Controversial

DOJ vs. Amex: Will Amex Prevail?

It’s taken four years, but a civil antitrust case the Department of Justice filed against American Express in 2010 is set to go to trial on July 7. The DOJ wants Amex to allow merchants to let customers know they have options to pay that are less expensive than Amex cards. Amex fears that could kill its core business strategy, which centers on negotiating higher rates with merchants in return for bringing them higher-paying customers.

To hear it from American Express’ perspective, the outcome of the upcoming civil trial brought by the U.S. Department of Justice could hit at its very strategic core. And it’s right.

On July 7, Judge Nicholas Garaufis of the U.S. District Court for the Easter District of New York will begin hearing arguments in the case, which the Justice Department filed in October 2010. The trial is expected to last up to 10 weeks, with a ruling by early next year, sources tell PYMNTS.com.

In its case, the DOJ is challenging Amex rules that prevent merchants from imposing extra fees for Amex cards and offering consumers discounts, rewards and information about card costs to lure them into choosing a form of payment that is less expensive to accept. As a result, consumers are paying more for the purchases, the antitrust enforcer contends.

At the time the DOJ filed the lawsuit, it also announced settlements with Visa and MasterCard on similar allegations. As a result of the networks’ deals, both bankcard brands agreed to allow merchants to impose surcharges and to offer discounts, incentives and information to consumers to encourage the use of less-costly payment methods. Amex refused on the contention that its business model is much different from those of the bankcard brands.

Unlike Visa and MasterCard, which sets  interchange rates that merchants end of paying for accepting their cards (though large retailers often negotiate cheaper rates), Amex doesn’t apply interchange fees. Instead, as both the issuer and acquirer, it negotiates the discount fees it assesses individually with each merchant.

Subsequently, merchants are free to accept or decline Amex acceptance based on those negotiations. Some 3 million merchants that accept payment cards have said no to Amex acceptance.

What the DOJ must argue to win its case is that Amex has sufficient market power to force merchants into accepting its terms, including the restrictions on discounts and other brand rules that are at the heart of the litigation. That might be difficult to do, and it’s uncertain what strategy the DOJ has in store to push its case. Perhaps in certain markets, such as travel and entertainment, Amex acceptance is relatively common. But on a broader market scale, that’s not the case.

Thousands of banks issue Visa and MasterCard debit and credit cards, while just nine U.S. banks issue Amex cards. Moreover, while U.S. financial institutions issue nearly a half-billion credit and charge cards, only about 50 million Amex cards are on issue. Add debit cards into the mix, and the Visa and MasterCard card totals approach 1 billion. Amex doesn’t issue debit cards, though it has ventured into the prepaid card market with Serve.

Visa and MasterCard share a combined 80 percent of U.S. card spend approximately, compared with less than 15 percent for Amex. On top of that, while virtually every Amex cardholder has a Visa or MasterCard in his wallet or purse, the likelihood that a Visa or MasterCard cardholder also has an Amex card is much lower.

Amex traditionally has argued that it can negotiate higher merchant fees because its cards attract wealthier clientele who generally spend more. In turn, Amex uses the revenue it generates to create attractive cardholder rewards designed to encourage more spending. That’s the Amex business model and its core strategy for growth.

So if the DOJ wins its case, and it allows merchants to steer customers to lower-cost alternatives, such as debit cards or cash, it would strike at the heart of Amex’s method of doing business, and Amex would have to compete on price instead of product differentiation. That, Amex fears, could force it to act more like Discover, which has struggled to grow its share of the card market.

Discover chose to compete on price, and it hasn’t been able to gain much more than a 5 percent market share, despite its cards being accepted virtually everywhere Visa and MasterCard are. Amex fears forcing it to do the same would limit its ability to compete as effectively as it can under its current strategy.

There’s also a certain irony in the DOJ’s case. When it fought successfully a decade ago for Amex and Discover in challenging Visa and MasterCard rules prohibiting their issuers from issuing competing non-bankcard brands, it called in Amex CEO Ken Chenault to testify how Amex had pushed competition by differentiating its product.

It’s unclear what has changed that altered the DOJ’s views. It’s likely that it has no problem with Amex negotiating higher merchant fees, but it wants the transparency it negotiated with MasterCard and Visa to apply to Amex as well. To Amex, such transparency would only confuse consumers, who wouldn’t understand the behind-the-scenes negotiations that led to the merchant accepting its cards. And it could kill its strategy to compete and grow.

Despite the removal of network bans on offering price discounts and other incentives designed to help merchants steer customers to less costly payment alternatives, only a small fraction of transactions receive a cash or debit card discount, and even fewer are subject to credit card surcharges, recently released research from the Federal Reserve Bank of Boston show. It found that less than 2 percent of transactions typically receive discounts for using cash or debit cards instead of credit cards.

“Larger-value transactions were somewhat more likely to receive a discount, although the effect is small when controlling for merchant sector,” the report notes. “There is little evidence that merchants have started taking advantage of their new flexibility to influence consumers’ payment choice by either discounting or surcharging based on the payment method.”

Amex also is facing pressure outside the U.S., where MasterCard recently released merchant-survey data showing retailers would like Amex and Diners Club cards included in any credit card rate-cap legislation. Pending legislation capping rates currently would affect only Visa and MasterCard.

Amex responded by saying it doesn’t have interchange fees or collectively agreed pricing, so it has never given rise to the sorts of concerns that have led to the competition investigations in the European Union into Visa and MasterCard pricing. “In fact, American Express has not been subject to any of the multiple investigations that have been initiated by EU and European national antitrust authorities regarding the dominant networks’ pricing practices,” Amex said.

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