Interchange Fees: The Pressure Builds

  Merchants fed up with paying ever-rising credit card interchange fees soon may get a break. But experts say immediate relief is more likely to come from new payment-system innovations than from federal legislation.
  Outraged at interchange fees that have risen to unprecedented heights, merchants are pressuring lawmakers and consumers for change. Simultaneously, a new crop of alternative payment systems is evolving, including online payment systems, which offer more opportunities for merchants to build their own loyalty programs (see story on page 32).
  The average interchange rate is about 1.8% of the sale, but rates can go as high as 3% of the sale for transactions made with rewards cards. Merchant acquirers pay interchange to card issuers and include the expense as part of the discount rate they charge retailers for their services. Interchange fees are among the biggest sources of revenue for issuers, and without them issuers would have difficulty funding card-rewards programs, which are crucial to maintaining market share.
  Although no one can say whether lower-fee alternatives will gain ubiquity, experts predict that new online and offline payment options eventually will force some changes in the way Visa USA, MasterCard Worldwide, American Express Co. and Discover Financial Services structure interchange rates.
  "A change is definitely coming in the way credit card interchange fees are handled," says Megan Bramlette, managing associate for Westbury, N.Y.-based Auriemma Consulting. "Over time, we're going to see a thinning of the wallet, blurred lines between payment options, and today's interchange fees will be divided up differently between merchants and issuers."
  Change cannot come soon enough for merchants. Last year, credit card issuers collected $36 billion in interchange fees, up 17% from 2005 and 117% since 2001, according to the Washington D.C.-based Merchants Payments Coalition. In its public-information campaign, the group also asserts that the average cardholder paid more than $300 in "hidden" interchange fees last year based on the added expense of goods and services caused by merchants passing their costs on to their customers.
  But the card-acceptance networks that set their interchange rates are not likely to yield control easily.
  The Electronic Payments Coalition, a Washington, D.C.-based organization that represents most of the nation's credit card networks and issuers, is prepared to battle with merchants over interchange. Among other issues, the group disputes the $36 billion total interchange-fee figure that the merchants' group espouses.
  "We have no idea how [retailers] arrived at that figure, but what it comes down to is this: electronic payments are a huge benefit to retailers, providing safe transactions that are fast and save them on the cost of handling cash," says Peter Madigan, the coalition's executive director. "There is already a tremendous amount of competition in the marketplace for different payment types, and we say bring them on. We are confident that it's a fair system, and merchants are free to choose the best payment system in the marketplace."
  LAWMAKERS LISTEN
  As interchange rates have risen, merchants have lobbied hard in Washington, D.C. They got lawmakers to hold two hearings to discuss interchange before the House Judiciary Committee's antitrust task force.
  Antitrust enforcers also are watching interchange closely. In the wake of the committee's second hearing in July, MasterCard Worldwide sought assurance from the U.S. Department of Justice that it was not the target of a federal antitrust investigation. The government's antitrust chief, Thomas O. Barnett, however, confirmed in September that the agency is reviewing the industry's interchange-rate policies.
  Further adding to the pressure on the card networks is a class-action lawsuit filed in 2005 by a group of merchants challenging how Visa and MasterCard set interchange rates. Judge John H. Gleeson of the U.S. District Court of the Eastern District of New York could hear the case as soon as next year.
  Merchants essentially believe existing interchange rates are unfair. "The rapid increase in interchange fees is unjustifiable and unsustainable," says Hank Armour, president and CEO of the National Association for Convenience Stores, which represents convenience and petroleum retailers and is one of the retail organizations whose members say they have been hit hardest by rising interchange fees.
  Fuel accounts for 71% of sales at convenience stores but only one-third of the profits. That means a disproportionate amount of fuel retailers' revenue goes toward paying credit card interchange fees, says Jeff Lenard, a spokesperson for the Alexandria, Va.-based association, which has 145,000 members.
  "Margins are very thin in the fuel industry, and although interchange fees keep going up, the basic function of the credit card is the same, year after year. We don't see any justification for their taking a bigger piece of the profit every year," Lenard says.
  Card-network rules forbid merchants from surcharging consumers who use credit cards instead of cash, but many fuel merchants are promoting carefully worded discounts on fuel for customers who pay with cash. Examples include a widespread practice of knocking a few cents off the advertised per-gallon price of fuel for those who pay with cash, without calling the lower price a "cash discount."
  Along with other members of the Merchants Payments Coalition, which includes the National Grocers Association and the National Retail Federation, the National Association of Convenience Stores says it is seeking relief from interchange fees through "litigation, legislation and innovation."
  But the Electronic Payments Coalition's Madigan says he is unclear on what, exactly, the merchants' group wants.
  "Merchants say they can't negotiate credit card rates, but they are free to work with any bank that issues cards. What this seems to be is a groundswell of merchants who have formed a national organization and are telling their members, 'We can help save you some money. Join us in this fight," Madigan says.
  OBSTACLES AHEAD?
  Government intervention to cap interchange fees could face major obstacles, say industry observers. But not everyone rules it out.
  The American Bankers Association last month published the results of an independent study by the Competition Policy Association, a Washington, D.C.-based economics-consulting firm, that assessed the need for regulation of credit card fees. The study concluded that competition within the sector already is "intense" and that there is no economic justification for such proposals.
  Marc Abbey, managing partner at First Annapolis, a Linthicum, Md.-based credit card consultancy, concurs. "There is pressure building for the public sector to act, but there is no consensus on how to deal with the issue," he says. "Legislation to control interchange fees is unlikely to occur."
  The effect of government regulation of interchange fees in other countries has not been wholly successful, opponents of interchange regulation contend. In 2003, the Reserve Bank of Australia regulated interchange fees, cutting them in half. Since then, issuers in Australia have recouped 30% to 40% of lost interchange revenue by increasing the fixed cost of cards and by watering down the benefits of rewards programs, according to the ABA's study.
  MERCHANT SURCHARGING
  The Reserve Bank of Australia's annual review of the country's payment system, released in September, reportedly found that bank credit card fees declined enough to save Australian merchants an estimated $920 million last year. But at the same time, 17% of large merchants in that country are now surcharging consumers for credit card payments, up from 7% that did two years ago.
  Such unintended consequences have raised the antennae of consumer groups, such as Washington, D.C.-based Americans for Consumer Education and Competition Inc.
  "Merchants in Australia lobbied the government to regulate fees, promising they would pass their savings from interchange fees onto consumers," says Rebecca Reid, the organization's executive director. "But our research shows that Australian retailers did not lower their prices after interchange fees were cut. In fact, some are surcharging consumers now for credit, which is a worse outcome for consumers."
  But Paul Turgeon, vice president and card industry expert at Boston-based Dove Consulting, warns that lawmakers could, indeed, step in to regulate interchange fees. "There is precedent for regulation in Australia, and if you look at the card companies as global players, that cannot be ignored," he says. "Interchange fees are coming under heavy scrutiny, and issuers need to take the threat seriously."
  Although the Merchants Payments Coalition has tried to mobilize consumer support through a public-information campaign (www.unfaircreditcardfees.com), consumers are not necessarily behind the cause.
  In a survey conducted earlier this year to gauge the opinions and attitudes of approximately 400 U.S. cardholders, Auriemma Consulting Group found that 95% of respondents did not know the definition of "interchange fee." After reading a brief explanation of interchange, 80% said they "knew more" about the issue. Asked if they thought it was fair for credit card issuers to charge merchants a fee to process their transactions, 53% of survey respondents thought it was unfair versus 47% who thought it was fair.
  "Turning interchange into a consumer-rights issue is messy," says Auriemma's Bramlette. "What it comes down to is that the businesses involved want to make more money. The card associations, the issuers and the retailers are all publicly traded companies, and interchange fees are important to their revenue streams."
  Upstart payment systems that offer sharply reduced interchange rates by operating on the automated clearinghouse system or on new, independent channels have provided a glimmer of hope for fed-up merchants looking for alternatives. So far, these new cards represent only a small slice of the total payments pie, but analysts and merchants are watching them with interest.
  "There are lots of ways to add value for merchants to the credit card payment chain, and most of the biggest innovations are happening online," says Frank Sui, principal at Deloitte Consulting LLP's financial services practice in New York. "As online transactions grow and new intermediaries enter the process, like Goggle Checkout, who are offering rewards to merchants who helped complete the sale, it's going to be very hard for credit card companies to continue to justify today's interchange fees."
  New payment forms and the accountability of e-commerce are putting pricing pressure on credit card companies. But it may be awhile before merchants generally agree that the cost to accept payments is both beneficial and rewarding.
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