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    A Tipping Point?

    MasterCard's announcement last month that it would post its interchange fee schedule, as well as put a limit on the fees it charges retailers who accept cards for fuel purchases, may be the tipping point that leads to some relief from rising credit card interchange fees.

    By W.B. King

    MasterCard's announcement last month that it would post its interchange fee schedule, as well as put a limit on the fees it charges retailers who accept cards for fuel purchases, may be the tipping point that leads to some relief from rising credit card interchange fees.

    The move comes after numerous anti-trust lawsuits filed against credit-card companies and banks over the fees they charge merchants. In a statement, MasterCard president Walt Macnee said, "Merchants have told us they [want] additional transparency around interchange rates."

    He added, "Because of the unique structure of the petroleum distribution business, gasoline retailers are disproportionately affected by high oil prices."

    Interchange allows transactions between disparate parties throughout the world. Without it, thousands of agreements between issuing banks and merchant banks would be required in order to achieve the same degree of universal acceptance afforded to merchants and customers alike. As a result, interchange fees reduce transaction costs. The issue under severe scrutiny is not eliminating interchange fees, but rather uncovering how percentage rates (presently, at nearly 1.56 percent per transaction) are determined. In today's market, when a consumer spends almost $3 a gallon on gasoline, for example, six cents goes to the credit-card companies.

    After a Senate hearing in July, Visa also announced that it would make its operating rules in relation to interchange rates available for review.

    It is not yet known how MasterCard's initiative will affect current lawsuits filed against the credit-card companies from retailers, including Kroger and Walgreens — and trade associations, including the National Association of Convenience Stores (NACS).

    While clearly pleased with the news, retailers weren't exactly doing cartwheels, either. NACS senior vice president for government relations Lyle Beckwith characterized MasterCard's release as "an acknowledgement" of the legitimacy of merchant concerns.

    The capped fee for gas retailers will provide benefits to merchants on gas purchases of $50 or more, according to MasterCard, which estimated that interchange fees could be reduced by 21 percent on a purchase totaling $60. However, at an average price of $2.73 a gallon (as of September 4), it would require a fill-up of almost 22 gallons to generate a $60 transaction.

    MasterCard's U.S. interchange rate schedule will be posted on its Web site by Nov. 1.

    Rising credit card interchange fees have become the bane of retail merchants across the nation. A groundswell of dissent reached a crescendo in late July when the issue was brought before a Senate Judiciary Committee hearing entitled: "Credit Card Interchange Rates: Antitrust Concerns?"

    "Two years ago, no one was talking about this huge fee. People were concerned with ATM fees, late fees and over-limit fees," said National Retail Federation (NRF) senior vice president and general counsel Mallory Duncan after the hearing, at which he testified. "From the outside, this is an unknown issue and the credit-card companies work to keep it hidden," he said. Speaking on behalf of the NRF, the world's largest retail trade association representing more than 1.4 million U.S. retail establishments, he added, "No one knows how bad retailers have been shafted."

    Senator Arlen Specter, R-Pa., and Senator Patrick Leahy, D-Vt., called the July hearing to focus on the impact the estimated $26.3 billion in credit-card interchange fees collected each year has had on American retailers and consumers, and whether the purported price-fixing practices involved in setting interchange fees violate federal antitrust laws. "There are complaints by many retailers, especially grocers, that there is collusion on the setting of the rates and that they are excessive," said Senator Specter, who heads the Judiciary Committee.

    Visa and MasterCard, which collectively account for about 80 percent of all credit-card transactions in the United States, have received the lion's share of the flack resulting from this issue. And while representatives from both companies dutifully testified during the hearing, Duncan said that retailer testimony was more compelling.

    Testifying before the Senate committee, Kathy Miller, owner of The Elmore Store, a 24-year-old independent c-store in Vermont, said rising interchange fees on top of escalating gas prices were squeezing the life out of her mom-and-pop business. "Last year (2005) in our store, we did $58,500 in plastic transactions. The credit card fees to us (out-of-pocket) were $4,400," she said. "Each time a customer swipes their card, it costs us 2.65 percent plus 20 cents per sale. For example, if we sell $10 worth of gas, we make 49 cents and pay credit card fees of 26.5 cents plus 20 cents. If a bicyclist stops for a bottle of water, it costs 23 cents to swipe the card. You do the math — it hurts!"

    In an interview after the hearing, Rhonda Bentz, vice president of public affairs for Visa, the largest payment card issuer, acknowledged that credit-card fee rates are rising, but said, "I disagree with the premise that they are being raised by two percent per year. It's a flat increase." She noted Visa's empathy for retailers and customers, but said increases parallel market growth. "What is happening in regards to rising rates is more a reflection of consumers using cards more often," she said, adding, "There is no price-fixing going on."



    C-Store Perspective

    Among those testifying was Bill Douglass, NACS' past chairman (2004-2005) and CEO of Douglass Distributing Co., operating 15 c-stores in the Dallas/Forth Worth region. "The merchants involved in this effort are united in our belief that something must be done to address the problems associated with Visa and MasterCard's practice of setting interchange rates and keeping their rules secret," he said in August. "Interchange rates aren't always clear to retailers and are hurting gas stations as fuel costs climb, and more consumers pay with plastic," he added.

    According to NACS' survey, credit card fees represent the number one issue for the convenience store industry as a whole. In 2005, for example, the industry generated $5.9 billion in pre-tax profit, $5.4 billion of which was paid in fees. "In my own company, my credit-card fees are up 33 percent this year alone," said Douglass.

    As a result of this ongoing issue, NACS, supporting its 140,000 members, was instrumental in establishing the Merchants Payments Coalition to help retailers across the nation fight back. "The Senate Judiciary Committee hearing was a great development because it demonstrated to NACS members that Congress is listening and this renews the industry's enthusiasm for the effort," said Douglass.

    Speaking on behalf of the Merchants Payment Coalition, comprised of 20 trade associations representing retailers, restaurants, supermarkets, drug stores, convenience stores, gas stations and on-line merchants, Duncan, its chairman, said that historically "we have had a line of communication with Visa and MasterCard and some actions have been helpful to retailers," he continued. "But on the big issues, we are not seeing the communication we would like to see."

    Bentz said that Visa is operating in a competitive market and as of last year, welcomed 400,000 new customers to its existing six million base. Visa's success, she said, results from its reputation for providing excellent service and security around the world, a service she likens to convenience stores. "At a convenience store, customers pay a little more for milk or a bottle of aspirin because it's pricing for convenience," she continued. "For us [Visa] not to price for convenience is an interesting irony."

    During his testimony before the Senate Judiciary Committee, Joshua Pierez, group executive, global public policy and associate general counsel for MasterCard Worldwide, explained that traditional payment options, such as cash and check, have been replaced by payment cards, electronic checks and virtual currency. "MasterCard competes against all these forms of payment … we also compete vigorously worldwide with companies like Visa, American Express and JCB, among others," he said. And while underscoring MasterCard's pledge to its customers to provide convenience and security, he said that merchants today have an unprecedented ability to accept payment whether customers pay by cash, check, credit card, offline or online debit, proprietary card, installment loan, ACH or PayPal.

    "Even with all these options, merchants prefer to accept certain types of payments or certain brands and are free to restrict payment options in their stores." While MasterCard furnished Convenience Store News with Pierez's testimony, it declined a follow-up interview. In regard to interchange fees, Pierez said:

    "Although MasterCard establishes interchange fees and collects and remits them on behalf of our financial institution customers, we do not keep any portion of them. Nonetheless, interchange fees are an important part of the system because they balance the demand of the cardholders and the merchants and have been arrived at through intense competition among payment networks and other forms of payment. This is true whether two banks agree to an interchange fee between themselves or rely on the MasterCard's default rates. Functionally, it is the equivalent of what three parties do on a balance sheet and what two parties do in reality — funding some portion of the issuing activity through revenues in connection with selling merchandise."

    And while Leonard Hodgdon, owner of Briarcliff Motor Fuels in Briarcliff Manor, New York, was happy to hear this issue has made it to Capitol Hill, he said talk alone can't help his situation. Credit-card fees became so costly for Hodgdon that in January he posted a sign on his pumps reading: "GIVE ME A BREAK. When You Put Less Than $25.00 On Your Credit Card, It Costs Me Money."

    After 45 years of operating a "mom and pop" unbranded service station, Hodgdon shook his head, pointing to the gas pumps, "I'm here by the skin of my teeth." On a great day, he'll sell approximately 600 gallons of gas. And before he pays federal and state taxes, he said it costs him "30 cents just to swipe a credit card." Curious on one "slow day," he looked into the process. From his kiosk in Briarcliff Manor, the credit card information is sent to the Tennessee-based Alliance Data Systems, which transmits the coded information to the Nevada-based Zions Bank for processing.

    On some sales, Hodgdon pays 17 cents a gallon "out-of-pocket" to break even. His once four-bay garage has been converted to two bays with the remaining space dedicated to a newly-constructed c-store that sits empty and idle. No one has expressed interest in opening an unbranded c-store at his location, which has the 67-year-old considering his options. "All these fees are choking me, and I can't fight it anymore."



    Retailers Taking It to the Courts

    While Hodgdon hasn't considered legal action, retailers across the nation have, and in growing numbers. Last year, three separate groups of merchants filed an antitrust class action lawsuit against the major credit-card companies, alleging that the companies colluded to charge inflated and fixed interchange fees for the acceptance of these credit-card payments.

    At least 50 interchange fee-related cases have been filed since last year, many of them class actions that are not expected to go to trial until late 2008.

    The ultimate goal of the lawsuits against Visa, MasterCard, Bank of America, Citibank, Bank One, Chase Manhattan Bank, JPMorgan Chase, Fleet Bank, Capital One and other major banks is to stop the alleged anticompetitive practices plus recoup damages, explained K. Craig Wildfang, partner at Robins, Kaplan, Miller & Ciresi LLP, who represents plaintiffs filing in Connecticut.

    When asked the status of the case, Wildfang responded, "We have been in the midst of early litigation. There has been lots of activity that is below the radar for the public, but the lawyers are keeping busy." However, he took a break from those proceedings to attend the Senate hearing. "The merchants were happy to air their frustrations," he recalled. "But it's too early to tell if Congress will legislate or this process will serve to keep the public informed."

    Visa's Bentz said that to her understanding, the class action suit has not been certified and a legal conclusion to this issue is, at best, several years away. "Proving their case will be a significant challenge," she continued. "I think we can all agree on the fact that the system is fairly complex and not easy to explain. We need to be at the negotiation table not asking Congress or [involving] litigation."

    According to Duncan, sometimes litigation is the only way to force change. In 1997, the NRF, Food Marketing Institute and Wal-Mart were among the plaintiffs in a class action over Visa and MasterCard "honor all cards" policies. Under these policies, a merchant who was accepting Visa credit cards, for example, was required to also accept Visa signature debit cards. In April 2003, as the trial was set to begin, the card companies settled and agreed to pay $3.05 billion over a 10-year period into a settlement fund to reimburse retailers.

    "The system needs to be fixed," said Duncan. "Think about it, if every grocery store got together and fixed the price of a box of oatmeal at $20, it would be illegal and wrong." He continued, "Right now it is lose-lose for merchants and customers."

    Pierez and MasterCard see it differently. "The suits that merchants have brought are based on a false premise that prices merchants pay for Visa and MasterCard are too high. It is widely known, however, that American Express imposes merchant discounts that, on average, are the highest in the industry," he continued. "The fact that merchants are willing to pay higher without challenge suggests that merchants recognize they should pay for participating in the payment systems. Merchant statements before Congress and other public forums show that the issues they are raising about merchant discount are really a business dispute about price and not an antitrust or policy issue."



    A Global Perspective

    U.S.-based retailers, however, are not the only merchants confounded by rising interchange fees. Since 2003, the European Union [EU] has been probing Visa and MasterCard and three weeks before the Senate hearing, the European Commission singled out MasterCard claiming that it was engaging in price-fixing thus restricting competition between banks. Before the EU makes a decision, however, MasterCard will have the opportunity to present its case, which is scheduled for later this year.

    When looking for a barometer on this issue, many analysts point to the Reserve Bank of Australia (RBA), which regulates bank card interchange rates. While RBA provided CSNews with supporting documentation, it declined to be interviewed on its regulatory practices.

    "The net effect of the RBA's arbitrary price caps has been that consumers have seen annual fees and finance charges increase while consumer benefits have decreased," Peirez said in written remarks. "There is also no evidence that merchants have lowered prices to consumers as a result of their paying lower fees for card acceptance."

    In order to recover losses imposed by the cap on interchange fees in Australia, card issuers have increased fees on the cardholder side of the market. According to one independent assessment, card issuers have recovered more than 30 percent to 40 percent of lost interchange revenues by increasing cardholder fees.

    And while back in the states the Federal Reserve Board does not regulate the credit-card industry or price competition, it regulates the banks that issue credit and debit cards, which represents a possible gray area.

    Senator Specter's retort during the hearing — "sounds to me like pretty anticompetitive practices" — presents a possibility that changes might be on the horizon.



    Transparency Required

    Prior to MasterCard's announcement to post its interchange rates on its Web site, Douglass called the credit-card companies' approach to providing information a "veil of secrecy. The first step in this process to unravel the mystery and determine a reasonable course of action is to ensure full transparency," said Douglass.

    And while opponents might disagree, Bentz says transparency is also Visa's objective. "In order for Visa to compete, we have to evolve, and adding more visibility and transparency to our system is something we are committed to," she said. "We do have some disputes with trade organizations, but by-and-large merchants benefit from the platform we provide."

    When asked if there is a "fair" ballpark interchange fee to work toward, Douglass said, "I am not going to propose a set fee, nor is NACS at this time proposing the establishment of a set fee at any level. We need to better understand how this market operates, and we need to provide Congress with as much information about the system as possible," he continued. "It is absolutely clear that the credit-card market is broken and retailers and our customers are paying for it. 'Is there a rationale for an interchange fee?' Of course there is. How that fee should be determined and assessed will only be better understood following a complete and transparent review of the card associations' operating rules and practices."

    After the hearing in July, Visa announced it would make its operating rules in relation to interchange available for review. "This is the first ray of light in a hidden process," said NRF's Duncan. "This is an extremely welcome step toward a competitive market," he added.

    However, NACS has expressed some concern that the Visa agreement requires merchants to sign a non-disclosure agreement, which may limit a retailer's ability to discuss what is in the operating rules with anyone — including legislators and trade associations.

    Nevertheless, the announcements of both MasterCard and Visa appear to indicate that the credit-card companies, at least, acknowledge the legitimacy and extent of the problem retailers face with rising interchange fees.

    By W.B. King
    • About W.B. King

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