Are Other People’s Credit-Card Rewards Costing You Money?

Amazon and other retailers believe so, and they’re going to war against high-end cards.

Photo: Andrew Harrer/Bloomberg via Getty Images
Photo: Andrew Harrer/Bloomberg via Getty Images

Amazon and Target have a surprising argument to make: The proliferation of rewards-rich credit cards is bad for consumers.

They are suing for the right to pick and choose which Visa and Mastercards they accept. They want to be able to reject the richest rewards cards – cards like Chase Sapphire Reserve, which offer generous cash back, points, and other perks, and which come with the highest transaction fees charged to merchants. They say, if they obtain this right, they’ll be able to charge lower prices to shoppers.

Card network-retailer litigation over processing fees has been ongoing for years, but while many retailers are headed toward a multibillion-dollar settlement with the networks, The Wall Street Journal reported last month that Amazon, Target, Home Depot and a coalition of others intend to opt out so they can keep litigating this issue of picking and choosing cards.

Did you know a merchant pays different fees to accept different classes of the same type of credit card? If your Visa card says “Signature” under the logo, merchants are paying a few extra tenths of a percentage point of your purchase price for the privilege of accepting your card, compared to a lower-tier Visa.

That extra money goes to your bank, which uses it to pay for the rewards and benefits you receive as a Visa Signature cardholder. (Congratulations.)

As rewards cards have become more popular (over 90 percent of credit-card transactions are now on cards that pay some sort of reward), merchants are paying out those higher fees more often. And here’s the part that drives Amazon, Target, Home Depot, and that coalition of retailers crazy: If they want to accept any Visa card, Visa imposes an “accept all cards” rule, requiring them to accept low-fee and high-fee cards alike. The same goes for Mastercard.

So, these retailers are suing. They want a federal court to declare that the “accept all cards” policy is anticompetitive, because it protects banks like Citibank and Chase from having to compete to offer merchants lower interchange fees on the Visa and Mastercard cards they issue.

The card networks and issuing banks defend the “accept all cards” rule, saying it’s consumer-friendly because it protects convenience and choice: If consumers know a retailer accepts Visa, they don’t have to worry about whether it accepts the particular Visa they carry. And they note that interchange fees support rewards programs that cardholders value and are sometimes even obsessed with.

If the retailers get their way, the landscape for those rewards cards could change significantly.

Photo: David Paul Morris/Bloomberg via Getty Images

One possible change would be that high-end Visa and Mastercard rewards cards could become more like American Express: accepted at fewer retailers. But another likely effect is retailers, especially giant retailers like Amazon, would gain more leverage to negotiate down the fees they pay to accept premium cards.

If that happens, banks may have to cut back the generosity of rewards programs to adjust to lower transaction-fee income.

That’s what happened after Australia capped credit-card interchange fees in 2003: Merchants’ costs to process cards fell sharply, as did the generosity of rewards paid to credit-card holders. Annual credit card fees went up.

Philip Lowe, then an economist at the Reserve Bank of Australia and now its head, said he was “confident that these lower costs will flow through into lower prices for goods and services,” estimating they would lower consumer prices overall by 0.1 or 0.2 percent.

If true, that probably means most consumers came out ahead under Australia’s regulation. But the value of credit-card rewards fell by 0.27 cents per dollar spent in the eight years after the rule was put in place, meaning the savviest rewards consumers may have actually come out behind.

Shifting the playing field to give retailers more power in negotiations with credit card networks — the approach Amazon and Target are suing to get in the U.S. — would be a much lighter-touch regulatory approach than Australia’s fee cap.

But any change that reduces interchange fee revenue is likely to lead to less generous deals for cardholders. Interchange fees are one of the three main revenue sources banks use to pay out rewards — annual fees and interest charges are the other two — so less interchange revenue will have to mean either fewer rewards or higher fees imposed directly on cardholders.

This last observation was key to a Supreme Court decision earlier this year, rejecting claims by many state attorneys general that another card-network policy was anti-competitive.

In Ohio et al. vs. American Express, the Court’s 5-4 conservative majority upheld Amex’s “anti-steering” policy against anti-trust challenge. Like “accept all cards,” this is a policy that props up merchant fees — in this instance, by barring merchants who take Amex from offering discounts to users of other credit cards or otherwise discouraging customers from paying with Amex. If merchants had the freedom to steer customers toward lower-fee payment methods, that would tend to mean less in fees paid by retailers to card networks and banks.

The justices in the majority said it wasn’t good enough for the plaintiffs to show that Amex’s policy increased the price retailers paid to process credit cards. Since credit-card networks are a “two-sided platform” (that is, they serve consumers and merchants together) the Court wanted to see evidence the policy increased the total costs borne by consumers and merchants. The Court wasn’t convinced of this, noting Amex “uses higher merchant fees to offer its cardholders a more robust rewards program.”

But the decision contains some bread crumbs suggesting the Court might be more amenable to a judgment against Visa and Mastercard than American Express.

As the Court noted, merchants who don’t like the Amex anti-steering policy have an option: They can decline to accept Amex. Many do: About a third of U.S. retail locations that accept Visa and Mastercard refuse Amex. Since a large majority of Amex cardholders also carry a Visa or Mastercard, this doesn’t alienate too many shoppers.

Opting out of Visa or Mastercard is a much more difficult proposition for a retailer because of their larger market share, and because they are often the only cards in a shopper’s wallet. So, the retailers can plausibly argue the top two players have a lot more market power to abuse than Amex.

It is worth thinking here about Costco as an exception that proves this rule about market power. Costco does not take whatever credit card you want to use; the warehouse club long accepted only American Express, and it switched in 2016 to take only Visa, striking a deal that gives it a steep discount on credit-card processing in exchange for exclusivity.

But Costco is a membership club with highly committed customers who pay annual fees. And Costco shoppers are used to trading choice for cost savings: You buy whatever brand of ketchup Costco has, and you use the credit card they tell you to use. Meanwhile, card networks are willing to offer excellent terms for exclusivity at Costco because Costco shoppers tend to have high incomes, and getting into those customers’ wallets at Costco means getting higher-fee transactions from those same shoppers at other stores.

All of which is to say, other retailers can’t do what Costco does. They will annoy customers if they take just one kind of card, and card networks won’t be willing to offer them the sort of generous exclusivity deal Costco gets. They are stuck paying the high fees for Visa and Mastercard processing under the “accept all cards” rule.

Suppose merchants are right that this situation is harming them. Should we consumers care about their plight?

My instinct is to say yes. Because retail is a highly competitive, low-margin sector, there is good reason to believe much of retailers’ cost savings from lower credit-card processing fees would flow through to consumers as lower prices. Not all the savings would flow through — but then, not all the incremental merchant fees paid to banks flow through as rewards points today.

And what consumer savings do emerge under a more retailer-friendly system would likely be more equitable.

“It is a transfer to people who are good at managing cards and points, and thus it is almost certainly regressive in its impact,” the economist Tyler Cowen of George Mason University said regarding the current, rewards-heavy system. “And objectionable on those grounds.”

Still, Cowen proposes a different solution than making card networks ax the “accept all cards” rule. He would let retailers offer whatever kinds of discounts they like for any method of payment — if they prefer that customers use low-fee, low-reward credit cards, they could knock a few tenths of a percentage point off their purchase price for customers who agree to do so.

That is, he would allow the sort of steering Amex has defended as its right to prevent.

The Dodd-Frank banking-reform law already created some rights for retailers in this area: They can offer discounts to steer you to pay by debit card or cash. But after Ohio v. Amex, you’d need a new law to give them the right to steer customers between credit cards. This is the sort of no-fiscal-cost consumer-protection reform Democrats could take up if they retake the government.

Or, as the retailers’ anti-trust case proceeds, maybe the courts will decide Visa and Mastercard are sufficiently more powerful than American Express to merit an anti-trust penalty, and grant the retailers more power in their negotiations with card networks.

If that happens, you may no longer get all the rich credit-card rewards you’ve gotten used to. But you should see slightly lower prices at the cash register.

Are Other People’s Credit-Card Rewards Costing You Money?