The Credit Card Surcharge Controversy

It is October 28, 2000. In four months, a U.S. law will expire that had prohibited surcharges by retailers on consumer purchases made with the use of credit cards. This law had routinely been extended in the past, but this time opposition from retail merchants – who are charged fees by third party companies such as VISA, MASTERCARD, and American Express for credit card transactions -- made its extension more problematic.2 Jennifer R. Hobarth, president of the National Retail Merchants Association, urged that the law not be extended and stated: "The result is that consumers get a wider choice, and cash customers will no longer be required to pay part of the cost incurred by merchants' for participating in credit card programs ... costs that are buried in the price of goods and services." Those costs were believed to be 3 to 4 cents per dollar of sales. The Federal Reserve Bank estimated that the costs of credit card transactions added 3.1 percent to prices. Other studies differed in their assumptions about the extent to which fees charged to merchants by credit card companies were ultimately passed on to consumers, resulting in lower estimates of the current subsidy to credit card users. The reaction to the surcharge threat by the local banks, credit unions, and financing institutions that issue VISA and MASTERCARD cards was predictable.3 Marvin A. Chamberlin, President of VISA USA Incorporated, stated, "In addition to the revenue merchants enjoy as a result of the increased sales generated from bank-card transactions, they would be able to squeeze additional windfall profits out of the unsuspecting consumer by tacking on surcharges." Jason S. Luther, President of the Payment Systems Division of American Express, characterized his concern by stating, "If you wanted -- or needed -- to use your credit card, you would be charged a penalty over and above the regular price." What the credit card companies feared most was retailers putting up a sign reading "5% surcharge on credit card purchases," since such a message could not only lead some consumers at the point of purchase not to use their credit cards but might also lead them to use credit cards less frequently even when no surcharge was used. 1. What are the issues and institutions in this case? What is the relevant information and who has it? 2. Provide a detailed analysis of the pro and con interests in this case. You may want to prepare a spreadsheet, but it is fine to convey the information in other ways. If you use a spreadsheet make sure you not only list each entry, but also justify it. Treat the interests on the American Express side as the “pros.” 3. What are the chances of success for the pro side? Explain 4. If the federal prohibition on surcharges does not get extended, American Express estimates it would lose $51,300,000 per year in fees in each of the next 10 years. What is the present value of the cumulative 10-year loss to American Express? Use a discount rate of 8%. Please show how you arrived at your answer. 5.Using your responses to 3) and 4), determine the expected loss to American Express. Please note that most important part of this question is that your assumptions are consistent with your previous answers, and that your final answer follows from those assumptions. Make your assumptions clear. 6.. From society’s perspective, how should we think about the 3 to 4 cents per dollar that Ms. Hobarth claims are “buried in the price of goods and services?” Assume that she is correct. Would making such a cost more explicit in the form of a surcharge provide a benefit? Why or why not?