As they reopen, small business owners across the country are looking to recoup increased costs they've incurred as a result of the Covid-19 crisis. These extra expenses might be related to increased meat prices for a restaurant, additional personal protective equipment (PPE) for a dentist's office, or lost revenue at a hair salon staggering appointments to allow for social distancing and extra cleaning between customers.

To offset these costs many have resorted to levying a "Covid-19 surcharge" or "Covid-19 fee" on the final tab. And it has stirred up a fair bit of controversy.

A Steakhouse Surcharge Snafu

For example, a recent Twitter post of a bill from Kiko Japanese Steakhouse and Sushi Lounge in West Plains, Mo., showed a "Covid-19 Surcharge" of $2.19 on a $50 check. It quickly went viral, garnering a mix of backlash and support:

  • @zack488: "I'm pretty sure hiding charges like that would fall under illegal business practice. You can raise your prices to account for higher costs of opening, you can't make it a hidden fee."
  • @Br212Br: "They have extra costs they need to cover. Eat at home if it's a problem. Food costs more. Extra gloves, chemicals, masks. Someone pays for that and it's the consumer."
  • @BernirisAlana: THANK YOU! All of these people complaining would be just the ones to skip the server's tip to compensate for the $2.19, so yes please just stay home!
  • @cravekate: "That's ridiculous -- restaurants are receiving extra money from the government to help...why should customers keep paying more? I will not buy again in a place with this charge... [it] is the cost of doing business and it does NOT fall on the customer."

Eventually, the criticism found its way to the actual restaurant, which created a situation that was "ugly to our employees," as owner Billy Yuzar told TODAY. As a result, Yuzar discontinued the surcharge and simply raised prices across the board on the menu.

Are COVID-19 Surcharges Legal?

Although they haven't been formally challenged in or ruled on by courts as yet, COVID-19 surcharges do seem to be legal, law experts agree. However, many municipal authorities have announced that such surcharges must be announced in advance through social media or clearly stated on signage on the business premises. The Illinois State Attorney General's office, for example, has stated that "Generally, if a surcharge is added due to increased costs, the business is clear and accurate about the surcharge -- i.e., not labeling it as a tax and ensuring it accurately reflects any increased costs -- and clearly discloses the surcharge before the transaction, then it would be okay." (So, you were right about the "hidden fee" part, @zack488.)

Whether COVID-19 surcharges are legal is one question; whether they are fair -- or rather, seem fair - is another.

How to Pass on Costs

While the desire of business owners to offset their additional costs or lost revenues may seem understandable, how they go about doing so can vary. And it can be a difficult decision. On one hand, a conscientious business owner may think they're doing the right thing by transparently itemizing a Covid-19 surcharge on a customer bill -- a practice analysts call "partitioned pricing" (PP). Other examples of PP include airline fuel surcharges, shipping and handling charges, hotel resort fees, and even the buyer's premium paid by a winning auction bidders.

The other choice is to adopt the approach that Yuzar eventually defaulted to: not singling out the surcharge, but "baking in" the extra costs by raising prices of all items, what analysts call "all-inclusive pricing" (AIP).

Partitioned vs. All-Inclusive Pricing

Economic and business academics have studied the question of partitioned pricing (PP) vs. all-inclusive pricing extensively.

In one 2018 study, published by a consortium of researchers from Iskander Business Partner GmbH, Penn State University, and the University of Groningen in the Netherlands, surcharge pricing was found to be detrimental to a company if the cause of the surcharge was perceived to be the company's fault, whereas surcharges levied in response to external forces (such as a natural disaster, catastrophe, or yes, a pandemic) were found to be beneficial to the company.

Indeed, the question of whether a business is acting ethically in levying a surcharge seems to be top-of-mind among consumers who are critical of the practice. A research review on partitioned pricing vs. all-inclusive pricing, conducted by the Columbia and New York University Schools of Business, cited several cases around the world in which governments and consumers brought criminal and civil charges against firms for their PP practices.

However, the review also cited studies in which PP practices worked to the advantage of a business. For example, if consumers perceived their total costs were less with PP than with AIP, consumers' willingness to pay increased, as did demand for affected products. In the e-commerce world, researchers discovered consumers would order more goods -- and order more frequently -- if shipping costs were separated, but listed as "free." This tactic is reminiscent of the Amazon Prime model in which Amazon customers pay an annual fee in exchange for getting "free" shipping on a wide range of products. In the context of a small business, perhaps this tactic could translate to offering special status or "memberships" of some type in exchange for an annual fee.

Before going the surcharge route, however, companies should consider their reputation in the marketplace. A study published by Amar Cheema, professor of marketing at Washington University in St. Louis, found that consumers pay greater attention and apply more scrutiny to surcharges levied by low-reputation companies versus buying from companies with better reputations. In one part of the study, Cheema measured the amount of time consumers spent deciding to purchase a designer scarf in an online auction when the seller had a poor reputation (72.37 seconds, on average), versus a good reputation (53.75 seconds). In another part of the study, he examined Ebay sales of the Godfather, Lord of the Rings, and Star Wars DVD trilogies. For sellers with feedback scores of 0 to 110, every $1 increase in shipping charges decreased the winning bid by $1.18. Meanwhile, he found the effect of surcharges insignificant for sellers with medium to high feedback scores.

"Surcharges are often important cues that consumers attend to, especially when buying from low-reputation sellers," Cheema says. "Eliminating this cue by offering consolidated prices therefore benefits low-reputation sellers more than high-reputation sellers."

Surcharges and Psychology

Given the widespread social and economic havoc the coronavirus has unleashed, the COVID-19 surcharge is an especially emotional subject. But ultimately, the deciding factor in opting for it, as with any partitioned pricing model over an AIP, may be have to do with appearances -- and customer psychology.

"Cost increases seem to feel especially egregious when they're itemized. It's a subtle psychological distinction, but customers don't like feeling nickel-and-dimed," as Ted Rossman, Industry Analyst for CreditCards.com, recently blogged. Even if it's for a worthy cause: He cites "an outcry several years ago when some restaurants began tacking employee health insurance surcharges onto diners' tabs."

"Surcharging is more of a public relations issue than an economic one," Rossman's post concludes. "It's a bad look...whether we're talking COVID, health insurance, or credit cards, trying to raise revenue with an itemized surcharge is a turn-off for customers, and any short-term benefit to the merchant is greatly outweighed by the longer-term consequences of offending the people who pay the bills."

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