Change is coming to the credit card industry following the government's recent antitrust victory against American Express, but the next few weeks could determine how deep the changes are and who wins and loses.
By ruling that merchants can encourage customers to use cards with lower interchange rates, a federal judge last week dealt a serious blow to Amex's business model, which is based on charging retailers higher fees in exchange for the chance to do business with a more affluent group of cardholders.
However, District Judge Nicholas Garaufis' decision did not detail how Amex had to change. Instead, he ordered the company to sit down with the Department of Justice and work out a compromise that would allow it to obey the law without scrapping its business model.
"The court is confident there exists a middle ground that strikes the appropriate balance between American Express' legitimate interests as a going concern and the public interest," Garaufis wrote.
He gave Amex 30 days until March 21 to hammer out an agreement with Justice officials. If it cannot, Garaufis will impose his own fix.
The negotiations could mean the difference between a modest and a radical change for all payment card networks' pricing structures, not just Amex's, because of the price war that could result among the rivals.
Amex is likely to hold a hard line; Chief Executive Kenneth Chenault has said the company's survival depends on the case, and Amex has vowed to appeal.
Amex will obey the judge's order to seek a compromise and propose its own reforms if the two sides cannot find common ground, a company spokesman said in an email.
But the odds of Amex and Justice officials reaching a mutually satisfactory pact are low, observers said.
"I can't see American Express agreeing to a voluntary remedy," said Matthew Cantor, an attorney with Constantine Cannon who has opposed card companies in antitrust suits. "I think 30 days will pass, there will be no settlement, and the judge will have to decide on a remedy."
Amex's prompt announcement that it plans to appeal suggests it does not expect much from the negotiations, Keefe, Bruyette & Woods analyst Sanjay Sakhrani said.
Garaufis' ruling states that Amex violated antitrust laws and illegally constrained free competition by prohibiting merchants from "steering," or encouraging, customers to choose particular card brands that are less expensive for the merchants.
Opening the door to steering could force card networks to do what they have not done in more than a decade: compete with one another on price by lowering interchange rates. A price war could drive down rates across the board, hurting all card companies as well as card-issuing banks.
It would likely be especially damaging for Amex, which charges the highest rates of the four major card companies. Each Amex transaction cost merchants an average of around 30 basis points more than a Visa or MasterCard transaction, KBW analysts say.
Amex has fought the suit more determinedly than other card companies because it has more to lose. Visa and MasterCard were sued along with Amex over their anti-steering rules, but they gave up the practice in settlements with the government in 2011.
Judge Garaufis sees plenty of room for reforms that would not cripple Amex. Provisions against steering will have to be dropped, but "it may be possible for other challenged clauses to be revised, amended or recharacterized in such a way that considers the interest of both plaintiffs and defendants," he wrote.
His ruling suggests that offering discounts or perks a 5% discount or free shipping, say would be acceptable forms of steering. However, he acknowledges that Amex could be damaged by merchant promotions that go too far, and that it has "a business interest in preserving a positive point-of-sale experience for their customers, and protecting their products from actual mistreatment, mischaracterization and denigration by merchants."
Industry participants will be watching closely for the judge's guidance about what forms of promotion he will allow and what Amex tries to fight.
"What's key is how the merchants encourage the use of other cards. It's very important how the court allows the promotion of one card over another," retail consultant Richard Mader said.
Appeal an 'Uphill Fight'
Amex's chances of reaching a satisfactory result through negotiation may not be great, but they are better than the odds of an appeal, observers say.
The judge's order, at more than 150 pages, contains an unusual amount of facts and details. That is bad news for Amex, because appeals courts are more inclined to overrule lower courts' legal interpretations than their factual findings.
An appeal could delay a resolution of the case perhaps as long as a year, wrote Brian Garner, a KBW analyst. He thinks the appeal will be "an uphill fight" that runs the risk of an appeals judge imposing a "harsher remedy" than the company could achieve through negotiations.
How Much at Stake?
Uphill or not, it's the path that Amex appears committed to.
Chenault testified during the trial that Amex "will not survive as a company" if steering is allowed.
Experts disagree over the possible impact on Amex and the broader industry.
Some observers think that Chenault's comment was way overblown. Sakhrani doubts most retailers will even bother trying to steer customers to cheaper cards.
"It's very difficult to discount at the point of sale," he says. "It creates a fair amount of friction that could lead to alienation of the consumer, and it is really unclear how much of a cost savings it would be for the merchants."
It is unlikely that merchants would bother training staff and slowing the sales process for the difference of roughly 30 basis points between the cost of Amex and Visa or MasterCard, he argues.
Furthermore, the debit-rate reduction mandated by the Durbin amendment in the Dodd-Frank Act has not been passed on to customers. Retailers get far more savings if a customer pays with cash or a debit card, but they rarely offer discounts to encourage customers to pay that way, even though it has long been legal to do so.
Sameer Gokhale of Janney Capital Markets had a similar take. It's "unlikely that we will see a large market share shift away from American Express even if the company loses on appeal," he said. Gokhale estimated that even in this worst-case scenario, the ruling could mean that Amex would lose about 5% of its card billings.
Others say the blow could be more significant over time.
Technological change could make steering more effective, Cantor said. Merchants could develop automated methods of steering while customers are paying, for instance.
"Where there's a spread to be made, merchants, particularly large ones with technical prowess like Amazon and Wal-Mart, may be able to shift consumers' methods of payment," he said.
Amex's determined fight against the lawsuit suggests that it agrees. It also suggests that the 30-day negotiation window is likely to pass without the company making key concessions.
"There might be some middle ground, but I think it's a slippery slope," Sakhrani said. "We're going down a path that speaks to the validity of their model."