The dogs of class war: US v American Express
The Department of Justice’s trial against American Express is the rare example of an antitrust case in which the majority of people in the courtroom – including the judge, lawyers, witnesses and even reporters – were carrying the defendant in their wallets.
Not only was the product one that individuals commonly buy for themselves, the courtroom’s demographic of professionals with higher-than-median incomes fit neatly with the company’s customer profile. In 2014, nearly 55 million American Express cards were circulating in the US, and the company estimated its cardholders had 60% higher incomes on average than non-customers.
From the beginning, when the DOJ sued the nation’s three largest credit card companies in 2010, American Express had said its rules for merchants who wanted to be part of its network – what it called “anti-discrimination” and the Antitrust Division called “anti-steering” – were necessary for its distinctive business model. After Visa’s 1990s campaign to direct merchants to say, “We Prefer Visa,” Amex tightened contractual provisions to forbid businesses that accepted its cards from saying anything that might put a customer off using an Amex card to pay for a purchase.
While the other two defendants settled the government’s charges, Amex said it had to fight for its strategy, which was different from that of the larger Visa and MasterCard. While nearly every Amex cardholder also carried at least one Visa or MasterCard, millions of Visa and MasterCard users owned no Amex card.
Chief executive Kenneth Chenault took to the opinion pages of The Washington Post on 8 October 2010 in a preview of what he would say at trial nearly four years later: “Compare the two different business models, and you’ll see the flaw in the government’s thinking. It is difficult to steer Visa or MasterCard holders to American Express because those consumers don’t carry our card. By contrast, it’s possible to pressure our customers toward one of the backup products they carry deeper in their wallet.” Allowing merchants to direct Amex cardholders to use a different card, Chenault said, would further increase Visa and MasterCard’s market shares.
In a conference call after the government filed its lawsuit, vice chairman Ed Gilligan spoke more explicitly about who benefited from Amex’s model. “Our cards are the product of choice for higher-spending cardmembers, and we partner with merchants who want to build business among those premium customers.” To fund high-end customer service and rewards for its cardholders, the company said it needed the higher fees merchants paid each time a customer bought goods or services using an Amex card. “When merchants do agree to accept American Express, they promise not to bait and switch by taking advantage of American Express’ investments in attracting desirable cardmembers, and then steering those customers to use cards from another network,” Gilligan said.
The DOJ said that by prohibiting businesses from steering Amex cardholders toward payment methods less expensive for the merchant to accept, the credit card company not only harmed merchants, but also prevented them from passing savings on to all their customers. In other words, where Amex defended its conduct based on the benefits to its cardholders, the government attacked that conduct based on the costs inflicted on everyone else.
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Officially, the voice of the consumer – whether an Amex cardholder or not – was absent from the trial in the Eastern District of New York. As is typical of antitrust cases, neither side asked an ordinary, everyday person to testify to the experience of buying goods and services. Merchants made up the majority of DOJ witnesses, as the division called 15 current and former executives, including the director of treasury service at telecommunications provider Sprint and even the finance director of a ski resort. (Witness testimony became particularly crucial when the trial judge refused to accept any designations that highlighted particular bits of depositions.) They testified in support of the government’s claims that Amex, despite having less than 30% of the market for credit card purchases in the US, held significant market power due to its cardholders’ “insistence” on using their Amex cards.
Jeffrey Rein, the former chief executive of Walgreens, said on the stand that the drugstore chain attempted to negotiate lower merchant fees from Amex, saying it would stop accepting Amex if no deal could be reached. But customers protested, and Amex itself had claimed that 41% of all the purchases charged at Walgreens “would be at risk if American Express were no longer accepted”, causing the retailer to relent on its demands – which Rein said emboldened Visa and MasterCard in turn to raise their rates to Walgreens.
What the DOJ called insistence, however, American Express said was just customer loyalty – and a very rational, transactional loyalty at that. In cross-examining the DOJ’s economic expert, Michael Katz, Amex defence counsel Evan Chesler referred him to an earlier deposition where Katz had compared customer loyalty to canine loyalty. At trial, Katz stood by the point: “Without meaning to disparage American Express, the analogy being that rewards were being analogized to dog food, you have to keep giving the cardholders the rewards in order to keep their loyalty, just the way you’d have to keep giving the dog food.”
Amex said it could keep its cardholders loyal only by maintaining the flow of chow: the complimentary airline flights, hotel stays and other rewards that customers earn by accumulating points on their purchases, plus the concierge service, rental car insurance and other benefits offered regardless of the amount of one’s purchases. It paid for those rewards, it said, with the revenue from the fees it charged merchants. In needing millions of merchants willing to accept American Express to make the product useful to cardholders, and needing millions of cardholders to make accepting the card seem necessary to merchants, the company said it operated in a two-sided market. It argued that the government had to prove that anti-steering rules were anticompetitive on the whole, not just that merchants disliked them. If the rules improved consumer welfare on net, they could not be violating antitrust law, Amex argued.
In ruling for the government in February 2015, Judge Nicholas Garaufis found that neither side “presented a reliable measure of American Express’s two-sided price that appropriately accounts for the value or cost of the rewards paid to cardholders.” He cited the DOJ’s expert, Katz, for the proposition that Amex spent less than half of its income from merchant fees on rewarding cardholders. Even if Amex did pass all the money it made from its anti-steering provisions to its cardholders, Judge Garaufis said, the higher fees charged by all credit card companies in a world where merchants could not nudge customers to a lower-cost option meant that merchants were passing those fees on in higher prices to consumers.
The trial ruling does not indicate an empirical economic basis for the view that higher merchant fees result in higher prices for consumers, nor for the inverse proposition that lower fees would result in lower prices. Rather, Judge Garaufis quoted Katz’s testimony on what “an economically rational merchant” would do, and appellate court precedent on the assumption that merchants will try to pass on costs to their customers. Meanwhile, customers, who might not even have the chance to carry an Amex card because they did not qualify, still had to pay the higher retail prices without receiving any of the benefits.
A family buying its groceries with food stamps, the judge wrote, was regressively subsidising “the cost of the premium rewards conferred by American Express on its relatively small, affluent cardholder base in the form of higher retail prices.”
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Ten months later, the parties reconvened at the US Court of Appeals for the Second Circuit for oral arguments in Amex’s appeal. While Judge Garaufis’s courtroom lies in Brooklyn, near the New York City College of Technology and a public high school that serves mostly low-income students of colour, the Second Circuit sits in Manhattan, just north of the financial district and less than a mile from American Express’s global headquarters.
The appellate judges spoke of themselves as customers of the defendant. “People who held American Express got more miles, or whatever it is we – or they – get with regard to holding American Express,” Judge Richard Wesley said. Both he and Judge Ralph Winter took an overtly sceptical tone toward the government’s case at oral arguments, and the next day the three-judge panel stayed Judge Garaufis’s injunction from taking effect. As Amex’s appeal was pending, it did not have to alter its contracts with merchants nor stop enforcing its anti-steering rules.
In September 2016, the Second Circuit overturned the trial court’s ruling and ordered Judge Garaufis to enter judgment in favour of American Express. Judge Christopher Droney and Judge Winter joined an opinion by Judge Wesley that held the government had failed to carry its burden of proof in showing a violation of Section 1 of the Sherman Act. The appellate court defined the relevant market to include consumers as well as merchants – but only those consumers who hold credit cards – and said the district court “erroneously elevated the interests of merchants above those of cardholders”. The DOJ’s allegation that merchants were passing on the higher fees to their customers in the form of higher retail prices, which Judge Garaufis had endorsed, appeared only in a footnote. There, the Second Circuit deemed erroneous the district court’s conclusion that the division offered sufficient evidence of harm from higher retail prices because “it fails to take into account offsetting benefits to cardholders in the form of rewards and other services.”
The interests of those customers who pay in cash, or with food stamps, were never discussed.
At the time of writing, the ultimate resolution of American Express remains unclear. In April 2017, a lawyer for MasterCard in the lawsuit brought by the DOJ in 2010 against the three biggest credit card companies for blocking merchants from steering customers to other forms of options, moved to withdraw from the case. Andrew Finch was leaving Paul, Weiss, Rifkind, Wharton & Garrison to become acting assistant attorney general for antitrust in the Trump administration, as the president’s nominee, Makan Delrahim, awaited Senate confirmation. After an extension on its deadline ran out in June before Delrahim could join the Antitrust Division, the DOJ chose not to seek a Supreme Court review – but 11 of the states that had been co-plaintiffs with the federal government did. Their petition for certiorari made multiple references to merchants’ passing on high fees from credit card transactions to all customers in the form of higher retail prices. It concluded: “At day’s end, it cannot be called an ‘efficiency’ justification for a Visa holder to pay higher prices at the gas station in order to subsidize an Amex holder’s frequent flyer miles.”