AmEx Courts Merchants, Aims to Avoid `Boston Fee Party' Repeat - 22Oct 2010

American Express Co., the biggest credit-card issuer by purchases, aims to win over retailers as it fights U.S. antitrust claims and seeks to avoid a repeat of a 1991 merchant revolt known as the “Boston Fee Party.”

The lender, which is scheduled to report third-quarter results after markets close today, has “accelerated our calls” to retailers after the U.S. Justice Department filed a lawsuit against the company earlier this month, said Bill Glenn, president of global merchant services at New York-based AmEx.

“We certainly wanted to reach out and proactively communicate with as many of them as possible to talk through the suit and why we took the position that we did,” Glenn said in a telephone interview. “We know we have to prove value to them, or they don’t need to accept us.”

Merchant support may help American Express counter Justice Department claims that its contracts unfairly prohibit retailers from steering customers to cheaper card brands. Merchants including Costco Wholesale Corp., which has an exclusive agreement with AmEx, and Boston restaurateur Steve DiFillippo, who led the Fee Party uprising, praise the payments network.

“American Express is fantastic,” said DiFillippo, 49, who gained nationwide notoriety in 1991 by stabbing an AmEx card with a 10-inch butcher knife to protest the lender’s rates, forcing the company to lower them.

“They listen to you. If you have an idea, they work with you. It’s a whole different ballgame,” said DiFillippo, who owns Davio’s restaurants in Boston, Philadelphia, Atlanta and Foxborough, Massachusetts.

Costco

Costco, the largest U.S. warehouse-club chain, offers a cobranded rewards credit card that brings AmEx’s affluent cardholders into stores while helping the lender add Costco customers, said Richard Galanti, chief financial officer for the Issaquah, Washington-based retailer.

“It’s been a great, long-term relationship,” Galanti said in a telephone interview.

Visa Inc. and Mastercard Inc., the world’s biggest payments networks, agreed to settle the antitrust case. That means about 4 million U.S. merchants who accept only those brands will be free to steer customers to different types of cards by offering discounts and other incentives, according to the Justice Department. Retailers who also take AmEx remain subject to its restrictions, at least until the suit is resolved.

Brian Dodge, a spokesman for the Retail Industry Leaders Association, said it’s “premature” to determine whether merchants will desert AmEx to take advantage of the settlement.

‘Excessive’ Fees

“American Express is comparatively more transparent and builds a more consistent working relationship with retailers than Visa and MasterCard, but their rules are no less restrictive and their fees are equally as excessive,” said Dodge, who represents merchants including Wal-Mart Stores Inc., Home Depot Inc. and Target Corp.

AmEx, MasterCard and San Francisco-based Visa dictate fees and terms with “impunity” at the expense of consumers and retailers, he said.

Spokesmen for Visa and MasterCard say their companies are transparent, publishing rules and rates on their websites.

“We always work together with merchants to provide value to cardholders through cobranded and promotional programs,” said Jim Issokson, a spokesman for Purchase, New York-based MasterCard.

“Visa is focused on helping retailers achieve their business goals with new products and services,” said its spokesman, Will Valentine.

‘Headline Risk’

AmEx’s rules prohibit merchants from steering consumers to lower-cost payment methods, said the Justice Department’s spokeswoman, Gina Talamona. “Our litigation seeks to allow merchants that accept AmEx to engage in the same kind of discounting and encouragement that the proposed settlement with MasterCard and Visa allows.”

The Oct. 4 complaint and AmEx’s decision to fight prompted a 6.5 percent decline in the stock, the biggest one-day drop since January, amid concern that the company would again be forced to lower merchant fees, its biggest revenue source.

“This is primarily headline risk at this point, because the Justice Department really has a tremendous task at hand to prove that American Express actually has market power,” said Fred Fialco at Bethesda, Maryland-based Torray LLC, which manages about $550 million, including AmEx shares.

Investors should take advantage of the selloff by buying AmEx ahead of today’s earnings report, according to Betsy Graseck, an analyst at Morgan Stanley.

‘Stock Is Cheap’

“The stock is cheap,” Graseck said in an Oct. 13 research note. “American Express is likely reaching out to bear-hug merchants, reiterate its value proposition, and at least partially offset any potential merchant discounts with other service offerings.”

AmEx, the top performer last year in the Dow Jones Industrial average, climbed 1.1 percent to $40.17 at 12:32 p.m. in New York Stock Exchange composite trading. The shares had fallen 2 percent on the year through yesterday.

The company may say third-quarter income surged more than 50 percent as card spending increased and fewer borrowers defaulted. AmEx may post a profit of $984.4 million, compared with $640 million in the same period a year earlier, according to the average estimate of 10 analysts in a Bloomberg survey.

Risk of Defections

Should American Express win the antitrust case, the lender may still face merchant defections or be forced to lower fees if MasterCard and Visa reduce theirs as a result of a separate antitrust lawsuit brought by retailers in federal court in Brooklyn, New York.

“I always see the risk of merchants dropping AmEx,” said Moshe Orenbuch, a Credit Suisse Group AG analyst who’s rated AmEx as “underperform” since 2002. “I think that’s increased as a result of the DOJ telling them that AmEx’s pricing is too high.”

More than 8 million U.S. merchants accept Visa and MasterCard, compared with fewer than 5 million for American Express, said David Boies, an attorney for AmEx, according to a company transcript of an Oct. 4 conference call with analysts and reporters.

AmEx, in disputing the government’s claim that the company wields market power, said its cards are accepted at fewer locations than those issued by Discover Financial Services, based in Riverwoods, Illinois. Discover isn’t a defendant.

American Express Chief Executive Officer Kenneth I. Chenault, 59, has said that merchants who agree to accept the company’s cards promise not to take advantage of the lender’s investments in attracting affluent consumers by luring them into stores and then steering them to other card brands.

‘Bait and Switch’

“The net result of this ‘bait and switch’ is an unhappy customer who was pushed to use a backup card that didn’t provide the customer service, buyer protection, benefits or rewards that he or she prefers,” Chenault wrote in a commentary published Oct. 8 by the Washington Post. “Only in Washington could that be called a consumer benefit.”

Retailers paid AmEx an average of 2.56 percent on each credit-card transaction in the three months ended June 30, according to the company’s second-quarter financial supplement. The debit- and credit-card rates Visa and MasterCard post online don’t provide weighted averages just for credit transactions. The Nilson Report, an industry newsletter, estimated the fees averaged 2 percent in 2008. AmEx doesn’t issue debit cards.

The fees help compensate card issuers for the risk of lending money, for processing costs and for rewards programs.

‘So Arrogant’

DiFillippo said he views accepting plastic as a business cost, like rent or payroll, that’s passed on to consumers. Cards account for about 70 percent of his restaurants’ $25 million in annual revenue and he pays an average of 2.5 percent for the service, with AmEx being the most expensive at about 2.9 percent, he said.

In 1991, AmEx’s merchant discount rate averaged 3.18 percent, about twice that of competitors.

“There was a recession, kind of like we have now, and we were going to our vendors and talking to them about trying to lower their costs,” DiFillippo said. American Express initially refused, with an executive telling him, “We’ll do some marketing for you, but the rates, it never will happen,” DiFillippo recalled. “They were so arrogant.”

A Boston Herald reporter overheard restaurateurs discussing their plans to stop accepting American Express and the newspaper later published a photograph of DiFillippo posing with the butcher knife as he stabbed an AmEx card, the restaurateur said.

‘Huge Story’

“I was on every channel, it became like this huge story, and then CNN calls me,” DiFillippo said. AmEx “knew from that day they had a problem in Boston, so they sent some people from New York who negotiated with us.”

American Express had just one product at the time, its flagship charge card that requires customers to pay their bills in full each month, and directed most of its services toward card holders, not retailers. Today, the company uses the data it collects to help merchants acquire and retain customers and market their products more effectively, and at a lower rate, said Glenn, the AmEx executive.

“We’re a totally different organization than we were then,” he said. “The evolution of the business has made us more acute to the needs of our customers, and in my organization, our customers are the merchants.”

By Peter Eichenbaum (Bloomberg)