Bryan Caplan  

Spotted on the Gas Pump at the Local Texaco

30-Year-Old Gasoline Mystery S... My Model of the Oil Market: O...

1. A big sign saying that due to the increase in "drive-offs," customers using cash now have to pay in advance.

2. A big sign telling customers that the station will soon adopt a discount for cash (and the Texaco credit card).

It's easy to see why high gas prices have increased drive-offs. But can you figure out why high gas prices also lead to cash discounts? (Hint: Credit card companies charge a percentage of every transaction).

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COMMENTS (13 to date)
Eric Larson writes:

Now that cash is payed upfront its more attractive to the seller (less risk) but less attractive to the customer, who would just assume pay with a card than pay in advance. The seller is paying for the customer to save him the fee and compensating for the inconvenience of advance payment.

Dan writes:

It's been many years since I set up a merchant account, but if I remember correctly, I had to agree with the credit card company not to charge extra for customers to use a credit card.

Jaap Weel writes:

It is true, as far as I know, that banks do not want merchants to charge for credit card transactions. That is why merchants do not explicitly charge for credit card transactions. I am not sure what the contracts say about advertising the fact that you give a discount for paying cash (which is of course equivalent to charging extra for credit card payments). I assume that most of them ban it, which explains why so many merchants will give you a discount off their listed price if you pay in cash, but they won't advertise up front that they do so. Basically, the credit card company is trying to forestall the inevitable, which is that in a competitive market differences in marginal cost translate into differences in price. Merchants have a strong incentive to find loopholes in those provisions, and they do. Also, some of the cheaper gas stations don't accept credit cards at all, but only cash and debit cards. Arcos in Southern California used to do that when I lived there.

Jaap Weel writes:

I found a merchant account provider's site that says the following:

Surcharging credit card transactions is strictly prohibited by the card associations,* MasterCard® , and Visa® . A merchant may, however, offer discounts for cash transactions provided it is clearly disclosed to cardholders as a cash discount and the cash price is presented as a discount from the standard price available for all other means of payment. *MasterCard® modified its regulations to allow the IRS to assess a 2% convenience fee. No other industries were part of that modification. Visa® is not part of the IRS program and has no exceptions to surcharge prohibition.

The IRS, whose "customers" cannot walk to a competitor, has a credible threat that it will simply stop accepting credit cards. As a matter of fact, I didn't even know that they accepted credit cards. As far as I can remember, I've always paid my US federal taxes by listing my bank account number on my tax forms and authorizing a direct withdrawal.

Les writes:

How can there be drive-offs? When I buy gas the pump won't work unless I pay in advance with cash inside the gas station or with credit card approval at the pump.

So how can there be drive-offs?

Jaap Weel writes:

Les, I think that where you live, the policy that customers paying cash have to pay in advance was instituted by most, likely all, gas stations a long time ago. I don't know where you live, but for what it's worth, I have most recently lived in the Los Angeles, California area, where that policy has long been in force at all the gas stations I ever saw, but also in the Amsterdam, The Netherlands area, where gas stations will normally let you fill up first and pay cash afterward. Apparently, in the comparatively wealthy and low-crime Northern Virginia suburbs where I suspect Bryan lives, the common policy had up till recently been the same one as in Amsterdam, but it has recently shifted to the more cautious one common in Southern California.

Jeff Akston writes:

Gas stations are hurt more for credit card transactions when gas is cheaper rather than when gas is expensive.

Credit card transactions have two charges. One a flat percentage (roughly 1.5-2% depending on the network) and one flat transaction fee (25-40 cents). So as prices get expensive, the transaction fee becomes less meaningful.

If it costs $50 to fill up a customer's tank, then the 40 cents is less meaningful than if it cost $15 to fill up the tank since the 40 cents stays constant. This is the reason why many merchants have minimum purchase amounts for credit card transactions.

I have no idea why gas stations are misunderstanding this and freaking out about credit card transaction costs. They retain a greater percentage of the transaction than they do when gas is cheap.

Paula writes:

I think that I remember reading that gas station owners typically make about 10 cents per gallon profit. Therefore the higher the transaction percentage, the less profit.

R. Pointer writes:

Credit card percentage is only part of the story.

Retailers make very little on gas, but they make a killing on snacks.

This is a way to get them in the door and in front of the goodies. I imagine that to get a texaco card you need to go inside and fill out a form, and therefore are once again in front of those sodas, sweets and generalized junk.

Use the same model as the movie-ticket business; give them a below cost ticket to get them in front of the concession stand. (If you are interested, listen to this week's Econtalk).

Jason Albert writes:

The rewards credit card companies give customers for purchases (cash back, air miles, etc.) have increased over the last few years. As the price of gas has increased, the rewards customers get for purchasing gas on their credit cards have also gone up.

These two factors lower the cost of using credit to purchase gas relative to cash. Thus, the frequency of customers using credit at gas stations has gone up.

Due to interchange fees, gas station owners earn higher margins on cash purchases than on credit purchases. The recent marginal shift from cash to credit purchases has lowered profits for owners. The discount on cash purchases is an attempt to recoup some of the lost profits by encouraging purchases that result in higher margins for owners.

Dr. T writes:

This example is like the earlier story where people value their time at zero. In this case, the gas station owner forgets that processing cash costs money. With credit card pumps, the customer and the automated verification system do all the work.

With cash, the customer gives money to a cashier who must check that the bills aren't counterfeit, count them, and put them in the till. If the customer wants to fill up, he has to come back for the change (more work for the cashier). Throughout the day, cash must be counted and removed from the registers for more secure storage. The cash must be taken to the bank where it will be counted again for deposit. Banks often charge businesses for counting money, especially coins. While at the bank, the station owner may need to get fives, ones, and coins to make change. Finally, the deposit receipt must be filed and the transaction recorded in a ledger.

Three of my uncles ran or owned service stations. The only thing they hated more than cash was personal checks. If your business has a high dollar volume of credit card transactions (so you get discounted fees), then credit cards become more economical than cash. As a bonus, fewer cash transactions means less temptation to embezzlers or robbers.

Martin writes:

Here in the UK we pay the equivalent of $8 a gallon for gas (only we call it petrol). Yet there is never any need to pay up front whether using cash or credit card. I guess drive offs do happen but in places of higher risk (urban areas) the gas stations all have CCTV.

Actually if I had to pay up front I would probably buy less gas in case I couldn't fit it all in the tank ....

dWj writes:

The first time I ever saw a gas station at which one was required to pay in advance, it was in the late nineties, in the Bronx, near the interstate, at night. My buying gas there was a consequence of poor prior planning, missing a turn, and the eventual realization that one thing that might be worse than having to get off the interstate in the Bronx at night to buy gas would be being stuck on the interstate in the Bronx without gas. It caused me a certain amount of confusion, though; I couldn't see how I was to know how much cash to give the cashier if I hadn't put gas in my car yet.

I haven't had a car in the past few years, but when I've bought gas it's mostly been by credit card at the pump, so I haven't noticed cash rules. Pay in advance still strikes me as the anomaly. (I grew up in Iowa, where my parents live, and most of my recent gas fill-ups have not been in an urban environment.)

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