U.S. Supreme Court Sides with Amex in Landmark Card Case

A divided U.S. Supreme Court sided with American Express Company and American Express Travel Related Services Company (Amex) over Ohio, sixteen other states and the United States based on the Court’s application of the theory of two-sided markets. Ohio v. American Express Co., No. 16-1454, slip op. at 2 (June 25, 2018). At issue were Amex’s antisteering provisions, which prohibit “merchants from discouraging customers from using their Amex card after they have already entered the store and are about to buy something,” to avoid Amex’s higher merchant fees. Id. at 1. The Court, in an opinion by Justice Thomas, held that Amex’s antisteering provisions were not anticompetitive under the two-sided market theory argued by Amex, affirming a 2nd Circuit decision which had also embraced the theory and which abandoned “traditional market-definition approaches,” according to Justice Breyer’s dissent. Id. at 18.

Background

Antisteering provisions “prohibit merchants from implying a preference for non-Amex cards; dissuading customers from using Amex cards; persuading customers to use other cards; imposing any special restrictions, conditions, disadvantages, or fees on Amex cards; or promoting other cards more than Amex.” Id. at 7. In October 2010, the United States, Ohio and ten other states sued Amex under the Sherman Act’s Section 1, claiming that its antisteering provisions were anticompetitive because they increased fees to merchants. The District Court evaluated solely the merchant side of the market and found that the plaintiffs had proven anticompetitive effects, shifting the burden to Amex. Amex appealed and the 2nd Circuit reversed, holding that the credit card market is one market with two sides, and based on an evaluation of the market as a whole, including an assessment of the benefit to consumers, found that the antisteering provisions were not anticompetitive. On June 25, 2018, the Supreme Court affirmed, with Justice Thomas writing for the Court. Justice Breyer authored a dissent joined by Justices Ginsburg, Sotomayor and Kagan.

Economic Theory

Commentators are already debating the opinion, which has made strange alliances. The Court’s conservative majority embraced a relatively new economic theory of two-sided markets, whereas the liberal contingent objected that the Court was moving away from established precedent. Id. at 19. Commentators have criticized the opinion as favoring the wealthy, e.g., Aaron Klein, Why the Supreme Court’s decision in Ohio v. AmEx will fatten the wealthy’s wallet (at the expense of the middle class) Brookings Institute (June 25, 2018), and others lauded it for embracing the reality of current economics. Editorial, Another Antitrust Bust, Wall St. J. June 26, 2018. The ramifications of the opinion will be interesting to watch and widely felt.

The two-sided market theory, part of Nobel Prize-winning economist Jean Tirole’s contribution to the approach known as “Post-Chicago Antitrust Economics,” while by no means new, has taken on a broad role in recent times because of the robust payments networks created by credit cards (cardholders and merchants) and his focus on game theory (gamers and game developers) as well as web portals (viewers and advertisers). The theory recognizes that when a cardmember uses her card with a merchant, the network is providing interdependent but distinct services to the cardmember and merchant (charging each party for the applicable service). To this end, the network is attempting to attract cardmember customers in part based on how many merchants accept its cards, and vice versa, and pricing its services in each side of the market as needed to maximize the number of customers who fit its risk appetites and other criteria. Thus, each card transaction involves two sides of a single market, involving different customer populations and prices. Amex, No. 16-1454, slip op. at 2-3.

In accepting the two-sided market theory in this case, the majority recognized the interdependency between the two sides of the credit card markets and that one side’s pricing affects the other. The majority also recognized Amex’s unusual strategy within the two-sided credit card market. While most credit card companies’ income derives mainly from the credit portion of the dual transaction, Amex’s model is different. Amex instead earns most of its revenue from merchant fees and, in exchange, brings the merchant a bigger-spending, wealthier consumer, to whom it offers better rewards than other networks.  Id. at 6.

Antitrust Law

The majority opinion and the 2nd Circuit recognized that Amex’s anti-steering rules constituted a “vertical restraint.” A vertical restraint is a restraint imposed by agreement between two firms at different levels of distribution. Unlike horizontal restraints, vertical restraints often impose no risk to competition unless the entity imposing them has market power. Id. at 11 n. 7. When assessing vertical restraints, the “rule of reason” requires courts to conduct a fact-specific assessment of market power and market structure to assess the restraint’s actual effect on competition.  Id. at 9. To determine whether a restraint violates the rule of reason, the court applies a burden-shifting framework under which the plaintiff bears the initial burden to prove that the challenged restraint has a substantial anticompetitive effect that harms consumers in the relevant market. Id. If the plaintiff carries this burden, the burden shifts to the defendant, who must show a pro-competitive rationale for the restraint. Id. If the defendant makes this showing, the plaintiff must demonstrate that the procompetitive efficiencies could be reasonably achieved through less anti-competitive means. Id. at 9-10. Analyzing this vertical restraint under the rule of reason, the Court found that the plaintiffs’ “direct evidence” of increased merchant fees was not enough to push the burden back to defendants because they did not factor in the benefits to competition on the consumer side.

The Court recognized that the “[t]he optimal price might require charging the side with more elastic demand a below-cost (or even negative) price.” Id. at 4. Thus, it required analysis of how both sides interact to determine economic effect. The Court concluded that Amex benefited competition by choosing to attract “wealthier cardholders who spend more money” and wanted high rewards, thus delivering to the merchants customers with high purchasing power. Id. at 16. Amex uses the higher fees “to offer its cardholders a more robust rewards program, which is necessary to maintain cardholder loyalty and encourage the level of spending that makes Amex valuable to merchants.” Id.

The Court found that the anti-steering provisions prevent the other card holders from “freeloading” on Amex’s investment in attracting these wealthier customers and bringing them to the merchant by steering them to other credit cards. Amex protects its investment in its structure and rewards by requiring merchants to pay its higher fees and not allowing them to direct consumers to lower fee cards. The Court also found that to compete with Amex, Visa and MasterCard both issued “premium cards” that had higher fees to the merchants and higher rewards to the consumers, a procompetitive benefit.  Id. at 18.

Initial Reception; Potential Impact on New Entrants

Some commentators have criticized the decision as enhancing income inequality by providing plain credit cards (with high interest) to the working class while rewarding wealthier cardmembers who could afford the higher spend minimum with higher and better rewards that come with platinum and “black” cards. See, e.g., Tim Wu, The Supreme Court Devastates Antitrust Law, New York Times, (June 26, 2018). However, the Supreme Court found that while these antisteering agreements were in place, the credit card market had actually expanded, increasing the “availability of card service, including free banking and card-payment services for low-income customers who would not otherwise be served.” Amex, No. 16-1454, slip op. at 18.

The Court’s decision may affect recent and potential FinTech entrants into the credit card market (or markets for close substitutes). These entities have thrived on disrupting inefficient systems, as some critics describe the present credit card system. See, e.g., Adam J. Levitin, Priceless?: The Economic Costs of Credit Card Merchant Restraints, 55 UCLA L. Rev. 1321 (2008). Such critics’ view is that new market participants could establish themselves by offering merchants lower fees and consumers faster and better service. Id. The Court’s affirmation of the validity of the anti-steering rules impedes these potential efforts at disruption. With price competition for merchant acceptance impeded, FinTech will need to focus first on addressing other arguable inefficiencies in the system.

Conclusion

While embracing the two-sided market theory is a welcome recognition of realities of current markets, not everyone is happy with the decision. But as Visa and MasterCard found premium cards the way to compete with Amex, FinTech will adjust and find ways to stay in the market as well. This decision may ripple out into other areas of antitrust analysis, and it will be interesting to see the effects.