As career entrepreneur and hobbyist economist, the one thing that seems to perpetually grind my gears is the “credit card minimum” that so many small businesses require. In my heart of hearts it makes no economic sense, but maybe that’s just my opinion, so let’s do some math. My local coffee shop (literally across the street from my apartment) pays a fee of $0.08 every time I buy a single cup of coffee and swipe my card to pay. Now that I no longer shop there (because of their CCM rule, yes I’m that fanatical), they must attract almost 38 single-cup-buying, cash-paying customers to replace my $3.00 missing coffee (37.5 x $0.08 = $3.00). Follow me so far?
Let’s take a step back. There is a lingering perception among the masses that the practice of charging “minimums” is illegal. It’s not. In 2010 the government passed the behemoth Dodd–Frank Wall Street Reform and Consumer Protection Act which included a provision for small businesses to include “up to a $10 Minimum on credit card transactions.” In fairness, this was designed for businesses like gas stations and convenience stores where the margins are pretty tight. Though in this day and age it’s hard to imagine too many people buying less than $10 of gas on credit. The act passed easily in large part because it was tucked into a massive package that dealt with far more important things like mortgage backed securities and other issues of national significance. Coupled with the fact the the credit card companies themselves didn’t really care because on the surface, most of them make more money off the deal. As they generally charge on a percentage basis they now make $0.27 on $10 instead of only $0.03 on the all too often $1 gas purchase.
My sarcasm notwithstanding, I’m not here to pick on the little guy or those businesses operating on tiny margins. I’m interested in addressing businesses who are actually operating on larger margins, but who may be addressing the math inappropriately and losing money because of it. Business school 101: Customer acquisition and retention. This is the core of any business, because without customers, all you have is free loading friends and family and you’re done in short order. Specifically back to my coffee shop example, some background. It was opened last summer by someone who was, in her words, an experienced shop owner who had run a few businesses in her time. Most recently exploring the world as an Uber driver. At first the shop was fully appreciative of any customer they could get. With me literally being one of their initial customers, the shop owner implored upon me to tell my friends about it. She constantly polled me about the neighborhood, it’s demographics, it’s psychographics, whether or not the weekly garbage pick-up would take away the old bookshelf in the corner. My wife provided the instrument they used to wash their exterior store windows for the first time. We were invested customers.
Everything changed in January when the dreaded “credit card minimum” sign went up. To add insult to injury it included a note about how the high cost of fees were unmanageable for a small business. More on that particular plea to your integrity, which I believe is actually an insult, later. What I surmised happened was this. They did the year end accounting and figured out, like the majority of small businesses, that they did not make nearly as much as they forecasted they would in the first six months of operations. Especially considering they were likely already underwater with the extensive renovation and capital expenditures to get the place up and running. So looking for something to blame they saw the bill for the credit card machine in the corner and said something to the effect of “holy Hannah, we’re getting killed on credit card fees!” This is mistake number one, in my mind. Rather than address their own misgivings at budgeting, marketing, product quality or the other drivers that bring people into a coffee shop, they pointed they pointed the blame outwards.
And in this instance likely didn’t factor in that the fees are percentage based. In the sense that if they earned $100,000 and paid $3,000 in credit card fees (using the 3% model which most services are based on) this is not something that should be looked at like anything else in the store. A business owner’s knee jerk reaction is that the credit card company took $3,000 out of their pocket. Simply not true. The credit card company helped them collect $100,000 and in turn took their pre-arranged fee. Just like the guy who sells them creamer, stir sticks and the rest of their accoutrement. But for some reason business owners look at these fees differently. In the same accounting session, similar conversations were probably had about the stir sticks, but being deemed essential to the business they were not eliminated and replaced with a customer-condescending note about how the business just can’t afford it. It’s just a cost of doing business. There’s even an accounting term for it, COGS. Sure you may look into a different supplier, switching from wood to plastic or other costs saving measures, but you’re not going to get rid of stir sticks. People, for whatever reason, love to stir their coffee before they drink it.
You know what else people love to do? Pay for things with plastic. It’s a trend that has been steadily growing in the past decade. According to a 2012 article in the Huffington Post “27 percent of all point-of-sale purchases were made with cash and that number is expected to drop to 23 percent by 2017.” That is staggering. Less than a quarter of transactions are made by cash in the USA. A far cry from the early 2000’s when numerous New York City bars, restaurants and all cabs were “cash only.” A big reason for that? Millennials prefer cashless payment. It’s how they grew up. Before you dismiss them as young, living with their parents and glued to their cell phones, remember that millennials, as of 2016, can be as old as 35. They have high powered jobs, houses, cars, commutes, kids. They, for the sake of this article are the growing consumer base for $3 (and higher) cups of coffee. And they don’t carry cash.
So back to our friend, the local coffee shop owner. Now knowing that less than 25% of purchases are made with cash and an exploding number of potential clients don’t carry cash, how many people are being alienated?
Admittedly I only have anecdotal evidence on this, but the majority of people I see buying coffee every day only buy one cup of coffee and nothing else. Generally not more than $5. Another small percentage of folks throw in a muffin or a donut, sure. But unless you’ve really gone to town on the add-ons of flavors and extra shots it’s generally pretty tough to hit $10. So now you have a choice to make as a consumer. Spend more money than you want to (buy those over-priced $3 mints on the counter?) in order to accomplish something that naturally happens in more than 75% of transactions and pay with your credit card, or dig out some cash from your pocket. If you have any. “About one in four millennials carries less than $5 cash on them seven days a week.”
Suppose you do have some cash on you, so it’s no big deal. You pay, the owner saves a 3% fee, everyone is happy. Right? This is where it gets a little dicey. And this is where I’m drawing from my own experience because it was exactly this transaction that brought me to author this article. I recently went to my local shop, as I had at least once a week (though admittedly I was away over the holidays and therefore not a regular), and bought a large cup of black coffee for $3. Only this time I was met with a sign telling me that a new $5 minimum on credit cards had been imposed, along with the aforementioned explanation that the associated fees were insurmountable for a business looking to survive. So I did what I suspect a lot of people would do. I fumbled around looking for some cash in my pockets. Oddly in this instance I had three dollars. Literally, three dollars. I’m not even sure how I had come to accumulate that precise sum, but there it was. I silently handed it over to the owner, said my good-byes and that’s that. Right? Only it’s not. I haven’t been back since.
I typically don’t carry cash and nor do I want to simply to appease my local coffee shop. And if I did, it would likely be in the form of ATM dispensed $20 bills which, I’m guessing, would be almost as infuriating to make change of as it is to be charged a fee. We’ve all had that conversation or dirty look at some point in our lives. It sticks.
Couple that with the fact that my weekday mornings are pretty rushed and that I know that I should make coffee at home. I, like everyone else I know, have a Keurig sitting on my kitchen counter. Failing that 30 seconds of arduous waiting, I have free, gourmet coffee available at work. All day. Also, I pass no less than seven coffee shops on my morning walk to the train. Several of them, Starbucks included, accept credit cards on all transactions. Starbuck’s even offer their own “credit” card which you can load up from your phone or computer. Upon asking the tattooed barista of another local coffee shop / book store if they accepted credit cards, he responded with “if we didn’t we wouldn’t have any customers.” Not shockingly (to me at least), there was no “minimum purchase” required.
So back to the initial point about customer acquisition, which in this case worked out well given my early adopter status and geographic location to the business. Retention should be a no brainer too, given both of those previously mentioned factors combined with my lifelong caffeine addiction and relative ease with which I traditionally part with $3 for something I could easily make at home.
With one simple attempt at perceived cost savings, my local coffee shop ends up with a notable net loss.
Under this new policy, at first glance, the coffee shop will earn an additional $4.16 in net revenue from me based on one coffee per week x 52 weeks. Not a ton, sure but that’s an additional $416 over the course of every 100 customers. Here’s the rub. I’m not going to shop there any more, or at least with anywhere near the frequency I used to. So that $4.16 net gain actually turns into a $156 annual gross loss (or if 100 people are like me, a $15,600 annual gross loss) and that’s not nothing. Say the gross operating margins are 85% (which is considered standard), that means a realized gross loss of $132.60 from me (subtracting the cost of the coffee and cup, things you require in order to actually sell me). Now this admittedly doesn’t factor in operating costs which include a human to open the store and make me the coffee, etc. But the math suggests that in an attempt to generate an additional $4.16 net profit, the shop has actually reduced it’s sales (-costs) by $132.60.
In a world where we consumers increasingly want to support the little guy, we must also encourage them to keep up with the trends and consumer desires of the times. As a business owner myself I treat every transaction with gratitude and go out of my way to make it as easy and convenient for my customers to pay me. After all I’m there trying to provide a service for them, not the other way around.
