Some small business owners shared their suggestions for minimizing credit card interchange fees, after yesterday's hearing on a bill to restrict some fees and increase transparency. (Interchange fees are what merchants pay to the bank when customers pay with swipe cards, on average about 1.75% of each transaction.)

A reader named Suzanne Riga writes about giving discounts for cash:

We discount 3% for cash sales to try to recover the cost on credit cards. The problem we've run into now is more customers use debit cards than cash. Debit cards are considered a "cash transaction" so we really get hit hardon those charges. We are debating now whether to consider not giving a discount on a debit card. That would antagonize the customers though, so we're caught in a catch 22.

Monte Smith says his restaurant recently started passing the cost of interchange along to customers:

Credit card payments are 48% of our payments. So you add all the fees it gets to be expensive. It seems that these card companies twice a year raise their rates and if a restaurnt raises it menu they get another raise based on their percentages....We just started calulating the cost of these fees [to] be included in menu pricing..

And J. Goldberg set a $20 minimum on taking credit cards, even though he says it breaks the rules of his agreement:

Recently in my small business I did an average cost per ticket anaylsis of my credit card transactions instead of trying to figure out the 40 page bill. What i found out is that it costs me $2.12 average for each transaction. I did 1100 transaction in July and it cost, with all of the fees open and hidden, $2332. Even though it is against the rules we have instituted a $20 minimum on the acceptance of credit or dedit cards.

Meanwhile, a spokesman from Visa got in touch with me yesterday to send over the network's statement. Here are some excerpts:

Merchants receive tremendous benefits from electronic payments including guaranteed payment, increased sales, faster checkout times, as well as greater convenience and security - all at a fair price. For these benefits, Visa's interchange rate for banks averages 1.62 percent for each transaction and has remained steady for a decade. Unfortunately H.R. 2382 is nothing more than a renewed effort by lobbyists representing some national retailers and trade associations to shift the normal cost of business onto consumers, while retailers continue to reap the benefits electronic payments offer and pad their profits.

...

Importantly, retailers already have numerous options to manage their acceptance costs. They can shop around and get a better deal on their merchant acquirer, negotiate a lower fee with their acquiring bank, steer consumers towards other forms of payments and offer discounts for cash, check or PIN debit.

Now, that may raise some eyebrows among merchants. Has anyone tried to negotiate lower fees with their bank? Share your story with us in comments below.

Here are some changes that the Credit Card Interchange Fees Act of 2009 would make:

• Ban the practice of charging higher fees to the merchant when customers pay with "rewards" cards
• Prevent credit card networks from imposing certain restrictions on merchants, like how they can display their prices or steering customers to use cash instead.
• Increase transparency for merchants and direct the FTC to police merchant agreements for unfair, deceptive, or anti-competitive practices

The big concern here is whether the market is working to set interchange fees in a way that reflects the value that credit cards provide to merchants and consumers. A great nugget from this US News piece suggests the opposite might be happening. Quoting payments expert Aneace Haddad:

"Interchange fees are set by Visa, MasterCard, and other card schemes as a feature of each card product that the scheme offers to banks," explains Aneace Haddad, an entrepreneur who works in electronic payments and blogs on the subject. "When a bank is deciding between a Visa or MasterCard logo on their cards, and between one company's platinum card and the other's, it is very tempting to choose the one that provides the highest interchange fees. This competition is what has driven interchange fees higher over the years."

In other words, competition from bank card issuers drives the prices up, rather than competition from merchants and consumers driving the prices down. Sound like a functioning market?

Please keep the comments coming on this one. It's a bit of an obscure topic, but one that matters to almost anyone doing business, particularly any consumer-facing business or anyone selling online. So your on-the-ground stories are invaluable to reporting on this.

The good news is that the global economic crisis appears to be reaching a turnaround. Nielsen says that with hopes for a full economic recovery accelerating in 26 out of 28 major global markets, consumers around the world might be expected to return to previous spending habits.

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Outsourcing manufacturing and product design to Asia has had an undeniably negative impact on the number of manufacturing jobs in the United States. But at least in the information technology industry, there is little evidence that outsourcing has slowed the rate of U.S. innovation or made the country less competitive. However, applying the lessons of IT to emerging industries where the U.S. has a weaker starting position — like electric vehicles — is another story.

There is a simple explanation: The inevitable march of value downstream toward customers and applications means that component technologies and processes become relatively plentiful, while the vision of how to combine and exploit increasingly capable, complex, and cheap building blocks becomes scarce. Thus, in IT, controlling demand for key technologies has proven far more valuable than attempting to control their supply.

DRAMs are a case in point. Since calls in the late 1980s to prop up the failing U.S. memory business through subsidies and tariffs were rightly turned back, the American IT industry has created many times more economic value by exploiting cheap and plentiful memories than U.S. chip makers lost by ceding the market to Japan, Korea, and Taiwan. And there is no evidence that companies mastering and controlling memory technology have gained any ability to move downstream — at the very least, their margins are too thin to fund anything other than the skills they need to stay where they are.

That the U.S. IT industry has been able to innovate over the past 20 years even while ceding leadership of component technologies and basic processes to industrial commons in other countries is a testament to the basic power free markets. Apple enjoys predictable and unfettered supply of leading edge technology because its software, design, marketing, and now retail prowess give it ultimate control over customer spending. Amazon, Google, Hewlett-Packard, IBM, AT&T, and Qualcomm have successfully used their investments in software, services, infrastructure, and intellectual property to do the same. All use their market power to force upstream vendors to invest for them to make the inputs to downstream innovations and transformations cheaper and more plentiful. As long as they innovate sufficiently to follow the flow of market value downstream, all are able to limit the eventual return and market power accruing to these upstream innovations.

While these upstream suppliers might control the knowledge of how to transfer new innovations from R&D to high volume manufacturing, they have every incentive to collaborate with innovators that lack such knowledge when doing so increases their share of or profitability in the markets where they compete. Witness the ability of the MIT One Laptop Per Child program to get Taiwanese LCD plants to produce its innovative LCD displays or the ability of flash-memory innovator SanDisk, which lacked its own fabs, to gain access to state-of-the-art process and manufacturing expertise through a partnership with Toshiba.

It's tempting to see IT as a special case, and to be more fearful of outsourcing in other areas. But the reality is not so simple. For example, it's likely that the U.S. will gain far more from low-cost manufacturing of solar modules in China than it will lose. The math is simple: Emerging photovoltaic technologies will reduce the manufacturing value added of a solar panel (i.e., transformation net of materials and capital costs) to less than 10 cents per watt of rated output power, or roughly the value of the energy it will produce in 600 hours of use.

But, installed in, say, California, a solar module will see 60,000 sun hours over its 20-year life, making its use 100 times more valuable than its production. There is still plenty of room to improve efficiency and lower solar-panel cost, and U.S. companies can and will gain market power by investing in the intellectual property needed to drive these improvements. But as the absolute cost of photovoltaic conversion falls over the next several years, economic opportunities around applications will swamp the payback on marginal innovation in the panels themselves, and ownership of manufacturing assets will not be required for the most valuable innovations.

Where this model breaks down is where U.S. companies and innovators do not naturally control downstream demand. Take batteries for electric vehicles. The U.S. has ceded both innovation in the critical building block (the battery) as well as leadership in the integration of these blocks into downstream value (competitive automobiles).

By investing early in alternative drive trains and capitalizing on decades of investment in related technologies for low-cost, high-quality automotive integration — indeed by anticipating innovation in batteries — Toyota and Honda have better positioned themselves to benefit from new technology, whether or not they develop it themselves, than any U.S. car company could, even if it instantly had access to some magic and unique U.S.-made battery.

It is not too late for the U.S. to invest in creating an infrastructure, or commons, for developing and manufacturing high-power batteries. But without the much greater investment in innovation of the downstream pieces, it's not at all clear that the U.S. will share in the greatest slice of the economic pie.

Andy Rappaport
Partner
August Capital

The House Banking Committee has just finished drafting a bill intended to stop anyone in the future from putting together another Bernie Madoff scam. It's a worthy aim that I wholly endorse, but I worry that passing the current draft will introduce more arbitrariness and cost into the regulatory system without solving the problems revealed by the Madoff debacle. Let's look at some of the bill's main features:

Higher fiduciary standards for financial professionals. Historically, brokerage reps providing incidental investment advice to retail customers have only been required to make "suitable" recommendations to their customers. The bill proposes replacing this requirement with a stricter "fiduciary" standard. This sounds promising, but the draft does little to tell us what the new fiduciary-type standard will be. Moreover, the bill does not address the practical challenge of how the SEC can inspect a larger group of financial "fiduciaries" — it has only 400 staffers to inspect 11,000 financial advisers. (Of course, there are ways to address that problem: we could extend the jurisdiction of the current self-regulatory organization for broker-dealers to include all investment advisers or at least those affiliated with broker-dealers. Alternatively, we could create a new self-regulatory organization for investment advisers.)

Expanded SEC powers. The bill would vest the SEC with broad new powers to "promulgate rules prohibiting sales practices, conflicts of interest, and compensation schemes for financial intermediaries (including brokers, dealers and investment advisers) that it deems contrary to the public interest and the interest of investors." The scope of this remit is alarmingly vague. For instance, I could imagine the SEC setting maximum commission rates or sales loads on the distribution of certain financial products. It could adopt a general prohibition on paying cash bonuses to brokers or advisers unless a substantial portion is deferred for a few years. These new powers could get the SEC mired in the micro-management of compensation. These decisions are better left to a firm's independent directors, who know the specific context of each firm

Court-based arbitration. As drafted, the bill would allow the SEC to prohibit mandatory arbitration clauses in the customer contracts of brokers and advisers. But the arbitration process is clearly faster and less expensive than court cases. And while consumer advocates have criticized certain arbitration procedures, most of these have been changed over the last few years. If this draft bill were adopted, then many customer complaints would be put together in class action suits against market professionals instead of being resolved through arbitration.

Larger bounties for whistleblowers. The bill would authorize the SEC to pay cash bounties to whistle blowers who supply information leading to SEC enforcement cases and these bounties could go as high as 30% of the monetary sanctions in the relevant cases. But the Madoff case did not show the need for cash incentives to whistle blowers. What we need is a more disciplined process for following up on complaints from whistleblowers.

Do you believe that the House Banking Committee's draft bill is an appropriate response to the problems revealed by the Madoff scandal or an over-reaction?

Bob Pozen is a senior lecturer at Harvard Business School and the author of "Too Big to Save? How to Fix the US Financial System" (John Wiley, forthcoming November 9, 2009)