCard is that it does not have an interchange fee. Between that and the lower incidence of reversed transactions from the use of PIN, Revolution Money claims significantly lower costs for merchants for a service that is pitched as being at least as good and probably better than traditional credit and debit cards. So Revolution Money, at least, does not seem to believe that interchange fees are necessary to develop their product.
As a general comment, are there economic benefits from interchange fees for more innovation and jobs growth? In the last few weeks, companies have made news with credit card features for wireless devices like Square, Revolution Money, and Chase Blueprint (features include: small business merchants can accept payment by credit card via scanner on mobile phone; service to scramble your credit card number for security; and software to allocate your payments in full per purchase, or on a monthly schedule). These new businesses add a great deal of functionality and security for sellers and buyers, with potential sales spanning domestic and international markets, see http://squareup.com or http://www.revolutionmoney.com or http://www.chaseblueprint.com. Could interchange fees be necessary to encourage development of complementary products that lead to greater consumer welfare, via faster payments, smarter tools, and safer identity protection? Or are these technologies outside the scope of analysis on interchange fees?
You raise an interesting question. Companies offering electronic payment methods have been working hard to reduce the time it takes to process those payment methods at the cash register, in large part because, historically, it has been time consuming. What you mention – no need for a signature and not getting a receipt – are methods that have been and are used, but those methods themselves have costs associated with them. Not getting a signature generally exposes the merchant to more risk, and not getting a receipt exposes the consumer to more risk. For payment methods there is often a trade-off between speed and risk. The more time spent verifying identity and establishing a record of the transaction, the less chance of fraud. The same applies, of course, to cash, as cashiers that are handed large denomination bills will frequently check them to see if they are counterfeit. For very small transactions at a high volume store, such as at a Starbucks, stores may be willing to assume the risk in order to keep the line moving.
Electronic payments at Starbucks in particular tend to be faster than at other stores for the reasons you mention, although my personal experience is that they are still slower than cash. The speed involved in processing a payment varies from store to store and product to product, but, generally speaking, studies that have put stop watches on transactions have found that cash is the fastest method at check out, while checks (and less common methods such as food stamps) are the slowest. Electronic payment methods tend to fall somewhere in between.
You write “If you’re at Starbucks getting a cup of coffee, you might use cash or credit, although the cashier and the other people in line are likely to grind their teeth if you choose credit.”
Is this a typo? Credit/debit transactions are faster than cash (particularly given no need to sign for small transactions and no need for a receipt unless you ask for one). I’ve had people at Starbucks groan at those paying cash.