How the Death of Cash Could Hammer Small Businesses

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Small businesses constantly face big challenges to their survival. With higher relative overhead than their larger competitors, local retailers struggle to control costs. A demographic shift threatens many small businesses in a new way: the rising costs of handling credit card and debit card transactions as a result of the spending behavior of millennials.

A recent survey from showed how habits have changed across generations in making purchases of less than $5. According to the national phone survey of 983 adult U.S. credit card holders, more than 80 percent of baby boomers age 65 and older prefer to use cash for small purchases, with the remainder split almost evenly across debit cards and credit cards. But among millennials age 18 to 29, the popularity of cash for small purchases falls below 50 percent, with the majority using plastic and with younger shoppers preferring debit cards to credit cards by a 2-to-1 margin.

For shoppers, the convenience of credit and debit cards largely explains the trend. Carrying and spending cash requires additional trips to the bank and poses a theft risk, while cards carry at least some level of fraud and theft protection in the event of their loss or misuse. Moreover, with point-of-sale transaction technology having improved substantially, paying with plastic no longer takes markedly longer than a cash transaction. Add to that the airline miles, cash-back rewards and other benefits that many cards offer, and it's easy to understand the popularity of cards over cash.

The Price Small Businesses Pay

Unfortunately, for the merchants that accept these transactions, the rise in popularity of card use for small purchases isn't necessarily good. The main problem is that many providers of merchant services -- the companies that help small businesses handle credit card transactions through popular networks like Visa (V) and MasterCard (MA) -- charge per-transaction fees on top of percentage fees. The per-transaction fees tend to be relatively small and therefore fade in importance for large purchases. But on small transactions, those fees have a much larger impact on profitability.

For instance, eBay's (EBAY) PayPal lets businesses accept transactions from credit cards or directly from PayPal balances. According to PayPal's website, standard pricing starts at 2.9 percent plus 30 cents per transaction, with higher-volume businesses having the potential for lower percentage charges. On a $5 purchase, that 30-cent transaction fee amounts to 6 percent, and that can take a huge bite out of razor-thin profit margins at businesses like gas-station convenience stores or local specialty stores. Similarly, Intuit (INTU) charges transaction fees of 25 cents on top of various percentages based on different types of transactions.

Alternatives and Competitors

Some merchant-services providers have offered solutions to the problem with micropayments. PayPal has an alternate pricing structure that can reduce total costs somewhat, with a 5 percent plus five-cent per transaction fee representing a total cost of 30 cents on a $5 purchase, compared to the 44.5-cent charge under the standard pricing structure. Nevertheless, any per-charge fee can add dramatically to truly small purchases, and the higher percentage that PayPal charges makes it harder for small businesses to stay profitable.

On the other hand, some competing services adjust their fee schedules. Square, for instance, offers a flat-rate 2.75 percent fee without a per-transaction surcharge as long as the seller didn't manually enter the transaction. For manual transactions, though, Square charges a higher percentage as well as a 15-cent transactional fee.

As the popularity of electronic payments increases, small businesses will have to find new ways to address the problem of high card fees. Given how many people now rely almost entirely on cards, businesses can't afford to refuse card transactions -- even if they can't afford to accept them, either. In the long run, small businesses will need to find service providers willing to recognize the crippling impact of small card purchases on their bottom lines.

You can follow Motley Fool contributor Dan Caplinger on Twitter @DanCaplinger or on Google+. He has no position in any stocks mentioned. The Motley Fool recommends and owns shares of eBay, Intuit, MasterCard and Visa. To read about our favorite high-yielding dividend stocks for any investor, check out our free report.
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