Merchant Fees in a Post-Settlement World

In what has been dubbed the largest-ever class-action settlement in US antitrust history, credit card processing networks Visa and Mastercard – along with a handful of banks that once owned the networks – recently agreed to a $6.2 billion settlement in the ongoing case between the networks and more than 12 million individual merchants who accept Visa or Mastercard payment cards.

The suit alleges that the banks and networks colluded to deliberately inflate interchange fees (the cost to process a credit card transaction) that merchants are charged to accept cards from the Visa or Mastercard credit card networks.

In addition to seeking monetary recompense for the inflated fees, the plaintiffs – primarily the large retailers – are also seeking structural changes that would allow more flexibility in how merchants charge consumers for interchange costs.

Given the sheer size of Visa and Mastercard, retailers have little choice but to hope for change through the courts. While only representing two of the four major processing networks in the US, Visa and Mastercard process the bulk of both debit and credit transactions – the top five US acquirers handled more than $3 trillion in Visa and Mastercard purchases in 2017 alone – making it nearly impossible for most merchants to refuse to accept their cards.

Settled, but not solved

This is the second settlement for the 13-year-old lawsuit, the first of which was rejected by a federal appeals court three years after the agreement was approved in the US District Court, primarily due to language that would restrict merchants’ ability to bring future lawsuits against the networks. Several major merchants also opted-out of the settlement early over concerns that the original settlement did little to address the root problem of uncompetitive pricing practices.

And it looks like, for the largest retailers, this new settlement is still not the result they had hoped for. Several major merchants, including Walmart and Target, have already chosen to opt-out of the new settlement. On the bright side, the second settlement allows larger merchants to opt-out without negating the deal for smaller merchants.

According to Patrick Coughlin, one of the lawyers involved with the case, The top 1% of the merchants make up 25% of the nation’s commerce, he said. They were never going to be part of the deal. But this is important for the other 99% who handle the other 75% of purchases.

While the larger merchants opting out will reduce the overall amount of the settlement, Coughlin said that the smaller merchants should still see a better amount than they would have in the original settlement.

A broader pricing problem

Of course, although there may be a monetary settlement on the table, the battle is far from over. Many merchants are still pushing for regulatory changes to the way Visa and Mastercard operate, emphasizing that the networks’ behavior is indicative of a broader problem.

While average per-transaction interchange fees haven’t seen a significant rise over the last decade – the last big increase from Visa and Mastercard was around 2011 and centered around their premium cards – the sheer volume of credit card transactions has meant that the amount of interchange fees merchants have to pay has risen considerably.

In fact, fees rose by 8.5% each year between 2012 and 2015 alone, and interchange fees now encompass more than 40% of the fee revenue for most major banks. Given that interchange fees are capped below 1% in the EU and many other major countries outside the US, it’s likely safe to say that a big chunk of those profits is from US-based merchants.

The monetary settlement doesn’t solve the problem. Swipe fees cost retailers and their customers tens of billions of dollars a year and have been skyrocketing for nearly two decades, said National Retail Federation Senior Vice President & General Counsel, Stephanie Martz. Ending the practices that lead to these anti-competitive fees is the only way to give merchants and consumers full relief once and for all.

Though the future may still be unclear as to whether merchants will succeed in obtaining fundamental changes in the way interchange fees are set, precedence may not be on their side. This new settlement comes just a few months after American Express, another of the ‘big four’ US credit card processing networks, won a landmark victory in the Supreme Court in its own antitrust suit.

The suit against American Express, filed by several US states, alleged that the company broke antitrust laws with anti-steering rules that prohibit merchants from encouraging customers to use credit cards from other networks that charge lower interchange fees.

The Supreme Court disagreed, with the final verdict stating, The plaintiffs have not carried their burden to prove anti-competitive effects in the relevant market. The plaintiffs stake their entire case on proving that Amex’s agreements increase merchant fees. We find this argument unpersuasive.

All in all, the Supreme Court found that American Express’ fees weren’t unreasonably high compared to other credit card networks and that the anti-steering language did not restrict market competition.

In a statement, Martz referred to the Amex decision as misguided, calling it a missed opportunity for controlling rising credit card fees.

By denying merchants the right to simply ask for another card or offer an incentive for using a preferred card, the Supreme Court has undermined the principle of free markets where one company should not be allowed to dictate the practices of an entire industry to protect its business model. This misguided decision represents a missed opportunity to take a stand in favor of free markets and bring soaring credit card fees under control.

Budding FinTech solutions to payments

In the end, merchants simply may not have the power to enact real change on the credit card processing space. Not only do the networks hold significant sway but moving consumers away from credit cards – a payment method growing exponentially each year – would likely be impossible in the current marketplace.

According to the 2017 TSYS US Consumer Payment Study, Americans make nearly half of all online purchases with a credit card, with less than a third of transactions occurring with a debit card. The study also found that credit card rewards are a huge incentive for most consumers, especially those in the highest income brackets.

Given that those rewards are, in large part, funded through interchange fees, issuers and networks are unlikely to feel much pressure to reduce fees outside of the courtroom. But there may be another source of pressure that could convince networks to play ball: FinTech.

In particular, the growing popularity of alternative digital payment methods has spurred an abundance of startups eager to make waves in the payments space.

Of course, a number of companies – like PayPal and Square – are working with the networks, rather than around them. The advantage that these FinTech companies provide for merchants is essentially a larger voice, rather than offering any major structural changes to the industry.

These large companies can negotiate directly with the processing networks for lower interchange rates thanks to the pull offered by representing thousands of individual merchants who would otherwise be unable to negotiate in any significant way.

At the same time, a number of spunky startups are trying to change how we pay entirely, looking to introduce new payment platforms, independent mobile wallets, and digital currencies that can be used – often in conjunction with one another – to make purchases and transfer funds without ever involving a legacy processing network.

In many ways, the rise of blockchain technology is at the heart of these changes. For years, blockchain has been hailed for its potential to revolutionize payments by decentralizing data and security. Now, blockchain is at the heart of dozens of new platforms hoping to take advantage of the technology’s potential for fast, secure transfers, and high levels of compatibility.

Indeed, that compatibility may be the key for many big changes to the structure of payments. One of the biggest aspects of the current payments problem that the FinTech industry hopes to solve with blockchain technology is the basic issue of interfacing countless legacy banking systems with one another, a task that networks like Visa and Mastercard have been handling for decades.

For example, some startups, like blockchain-based Circle, are hoping to skip the pricey middlemen processing networks by building a system that can connect two digital wallets directly, which eliminates the need to go through third-party infrastructure. The company’s CENTRE platform is built on Ethereum, an open-source computing platform that allows compatibility with other DLT systems, making for seamless transactions. According to Circle, CENTRE provides a smart contract container that enables wallet-to-wallet transactions within and across currencies, including native digital assets as well as digital fiat assets.

Some companies are attacking the issue from the other end of the spectrum by developing digital currencies that exist outside the legacy systems, like the now-mainstream Bitcoin. Because cryptocurrencies operate on compatible blockchain platforms, currency can be moved from user to user with simple updates to the chain, rather than having to navigate complicated infrastructure differences between banks and processors.

More and more merchants are accepting Bitcoin and similar currencies as a payment method, and dozens of companies have created easy-to-use Bitcoin wallets that help users spend the digital currency nearly as easily as cash or credit. The early cryptocurrency exchange site, Coinbase, for instance, offers a Bitcoin and Ethereum wallet that enables users to make in-store purchases anywhere that allows its currencies.

Cryptocurrency trading has also gained significant popularity, proving even the stock market isn’t immune to disruption from advances in FinTech.

While the future of payments certainly looks fraught with change, however, it’s important to remember that finance is a slow-moving beast. Few people, from customers to bank CEOs, loathe taking too many risks when it comes to money – and that includes jumping onto the bandwagon of a new payments structure.

Not only will it take time to prove the viability of any new system, but integrating and implement new payment systems takes time and money. Most major banks have spent decades building and adapting their technology, resulting in cobbled-together systems that need more than a basic software upgrade to become compatible with newer technology.