Credit card competition case before U.S. Supreme Court leaves consumers and competition in the balance
The U.S. Supreme Court next week will hear oral arguments in Ohio v. American Express, an antitrust case involving competition in the credit card industry. The U.S. Department of Justice and a group of state attorneys general alleged that American Express Co. has effectively eliminated competition between credit card companies that could lower merchant fees. As a result, merchants are paying higher fees and passing those costs on to all consumers. The case exemplifies the challenges of modern antitrust law. The court of appeals, in ruling for American Express, adopted a complex doctrinal analysis that confused what should have been a straightforward antitrust analysis. In practical terms, the decision sanctions a likely transfer from generally less wealthy consumers to more wealthy companies and, in this case, from less wealthy consumers to more wealthy ones.
But first, here’s the background of the court case. Credit cards serve two sets of customers: the consumers who use the cards and the merchants who accept them. The demand between the two groups is interdependent. The more people who carry a credit card, the more likely a merchant is to accept the card, and the more merchants who accept a credit card, the more likely a consumer is to carry that card.
That relationship affects how credit card companies compete. American Express, for example, charges merchants a relatively high fee to process transactions, but it provides substantial benefits to consumers through its rewards program. The company is betting that consumers’ preference for using American Express credit cards will convince merchants to accept them, despite merchant fees that are higher than those charged by its competitors-Visa Inc., MasterCard Inc., and Discover Financial Services.
Alternatively, a credit card company might charge merchants a low fee, hoping the merchant will induce customers to use the cheaper card. Merchants might disclose the different fees, give a discount for using the card, or provide an additional benefit such as free shipping. Customers then would have to make a choice: Use the American Express card to obtain reward points or take advantage of the benefit offered for using other cards.
Right now, customers can’t make that choice because of nondiscrimination clauses in agreements signed by merchants who agree to use American Express cards. Any merchant accepting American Express must agree not to encourage the use of one card over another. Because the merchant may not steer customers to a preferred card, lowering the merchant fee will not generate additional use of that card.
That clause has a marketwide impact. More than 6 million merchants nationwide accept American Express. Roughly 90 percent of all credit card transactions involve merchants subject to these clauses. As a result, credit card companies do not compete on merchant fees. Given that impact, the only question is whether nondiscrimination clauses harm competition.
The original trial court found that such clauses eliminated competition and increased merchant fees, which were passed on to all consumers in higher prices. American Express argued that the clauses, although limiting competition, were necessary. Otherwise, merchants would accept the company’s card to attract its cardholders, then convince those customers to use a different card. Distilled to its essence, American Express is saying that, given a choice with full information and competition, consumers will stop using its cards. That is competition. And the trial court rejected the company’s justification.
The court of appeals reversed that decision, finding no antitrust violation. Because credit cards are a two-sided market-meaning there are two sets of customers whose demand is interdependent-the court of appeals decided that the government had to prove that increased fees were greater than any increased consumer benefits as a threshold issue. The issue in the case, however, is not that American Express was shifting costs between two sets of customers; the issue is whether the company can prevent its competitors (Visa, MasterCard, and Discover) from competing by incentivizing merchants to prefer one card over another.
Why does this matter? First, credit card fees are substantial. In 2013, the four major credit card companies collected more than $50 billion in merchant fees. Second, the restraints embedded in the merchant agreements that American Express is defending in court cause low-income consumers to subsidize higher-income consumers. Merchants pass the fees along by raising retail prices to all customers, which means cash customers or customers using a different credit card pay the higher costs, but only relatively more affluent American Express cardholders receive the benefits.
Finally, two-sided markets are common. Newspapers, television, and much of the internet are two-sided markets where consumers-newspaper readers, TV viewers, travelers, or search-engine users, among many others-use a service for free or at a reduced price and advertisers or the seller pays the platform. It is unclear whether a court could ever balance the costs and benefits to two separate classes of customers. This complexity would apply not just to credit cards, but also to any market in which a company could establish it was a two-sided market.
The Supreme Court hearing next week and its final decision, announced sometime before the end of June, will go a long way toward determining whether U.S. antitrust law can rise to the challenge of protecting consumers and competition or whether its force will be unduly circumscribed.