Pesky contactless surcharges, Part 1: comparing payment costs

Friday, 25 October 2024

Why are Kiwis charged a fee in order to use their own money via contactless? It’s bonkers, says Explainer Editor Lloyd Burr. So bonkers that he is having to break it all down in two parts. This is Part 1, first published in October 2024, where he compares the costs associated with different payment methods. You can read Part 2 here, where he explores who makes money from contactless surcharges.

There’s nothing more irritating than having to pay extra in order to spend your own money in a way that’s convenient to you.

Yet here we are in 2024 with a tatty note cello-taped onto the payment terminal with a scribbly Sharpie message telling you to pay 2.5% for using contactless.

You know something is wrong with the system when retailers are shamelessly making your experience less convenient, more expensive, and happily let you walk out the door internally fuming.

So why do they do it? And why are they not surcharging other forms of payment like cash and EFTPOS and debit?

Here’s the simple answer:

1. Regulations allow surcharges.

2. Mastercard and Visa charge banks to use their services

3. Banks pass on costs instead of absorbing them.

4. Those costs are a percentage rather than a flat fee making a surcharge easier to calculate (and justify).

5. Terminal providers make it easy for retailers to add a surcharge.

6. Retailers pass it on instead of incorporating it as a business cost.

7. Many retailers have no idea what the surcharge should be so it’s usually higher than it should be.

What I’ve discovered while looking into this is that the whole system of payments is incredibly complex, confusing, commercially sensitive, and many are clipping the ticket along the way. The complexity is good for those involved because the fewer people who understand it, the fewer people can stand up against it.

The bird’s nest that is the system of payments may actually be the hardest thing I’ve had to explain so far. This is why I’ve split it into two parts.

Part 1: How different payment systems work and how much they cost

Whether it’s cash, EFTPOS, debit, contactless or credit, there’s a cost to the retailer/merchant/shop-owner of processing that payment.

Here’s the breakdown of the payment types and their associated costs. The costs are a mix of industry guesses (because no one wants to give me an actual figure), Commerce Commission data, insights from Westpac, and some are based on a report by Boston Consulting Group (BCG), commissioned by Mastercard.

1. Cash.

While it’s easy to think there are no costs associated with accepting cash payments, there are when you look at the whole process from beginning to end.

Retailers have to cover the overheads including the cash register system, counting the cash, giving change, safely storing the cash, doing the cash paperwork, depositing cash at the bank or having it collected by Armourguard. There are other costs of cash to the business like an increased security threat because there’s cash on site, cash handling errors, fake money, longer processing times, and transport. Many places are cashless given the complexity of cash and ease of contactless payments.

Costs involved (according to the BCG report):

• 0.1% for direct costs (secure transportation to bank, depositing)

• 1.2% for indirect costs (register, safe, teller, theft, cash handling errors, crime)

• 2.3% for back office costs (labour costs of counting, reconciliation, till/float preparation)

• 0.5% for consumer costs (withdrawal and transaction fees)

OVERALL COST OF CASH: On average, BCG says it’s 4.1% of the transaction value. But it really depends on the size of the retailer and the benefits of economies of scale:

• Large retailer: 2.7%

• Medium: 3.7%

• Small: 4.9%

Do retailers pass it on? No, because it’s not easy to calculate and consumers would laugh themselves out the door if there was a cash surcharge. It’s classified as a cost of doing business and the retailer stomachs it.

2. EFTPOS.

New Zealand was an early adopter when it came to ‘electronic funds transfer at point of sale’ (EFTPOS). It was rolled out in the 1980s and as its popularity grew, two system providers emerged. One of them used to be owned by the big four banks called ETSL, which became Paymark, which is now Worldline. ANZ used to own the other one EFTPOS NZ, which is now owned by Verifone. It’s a unique system and the only one of its kind in the world. Around 30% of transactions are processed this way (including Debit cards that are swiped or inserted. It’s confusing but more on that further down).

Given the banks initially owned the systems, the swipe-and-PIN systems were set up to be easy for the banks to settle transactions and the operating costs were (and still are) low.

Costs involved:

1. Terminals. Retailers pay around $40 per month per terminal. These terminals are also used for credit, debit and contactless payments. If they’re a mobile terminal, they’ll need a SIM card and a data plan too.

2. Connection. Retailers pay a flat fee of $21.73/month to Worldline or $17.25/month to Verifone.

3. Bank fee. The cardholder’s bank has to pay a ‘switch fee’ to Worldline or Verifone. These vary depending on the size of the bank. Smaller banks pay higher fees.

OVERALL COST OF EFTPOS: It’s impossible to land on a specific number given the terminal and connections are flat fees, and the turnover fluctuates month to month. But here are some calculations with differing turnovers and EFTPOS costs of $76.73 (one machine, mobile connected):

• Retailer processing $120,000/month: 0.06% per transaction.

• Retailer processing $50,000/month: 0.1% per transaction.

• Retailer processing $10,000/month: 0.7% per transaction.

• Retailer processing $1,000/month: 7.6% per transaction.

Do retailers pass it on? No, for the same reason as cash: it’s not easy to calculate and consumers would laugh themselves out the door. As with cash, the retailer stomachs it as part of the cost of doing business.

3. Credit Cards

Credit cards rose in popularity in the 90s and 00s because of easy access to credit, decent reward schemes, and ability to shop online.

They are provided by companies that sit in one of two ‘schemes’. Visa, Mastercard, and Union Pay International are a ‘four-party scheme’ while AMEX, Diners Club, and Farmlands are a ‘three-party scheme’. They’re silly names that relate to the number of stops along the journey.

There’s a lot of complexity so for the sake of simplicity, we’re just going to focus on Visa and Mastercard given their market dominance in New Zealand.

Up until 2009, retailers were not allowed to pass on credit card transaction costs to customers. Petone’s PakNSav tried to charge a 1% surcharge in 2000 but both Visa and Mastercard retaliated and withdrew their facilities.

But in August 2009, the Commerce Commission did a deal with Visa and Mastercard which allowed retailers to introduce surcharges on credit card payments which have remained to this day.

Costs involved:

1. Terminal and connection fees as per EFTPOS.

2. Merchant Service Fee. This is what the retailer’s bank charges the retailer for processing credit card payments. Westpac says the average across the country is around 1%, Consumer NZ says it’s around 1.5%, and the Commerce Commission says it could be as high as 2%. This covers interchange fees (see below), fees to Visa or Mastercard (see below), fees to Worldline or Verifone (separate to the ones above), tech systems, fraud and scam monitoring, and staffing. They vary depending on the size of the retailer with big companies with big turnovers like supermarkets having low fees, but high-risk, low turnover retailers having much higher ones).

3. Interchange Fee. This is a fee paid by the retailer’s bank to the consumer’s bank. It is capped at 0.8% but it differs depending on your bank (Westpac says its fee breakdown is commercially sensitive) but you can see what Visa believes is appropriate here and Mastercard’s here (warning: it’s dense). They help to cover rewards scheme benefits (like Airports or Hot Points), customer protections, and bank product development. Some argue this fee is good for innovation and competition.

4. Scheme Fee. The banks pay fees to Visa and Mastercard to use their global network. The fees vary depending on the type of card (gold, platinum, signature, commercial, consumer), what kind of fee the bank has managed to lock in, the location of the transaction (overseas transactions cost more to process), and the type of purchase (online, in person, charity, bills, insurance, recurring payments, etc). These fees are also commercially sensitive and vary between banks, depending on incentives and other discounts.

OVERALL COST OF CREDIT: Given most of the fees and costs within this credit card tapestry are commercially sensitive and change depending on so many factors, it’s very hard to give an overall cost of processing credit (hence the headache for retailers (and me) trying to calculate (and explain) it). BCG says the overall average cost to retailers for processing credit cards is 2.3% but they break it down depending on size:

• Large retailer: 1.2%

• Medium: 2%

• Small: 3.5%

Do retailers pass it on? Yes, but not always. Retail NZ says 25.6% of its members surcharge, and it’s likely higher in the hospitality sector. A study by RFI Global finds it’s 50%. Some absorb the cost as part of running a business (not just big companies like supermarkets but small ones too like the Whananaki General Store which is very remote but doesn’t have a surcharge).

Many dairies, bakeries, cafes, bars, gyms, event providers, car parks, and beauty salons enforce the surcharge. Some have an ugly post-it note on the terminal, others have more professional signs. They vary from 0.5% to more than 16% (according to Consumer NZ. More on this tomorrow).

4. Debit cards

Debit cards came along from 2005 due to demand from people wanting to spend their own money online like a credit card but without going into debt. They are essentially credit cards that are hooked up to your EFTPOS account. Debit cards feature a chip which means in stores, they can be inserted, and the PIN number entered (or swiped-and-pinned like an EFTPOS card too).

In order to boost the uptake of debit cards, both Visa and Mastercard agreed with the banks to waive the transaction fees for in-store, physical debit card purchases.

Costs involved:

1. Terminal, connection, and bank fees as per EFTPOS. This means the costs involved are essentially the same as they are for processing EFTPOS (anywhere between 0.06% - 7% of each transaction, depending on turnover).

Do retailers pass it on? Not when you swipe-and-pin or insert-and-pin. BUT a surcharge will apply to online shopping or contactless debit card payments (see the next section). The cost to the merchant to process online or contactless debit card transactions is around 0.7%, although some retailers don’t offer different surcharge rates and will process these in the same way they do with credit cards.

5. Contactless.

There are two types: cards and devices.

Contactless cards came along from 2010 when Visa launched Pay Wave and Mastercard launched PayPass. The cards use a technology called RFID (radio frequency identification) which features a built-in chip and antenna. When it’s in close proximity to a card reader, the radio signal is picked up and there’s a transmission of transaction details.

Costs involved:

1. The same as credit cards (even when you use your debit card, although sometimes it’s a lower fee for debit).

Contactless device payments came along a few years later with the introduction of Apple Pay and Google Wallet (which became Android Pay, then Google Pay then Google Wallet again). They work in a similar way as the cards but use NFC (near-field communication) on smart phones and smart watches.

Costs involved:

1. The same as contactless cards above.

2. BUT for Apple Pay, the cardholder’s bank pays a fee to Apple (no one could tell me what that fee is). Google/Android doesn’t charge a fee.

Do retailers pass it on? Same answer as credit cards. See above.

Consumer NZ says Kiwis pay around $250m more than they should for surcharges, and it’s more than $1b across the ditch.

So where does the money go? And who’s making a profit at the expense of customer convenience? That’ll be revealed tomorrow in part two.