Since April 1996, when the Plus and Cirrus networks lifted their bans on automated teller machine surcharges, these fees have taken off like gangbusters-and have become the most controversial issue facing ATM networks and their bank members.

Though banks and some nonbank deployers are enjoying increased revenue, the public debate has intensified, opposition to surcharges has hardened, and the threat of federal and state legislation looms.

How do surcharges really affect consumers, banks, banking competition, and ATM networks? Is the evolution of surcharges simply the free market at work, or are banks just double-charging consumers? Are large banks using surcharges to hobble their smaller rivals-and should we care?

How do surcharges affect competition, and are they just the sign of a healthy free market? Are surcharges the end to the antitrust headaches of ATM networks, or do they portend even greater problems? As I have discussed in earlier articles, surcharges arose from problems quite outside the control of banks and their networks.

Because the networks are joint ventures, a restriction on ATM charges (even one mandating a zero price) can be considered a form of price fixing. The antitrust laws treat price fixing by competitors with a great deal of skepticism and often condemn it without consideration of whether it is efficient.

The Plus national ATM network led the fight against surcharges in antitrust courts for almost a decade. (The first antitrust decision, requiring the Pulse network of Texas to permit surcharges, celebrates its 10th anniversary next month.) Antitrust litigation is costly and complex, and it took a group like Plus, with the backing of its parent, Visa, to afford the battle.

A plaintiff in an antitrust complaint has the opportunity to secure treble damages, and Plus seemed like a convenient target. Plus argued that surcharge bans were pro-consumer and that networks needed to "self- regulate" to provide a uniform, consumer-friendly product of "no-hassle cash."

In 1995, Plus finally won in a lawsuit in Alabama, but its victory was short-lived. There was another "court" where surcharge-hungry institutions sought relief-their state legislatures-and there these banks had a distinct "home court" advantage.

Since 1989, local banks had used state legislation to trump the Plus surcharge ban. The first law, in Nevada, was literally considered and passed at midnight to permit a bank to surcharge at ATMs in Las Vegas casinos. From 1989 to 1995, 15 state legislatures enacted statutes to prevent networks from regulating surcharges.

Plus ultimately decided the cost of self-regulation and protecting consumers was too great and eliminated its anti-surcharge rule in April 1996.

The efforts at state regulation may be examples of the law of unintended consequences. Though legislators may have thought they were helping small banks and consumers, the long-term effect of surcharges may not be particularly salutary for either.

After two years of the surcharge regime, indications are that banks, especially large ones, are the main beneficiaries. Surcharges have led to some significant increases in ATM deployment, mostly at remote, low-volume locations. (Of course, ATM deployment was increasing at about 5% a year without surcharges.) They also have brought new nonbank ATM deployers into the market.

The impact on the banks' bottom line is substantial. Surcharges brought a windfall to what were already very profitable operations.

According to a U.S. Public Interest Research Group study, consumers paid $2.5 billion to $3 billion in surcharges last year. That was on top of almost $1 billion of interchange fees banks had already been collecting on these transactions.

Not surprisingly, relatively few banks have failed to jump on the surcharge bandwagon. The proportion of banks imposing surcharges has risen to about 70%. More than 80% of large banks surcharge, compared with 65% of small banks and 13% of credit unions.

The average surcharge increased from $1.15 in 1996 to $1.23 in 1997. On average, large banks charge a 15% higher surcharge than smaller rivals, though the larger banks should have lower costs because of economies of scale.

Consumers, by contrast, are clearly unhappy. Surveys have shown that only about 20% are willing to pay the additional charge. More than 80% say they have changed their behavior and now limit their transactions to their own bank's ATMs.

For these people, surcharges have brought "the incredible shrinking ATM network"-less convenience and longer searches, and lines. A Federal Reserve Bank of New York study found that "to avoid surcharges, many consumers are likely visiting ATMs that are less convenient than those used previously."

Even those willing to pay surcharges pay a higher price. For banks do not simply impose surcharges on ATMs that are unprofitable without the fees. Surcharges are imposed on all ATMs. Thousands of consumers who might never benefit from the new wave of more widely available machines still pay surcharges locally.

Consumers thus end up paying handsomely for some slight additional ATM deployment. Assuming that surcharging led to the deployment of an additional 40,000 ATMs, the $2.5 billion of surcharges would amount to more than $60,000 a year per "new" ATM.

ATM networks seem to be the clear losers in a world of surcharges as consumers no longer look for their regional ATM mark as the sign of no- hassle cash. The way they avoid surcharges is to use their own banks' ATMs.

Not surprisingly, the trend of ATM network growth has been reversed. Before surcharges were permitted, those networks experienced consistent ATM transaction growth, typically about 5% a year. Surcharging reversed that trend. Last year ATM transactions declined by about 9%, and some networks experienced much greater losses in transaction volume.

Those who advocate surcharges suggest this is simply a free market at work. But is the market competitive?

In a competitive market we should expect that price would be pushed down to marginal cost. Whenever there is sufficient choice, consumers would seek out those competitors that offer the best combination of price, quality, and service.

For an undifferentiated product like ATM access, one would expect that companies would compete aggressively and prices would be driven down to marginal cost. But the evidence shows that in spite of an increase in the number of ATMs and the number of machine deployers, the average surcharge price has consistently increased over time.

In Texas, the 1988 Pulse arbitration decision permitted banks to assess surcharges or provide rebates. Since then, contrary to the arbitrator's rosy belief in free competition, no bank has offered rebates. Surcharges have consistently increased. And there is little evidence of banks competing by reducing surcharge amounts or advertising lower ones.

What about competition between networks? Some small banks have formed "no-surcharge" alliances to counter the perceived threat of large banks' imposing surcharges. Participants often agree not to surcharge each other's cardholders, while reserving the right to impose fees on cardholders from other institutions.

Some ATM networks, generally smaller ones such as Magic Line, Shazam, and Tyme, have tried to ease the emergence of these networks by offering to switch their transactions.

Yet except for one alliance in California, these endeavors have failed to garner a significant number of transactions or, more importantly, to dampen big banks' ability to increase surcharges.

The painful reality is that almost every region of the country is dominated by a monopoly ATM network. Competing against these monopolies is a daunting task. When an incumbent network offers almost complete ubiquity, it is hard to sell consumers on a much smaller network.

Moreover, many of the dominant networks have "nondiscrimination" rules that prevent selective surcharging of cardholders of other banks. Ironically, networks adopted these rules in the late 1980s in response to the threat that some banks might surcharge. Now they impede the development of no-surcharge alliances that wish to selectively surcharge. Last year, Georgia enacted a law prohibiting these nondiscrimination rules.

Meanwhile, in 15 states, "pro-surcharge" legislation presents an obstacle to the formation of no-surcharge alliances.

Finally, for a network to be a viable alternative, it must have a critical mass of cardholders and ATMs to meet demands for ubiquity. In markets where one or two banks have a dominant share of ATMs, it may be difficult to make a no-surcharge alternative viable. For example, a group of small banks may have no locations in downtown areas.

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