Emotional Framing: Cash vs Credit Card Payment – Gain vs Loss

Behavioral economists have argued for a long time that “costs are not necessarily considered losses” (Richard Thaler, 1980). For example, if somebody is told that they are paying a discount compared to the regular price, they will feel that they are gaining in that situation. Further, numerous Prospect Theory studies demonstrated “loss aversion” behavior.

A practical arena where this can play a role is, for example, a decision to pay with cash or credit card when buying gasoline. The credit card industry without prior education in BE also understood this issue a long time ago. Its lobby always argued that any difference between cash and credit card customers should take the form of a “cash discount” (gain) rather than a credit card “surcharge” (loss). The belief is that the consumers would view the cash discount as an opportunity cost of using the credit card (gain) but the surcharge would be viewed as an out-of-pocket cost (loss).

Just recently, a related issue appeared at the Supreme Court (January 10, 2017). Expressions Hair Design took NY State to the highest court in the country due to the ban on credit-card surcharges.

According to the Wall Street Journal:

“For decades the state has barred companies from tacking on a fee when customers pay with plastic instead of cash. A hair salon now challenges that law, claiming businesses have a constitutional right to impose surcharges—and that behavioral economics provides the theoretical foundation.”

At first glance this idea is puzzling. Congress originally prohibited credit-card surcharging in 1976, but that ban lapsed in 1984. In response, several states, including New York, enacted laws that mirrored, more or less, the federal prohibition. For decades these statutes were largely moot, since the contracts between card networks and merchants also barred surcharging. The dormant laws came back to life after a 2013 class-action settlement dropped that contractual language.

The hair salon’s argument starts with a 1974 federal law guaranteeing businesses a right to offer cash discounts. In one school of thought, this is functionally equivalent to a credit-card surcharge. The salon can already give customers, say, $1 off for paying in cash. So why does it want the ability to add a $1 surcharge for paying with credit? What’s the difference?

Enter behavioral economics. Although the two appear to be mathematically equivalent, the salon argues that surcharges are more effective at changing behavior because consumers suffer from a “loss aversion” bias. More customers will decide to pay with cash, the theory goes, if faced with a “loss” (the $1 surcharge) than a “gain” (the $1 discount).

In support of their argument Expressions quoted a Dutch study from 2000. The study was conducted on behalf of the European Commission’s (EC) Directorate General Competition. The purpose was to investigate the effects of the abolition of the so-called No-discrimination Rule in the Netherlands. The No-discrimination Rule or ‘NDR’ is a rule contained in some payment card schemes which prohibits merchants to surcharge consumers for paying with a card. One of the main findings was that, indeed, most cardholders (74%) thought it is (very) bad that merchants are allowed to ask for a fee when customers want to pay with their payment card, i.e., they saw it as a loss. In contrast when offered a discount when paying with other means, the respondents were less negative: 49% said it is (very) bad, 22% is neutral and 21% said it is a (very) good thing. In other words, customers were “loss averse” as Prospect Theory argues. As a consequence, the merchants who participated in the study estimated that about 43% of the customers told about the discount they get for paying by other means of payment refrained from paying with credit cards. In other words, the customers altered their behavior based on framing of the costs.

To us it is interesting that BE is reaching the constitutional court of the country. The WSJ article authors argued that BE is unproven and this is frivolous and unworthy of Supreme Court attention. We are not interested in judging if this issue is worthy of the Supreme Court, but, we believe Expressions is correct in thinking this would change the behavior of their consumers. In his statement at the Supreme Court, the lawyer for Expressions argued that they would like to indicate to customers that credit card charges are a surcharge. They are right in assuming that this approach to labeling prices (i.e., cash=discount vs. credit card=surcharge) would impact consumer decision-making and frame credit card purchases as “losses”. This, in turn, is likely to change behavior by motivating more cash payments.