Coyote Blog

Nothing makes purity more interesting than temptation.  This applies to ideological purity just as much as the physical sort.  As a libertarian, my greatest temptation to call for government action comes when I deal, as a retailer, with Visa and Mastercard (V/MC).

This post is not a call for government action, so I guess I am resisting temptation.  But I at least need to vent, sort of like a monk pounding his head on the wall after getting the Victoria's Secret catalog in the mail.  So here is my rant.

First, let's start with how credit card companies make their money.  I will confess that I do not know how the card companies (V/MC) and the card processors (often large banks) split the take, so this is how they make money together.  V/MC and the processors charge fees to merchants.  Typically this is a fixed fee per transaction plus a percentage.  On average, a merchant might be paying 2.5-3.5% of a transaction.  The card companies also make money from card holders, charging annual fees, interest fees, etc.

You will have seen of late that most credit cards offer various loyalty programs, from airline miles to cash rebates.  You might have thought those were marketing expenses paid by the credit card companies.  Wrong.  The card companies simply charge merchants a higher fee for processing transactions using these cards.  In a sense, the card companies have organized with card users to use their power to extract extra value from merchants.

All of this I can generally live with.   Visa and MasterCard, through both their credit facility and their implicit standardization, bring enormous value to retailers and customers.  Its a big circular game anyway -- customers get 1% back and think they are getting a deal, merchants pay this extra 1% in fees, and then add it into the price of what they are selling.  It's a wash, except to the extent that customers with reward cards in the end extract a bit of value from customers who pay cash (for reasons explained below).

For this value one must accept the typically arrogant and indifferent customer service provided by any monopoly  (American Express is particularly awful to deal with as a retailer).   But they are no worse to deal with than the government, so its unclear how the government could make the service any better.

What tends to tick me off, though, are rules and restrictions.  Like the creeping work rules in the UAW contract, these are in many ways more insidious than the service and pricing.  Here is what set me off today, from one of my card processors  (in this case Bank of America, which, to be fair, is someone I would recommend for merchant account processing).  Click to enlarge.

So, why are businesses breaking these rules so often?  Let's take a look:

• No minimum transaction. Remember that V/MC charges a minimum fee, from 10-40 cents or so, per transaction.  So if someone buys a pack of gum in our store, likely 100% of the sales price is going to V/MC.  Typically it takes at least a one dollar total sale for there to be any money left over beyond paying cost of goods sold and the credit card folks.  So merchants logically want to set a minimum.   V/MC hates this practice, but it is rampant.  I plead the fifth on our own practices.
• Surcharging. Credit card customers cost more than cash customers.  Sure, we get some non-sufficient funds checks, but the eventual cost of these is nowhere near 2.5% of sales.  Merchants logically don't like having their cash customers having to subsidize the frequent flyer rewards of their credit customers.  However, unlike transaction minimums, card processors have mostly been able to drive out cash discounts.
• Requiring ID and Fraudulent Transactions. I will take these two together, since they are so ironic one after the other.  V/MC is telling merchants that they can't check ID, which is the only reasonable approach to limiting fraud, but that they can't submit fraudulent transactions.  You say that the text says "known fraudulent?"  Well, read on --

To the latter point, I think most people assume that the credit card companies are absorbing the fraud, which is how they justify the fees they charge.  Wrong again.  Credit card companies only absorb credit risk.  Over the last 10+ years, they have pushed fraud back on the retailer.  If a consumer claims fraud on his card with some transaction, then the credit card company refunds the customer and takes the money from the merchant unless the retailer can absolutely prove he made delivery to the consumer personally (which he can't prove because he can't check identification) .  Merchants bear the cost of fraud, not card companies.  Which I could accept (since I have more ability than the card companies to control fraud) expect the card companies ban me from controlling fraud.  So I have to take financial responsibility for something I am not allowed to prevent.  And that really ticks me off.

Anyway, maybe someday we can organize a large merchant boycott, where, even for a day, we all refuse to accept Visa and Mastercard.  Of course we would be breaking the rules, because that is not allowed by our V/MC agreement.

Postscript: I suspect that a few retailers with some power are starting to crack this, at least for themselves.  Costco only takes American Express.  Sams Club only take one card (MC, I think).  My guess is that both, with their large size, bargained for exclusivity in exchange for concessions on fees and/or terms.

Postscript #2: I expect comments like, "Well so-and-so always makes me show an ID."  I don't doubt you.  I am merely saying that by doing so, they have either negotiated an exception to the V/MC agreement (very unlikely, as V/MC holds to these rules like the Maginot Line) or the retailer is breaking the rules.

Several people I know have argued with my "do nothing" approach to the current mortgage and liquidity mess.  Their argument is that the current crisis has frozen the short term money market, with banks refusing to lend to each other, and only doing so via central banks.  The problem, they claim, is that this could lead to an extended drying up of business to business credit.  For example, two people both used the fuel retailing example, arguing that inventory purchases are made on credit, and paid off as the inventory is sold.  The logic, I assume, is that businesses have all reduced their working capital, and so a drying up of short term business credit will cause the economy to lock up, with producers and retailers unable to buy components and inventory.  One such argument here.

I guess the questions are 1) for how long and 2) how best to fix it.  To the first question, this is by no means the first time in my lifetime that short-term credit has dried up.  Liquidity eventually returns, mainly because lenders need to lend as much as borrowers need to borrow.  As to the second question, central banks are currently handling this by increasing the amount of money they will lend short term.  Rather than lend to each other directly, bank A deposits with the Fed and then the Fed lends to bank B.  The cycle ends NOT when every bank is healthy but when banks and other institutions are confident they know which banks are healthy.  All the bailout is doing is delaying this reckoning.  I don't think it matters that banks and certain financial institutions survive, I think it matters that the ones who are not going to survive are identified quickly so the rest can start lending again to each other.

Given these concerns, I reiterate my position that if the government is going to inject liquidity and create new financial asset insurance programs, it makes more sense to me to do it at the point of concern, i.e. in the credit market to main street businesses, rather than dumping the money into the toxic sludge of credit default swaps. 

Decades ago, anti-trust regulation abandoned any pretense that its goal was protecting consumers.  The vast majority of anti-trust laws and cases today are more about protection of businesses from competition.  A good historic example is the Microsoft case, where consumers were bravely protected by the government from getting various utilities included free with their operating system.  You only had to look at the major defenders of the anti-Microsoft anti-trust suit (e.g. Sun, Oracle, etc) to know that the suit was about protecting other businesses rather than protecting consumers.

It would be difficult to find a better example of this today than for gasoline in Maryland:

A gasoline price war erupted in St. Mary's County last week after one station
slashed its price for regular to $1.999 a gallon and spurred three others to
follow suit, giving drivers some hope of relief at the pump.

But the price dip proved fleeting.

Maryland regulators quickly stepped in and told the stations that their prices
were too low. They needed to go up by 5 cents...

The sudden fluctuation in the Lexington Park area was the result of a
little-noticed Maryland law that took effect in 2001. The General Assembly
mandated that stations cannot charge less than what they pay for gas -- unless
they're lowering prices to compete with a nearby station.

The rationale for the law is ostensibly this:

Independent service station owners pressed lawmakers for the measure as a way to
protect themselves from big retailers selling gas below cost to drive them out
of business and limit competition. Maryland is one of at least 13 states to
adopt similar laws, which are not in effect in the District or Virginia.

First, its not the government's job to protect individual businesses.  Businesses should be treated like adults who knew the risks they were getting into in a business.

Second, this argument is specious anyway.  The logic is that ostensibly these dealers will be driven out of business, and then the big guys, without competition, will jack up their prices.  This is absurd.  It is important to note that it never happens this way, not for any sustained period of time in any market in the hundred years of gasoline retailing.  Gasoline retail margins are low, have been low, and will always be low.  If they ever creep up locally, someone has the incentive to undercut prices because volume is so important to profitability.  In fact, people have accused Wal-mart of this for years - ie they cut
prices and drive out the independents.  But so what, particularly if
prices never go back up?  This is even more true in gasoline retailing because gasoline station capacity never really leaves the market.  Because of the unique nature of the infrastructure, and the environmental rules vis a vis underground tanks, the best use for a gasoline station sold in bankruptcy is another gasoline station.  Even if an independent goes bankrupt, the site will likely stay a gas station, under different ownership.

Finally, in the current gasoline market, there are very good reasons not related to driving competitors out for one to sell gas under cost.  Many modern gas stations make as much or more profit on their convenience stores, car washes, and other services than they do on gas.  I know my company does in the few places where we sell gasoline.  Using gasoline as a loss leader to bring in convenience store traffic is perfectly valid.  Grocery stores have been doing this with eggs and milk for years.

This type law is a lazy protection device for a few companies that happen to have political clout in the government.  Maybe the IJ will get on the case.  Overlawyered.com has commentary and examples from other states.

Update:  One should also note that it various circumstances, the oil industry has, in addition to this case where a company was hit by the government for selling at a lower price than competitors, been accused of gauging (selling above cost and other competitors) and collusion (selling at the same price as competitors).  The Mises Blog has a nice link to R.W. Grants the Incredible Bread Machine, a poem that includes this stanza:

"These very simple guidelines,
You can rely upon:
You're gouging on your
prices if
You charge more than the rest.
But it's unfair competition if

You think you can charge less!
"A second point that we would make
To
help avoid confusion...
Don't try to charge the same amount,
That would
be Collusion!
You must compete. But not too much,
For if you do you see,

Then the market would be yours -
And that's Monopoly!