Why surcharging remains controversial, even when most states allow it

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Oklahoma lawmakers' decision last month to drop the state's surcharging ban was yet another signal that U.S. merchants have the final say in whether to apply extra charges to credit card transactions to offset interchange fees.

It's been a bone of contention with the card brands for years — until lifting the rules against surcharging five years ago as an initial concession in the merchants' class-action antitrust lawsuit against the card brands and the resulting swipe-fee settlement.

But even though retailers fought hard for this right — prevailing on a free speech argument in front of the Supreme Court and circuit courts — it remains a slippery slope in the minds of many merchants who fear consumer reaction or compliance issues.

With Oklahoma now allowing surcharging, only Colorado, Connecticut, Kansas and Massachusetts remain as states banning the practice of surcharging.

CardX has kept close tabs on the states that are allowing surcharging on credit card use, mainly because the Chicago-based payments tech company provides e-commerce and physical retail stores with terminal software able to add a 3.5% surcharge or higher, depending on the merchant, as well as assuring compliance.

The company has also been working with attorneys general in each state that is still debating the bans. Its work with Oklahoma state Sen. Michael Brooks helped pave the way for dropping the ban, CardX CEO Johnathan Razi said.

"Probably the biggest thing out of the Oklahoma result, and exciting for 2020, is that it predicts an inevitable makeover coming to payments," Razi added, noting that with Oklahoma in the mix, 94% of the country, by population, is open to surcharging.

Surcharging has been more readily adapted to e-commerce transactions, as CardX notes that two-thirds of its client base operates in card-not-present environments. But it's becoming increasingly common in certain verticals — automotive, insurance, B2B wholesale distribution, recurring membership billing, and professional services such as law, medical, accounting and residential contractors.

Still, merchants are reluctant to apply a surcharge, especially in seeing the consumer reaction in Australia. Over time, however, it became an accepted practice for nearly half of Australia's merchants.

Doing the math

It's been a complex road in the U.S., particularly with so many states not allowing merchants to surcharge up until now. Initially, merchant organizations declared disinterest, feeling it was too complex to try to figure out how to engage in the process lawfully. Much of that consternation had to do with percentage caps on surcharging based on the amounts the card brands issue periodically, and not allowing higher surcharges than what an acquirer is charging for payment processing.

Other factors make merchants uneasy about surcharging to this day, said John Drechny, CEO of the Merchant Advisory Group.

"From a merchant perspective, surcharging is still pretty hard to execute and be compliant with all of the network rules," Drechny said. "One of the biggest issues is the rules do not allow merchants to differentiate the surcharge to match fees being charged for different card products or networks."

American Express still does not allow surcharging for certain merchants, Drechny added, and Visa and Mastercard require all products in credit or debit to be surcharged equally.

To avoid being singled out in the surcharging process, Amex has held tight to its rule that a merchant can only surcharge Amex transactions if they are doing so equally for credit on Visa or Mastercard. "Equally" is the key there, as a merchant might find it beneficial to surcharge higher on a premium Amex card than a standard Visa card — if the rules allowed it.

Along those lines, merchants who negotiate a lower price on a certain credit brand cannot apply a surcharge on the other brands that would not negotiate a lower price, Drechny said. In the same manner, a merchant cannot surcharge on rewards cards only, he added.

Still, surcharging can help "signal to the consumer the actual cost associated with the product, but only if the rules which create parity among all networks and card levels are removed," Drechny said.

State by state

Last year, Texas had a circuit court ruling that allowed surcharging, giving merchants an option to add the extra charges on credit card transactions. It was a continuing trend that rides on the argument that charging more for credit card transactions is no different than charging less for cash payments.

Just three years ago, 11 states and Puerto Rico continued to have surcharging bans. At the same time, 10 states and Puerto Rico had laws that allowed merchants to give discounts to encourage consumers to use forms of payment other than credit or debit cards.

Such a disparity has led to the surcharging argument boiling down to how a merchant communicates the differences in charges. And that is a key part of the transition now — merchants have the right to educate their customers via signs and other materials within the physical store.

But no matter how the store words it, some consumers may not be enamored with paying extra fees, Drechny contends.

"Customers have an expectation in the U.S. that cards have no cost for making purchases, thus the burden would on the merchant to educate the consumer on the cost they bare every time a card is used," he added.

Proof that merchants remain reluctant to surcharging lies in the fact that major retail or food-service verticals have not added the extra fees to credit card transactions, said Brian Riley, director of card services for Mercator Advisory Group.

"When you look at surcharging in general, the biggest stores are not moving toward that," Riley said. "It might be stronger with local retailers or non-chain firms. As long as Walmart, Home Depot, Amazon and McDonald's don't do it, that's a big portion of all payments."

However, at the rate interchange fees have risen, merchants have to give surcharging some serious thought now, CardX's Razi said. In his own business, Razi said his company's services have attracted interest from more large merchants than in the past.

While declining to give numbers related to his client database, Razi said processing volume for merchants who adopted CardX in 2019 was $1.2 billion.

Citing a Wall Street Journal report, CardX tells its clients that interchange fees have gone up 77% since 2012, at an estimated $64 billion in Visa and Mastercard credit and debit interchange alone last year.

Without surcharging, those costs get passed along to all consumers, including those who prefer cash, Razi said.

"That is a negative thing because people with cash and debit cards are generally from a lower socio-economic track and often underbanked consumers," he added. "They are paying more for rewards of credit card users, and that is a regressive subsidy."

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Network rules Compliance Retailers Credit cards Interchange fees Payment processing Payment fees Payment cards