American Express Wins in the Courts
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American Express (NYSE: AXP) just won big in the courtroom.
The Second Circuit Court of Appealsdecided American Express can require that its merchants do not steer their customers to other, lower fee cards like MasterCard (NYSE: MA) or Visa (NYSE: V) cards, reversing an earlier decision by the Department of Justice.
The court's decision
At issue are American Express's so-called "nondiscriminatory provisions" (NDPs) in its merchant agreements, which prohibit merchants from offering cardholders discounts for using lower fee cards, expressing a preference toward any one card, or disclosing the costs that the merchant pays to accept different types of cards.
American Express's cards typically carry higher fees for merchants. The DOJ ruling against the company revealed that it sets fees by adding a premium to the fees charged by Visa or MasterCard, intentionally making sure that it always charges the highest fees on every swipe.
Perhaps the most compelling argument by the Second Circuit Court of Appealswas that the DOJ may have only looked at the issue through the lens of merchants, failing to consider the benefits of higher merchant fees for consumers. By charging higher fees on each transaction, card networks and issuers can fund larger rewards to consumers, who enjoy lower prices when rewards are taken into consideration.
The Second Circuit Court of Appealswrote the following in its decision:
We don't often think of American Express cards being "cheaper" than Visa or MasterCard. After all, American Express is known for having wealthier clientele, charging consumers annual fees for access to its most prestigious cards, and taking higher fees from merchants on every swipe.
However, taking into consideration the rewards and ancillary benefits of any given card (free insurance on rental cars and access to airport lounges, for example), an AmEx card may very well be a "cheaper" form of payment for consumers than a card issued by another bank or network.
Not all is said and done
American Express isn't free and clear just yet. The Department of Justice, which originally decided against American Express, can and may appeal the most recent decision by theSecond Circuit Court of Appeals.
In truth, "steering" is just one of many potential problems plaguing American Express' business model. In the last two years, American Express has lost co-brand deals with Costco and Fidelity, which now issue cards on Visa's network.
With the help of former AmEx executives, JPMorganChase is increasingly competing for American Express's wealthiest and most creditworthy cardholders. The bank recently launched a Chase card that, in exchange for a $450 annual fee, potentially offers $2,000 or more in travel benefits in the first year. It may be the most stunning display of how competitive the market for card users has become.
But perhaps the biggest competitive threat to American Express is the muted profitability of the traditional banking industry. American Express has long targeted a return on equity of 25% or more for any given credit card deal. Traditional banks would be happy with half that. Banks haven't earned 25% returns on equity since the pre-crisis days of outsized (but temporary) profits from mortgage banking.
So although this decision does nothing to protect AmEx against increased competition from rivals in its customers' mailboxes, at least for now AmEx won't have to worry about losing swipes to lower fee cards at the point of sale.
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Jordan Wathen has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Costco Wholesale, MasterCard, and Visa. The Motley Fool recommends American Express. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.