Assessing the Competitive Effects of Surcharging the Use of Payment Mechanisms

The Department of Justice’s theory of liability in its case attacking the non-discrimination provisions in American Express’s merchant acceptance contends that point-of-sale competition on the price of making a purchase with a credit card is an instrument creating economic efficiency. That is, the economy would run more efficiently, and consumers would be better off, if merchants were free to charge variable prices for different types of credit cards. After all, charging different prices for using different types of payment mechanisms appears to be just another form of presumptively positive price competition. The Second Circuit rejected that conclusion, recognizing that in credit card markets competition already occurs at multiple points. American Express must compete to: • convince cardholders to apply for and use its cards; and • convince merchants to accept its cards. The question, the Second Circuit correctly recognized, is whether adding a third type of competition – for cardholders to use the card when merchants pass through their card acceptance fees – would make American Express’s card network more efficient? By prohibiting merchants who accept American Express cards from discriminating against the brand, the card company imposed a unilateral vertical restraint. Such restraints are often deemed to be reasonable under the antitrust laws because they may “stimulate inter-brand competition.” This is because an upstream provider, like American Express, has little interest in reducing its downstream sales. It would only impose a vertical restraint if that restraint efficiently helped it to sell more products. Only when an upstream or downstream provider has market power enabling it to impose restraints that harm consumers by raising price or lowering quality does a vertical restraint violate the antitrust laws. The Department of Justice’s theory postulated that the non-discrimination provisions in American Express’s merchant agreements harmed consumers by effectively requiring merchants to increase their prices to cover higher credit card fees for all customers because merchants could not pass the cost of accepting American Express directly to American Express’s own customers. The Second Circuit acknowledged the potential for consumer harm would exist if American Express charged merchants supra-competitive prices and pocketed the excess as rents. But the court held that the government failed to prove that rivalry on the price consumers pay to use a credit card at the point of sale would increase efficiency in credit card markets. As the Second Circuit explained, credit card markets are two-sided. In order to prove harm to consumer welfare in a two-sided market, an antitrust plaintiff needs to show that a restraint makes the overall system less efficient. That is, do consumers overall pay more for less because of the restraint. A card network like American Express must compete for both cardholders and merchants. One therefore cannot demonstrate that price increases on one side of the market are inefficient without examining how those prices impact competition on the other side of the market. American Express argued that it used increased revenue from the merchant side to offer a better card product to its cardholders and compete more effectively with other card networks, like Visa, for cardholder loyalty. The Second Circuit did not definitively decide whether American Express’s non-discrimination provisions were pro- or anticompetitive. It simple concluded that two-sided market economics made the question more complex than the government plaintiffs acknowledged in trying the case. And based on the record evidence, the court couldn’t tell whether the non-discrimination provisions made the market more or less efficient. Since the plaintiff bears the burden of proving harm to competition, i.e. a reduction in efficiency to the overall market, the government plaintiffs had failed to prove their case. Part I reviews the economics of two-sided markets and provides reasons to conclude that non-discrimination provisions in credit card markets are efficient. Part II explains that two-sided market economics do not guarantee against supra-competitive merchant fees that would make the market less efficient. It then contrasts Visa’s and MasterCard’s fees in the 1990s and early 2000s – which were challenged by merchants in a class action – with American Express’s current fees. It concludes that the factors giving the merchants a plausible case against Visa and MasterCard do not support the government plaintiffs in their case against American Express. Part III addresses a systemic concern expressed in a recent New York Times editorial about how a decision in American Express’s favor might impact the future enforcement of antitrust claims against dominant firms. This Part concludes that those concerns are unfounded because truly dominant firms would be subject to scrutiny under Section 2 of the Sherman Act, and Section 1 vertical restraint cases already require proof of consumer harm no different from what the Second Circuit required in its decision favoring American Express.