American Express' network rules have deterred Discover from using lower interchange rates to lure more merchants, a high-ranking Discover executive testified in federal court.

Discover (DFS) President and Chief Operating Officer Roger Hochschild took the witness stand on Thursday in a high-stakes antitrust battle over the legality of American Express' (AXP) anti-steering rules.

He described what he saw as a "vicious circle" created by those rules, which prevent retailers from encouraging customers to use lower-cost cards. "In an environment where networks with market power can keep increasing their rates for merchants, they can use some of that money for profits," executive compensation or investing in loyalty programs.

"In essence [it's] taking the merchant's money, and using it against them," he said.

The Justice Department has charged that American Express' rules impede price competition in the market.

"American Express' rules are roadblocks to the path of any merchant who wants to take advantage of competitors' low prices," Justice Department attorney Craig Conrath said in opening arguments on Monday.

American Express' legal team said on Monday that attempts to block anti-steering rules would give an edge to its bigger competitors. "You can steer virtually every single one of our card members away," said Evan Chesler, a partner at Cravath, Swain & Moore, who noted that consumers have fewer than 55 million Amex cards, whereas more than 1 billion cards in the United States carry the Visa or MasterCard logo.

Riverwoods, Ill.-based Discover, the smallest of the four credit card networks, was the only network not named in the government's 2010 antitrust lawsuit, which charged that credit card rules prevent retailers from offering consumer discounts. Visa (NYSE:V)and MasterCard (MA) settled, while the department continued litigation against American Express.

In an approximately two-hour cross-examination, government attorney Mark Hamer questioned the Discover president about his company's attempts to lower its merchant fees.

When Visa and MasterCard increased their interchange rates in the late 1990s, Hochschild said, Discover "launched a major campaign to bring merchant attention" to the price hikes.

He explained that merchants had expressed frustration about not being able to control their credit card costs. A survey commissioned by Discover, he said, showed that more than 60% of its merchants said they would be willing to shift their sales volume to a lower-priced card in order to save money.

"We felt it would be profitable for merchants and profitable for Discover," Hochschild said, adding that the company would compensate for the lower swipe fee with benefits gained by having a larger market share.

He said that Discover worked with merchants to make their credit card a preferred card at the point of sale. Discover even considered offering merchants an equity stake inits network, so that they could have some control over the charges.

But anti-steering rules prevented the company's efforts from gaining traction, Hochschild said.

"In some of the discussion with the largest merchants, they made it clear that the rules of the other card networks prohibited them from preference programs," Hochschild said.

So Discover raised its rates in 2000 and 2001. "To the extent that offering a lower price was not going to give us any business benefits, it was leaving money on the table," he said.

Hochschild said that the switch in the company's pricing model was a direct result of anti-steering rules imposed bythe other credit card companies.

"If steering were permitted, I believe we would have continued with our original structure to be the low-cost network," he said.

American Express has defended its higher fees and anti-steering rules as necessary to protect the company from being crushed by Visa and MasterCard, the two largest credit card companies.

In order to survive as a smaller card network, Chesler said Monday, the company has had to distinguish itself by offering high-ticket rewards for travel and dining.

Chesler reiterated these points in his cross-examination of the Discover president on Thursday.

He questioned Hochschild about Discover's acceptance rate among merchants, asking him if he sees the metric as a "weakness."

"We have a goal of closing the acceptance gap with Visa and MasterCard," Hochschild said, noting that Discover cards are accepted "in the mid to high 80% range" of merchant locations where Visa and MasterCard are also accepted.

Chesler also pressed Hochschild on the clarity of his company's low-price model, noting that "byzantine calculations" would be required to compare the interchange rates of all four credit card networks.

"It can be challenging given the fee structure for merchants to compare our fees to Visa and MasterCard," Hochschild said.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.