Supreme Court Decision Keeps Consumers in the Dark
A bedrock principle of classic micro-economic theory is that rational consumers will make better decisions when they have access to all the information that affects a transaction in a given market. But in a head-snapping decision in favor of American Express, a 5-4 majority on the Supreme Court ruled that consumers would be better off if they were not exposed to the full costs of credit (and debit) card transactions.
Ohio vs. American Express
In 2010 the Federal Government and more than a dozen states sued American Express, Visa and MasterCard over the “anti-steering” provisions they had inserted in their contracts with merchants who accept their cards as payment. These anti-steering provisions prevent merchants from encouraging their clients to use the payment method with the lowest “swipe fee” – the amount taken off the top every time a purchase is made with a credit or debit card. Visa and MasterCard agreed to change their business practices and to settle the case; American Express, which charges the highest swipe fees, chose to go to court.
American Express argued that its higher swipe fees were justified as they help to finance its generous rewards program, a significant benefit to card members. AmEx also argued that, on average, its card members were wealthier and spent more when shopping or dining out, thereby providing a benefit to the merchants who accepted their card. Finally, they argued that competition in the credit card market was robust and that their swipe fees had caused no obvious damage AmEx’s competitors. The plaintiffs countered by arguing that American Express’ anti-steering provisions stifled competition between credit card networks leading both to higher fees for merchants and, ultimately, higher prices for consumers.
Better for Consumers?
The issue underlying the dispute is the difference in “swipe fees” charged by the major credit card companies and banks. It is estimated that merchants (and consumers through higher prices) pay more than $50 billion annually in swipe-fees. Swipe fees vary by brand of credit and debit card and by the size and negotiating power of the merchant, but can be as high as 5% of the total. American Express charges higher swipe fees than Visa, MasterCard or Discover Card and small, local businesses, with limited negotiating leverage, are charged the highest rates.
Merchants, especially small merchants, clearly would prefer that consumers pay with the method that charges the lowest swipe fee. If they were fully aware of the magnitude and the differences in those swipe fees, consumers probably would choose the lowest cost option as well because, in the end, it all comes back to them in terms of higher prices at check-out.
But the Supreme Court sided with American Express by allowing it to continue to bar merchants from “steering” consumers toward credit (and debit) cards that charge lower swipe fees. I have no sympathies for either Visa or MasterCard, as will be explained below, but this decision should give pause to everyone who is really committed to free-market competition.
Writing for the majority, Justice Clarence Thomas argued that American Express was justified in charging higher swipe fees because:
- Its card holders are wealthier and spend more when they shop,
- AmEx offers its clients better rewards and
- Its business model has spurred “robust interbrand competition and increased the quality and quantity of credit-card transactions.”
He also commented on the presumed unique features of “two-sided platforms” – a line of argument that could, in the future, be used to protect the established positions of major internet-based companies such as Google, Facebook and Amazon– a chilling thought of any startup looking to disrupt a mature market.
In response, the National Retail Federation described the court’s decision as “a blow to competition and transparency in the credit card market. The American Express rules in question have amounted to a gag order on retailers’ ability to educate their consumers on how high swipe fees drive up the price of merchandise.” Writing for the minority, Justice Stephen G. Breyer, who taught antitrust law at Harvard, suggested that AmEx had at least two remedies for its dispute with merchants apart from preventing them from educating their consumers on swipe fees:
- It could use its incentive program to create to increase consumer demand by building brand loyalty; or
- It could lower its swipe fees to a more competitive level.
“What it may not do,” he suggested, “is demand contractual protection from price competition.”
History Repeating Itself
Let me stop here and inject a personal and historical observation on the major players in the credit card market. I was a member of the marketing team that relaunched Discover Card with an emphasis on “Cashback Bonus” – a cardholder incentive program that was explicitly designed to spur Discover Card usage. Discover Card took this step out of necessity because Visa and MasterCard would not process Discover Card charges using their existing payment clearing network. In order to operate, Discover Card had to build a new credit card clearing system from scratch. To amortize the enormous cost of that investment, Discover Card needed to build transactions volume as quickly as possible.
The answer was to incentivize cardholders by offering 1% back on every purchase made with Discover Card. (… and to heavily advertise that feature!) Yes: the resulting Cashback Bonus program helped to distinguish Discover Card in a mature market. It also precipitated the explosion of the now pervasive (and confusing?) assortment of credit card incentive programs. But the underlying motivation was necessity: the established players tried to kill us at the starting line by denying access to their payment clearing system and we needed to find a way around their blockade.
Discover Card also offered a lower swipe fee to merchants, something that Visa and MasterCard tried to counter by discouraging merchants from accepting the card. To counter that program, and to dramatically increase merchant acceptance in one move, Discover Card quietly acquired a failed bank that was an existing member of the Visa/MC association. As we were preparing to launch our Discover/Visa card (with an enhanced cash back program), Visa learned of the plan and sued to stop the rollout. The case lingered in the Federal courts for years – and Visa eventually lost – but the damage was done: consumers never had the option of comparing the features of a typical Visa Card with those offered by our Discover/Visa card with enhanced Cashback Bonus.
In both situations, Visa behaved like classic oligopolist: the network used non-market mechanisms to stifle competition and to protect their ability to extract excessive profits from a market that lacked genuine competition. Economic theory – especially market-centered conservative economic theory – argues that markets of this type are inefficient and ripe for regulation. Apparently the majority on this Supreme Court disagrees: they voted to protect the position of an established player by limiting the dissemination of essential market information.
Providing Transparency and Alternatives
AeroPay disagrees with the Supreme Court majority in this case. With tortured reasoning linked to the presumed unique features of “two-sided platforms”, this majority voted for restraint of trade by allowing American Express to protect itself from price competition through contractual arrangements accompanied by a gag order. What the majority apparently failed to consider is the wider implications of this decision: by providing relief for AmEx in this case they may have further stifled price competition across the credit and debit card payment clearing market – and on into other internet-based businesses, as well. This is where AeroPay comes into the picture: the payment clearing system we have developed will substantially undercut the swipe fees currently charged by all the existing players. We want both merchants and consumers to know that we offer the best deal in retail payment processing.
Hiding the true cost of credit card usage from consumers does nothing to enhance completion and innovation. The surprising remedy, as suggested by the United States Court of appeals, is for merchants “to not accept” AmEx. But what about Visa and MasterCard: should small merchants opt out of the credit and debit card system altogether? If so, that’s where AeroPay steps in: we offer a payment processing system that work like cash, that clears overnight and that costs the merchant less than half the current swipe fees.
For the local merchant who wants to keep the convenience of credit and debit payments without the current cost structure, we have the answer: AeroPay.