When the two major credit-card associations, Visa USA and MasterCard, imposed big annual increases in interchange fees April 1, citing the rising cost of ?reward? and ?premium? card programs, newspapers called it an ?invisible? change to American consumers.
It?s not invisible to retailers.
The Food Marketing Institute estimates that on a $100 purchase at a supermarket, Visa raised processing fees for its branded card 36 percent and MasterCard increased its fee 9 percent. The National Retail Federation says the typical American household pays $230 a year for interchange fees—even if family members never use plastic. And credit card use at supermarkets increased 16 percent last year, FMI says.
You, the retailer, are paying for your customers? frequent flyer miles and early access to Bruce Springsteen tickets.
?The last two years, there have been very significant increases? in bank card fees, says Eric Reed, retail systems manager at Vitamin Cottage in Lakewood, Colo.
Some retailers decided to fight back via the courts.
Four small businesses filed a class-action suit against Visa and MasterCard in U.S. District Court in Connecticut June 22, claiming to represent the interests of millions of businesses in the United States. They charge the two associations and their member banks with price-fixing, collusion and various anticompetitive practices.
On July 7, a coalition of national retailers—Kroger, Albertsons, Safeway, Ahold USA, Eckerd, Maxi Drug and Walgreens—filed a similar suit in federal court in New York, accusing Visa and its 14,000 member banks of ?horizontal price-fixing.? The same group filed suit Aug. 3 against MasterCard, separating the actions by more than a month to emphasize that it is not accusing the associations of collusion.
To emphasize that mega-retailers are not immune, Kroger, the nation?s largest supermarket chain, said its tab for interchange fees has grown more than 215 percent in five years. Visa, it claims, has raised Kroger?s interchange rate 11 times in that period.
Said Kroger general counsel Paul Heldman: ?This hidden cost must be borne by all Kroger customers, whether they pay for their groceries with cash, by check or by debit or credit card.?
Visa and MasterCard have said the suits are meritless.
While these complaints grind through the courts, one natural grocer advises that the small merchant?s best weapon is to research the best deal on merchant banking services.
Reducing the bite
Some retailers have reacted to the April 1 increases by imposing a minimum purchase for credit card payment or adding a fee for small purchases. Some asked customers to use debit cards, which often charge lower fees, or pay by check. Some stopped taking plastic altogether.
Some gritted their teeth and absorbed the expense into margins already reeling from the trickle-down impact of higher energy prices.
At Vitamin Cottage, a 21-store natural grocery chain, rising costs prompted management to negotiate hard on its merchant-banking contract, says Reed.
?Our credit card volume is more than half of sales,? he notes. When the bank?s three-year contract was up for renewal, Vitamin Cottage put it out for bid and required candidates to compete head-to-head.
?They have to be paid by, ultimately, the customer,? Reed says of the fees. ?But they come out of the merchant?s pocket. It?s on us to negotiate the lowest rate.?
New Vitamin Cottage stores have point-of-sale terminals that allow the customer to swipe a card and choose ?debit? or ?credit.? Older stores require the cashier to check with the customer before swiping. Why? Because a Visa debit card processed mistakenly as a Visa credit card costs Vitamin Cottage more than double the fee, Reed says.
Even something as innocuous as a magnetic stripe that won?t work on a card can cost a merchant money. If the clerk has to key in a card number, rather than swiping the card through the terminal, the fee for that transaction will be considerably higher.
How it works
In a typical credit card transaction, four parties are involved: the consumer, the retailer and two banks. Lurking in the background are the two associations, Visa USA and MasterCard International. They?re separate companies on opposite coasts, but because most issuer and merchant banks belong to both associations, most retailers accept both cards and the largest banks often hold a seat on both associations? boards, there?s ample opportunity for information-sharing and price-fixing, the suits allege.
When a retailer accepts a credit card payment, it?s sent first to the bank that represents the retailer with the credit-card association, then to the bank that issued the card to the customer. The issuing bank posts the transaction to the customer?s account, while the merchant bank pays the retailer the transaction amount minus various fees.
The interchange fee, which is set by Visa or MasterCard but paid to the merchant bank, makes up the largest part of the ?discount fee? the retailer pays, usually as a percentage of each transaction, but sometimes as a flat fee plus a percentage. Retail outlets get charged different rates depending on their size, store type and amount of sales—and yes, small retailers typically pay the highest rates.
Visa and MasterCard have encouraged issuing banks to offer premium cards, which shower customers with freebies ranging from cash back on purchases to frequent flyer miles, concierge services or donations to charity. And banks are hiking transaction fees on these premium or ?signature? cards, telling retailers that they should pay more to attract a premium customer.
At MBNA, a big credit-card issuer, interchange fees in 2004 brought in more than $500 million. Interchange fees, according to the attorneys in the class-action lawsuit against Visa and MasterCard, were established in the 1970s to cover the costs of card transactions when they involved paper receipts. They also were designed to cover costs of fraud and ?customer acquisition,? meaning both retail customers for merchant banks and cardholder customers for issuing banks.
As electronic processing has replaced paper, costs have declined dramatically, according to the pleadings for the class-action suit, and the increased volume of transactions ought to drive costs down further.
Instead, a report by investment firm Morgan Stanley found that the weighted average of interchange fees grew from 1.58 percent in 1998 to 1.75 percent in 2004, a 10.8 percent increase. In April, new fees grew to 2.9 percent on some premium cards.
Meanwhile, debit card payments increased by a factor of 17, according to the Federal Reserve. Checks cost one-tenth of what cards cost to process because the Fed limits check processing fees to the actual costs incurred.
According to the Merchant Payment Coalition, dollar volume of interchange fees has grown from $9.4 billion in 1998 to $17.4 billion in 2004, an 85 percent increase. It?s projected to reach $32.4 billion in 2010, another 86 percent rise. Coalition members include such retail trade associations as the Food Marketing Institute and the National Association of Convenience Stores.
The lure of something for nothing
At the same time, card issuers are getting more people to use more credit cards on more purchases than ever before.
Credit cards were originally pitched as an upscale indulgence, but lately they have been positioned as a way to pay for everyday purchases from groceries and gas to fast food, says David Morris, an adjunct professor at DePaul University in Chicago and author of ?The U.S. Market for Rewards Cards,? a new report from market research firm Packaged Facts.
Morris? research estimates that rewards cards make up 69 percent of the credit card market today. He predicts that by 2009, 85 percent of consumer credit cards will offer some reward feature. ?It?s basically a cost of entry at this point,? he says. ?Consumers have come to expect them.?
Banks have hiked retailers? fees on these cards to new highs, Morris says, ?under the thesis that greater spend can help everyone.?
But issuers and merchant banks have the most to gain. The mature credit-card category needed to come up with a way to grow business when most American adults already had a wallet full of plastic. ?Customized? programs that allow shoppers to earn credit or discounts at their favorite retailers, or to rack up miles or cash-back points, re-energized the category, Morris says.
Consumers have traded in older cards for newer models that offer whatever reward motivates them. Issuing banks collect the interest on new revolving balances, while merchant banks collect the higher transaction fees.
Consumers believe they are getting something for nothing, but the National Retail Federation points out that the higher fees represent a 2 percent ?tax? on purchases that retailers ultimately must pass along to shoppers.
And while some retailers have the transaction volume to negotiate with potential merchant banks, as Vitamin Cottage did, independent stores will have to hustle to find any leverage to lower their transaction costs.
?The little vitamin store down the street doesn?t have many options,? Morris says.
Natural Foods Merchandiser volume XXVI/number 9/p. 48, 52