American Express’ network rules have deterred Discover from using lower interchange rates to lure more merchants, a high-ranking Discover executive testified in federal court.

Roger Hochschild, Discover’s president and chief operating officer, said American Express’ anti-steering rules create a “vicious circle” that prevents retailers from encouraging customers to use lower-cost cards.

“In an environment where networks with market power can keep increasing their rates for merchants, they can use some of that money for profits,” Hochschild said during a trial on American Express’ card fees. “In essence [it’s] taking the merchant’s money, and using it against them.”

The Justice Department has charged that American Express’ rules impede price competition in the market.

“American Express’ rules are roadblocks to the path of any merchant who wants to take advantage of competitors’ low prices,” Craig Conrath, an attorney for the Justice Department, said in opening remarks.

Riverwoods, Ill.-based Discover, the smallest of the four credit card networks, was the only network that wasn’t named in the government’s 2010 antitrust lawsuit, in which the department charged that credit card rules prevent retailers from offering consumer discounts. Visa and MasterCard settled, while the department continued litigation against American Express.

In a two-hour examination, government attorney Mark Hamer questioned the Discover president about his company’s attempts to lower its merchant fees.

When Visa and MasterCard increased their interchange rates in the late 1990s, Hochschild said, Discover “launched a major campaign to bring merchant attention” to the price hikes.

He explained that merchants had expressed frustration about not being able to control their credit card costs. A survey commissioned by Discover, he said, showed that more than 60% of its merchants said they would be willing to shift their sales volume to a lower-priced card in order to save money.

“We felt it would be profitable for merchants and profitable for Discover,” Hochschild said, noting that the company would compensate for the lower swipe fee by gaining market share.

Discover worked with merchants to make their credit card a preferred card at the point of sale, Hochschild said. Discover even considered offering merchants an equity stake in its network, so that they could have some control over the charges. But anti-steering rules prevented the company’s efforts from gaining traction, Hochschild said.

“In some of the discussion with the largest merchants, they made it clear that the rules of the other card networks prohibited them from preference programs,” he said.

So Discover raised its rates in 2000 and 2001. “To the extent that offering a lower price was not going to give us any business benefits, it was leaving money on the table,” Hochschild testified.

The switch in the company’s pricing model was a direct result of anti-steering rules imposed by the other credit card companies, Hochschild said. “If steering were permitted, I believe we would have continued with our original structure to be the low-cost network.”

American Express has defended its higher fees and anti-steering rules as necessary to protect the company from being crushed by Visa and MasterCard, the two largest credit card companies. American Express’ legal team
contends that attempts to block anti-steering rules would give an edge to its bigger competitors.

American Express’ lawyer, Evan Chesler a partner at Cravath, Swain & Moore, reiterated those points in his cross-examination of the Discover president. Chesler questioned Hochschild about Discover’s acceptance rate among merchants, asking him if he sees the metric as a “weakness.”

“We have a goal of closing the acceptance gap with Visa and MasterCard,” Hochschild said, noting that Discover cards are accepted “in the mid to high 80% range” of merchant locations where Visa and MasterCard are also accepted.

Chesler also pressed Hochschild on the clarity of his company’s low-price model, noting that “byzantine calculations” would be required to compare the interchange rates of all four credit card networks.

“It can be challenging given the fee structure for merchants to compare our fees to Visa and MasterCard,” Hochschild said.

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