Amex Vows To Fight DOJ Antitrust Suit, Questions Economic Benefits Of Steering

American Express Company chairman and CEO Kenneth Chenault vowed to fight the U.S. Department of Justice antitrust lawsuit over merchant card fees and policies. As he downplayed the impact the lawsuit would have on the payments industry in light of other regulatory changes, he questioned whether "merchants would disrupt the transaction at the point of sale and risk a potential loss of customer good will for the sake of a relatively small [fee] differential."

In an antitrust suit filed this month, DOJ alleged that Amex, MasterCard and Visa have "rules that prohibit merchants from encouraging consumers to use lower-cost payment methods when making purchases." DOJ immediately announced proposed settlements with both Visa and MasterCard that, if approved by the court, would allow merchants to "offer consumers an immediate discount or rebate or a free or discounted product or service for using a particular credit card network, low-cost card within that network or other form of payment." The proposed settlement also would permit merchants to express a preference for or promote one card network or a low-cost card in a network over another and tell consumers how much acceptance of a particular card product costs. The attorneys general of seven states joined with DOJ in the antitrust suit and the proposed settlement with MasterCard and Visa.

"We're taking the DOJ lawsuit very seriously, however a number of the changes we're currently seeing are likely to have a far greater impact on industry growth, pricing, consumer behavior and merchant relationships than the DOJ suit alone," Chenault said during a briefing with analysts. "The lawsuit after all is about steering between credit products."

Using fees of competitor Visa as an example, Chenault said the difference between Visa's highest and lowest merchant fees is about 90 basis points, or 90 cents on a $100 purchase. "For context, the Amex average rate is about 25 basis points higher than Visa's and MasterCard's average for credit products, or about 25 cents on a $100 transaction," he said. "Assuming these differentials remain constant, steering between credit products does not offer a lot of marginal economics for merchants, particularly when weighted against the potential alienation of good customers and the operational difficulties of implementing these actions at the point of sale."

The core issue of the lawsuit "is about consumer choice--the right of a customer to select the card that they want to use at the point of sale," Chenault said. "I don't believe in the government or merchant making this choice. This choice should belong to the customer."

Credit card acceptance costs merchants $35 billion a year, according to DOJ, which noted that "those costs are collected from merchants in the form of a 'swipe fee' they pay every time a credit card is used. American Express has the highest merchant fees of any credit card network. Merchants pass on these billions of dollars in fees to all their consumers in the form of higher retail prices. By preventing merchants from rewarding consumers when they use less expensive credit cards to make a purchase, American Express, MasterCard and Visa have inhibited merchants' ability to reduce card acceptance costs, and therefore their retail prices to consumers." In 2009, cardholders used Amex credit and charge cards for $419.8 billion in purchases, MasterCard credit and charge cards for $476.9 billion and Visa for $764.2 billion in purchases, DOJ stated.

In merchant fee schedules, corporate and premium reward cards typically carry higher fees than basic cards and certainly more than debit cards used by consumers.

"We're the smallest network, smaller even than Discover, who is not a party to this suit," Chenault said. "The irony here is that if the DOJ's case against us were successful and merchants did engage in steering, it is far more likely for merchants to steer customers to Visa and MasterCard and away from us, thereby making the two dominant players in the industry even more dominant and harming competition. This is why we must defend and win this case, and we will."

During the briefing, Chenault summarized the potential impact of the lawsuit in context with other "regulation and legislation that has clearly been the most significant in the history of the card industry. The Card Act will have the biggest impact on issuers who have relied heavily on interest-income from basic revolving products. Durbin will have the biggest impact on debit card issuers and potentially on merchants steering to debit from other payment products. The DOJ impact is yet to be determined, but it is more likely to have a smaller dollar impact on the industry than the Card Act or Durbin."

Named after sponsor Sen. Dick Durbin (D-Ill.), the Durbin amendment to the Senate Wall Street reform legislation requires the U.S. Federal Reserve to determine if the current interchange fee structure is "reasonable and proportional" to the real cost of processing a debit card transaction, and allows small businesses to offer discounts to consumers who pay with cash, checks or debit cards. Durbin's office said the amendment would bring "reasonable regulation to the $20 billion per year debit interchange fee system." Visa and MasterCard control 80 percent of the debit market, the senator argued. In 2008, nearly $50 million in interchange fees were charged by credit and debit card networks.

The legislation has made the debit card business "much less attractive to banks. The Federal Reserve's 'reasonable and proportional debit study' has the potential for a 50 to 100 basis point reduction in debit interchange fees from current levels. This could increase the gap between debit and credit rates to approximately 150 to 200 basis points," Chenault said. "With this potential benefits, some merchants may try to steer their customers towards debit. But given this rate differential, it's possible they could fund some discount or incentive to encourage customers to switch to debit. There is still a question whether the amount will be significant enough for merchants to disrupt the sales process and risk potential loss of customer good will."

The new regulatory environment, he added, will prompt "the traditional lend-centric models most banks relied on" to be refashioned, and debit-based models to cost more for consumers and offer fewer rewards. Despite the changes, Chenault said he believes "many consumers and merchants will continue to place a premium on superior value and services." While merchants will always want a lower price, they also "want high-spending customers and value from the payment networks they choose to accept."

"The merchant wants to generate more spend and they're going to get that from those customers who carry the premium products and will spend more," Chenault said. "That's why our average spend is four times that of Visa and MasterCard."

Earnings Boost For Amex

Amex reported that third-quarter profits rose 71 percent from a year ago to more than $1.1 billion, and total revenues increased 17 percent to $7 billion. Company executives said the improved performance was due to improved credit quality and "higher cardmember spending and higher travel commissions and fees."

Cardmember spending rose 14 percent "with the largest increases coming from businesses where we've been making significant investments: charge and premium co-brand products, corporate cards and cards issued by our bank partners," according to Chenault.

Within its Global Commercial Services unit that includes commercial cards and travel, Amex reported net income of $159 million, up 56 percent from a year earlier. Total revenue for the unit grew 17 percent to $1.1 billion, owing to "increased spending by corporate cardmembers and higher travel commissions and fees."

Worldwide airline volumes increased 20 percent, driven by a 12 percent increase in airline transactions and a 7 percent rise in average airline charges. U.S. airline-related volume, which represented 9 percent of total U.S. volume during the quarter, increased 19 percent due to a 13 percent more transactions and a 6 percent increase in the average charge.

Amex for the quarter reported $487 million in travel commissions and fees, up 27 percent from a year earlier, "primarily reflecting a 21 percent increase in worldwide travel sales, as well as a higher sales revenue rate."

Billed card business within GCS was $33.2 billion, up 19 percent on 7 million cards, which were 1 percent fewer than in September 2009. Average basic cardmember spending was up 21 percent to $4,734 for the quarter.

In other developments, Amex hired Dan Schulman as group president of a new enterprise growth unit charged with expanding "alternative mobile and online payment services," business development, mergers and acquisitions, and the Revolution Money and Global Prepaid groups.

This month, the company also announced a joint effort with SAP AG to develop and introduce in the first quarter of 2011 an "integrated solution enabling SAP customers in the U.S. to process electronic payments more seamlessly" with Amex.

The company also reported increased expenditures, up 68 percent to $847 million percent for marketing and promotions, up 26 percent to $1.4 billion for cardmember rewards and services, and up 36 percent to $1.4 billion for other operating expenses. "As conditions improved, we said we would continue to invest" in the business, noted CFO Dan Henry. "Investments are not solely marketing and promotion, but include bringing on the right capabilities, having the right talent to move forward with our new business initiatives and having the right sales force to move forward with both our merchant and commercial business. The increases you're seeing in operating expenses is a reflection of that."

The business also benefitted from "consolidating the card businesses under Ed Gilligan," Chenault said. "We were able to more quickly make portfolio acquisition changes of how we're going to allocate those dollars across markets and products--that has really helped us in a major way."

Expansion into categories other than travel has been part of Amex's strategy for several years; non-T&E categories now make up "approximately 72 percent of our U.S. billed business," according to Chenault. Added CFO Dan Henry, "Over time, we've really transitioned from two-thirds T&E to clearly more than two-thirds non-T&E." He noted that Amex recently has observed a "bounce back" for both T&E and non-T&E segments."

Chenault said Amex since 2000 has talked of plans to diversify its base. "Even in our commercial card business, that is one of the priority areas and where we've invested in this year--where we've been very pleased with the progress that our non-T&E spending has increased," he said. Such development helps establish "a more balanced model, so as we go through different economic times we don't have the reliance on T&E categories that we had historically. Frankly, that gives us more balance and puts us in a more stable situation."