Why Surcharge a Credit Card Sale?
Business owners in the United States are becoming more aware that they can pass their credit card processing fees along to their customers, and more processors are starting to offer this service as an optional feature. But, is this really a good idea make your customers pay your credit card processing fees?
Processors are marketing this new service as as “credit card surcharging” and “zero-cost credit card processing,” and it is understandably a very tempting practice to implement into your business. The cost of accepting credit cards has continually become more expensive over the last decade. This is making businesses begin to question why they should be on the hook for the cost of accepting card payments, especially considering that it has become the preferred method of payment among consumers.
The 2%-4% cost in processing fees can significantly eat into the profit margins of a business. There are also additional flat fees of 10-50 cents per transaction on top of the “discount rate” which can significantly the increase cost of small transactions. In some cases, business owners have reported that processing fees can cost upwards 40% of the transaction when factoring in the flat transaction fees on low-dollar sales, such as those at convenience stores where someone might just buy a pack of gum.
Why Credit Card Processing Fees are Expensive
First, it’s important to understand a few things about merchant accounts. Often, it’s thought that the only thing a credit card processor does is transfer money from a customer to a business during a sale and then collect a fee for doing so. However, it is much more complicated.
What Actually is a Merchant Account?
Let’s use an example of sale to illustrate what happens in a typical credit card transaction. Imagine that Jack takes Jill out for an anniversary dinner at a the newest most hip sushi restaurant in town, let’s call it Kyoto, and spends $300 on a meal. Kyoto runs the credit card, the sale is completed, and then 24 hours later the $300 is deposited into Kyoto’s bank account. Seems straightforward enough, right? But, if we dig a little deeper, where did the $300 come from? Jack didn’t pay his credit card bill immediately after dinner. In fact, he won’t even get his bill for another 30 days.
There’s Credit on Both Sides of a Sale
Since Jack hasn’t paid his bill yet, that means that the bank that issued Jack’s card paid Kyoto. If we assume that Jack pays off his credit card bill every month, what’s in it for Jack’s bank to loan out money for him to make purchases? That’s where merchant processing fees come in. Jack’s bank assumes the risk of loaning money on his behalf and Jack’s bank enters into agreements with businesses like Kyoto that allow them access to these loaned out payments so that they can sell things to Jack using his preferred payment method.
Additionally, the bank that issued Jack’s card also agreed to let Kyoto keep the money from the $300 loan even if Jack never pays his credit card bill and defaults on his obligations. The bank does not claw that money back from Kyoto and just accepts the loss of the $300. For the risk that the bank assumes, it charges a small loan rate of around 1.7% to Kyoto that we commonly call a processing fee. Essentially, a merchant account is a line-of-credit extended to the business because the bank pays the business before it actually collects the money from the customer.
Let’s breakdown processing fees further:
Interchange Fees
There are two base fees packaged into a credit card processing fee. The first fee is the “discount rate” and it is a percentage fee of the total sale. The average cost of this fee is around 1.7%. The second fee is known as the “transaction fee” and is a flat cost of around $0.20, on average. These fees can vary depending on several reasons which we will cover below. The combination of the discount rate and transaction fee together is known as the “Interchange rate” in the credit card processing industry. The interchange rate is charged by the bank that issued the customer’s credit card. Banks determine this rate based primarily on three factors:
1. Business Type
First, the industry of business that is accepting the credit card. For example, a grocery store may pay a different Interchange rate than a yoga studio. Online businesses typically have higher interchange rates then face-to-face businesses due to a higher risk of fraudulent transactions and chargebacks.
2. Collection Method
Second, how the credit card is being accepted. For instance, a card number that is manually keyed into a terminal is often more expensive that one that is swiped or dipped into a credit card terminal.
3. Card Type
And third, the type of credit card the customer is using. In this last case, numerous banks offer customers rewards for using their credit card. These rewards most commonly come in the form of cash back or points that can be used to redeem flights or merchandise. Essentially, the Interchange fees that a business incurs for accepting a credit card pay for the customer’s rewards, which makes the processing fees more expensive. This might seem unfair at first, but there are tradeoffs to accepting cards versus only accepting cash that we’ll cover below.
Merchant Account Provider Markups
On top of the Interchange rate, the companies that manage your merchant account also bake in their own profit margins on top of the Interchange fee in the form of both a percentage and flat fee. These markups are determined by the company that you use for your merchant services. Some companies offer transparent markups on top of Interchange (known as Interchange-plus) and others hide their markups in murky tiered pricing buckets, or as a single flat-rate for all transactions. Choosing the wrong merchant account provider can severely impact your processing costs, so you should take great care to fully understand your pricing before entering into any service agreements.
Monthly, Annual and Other Junk Fees
In addition to transaction fees, most merchant account providers charge additional monthly and annual fees. Again, these fees can vary widely depending on the company that is providing the merchant account. Most, if not all, of these fees are junk fees that can be avoided by selecting providers that do not charge them. Such junk fees are often labeled with obscure industry jargon, but the most common junk fee that businesses experience is the nearly ubiquitous “PCI Compliance” fee. This fee is often touted as a non-optional fee, but several providers have opted to do away with it altogether which clearly makes it nothing more than a profit driver for merchant account providers that do impose them.
Equipment Costs
In most cases where the sale is taking place in a face-to-face environment, such as a retail store, businesses need equipment in order to accept the credit card payment. Some businesses require sophisticated point-of-sale systems that track numerous processes, such as inventory levels, while others only need a device that can read the customer’s credit card. Equipment costs can range from completely free to thousands of dollars depending on the agreement you enter into. Credit card processing hardware can be also leased like you would with a car. In most cases, we strongly discourage businesses from leasing equipment as the lease terms are often predatory and expensive.
At the end of the month, accepting credit cards can cost businesses thousands of dollars so it isn’t surprising that some would want to offset this cost by passing it along the customer as a surcharge during the sale. But is it a good idea to do this?
The Risks of Surcharging Credit Card Payments
Surcharging Compliance
Is it legal to surcharge a customer for paying with a credit card? The short answer is that it depends. Each state has its own laws regarding surcharging credit card transactions. In some states, it has been banned altogether (See: Each State’s Law on Charging for Credit Card Purchases). Additionally, if your customers are in different states than your own business, it can get even more complicated. Do you comply with your state’s laws or the customer’s? In most cases, the answer is unclear. In nearly all states, the fee for surcharging a customer’s credit card cannot exceed the actual cost of the fee incurred by the business owner.
Card Brand Policies
Visa’s policy states that the maximum fee must be the actual cost to the merchant or a maximum of 3%, whichever is less. Violating this policy can cost a business owner $5,000 for the just first offense, with fines increasing if the business doesn’t come into compliance. Mastercard allows businesses to charge up to 4% with no other stipulations, while American Express and Discover offer little to no guidance. Businesses must also inform the card brands of their intent to surcharge 30 days before the begin the practice. Failing to do so could have costly consequences.
Non-Compliant Credit Card Surcharges
Calculating a surcharge correctly can be difficult. In nearly all cases where we’ve researched credit card processing companies that offer surcharging services, the surcharge is not being calculated correctly. In most cases, these processors are adding a flat surcharge of 4%-5% even if the actual fee is only 2%. So what happens to the difference of the fee if the processor is adding a surcharge above the actual cost to the business? The processor is pocketing it, which is often undisclosed to either the business or the customer. Surcharging can be very profitable to processing companies in the short-term, which is why some narrowminded companies are promoting it. However, surcharging discourages credit card use among consumers and will ultimately damage the entire industry in the long-term, along with the businesses that are engaging in it.
Signage
Businesses are required to post signage at their entrances and the point of sale stating that they will charge a fee if a customer pays with a credit card. The sales receipt must also be clearly labeled as a fee for paying with their card. Not only can this signage cause a customer to take their purchase elsewhere, but if it is not done correctly, it could result in legal actions and fines.
Debit Card Surcharging
Surcharging debit card transactions is prohibited by both Visa and Mastercard as well as by most legal jurisdictions. Despite this, we have seen several cases wherein processors are still adding surcharge fees to a businesses’ transactions despite the customers paying with a debit card. Failing to add surcharges correctly can result in fines being levied on the business by Visa and Mastercard, potential legal actions by states and cities, and even result in the business losing its ability to accept card payments permanently. See Visa’s rules about card surcharging and Mastercard’s surcharging rules. American Express doesn’t issue debit cards and encourages businesses to comply with state laws. See the American Express Merchant Guide for more information regarding policies regarding accepting Amex cards.
Drastic Impact to Customer Loyalty
By far, the biggest danger posed to a business that charges customers for using credit cards is the negative impact on customer loyalty and repeat business. According to a survey conducted by American Express in 2021, 78% of consumers agreed that getting surcharged makes them feel like a business does not appreciate their patronage or value them as a customer. Another 77% stated that they would take their purchase to competitor who does not charge a such a fee. Have you noticed that chain restaurants do not add surcharges? Enterprise level retail organizations have spent millions running studies to figure out if they can add credit card surcharges, but in the end they have determined that the risk of losing customers outweighs the risk of adding surcharges.
Negative Customer Reviews
Consumers hate getting surprised by a credit card surcharge fee after they have paid for a purchase. This sentiment can be even more exaggerated at restaurants if the fee is only noticed at the end of the meal. Businesses risk substantial cost to their online reputations by adding surcharges and negative reviews can result in lost business that far outweighs the costs of credit card processing fees. Do believe us? Just check out this Reddit post with over 300 comments stating how they will be taking there business elsewhere after a restaurant started surcharging.
Reduced Consumer Spending and Smaller Sales
By implementing credit card surcharging, you may be hoping to encourage your customers to use cash. However, research has shown that consumers are more likely to spend higher dollar amounts when using credit cards over cash. A Federal Reserve Bank of Boston survey found that the average value of card transactions was $112 as compared to $22 for cash transactions. A Dun & Bradstreet study corroborates this data finding that consumers are likely to spend 12%-18% more when paying with a credit card.
There are several factors that contribute to this phenomenon of higher spending with credit cards. First, psychological factors play a role because credit card users lose a concrete sense of how much they are spending since the money is not immediately deducted from their checking account. Secondly, rewards programs incentivize users to spend more in order to earn rewards, which is especially true for purchases made with company or corporate credit cards. Speaking of corporate cards, most employees can only be reimbursed for spending done on their company cards. They don’t have the option to pay in cash.
Thirdly, credit cards are more convenient than cash and allow people to make larger impulse purchases. In fact, consumers are likely to have less than $30 of cash on their person at any given time according the Federal Reserve Bank of Boston survey mentioned in the previous paragraph. Lastly, many people consider cash to be a medium of spreading germs. In fact, numerous studies have shown that almost all cash is contaminated with trace amounts of fecal matter.
Next time you are shopping at a large corporate retailer, like Target or a grocery store chain, check your receipt to see if they are adding a surcharge. It is unlikely that they are. Consider that these companies have dedicated analysts who have researched and vetted adding credit card surcharges. If they are not adding them, its because they have determined that doing so would harm their sales.
Cash Management Costs
They say that cash is king, but managing cash comes with its owns costs and risks. First, many banks charge businesses for depositing large amounts of cash as it requires more time and resources for the bank to manage cash. In some cases, cash management fees may be less than credit card processing fees but a business also needs to secure the cash at their place of business. Such costs can come in the form of requiring expensive safes as well as added security personnel or equipment.
Robbery and Burglary
Businesses that are known for accepting high amounts of cash put themselves at a significant risk of robbery and burglary. Not only does it pose a danger to the life and limb of owners and employees, but one robbery could result in losses that far exceed all processing fees that a business would ever incur. If an employee is harmed during a robbery, this could also result in legal actions and all the costs associated with such an event. Accepting card payments greatly reduces the liability associated criminals targeting a business for nefarious gain.
Employee Theft
Businesses that encourage cash transactions as a method for customers to avoid credit card surcharges will almost certainly experience losses from employee theft. This not only results in lost revenue from sales but also the loss of the merchandise. It is an unfortunate and sad fact that some employees will be give into the temptation to pocket cash from sales. In the event that an employee is stealing card payments through their own device, such transactions are recorded and trackable. This not only deters employees from stealing, but can provide a paper trail for business owners should they need to take legal action against a thieving employee.
Bottom Line
Businesses that choose to charge customers for using a card for payment put themselves and their businesses at significant risk. Not only can it result an immediate loss of a sale, but can cause the permanent loss of a potentially loyal customer. Futhermore, a business must comply with policies and laws to avoid costly fines and legal actions. These policies and laws may change without an owner’s knowledge, posing even a greater risk of running afoul with compliance.
Many merchant account providers are also failing to add surcharges correctly of which the liability may fall on the business owner. A business could even lose its ability to accept card payments for incorrect surcharging, which could spell the end of its operation. Lastly, opting to accept cash over card poses costs that are often overlooked and greatly increases the danger to employees and owners in the event of a robbery. Although credit card processing costs are annoying, it’s a cost that can be greatly reduced by choosing a reputable merchant account provider. See our article comparing the best credit card processors to find a highly rated low cost merchant service provider.
Ethical Processors That Offer Credit Card Surcharging
If you plan to add surcharging in spite of the information above, this is the only processor we recommend for credit card surcharging at this time due to the company’s stellar reputation, pricing, and support.
