AmEx Used Merchants Money Against Them, Discover COO Says

American Express Co. fueled a “vicious circle” to secure its standing with rules barring merchants from promoting credit cards with lower processing fees stunting Discover Financial Services (DFS)’ growth, Discover’s Chief Operating Officer Roger Hochschild said.

Hochschild testified today in Brooklyn, New York, federal court in the U.S. Justice Department’s antitrust lawsuit against AmEx. AmEx’s requirement that merchants live by its rules as long as they want to accept its cards is illegal and stifles competition, the government claims in a suit joined by 17 states.

Established companies like AmEx can boost merchants’ fees without fear of losing customers because they prohibit the retailers from steering customers toward cards with lower costs, Hochschild said. Those companies can then use the increased revenue to build customer loyalty and further cement their market power, “in a sense, taking the merchants’ money and using it against them,” he said.

Discover’s share of U.S. credit card spending has remained at about 5 percent for at least the past decade, Hochschild said.

There are 9.2 million businesses that accept Discover cards, which is about 3 million more than accept AmEx, said Evan Chesler, a lawyer for American Express.

Wooing Merchants

In the late 1990s, Discover began trying to woo merchants by positioning itself as a low-cost alternative to Visa Inc. (V), MasterCard Inc. (MA) and Amex, Hochschild said. Even though businesses expressed “tremendous frustration” with rising fees, merchants couldn’t encourage customers to switch to Discover without giving up the more popular, higher-priced competitor cards, he said.

“Eliminating a payment vehicle that may represent 25 percent of their sales was, I think quite rightly, viewed as risky,” Hochschild said. “That shows the extreme measures they’d have to take given the limitations they faced from Visa, MasterCard and American Express.”

In a presentation to one of its merchants, Discover estimated that its lower fees could save the business $366 million over five years if it were able to shift a certain volume of transactions to the Discover system. Even so, the initiative gained little response from merchants and failed to significantly increase Discover’s market share.

Around 2001, Discover gave up on its low-cost strategy and began more closely matching the fees charged by Visa and MasterCard, Hochschild said.

Low-Cost Network

“If steering were permitted, I believe we would have continued with our first strategy, which is to be the low-cost network,” he said.

Discover currently has its own version of a non-discrimination rule in place for merchants, Chesler pointed out during cross-examination. The company hasn’t used the rule to crack-down on merchants who steer customers to other cards, Hochschild responded. The company is reviewing its policy and will make a final decision based on the outcome of the AmEx trial, he said.

The trial, which started July 7, is the latest stage of litigation by the Justice Department against credit card companies. The U.S. sued Visa, MasterCard and AmEx over the rules in 2010.

Visa and MasterCard agreed to change their rules and settled. The AmEx trial also follows years of private litigation by merchants against card companies over fees, which are largely hidden from consumers and, the government says, amount to about $50 billion a year.

The case is U.S. v. American Express Co. (AXP), 1:10-cv-04496, U.S. District Court, Eastern District of New York (Brooklyn).

To contact Bloomberg News staff for this story: Patrick G. Lee in New York at plee315@bloomberg.net

To contact the editors responsible for this story: Michael Hytha at mhytha@bloomberg.net Joe Schneider

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