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Unintended Consequences


									Unintended Consequences
Jane Adler

Instead of satisfying merchants, the publication of interchange rates has drawn reactions ranging
from confusion to anger from some retailers. Meanwhile, observers say the posting of the rates
could presage a major change in the way card acceptance is priced.

While legal wrangling continues between the bank card networks and merchants that have filed antitrust
lawsuits over interchange fees, the issue of transparency has emerged as the latest wrinkle in the
contentious battle over the cost of credit and debit card acceptance. Under pressure from retailers, both
Visa USA and MasterCard Worldwide published interchange rate schedules on their Web sites last fall.
    The bank card associations say the newly disclosed rate schedules provide the kind of transparency
retailers have asked for. But instead of placating merchants, publication has raised more questions perhaps
than it has answered. Some merchant advocates say the schedules are too complex and confusing, especially
for small merchants, making it difficult to determine exactly how much cards cost retailers to accept.
    And others wonder if misunderstandings over interchange could make retailers question the rates they’re
paying. One independent sales organization reports that a merchant client, after seeing interchange rates
posted on the Web, threatened to sue the ISO for a refund on the interchange it paid as part of its discount
    Interchange is the amount of a bank card transaction that is forwarded by the merchant acquirer to the
issuer of the card the buyer used for a purchase. Visa and MasterCard set interchange rates, and acquirers
simply pass the cost on to their merchant clients. Interchange can amount to 75% or more of the total
discount rate a merchant pays its acquirer for accepting cards. The rest of the discount rate covers the
processor’s cost as well as a small network fee.
    Meanwhile, some observers look overseas for guidance. Rate transparency, and even lowered
interchange rates, have been mandated in some countries, though with mixed results.
    “Everything related to interchange has been under a cloak of darkness,” says Mallory B. Duncan, senior
vice president and general counsel at the National Retail Federation, Washington, D.C. “What we want is
    Consultant Norman G. Litell, a former Visa executive, thinks the card associations have been their own
worst enemies in the interchange debate by keeping the rates confidential for decades. Though interchange
schedules generally were available to anyone who was “seriously” interested enough to find them, he notes,
merchants couldn’t get them directly from the associations; they could only hope that their acquirer or ISO
would divulge them voluntarily. “The secrecy around interchange rates was somewhat foolish,” says Litell.

Merchant Howls
Big retailers with clout typically have been able to negotiate the best prices for themselves because of their
transaction volume. Small and mid-size retailers are less likely to know their interchange costs since they are
bundled in the merchant discount rate. Many such merchants say they feel powerless, having little choice but
to accept cards in order to stay in business.
    Stuck in the middle are ISOs, the entities through which most small merchants obtain their card-
processing services. ISOs say they’re working on slim margins and must pass through to merchants the
interchange rates set by the networks, which many merchants accuse of working on behalf of their card-
issuing bank members.
    All manner of economic events can spark a round of interchange howls from merchants. For example,
quickly rising gasoline prices in the first half of 2006 caused many consumers to switch from cash to cards
when filling their tanks. Responding to complaints from gas sellers, MasterCard agreed to cap interchange
on transactions over $50. (A MasterCard spokesperson says the rate for the cap has yet to be set, but the cap
should be in place no later than April 1.)
    And in Philadelphia, cab drivers recently protested a new requirement by the city that they install credit
card readers in their cabs. The drivers said card-acceptance requirements amount to a pay cut because
processing companies charge 5% to 10% per transaction.
    Little wonder interchange has led to a slew of antitrust lawsuits that charge price fixing by the card
associations. In April 2006, nearly 50 suits against Visa, MasterCard, and some of their member banks were
consolidated in the U.S. District Court for the Eastern District of New York. The successor class action asks
that the plaintiffs be compensated for the alleged overcharges they have paid in the form of excessive
interchange over the last several years. “The fees are too high as a result of the horizontal fixing of fees by
the banks,” says K. Craig Wildfang, an attorney for the plaintiffs and partner at Robins, Kaplan, Miller &
Ceresi LLP, Minneapolis.
    With the case still winding its way through pretrial motions, Wildfang doesn’t expect trial to start until
the fall of 2008. But the proceedings won’t be impacted by the publication of rates, he says. “It was a
cosmetic move by Visa and MasterCard in response to getting grilled at (U.S. Senate) hearings last July
about why rates were so high,” he notes.
    Further inflaming merchants, interchange rates have been on the rise. For example, from 1991 to 2005,
average Visa credit card interchange on a $60, cardholder-present transaction rose from 75 cents to $1.024,
according to a 2005 report from Boston-based research firm Aite Group LLC. And since then, overall rates
have continued to rise, notes Gwenn Bézard, Aite research director.
    The only declines came after Visa and MasterCard settled a merchant class-action lawsuit in 2003 over
signature-based debit cards, a suit led by Wal-Mart Stores Inc. Just before trial, after seven years of
depositions and procedural hearings, the associations agreed to a temporary, 30% reduction in debit
interchange, dropped “honor-all-cards” rules that forced merchants to accept signature-based debit cards if
they took credit cards, and agreed to pay just over $3 billion to the plaintiffs.

‘Window Dressing’
Though some merchants have filed individual lawsuits challenging interchange, the main class action
focuses on alleged price fixing involving credit card and signature-based debit card interchange. Merchants
are especially upset about interchange for premium credit cards such as Visa Signature and World
MasterCard. These cards offer rich cardholder rewards that are funded in part by interchange rates that are
higher than standard credit interchange rates. Issuers argue that premium cardholders spend more with
merchants, making it all worthwhile.
     A 2006 report by Diamond Management & Technology Consultants, Chicago, estimates that rewards
account for as much as 44% of interchange costs. The report predicts issuer rewards programs will be the
first casualties if interchange rates are lowered. But Diamond also says the publication of interchange rates
will give merchants the information they need to eventually force an unbundling of interchange fee
     “Premium cards are a further rip-off of retailers,” says the NRF’s Duncan, who also heads the Merchants
Payments Coalition advocacy group. “The cards are issued with the banks making promises to customers
and the expectation that retailers will pay for (the rewards), which drives up the cost of goods for everyone.”
     Even so, the publication of the rates is a small, but positive, first step in the unbundling process, Duncan
says. But he complains that the rules related to the acceptance of credit cards are still not provided to
retailers, and, he says, the “charts are not the simplest to follow.”
     One look at the charts bears out the complaint. The MasterCard rate schedule is 72 pages long. Under
consumer credit cards for gas stations and convenience stores, for instance, there are seven categories and
seven different prices. At five pages, the Visa charts are shorter than MasterCard’s, but no less complex,
retailers say.
    “The (charts) have made retailers furious,” says Mitch Goldstone, owner of a photography store in
Irvine, Calif., and founder of, a Web site devoted to interchange. “Everyone is upset
(about the publication),” says Goldstone. “It’s window dressing, a way to appease retailers, but it’s not
    Goldstone, a lead plaintiff in the class-action interchange lawsuit against the card groups, has mounted
a campaign to have the interchange fee for every transaction printed on the customer’s receipt. “That would
be transparent,” he says. He figures that once consumers see such charges on their receipts, their outcries
would reduce or put an end to interchange fees altogether.
    Asked if an interchange line item on receipts would confuse customers, Goldstone says he indeed would
expect questions, “which is good.” He adds that consumers will be “educated” and “infuriated” about the
true cost of card acceptance when they see the fees set out on paper.
    Purchase, N.Y.-based MasterCard has received no complaints about the publication of its rates,
according to Joshua Peirez, group executive of global public policy. “We have heard from some retailers that
the information is good to have,” he says. “We have not had people call and say the information is
confusing.” He adds that many visitors to MasterCard’s Web site have downloaded the rate information,
though he could not provide the exact number of downloads.
    A statement by Visa USA vice president Rhonda Bentz, issued in response to a request for an interview
for this story, says: “We’re committed to enhancing our relationships with all our stakeholders by being
more responsive to their requests, and by providing as much visibility as possible to all stakeholders in the
Visa system.”

Radical Change
The publication of interchange rates hasn’t had an impact on business at First American Payment Systems
L.P., a non-bank merchant acquirer in Fort Worth, Texas. But president and chief executive Neil L. Randel
finds the act “a bit odd.” He explains that most of his clients pay a blended discount rate of which
interchange is only one component. Randel likens the publication of interchange rates to an automaker
providing car buyers with the cost of a particular part. “Small and medium-sized merchants are not in tune to
the [interchange] costs,” Randel says.
    Jeff Thorness, president and chief executive at ACH Direct Inc., an Allen, Texas-based ISO, says he’s
personally in favor of making transactions as clear and simple as possible. But the charts are a lot of
“gobbledygook,” says Thorness, who worries merchants will have the perception that the processor is
making a killing on transactions, even though most of the processing fee goes to the card-issuing bank. He
adds: “I am hopeful we will see some price relief. There’s some room for [fees] to go down.”
    R. Scott Hatfield, vice president of corporate development at Tempo Payments Inc., a PIN-debit card
network designed for retailers, thinks publication of the rates has added to merchant confusion, but the
change will get processors off the hook, so to speak. “Processors have been blamed for raising fees and
they have nothing to do with it,” notes Hatfield, whose San Mateo, Calif.-based firm until recently was
known as Debitman Card Inc. “Retailers will understand who is actually raising the fees. It will open their
eyes to alternatives.”
    The publication of the rates is one step in the process of the card associations possibly getting out of the
business of setting interchange rates, according to Dean V. Nicolacakis, co-managing director of the
financial-services practice at Diamond Management. That would be a radical change, but since MasterCard
became a public company last May and with Visa planning to follow suit, at a minimum pressure will grow
to lower interchange rates, he thinks. Added pressure will come from the lawsuits as well as the growth of
alternative payment methods.
    At the same time, Nicolacakis says MasterCard and Visa have become much more merchant-oriented and
he expects their ties to retailers to strengthen, not weaken. “The [card associations] are looking for ways to
add value for the merchant,” says Nicolacakis. As an example, he points to the Visa’s so-called incentive
network, which allows merchants to target consumers who use their Visa cards at participating merchants’
    Critics of interchange look overseas for models of how rates might be lowered here in the United States.
“Interchange is under attack around the world,” attorney Wildfang says. The Reserve Bank of Australia, for
instance, a few years ago instituted regulations that lowered credit card interchange. The Reserve Bank,
Australia’s central bank, plans to review the reforms later this year.
    Diamond Management says the Australian reforms killed loyalty programs, which have been replaced by
fee-based programs that allow merchants to impose a surcharge on consumers for credit card use. Annual
cardholder fees also have risen.
    Besides Australia, some European countries have intervened in interchange matters. According to the
Aite Group report, however, regulators have not been able to show that lower interchange rates have lowered
prices for consumers. The report suggests that mandating lower rates helps merchants but not consumers.
Also, “There are a lot of countries where there is no pressure on interchange,” notes analyst Bézard.
    The United States certainly has less appetite for regulation than many countries, observers say. And
however the court cases turn out here, they leave open the question of how much rates, despite their
publication, might eventually be reduced. “Only the lawyers win in court battles,” says Hatfield at Tempo
Payments. “True competition is the way to lower interchange rates.”

Where To Find Interchange Schedules
MasterCard Worldwide:
Visa USA:

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