William Weidman Aug 17, 2012

Credit Card Fees: The Banker Response

While the $6.6 billion lawsuit between the credit card industry and a trade association of merchants has been settled, the battle is far from over. A recent Wall Street Journal article highlights a part of the settlement with far-ranging future consequences: the right for retailers to charge more for customers who use a credit card. Banks need to immediately start preparing for the possible outcomes of this legislation, including retailers’ reactions at the register.

To be sure, a retailer would be ill-advised to impose fees on customers using credit cards without testing that strategy first. In our work with over a third of the top 100 retailers in the U.S., we have observed that the impact of price increases varies significantly by product, price point and industry. There is a wide range of customer responses to raising the price of gas by a penny, increasing the price of a burger from $5.99 to $6.09, or charging $5 more for a pair of jeans. Some price increases work, but others drive away too many customers and transactions and are thus unprofitable.

A credit card charge at the register would be a particularly risky price increase since it would affect all products in the store. As banks have experienced, customers react negatively to new fees they are not expecting. Given this broad product impact and the fact that many leading retailers have a strong culture of testing new ideas, most retailers will be cautious in making wholesale changes. They will also likely test different messaging for the new charges to determine which elicits the most favorable or least undesirable customer response.

Airlines, for example, succeeded in adding baggage fees in part by blaming higher oil prices. Retailers will be looking for similar ways to sell these new charges, such as blaming banks and credit card companies for higher interchange fees. Still, for those who do implement a price increase, it is unclear that competitors would follow suit, rendering these such first movers vulnerable to losing market share. Furthermore, all the media attention to such increases could spark a wider consumer reaction.

Banker Response

While retailers will likely implement only small scale tests for now, there is risk they will take broad action in the future and banks need to be ready. The consequences are obvious for the major issuers but retail banks would also be impacted in several important ways. First, credit card surcharges would undoubtedly increase the usage of debit cards, which are less profitable for banks after the Durbin Amendment. Banks should start preparing to test ways to mitigate the impacts of this shift, such as increasing the value of credit card reward programs.

Second, higher prices for credit cards would also hasten the adoption of pre-paid cards. Many banks are in the early phases of launching pre-paid cards. Most are still trying to determine the right fee structure to make these cards both profitable for them and a good value for the customer. If customers start shying away from using credit cards, it will be all the more important to get the pre-paid strategy right. Banks should also think about more heavily marketing pre-paid cards as other forms of payment become less desirable for both consumers and banks.

Finally, in the event that retailers do introduce marketing that blames surcharges on banks and credit card companies, banks need to be ready with their response. Banks should be prepared to ramp up marketing that highlights the value provided by credit cards, such as incredible convenience, valuable rewards programs and rigorous fraud protection.

All too often, banks wait for the impact of regulation or legislation to bite before taking action and then act too quickly and sweepingly before understanding the full impact of those actions. The best-case scenario for bankers is that this part of the credit card settlement is overturned or retailers decide not to actually change prices. But the risks are too big to simply hope for the best; banks need to start testing different response strategies now.

Mr. Weidman is vice president at Washington, D.C.-based Applied Predictive Technologies, a data analytics firm that helps retail banks test how various business changes alter customer behavior. He can be reached at wweidman@predictivetechnologies.com.


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