The question this week is from an agent with a big opportunity to sell a multi-location business of drive-through coffee shops.  This is a small transaction business with average ticket size of $5 to $6.  They are currently processing with PayPal at 2.7% and no swipe fee, and they are open to eliminating their processing fees.  So, the question is whether to pitch compliant surcharging or cash discounting for this sale and how to structure the pricing.

To answer this question, I suggest also considering a third option – per-item cash discount.  This is a topic which I seldom, if ever, have mentioned in my previous content.  Instead of 3.99%, the charge per transaction would be $0.35 or $0.40, meaning the price for credit card payments would be that much higher than the price for cash payments.

Let’s consider each option:

COMPLIANT SURCHARGING

Surcharge adds a service fee (usually around 3.5%) on credit card transactions only, not debit.  Since coffee shops are probably doing 80%+ debit, surcharge is a non-starter for this small ticket merchant.  A surcharge program usually charges a bit more on debit than traditional processing would.  Thus, the surcharge program would likely not generate savings for this business.  Rather, their costs would be higher with surcharge.

Example:  Switching to surcharge might entail a 3.5% service fee and 1% plus $0.25 on debit.  That’s probably more than is currently being paid on debit.  Since the majority of transactions will be debit, they may pay nothing for credit but more for debit.  Thus, surcharge would cost them more.  Compliant Surcharge is not a good option for small ticket business, especially when the average ticket drops below $15.

PERCENTAGE CASH DISCOUNT PROGRAM

The cash discount program is basically a cash price and a non-cash price.  This may potentially be a good option.  However, implementation would be a little different than normal for this account.  

Most processors won’t go above a 3.99% non-cash adjustment.  The effective rate of interchange is probably above 5% for this small ticket merchant.  Thus, you can’t promise to eliminate processing costs with a percentage cash discount.  Because of Durbin Amendment regulations, the cost of running a $3 to $5 transaction is 6% or 7% ($0.22 + 0.05%).  Most signature debit transactions are regulated.

The Durbin regulation includes $0.22 per-item fee, plus 5 basis points.  That pertains only to interchange cost, without consideration of basis points of mark-up or per-item fees.  $0.22 divided by $3.00 = 8%.  With the 3.99% cash discount, the agent will be losing money if he gives the merchant a flat rate 3.99% and promises to eliminate the fees.

You can still pitch a percentage cash discount, but you can’t promise to eliminate all the fees.  The business can honestly tell patrons they aren’t even passing the whole cost through to consumers.  You will save the merchant a ton of money, in spite of the amount still owing each month.

You might keep the merchant on interchange plus pricing with a 3.99% non-cash adjustment and a 3.99% daily discount.  The usual implementation of a cash discount program would include 3.99% non-cash adjustment, 3.99% (or a lower amount to make the batch match up) daily discount, and 3.99% flat rate to offset.  However, you can’t do the flat rate for this business.  You wouldn’t bring in enough fee revenue to cover the cost.

So, this approach would allow the merchant to collect an extra 3.99% in revenue from customers using a card.  Your company would implement the daily discount to collect this revenue.  At the end of the month, their fees with interchange plus pricing might be 6%.  However, you would have already collected 4%, leaving them to pay only 2%.

PER-ITEM CASH DISCOUNT

For this option, rather than offering 3.99%, you say it’s $0.35 or $0.40.  In my opinion, there is nothing wrong with this from a compliance perspective.  Although you’ll collect an amount above 4%, that ruling pertains to surcharge compliance, not cash discounting.
The problem with selling the per-item cash discounting program is the possibility of significantly more consumer push-back.  

In this version of cash discounting, the other hurdle is collecting the fee revenue.  It is not possible to do a per item daily discount.  Therefore, you have no way of knowing how much to collect on a daily basis.  My advice in these situations is to charge the merchant the same amount per item that you are charging the customer.  Explain that at the end of the month, it will be a wash. 

There are a few providers (I know of only two) who offer per-item cash discounting along with escrow type billing where the right amount is collected each day from the merchant.  This is not something any of the larger processors do, at least not that I am aware of.

Whatever option you choose, commit to your approach before walking in.  The pitch must be:  “This is the way the program works for a coffee shop; do you want it or not?”  The argument to the merchant is whether the customers will be all right with it.  You don’t want to get into a big discussion of per item versus percentage with the merchant; you are the expert.  Decide which approach is best; make sure you are able to offer the one you want; and then pitch that with confidence.

Before making your pitch, you should fully understand:

#1.  If PayPal is actually charging 2.7%, they are losing money – big time.  You can’t compete on traditional processing.  Square was in a similar situation before they implemented their price increase – the reason they did the increase.  You can’t compete on that.  Although they may be willing to lose money, you’re not!

AGENT QUESTION:  Why would PayPal even set up such an account?

MY ANSWER:  The people at PayPal who set up such accounts don’t understand this business.  The same is true with Square.  Square processed for Starbucks for about a year.  Finally, they realized losing a million dollars a month was not good!

AGENT QUESTION:  Are you confident their financial people will understand the benefit when they look at this plan?

MY ANSWER:  Yes, they will be astute enough to easily see it’s going to save them a fortune.  Your priority task will be selling them on the concept of cash discounting and reassuring them concerning consumer reaction.  Data has shown for three years that consumers will be fine.  You must sell them on that.

The only other hurdle for you is why, after collecting 4% from customers, the merchant still has a charge.  This will seem strange if they are only paying 2.7% now.  Of course, the reason is that PayPal is losing money.

To summarize, you’ll put this business on a flat-fee cash discount while the merchant is on interchange plus pricing.  Here are the separate components for this business:

  1.   The merchant collects 4% from the consumer.
  2.   You collect 4% from the merchant.
  3.   You charge the merchant whatever interchange plus pricing looks like – probably an effective rate of 4.5% to 5%.
  4.   The merchant pays the difference every month.

AGENT QUESTION:  Why wouldn’t this business just do a price increase instead of Cash Discounting?

MY ANSWER:  A coffee shop does have many cash paying customers.  Is it fair to their cash paying customers to implement a significant price increase for everybody when the only reason to make the increase is to offset the cost of credit card payments?  That action would be wrong for their customers.  

If the rent on the building goes up, that does affect everyone; everyone should pay.  But when the cost of payments goes up, that is only due to customers using their rewards cards or frequent flier miles, etc.  Thus, that charge shouldn’t be passed on to everyone.

I hope this Q&A session has been helpful to you.  I’ll answer another question next week; stay tuned!