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This is a guest post with Vass Bednar, one of Canada’s best and brightest public policy entrepreneurs working at the intersection of technology and public policy. In addition to being the executive director of McMaster’s Master of Public Policy program, she is a prolific writer and has brought us the wonderful Regs to Riches (to which I’m a loyal subscriber).
It was recently reported that Telus has asked the CRTC for approval to charge a 1.5% fee starting in October. If the regulator approves the proposal, the new surcharge would start in the fall.
The firm is seeking to pass on a portion of the processing costs that they incur to accept credit card payments. But all is not lost - customers would avoid paying a fee if they paid their bill through a bank or debit transaction. Telus is nudging people away from credit cards - robbing them of precious loyalty points, but saving them a few bucks on their monthly bill.
Based on online chatter, the announcement stoked the public ire that has recently been reserved for Rogers. But the reason that Telus is requesting this ability to pass on these costs to consumers isn’t related to telecommunication or competition policy per se. The move is actually intriguing: Telus is flexing market power in an uncompetitive market (payments) as a challenge to Visa-Mastercard. Amazon did something similar with Visa credit cards in the UK earlier this year, when the firm was expected to prevent Brits from using Visa-issued credit cards on its platform. The move was interpreted by experts as a way for Amazon to leverage bargaining power in an effort to force Visa to lower its fees.
Credit cards have long been controversial for the companies that accept them. Why? They think interchange fees are too high, and neither banks nor credit card networks seem willing and able to do anything about it. As an old Senate banking committee report noted, “something is wrong when so many merchants, big and small and from across a variety of sectors, feel that other participants in the payment system are not adequately responding to their concerns.”
The economics of payments is one part of what’s wrong. The payments market is a textbook example of what economists call a two-sided market. There are merchants who want to be paid on one side of the market, and there are consumers who want to make payments on the other. And in between the two sides is the intermediary platform: the credit card network that gives willing parties a way to transact with each other.
The credit card payment flow is long and complex. To work, it requires near-instant cooperation between the credit card network, the consumer’s bank that issues the card, the merchant’s bank that accepts the card, and a payment processor that gives the customer a way to use the card, whether that’s online (e.g., Stripe) or at the physical point of sale (e.g., Square).
Incentives matter, and so this whole dance is only performed when it’s choreographed by an interchange fee. To get consumers willing to use a credit card, you have to incentivize them. So why not pay them with loyalty rewards? But there’s also no such thing as a free lunch, and so the cost has to be accounted for. As Jean Tirole, a pioneer in the literature on two-sided markets, wrote:
If one side of the market benefits a lot from interactions with the other side, then the platform can charge more to the former and, in a “seesaw” pattern, will want to charge less to the latter side to make it more attractive to join. The platform thus needs to know which side of the market is most interested in the service (has the lowest elasticity of demand, and is therefore likely to pay more without ceasing to consume), and which side brings more value to the other.
Translation: the side that wants to interact with the other side the most pays the price and funds the loyalty rewards. It’s the merchants. No merchant wants to lose a sale because a customer can’t pay with their preferred payment method, and so they all end up accepting credit cards as payment, even though they’re more expensive than other payment options, and even though they like to complain about the costs. Throw enough credit card networks and banks in the mix and fees can actually go up, as banks compete with each other for customers with ever more lucrative loyalty rewards programs.
Credit card networks and banks set this price and call it the interchange fee, which is then split between the parties in the long and complex credit card payment flow. Most of the fee goes to the banks that issue the cards, with everyone else splitting the rest.
In the strictest sense of the word, merchants have “choice” in the payments market. But in practice they don’t because the “choice” comes at a prohibitive cost—unless you’re an industrial giant, with enough market power to nudge customers to pay by other methods. How competitive can pricing in a market be if only the firms in other markets with excessive market power can drive them down?
The government has tried a few things to solve the problem. Then-commissioner of competition, Melanie Aitken, launched a case against the credit card networks not too long ago, alleging that their rules were anticompetitive, but failed to win for reasons of legal esoterica. Since then, the government has opted for “moral suasion” to keep interchange fees capped. Moral suasion is just a nice word for government threats of regulation. In 2010, the government passed the Payment Card Network Act, which gave the government the power to regulate the “commercial practices” of credit card networks. But the PCNA doesn’t really do anything. It just stands there, all menacing looking, threatening future regulation. That said, moral suasion has resulted in a set of voluntary agreements to cap interchange fees. The latest one is from 2018, where the average interchange fee was capped to 1.4 percent, which is nearly identical to the surcharge Telus is passing on to its customers who choose to pay by credit card.
The other question is whether we’ve already been paying these fees for merchants most of the time. For instance, small businesses likely pass on the price of payment processing to people by adding it to the sticker price of an item. Have you ever noticed that so many merchants signal that they don’t accept American Express? The reason for that is simple: American Express charges merchants a higher fee than competitors do.
So why is Telus doing this, and why now (or ’then,’ given that some time has passed)? Our interpretation is that the government is not really doing its job here, because there is not enough competition to moderate prices in a healthy way. In the absence of appropriate regulations, we see market power fighting market power.
Anyone making this announcement about Telus may be interested to learn that the Canada Revenue Agency also passes credit card charge fees onto consumers. Instead, we should pay more attention to the credit card networks and the banks that earn revenue from credit card payments. It’s the banks that issue credit cards to consumers that get to keep the biggest chunk of the interchange fee. The Retail Council of Canada told the Toronto Star that merchants paid upwards of $9 billion in interchange fees in 2019.
The innovation of buy-now-pay-later schemes represented a major threat to credit card companies, as people had a new and less punitive way to smooth large purchases over time.
Deputy Prime Minister Chrystia Freeland’s wo-mandate letter addresses this, instructing that she “continue to engage with stakeholders to lower the average overall cost of interchange fees for merchants, proceeding in a way that ensures small businesses benefit from this work and protects existing reward points of consumers.”
Other interventions that could improve the landscape for merchants and consumers when it comes to credit card fees are related to price transparency. Breaking out the interchange fee as a proportion of price could help people recognize the surcharge and note any variability across company and terminal. Introducing competitive alternatives to the major credit card networks could help, too, by lowering the interchange fees and the amount that merchants feel the need to surcharge altogether. In line with its current plans, the federal government could give soon-to-be-regulated payment service providers, such as Square or Stripe, access to national payment systems, such as Payments Canada’s new real-time rail. By circumventing credit card networks and banks who profit from credit cards, payment service providers could compete by offering alternatives to Visa and Mastercard. Another option is capping interchange fees with regulation, as policymakers have done in the EU.
Telus is likely pursuing this change as a tactic to renegotiate its agreement(s) with Mastercard and Visa. More large Canadian merchants should mimic this with an eye to levelling the playing field for everyone - not just themselves.
In October, there are going to be thousands of businesses in Canada - large and small - that are doing this. Telus’ name got out there early because they needed regulatory approval for certain lane line legacy services from the CRTC. As it stands, the government takes a very hands off approach to payments of all kinds, and that has resulted in transaction costs that are higher than they should be.
For just over the past month, I haven’t been producing as much for the Medium of Exchange. My “productions” have been finding themselves in other places.
Here’s a story in L’actualité about why sending money should be as fast and cheap as sending an email.
Here’s a piece from Nick Catino and me, arguing that Canada’s financial sector is not robust.
And here’s a deep dive from BetaKit on the what’s the latest in the open banking working groups.
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