The Department of Justice (DOJ) and seven states recently filed a civil antitrust lawsuit against MasterCard, Visa and American Express to challenge restraints on merchants’ ability to offer consumers discounts, rewards or cost information to promote the use of competing cards. DOJ argued that the restraints reduced competition among the card issuers and raised costs to merchants and consumers. DOJ announced a proposed settlement with MasterCard and Visa, while litigation against American Express continues.
Visa, MasterCard and American Express provide network services for authorizing, settling and clearing payments. The market for these services is a classic example of a two-sided market. Each network connects two groups of customers: cardholders and merchants. Network externalities arise because cardholders value a brand of card more if more merchants accept it and merchants value a brand more if more cardholders carry it. Also, usage externalities arise because cardholders consider only their own costs and benefits, not those of merchants, when choosing which card to use.
In two-sided markets, suppliers structure their pricing to attract an appropriate balance of both types of customers. In this case, merchants must pay a “swipe fee” every time a consumer uses a brand’s card. The swipe fee is generally lower for debit cards than for credit cards and higher for credit cards with richer rewards programs. Merchants pay approximately $35 billion in swipe fees each year. Cardholders face relatively low prices for services and may even be rewarded for participating. However, consumers may be hurt by higher swipe fees if these are passed through in the form of higher retail prices.
The DOJ suit directly targets only the merchants’ side of the market. Each network required member merchants to abide by rules that restricted their ability to steer consumers towards lower-cost payment methods. Such rules prohibited offering discounts or other incentives for using a lower-cost card, promoting a competitor’s card, and sharing information about the relative costs of different cards. DOJ contends that these rules reduce interbrand competition and help to maintain high swipe fees. The proposed settlement with Visa and MasterCard weakens or eliminates these rules. For example, Visa and MasterCard now must allow merchants to offer discounts or otherwise promote the use of debit cards or even credit cards from specific issuing banks. DOJ hopes that merchants will use these measures to promote the use of lower-cost cards, thus reducing their costs and encouraging more efficient card use by consumers.