Thursday, June 19, 2008

Puzzle: Credit Card Merchant Fees

Why do credit card companies charge merchants a percentage of sales, rather than a flat fee?

I saw these two articles today discussing the effect of gas prices on retail gas stations. Both suggest that gasoline merchants are feeling a squeeze. Their margins on gasoline are razor-thin--just cents on the gallon. As the price rises, the fees they must pay to the credit card companies rise, turning their small profit to zero or even negative profit. The puzzle to me is, why do they charge a percentage? Does it really cost more to process the transaction for someone who filled up a 15 gallon tank than it does for someone who filled up a 10 gallon tank? The only explanation I can come up with is that there is a greater risk of fraud with larger purchases (the $1,000 TV purchase might be more likely to be fraud than the $30 gasoline purchase), but it seems to me that this at best explains a sort of tiered fee structure with a series of flat fees (or possibly a flat fees at some levels and percentages at others).

A naive answer would be "they do it because they can and gasoline station owners have no choice". But if they have no choice, why not charge even higher fees? Or why not charge a very large lump sum? Why this particular fee structure? Also, there is more than one credit card company; if some other structure is obviously superior, why doesn't one of them offer it, and see all the gas stations switch over to using them exclusively? Some stations are apparently refusing to accept credit cards; will this lead the credit card companies to change the terms?

Now, in any case, gas stations use gasoline as a loss leader to bring customers into the actual store to buy expensive sodas and bags of chips (much like the famous movie theater popcorn story; search the page for the word "popcorn"). There's no iron law that says they must make a positive accounting profit on their gasoline sales to stay in business. What matters is that their overall economic profit is zero or positive.

I'm guessing that someone has solved this problem already, so link me to it!