04 Oct 2012

(by Morten Hviid) Surcharges have become a common feature of purchasing products and services online. The airline industry has been subject to particular criticism for charging excessive surcharges that are often hidden until the payment stage of the transaction, and for not offering a free payment option. Under the EU Consumer Rights Directive (2011/83/EU), due to come into force in 2014, “Member States shall prohibit traders from charging consumers, in respect of the use of a given means of payment, fees that exceed the cost borne by the trader for the use of such means.” (Article 19). The focus here is on the level of the surcharges. The UK’s Department for Business, Innovation and Skills (BIS) are on whether to bring the implementation of this prohibition forward. However, an responding to a super-complaint by the consumer group, Which? proposed a different remedy. This would have required firms to “provide clear information on the surcharges/discounts that apply to different payment mechanisms, when first displaying prices on a website” (para 1.22). It would thus focus on the transparency of the surcharges. I argue that the measure proposed by the OFT would be more appropriate than the prohibition prescribed by the EU directive and pushed forward by BIS.

What is right with the OFT approach?

As the OFT report carefully explains, firms hide their surcharges because of a behavioural assumption about consumers. Consumers for a variety of reasons may fail to allow for such later surcharges and by the time they get hit by them, they have already invested so much in the purchasing decision that they are reluctant to bail out. Once the consumer has failed to anticipate the surcharge, this may be rational if it is costly to go through the purchasing procedure with another supplier, or if the consumer forms an expectation that any alternative supplier is likely use the same approach to pricing.

If the problem is the hidden nature of part of the price, the OFT proposal to force firms to reveal this as early as possible in the shopping experience is direct and to the point. It has the important merit of being easy for consumers to enforce. Not only is the absence of the required information readily observed, it is also readily demonstrated to a third party, be it an ombudsman, Trading Standards or even the courts.

It may not be necessary for firms to display the actual size of the surcharge, beyond its existence. One would expect the majority of consumers to respond negatively to a firm telling them that “yes we will apply a surcharge but no we will not tell you how much”. Essentially without adding the level of the surcharge, the firm is sending a very bad signal about itself, a signal warning the consumer to beware. Once the level of the surcharge is out in the open, then competition begins and where there is competition, we would expect to see surcharges being competed down to levels at or below costs. The fact competition can force below cost charges is evident in the failure of UK banks to stamp out “free banking”.

It is important to add that any rule on early disclosure should not be restricted to surcharges, but should be in force for any fee which may be added later and where there is a cost of “starting again”. The OFT is right that for competition to work, consumers must know what prices they are likely to be charged. Surely the point is that any surprise fee is meant to deceive the consumer and they or their representatives must be given the powers to deal with this.

What is “wrong” with the BIS (EU) approach?

Whereas consumers can easily observe and prove that a firm had breached a commitment to put information about surcharges or other fees up front, establishing whether a particular fee is excessive is not generally possible for the consumer, or possibly even for an ombudsman, OFT or Trading Standards, at least not without a significant of effort. As is evident from question 6 in the consultation document, the merchant service charge (for example for paying by credit card) is not the only cost element. One example (para 69) is “any operational costs that can be separately identified as internal administrative costs arising from activities dedicated exclusively to card payments”.

The consultation document asks what costs the firm should be allowed to pass on to consumers. This is no easy question. As a first principle, the cost of the least expensive payment method should be included in the price. Any surcharge should then be relative to this minimum cost. There may well be a presumption that cash payments are costless. This is clearly not the case. Not only are there security issues which arise for firms holding large sums of cash, there are also the issues related to counterfeit money. So any method of transaction imposes costs on the recipient of the funds.

Who is supposed to enforce this? If you allow the merchant to include all sorts of more or less obscure costs to be included, a customer would have no way of demonstrating that they are being charged too much, basically leaving them with the current option of either liking the deal or lumping it. Equally without a very simple rule, the OFT, or possibly in the future Trading Standards, would also be wasting too many resources monitoring this.

Finally, allowing firms to treat the costs of transacting on a cost-plus basis by passing on all charges to consumers will take away any pressure on both merchants and on the suppliers of payment methods to keep fees low and to innovate to make payment cheaper. There has been enough competition law scrutiny of payment method industries for there to be reasonable doubt about the competitive nature of these industries. Reducing competitive pressure does not seem the obvious approach.

The best one can say about the BIS proposals is that it is likely to do little harm. That is echoed in the impact assessment which expects only negligible costs on business and that consumers will not make any significant cash savings as a result of the preferred option. BIS should be brave and tackle the real problem by forcing early disclosure of all surcharges or any other late fee.

If we did not do that, we would need to explain why firms are not generally allowed to quote prices before vat and simply add these taxes at the till.