Merchants Misunderstand How Interchange Works, Former Visa Exec Says

Merchant complaints about credit card interchange pricing, which culminated last week in a class-action antitrust suit against the bank card associations and major banks, rest on a fundamental misunderstanding of how the interchange mechanism works, says a former Visa U.S.A. executive and payments-industry expert. The pricing system, indeed, allows for much more flexibility and negotiation than the merchants allege, argues Norman G. Litell, a long-time banker and formerly vice president of strategic planning at Visa U.SA. But the notion that interchange should be set in multilateral negotiations among merchants, acquirers, issuers, and consumers, says Litell, is unrealistic. Such a pricing model is a central point in the merchants' argument, according to the lead attorney representing them (Digital Transactions News, June 29). The attorney, K. Craig Wildfang, contrasts this model with the current system, in which the networks set interchange. “In my view, the idea that interchange should be 'negotiable' between Visa and the merchants?as the recent lawsuit suggests?is laughable on its face,” says Litell in an e-mail exchange with Digital Transactions News. He argues that, with tens of millions of merchants accepting cards, such direct negotiation is impossible. He points out that Visa (as well as MasterCard) do not have direct relationships with merchants, which deal with acquiring companies and banks for card acceptance. “The acquirers and merchants are free to negotiate whatever aspects of pricing they choose,” Litell says. In an interview this week with Digital Transactions News, Wildfang, a partner with Robins, Kaplan, Miller & Ciresi L.L.P., Minneapolis, argued that advances in computer technology made multilaterial negotiation possible, citing electronic stock exchanges as examples. Litell adds that interchange is simply the network-level price for moving payments. The actual price merchants pay?as well as the terms under which issuers collect payment from cardholders?are negotiable matters. “How and when the acquirer (or the merchant processor) makes funds available to the merchant, and what fees the acquirer and processors charge, are…separate arrangements between those parties,” he says. “Much depends on the size and market power of the merchant, as well as the risk level of the merchant.” The bank card networks, recognizing these as well as other factors?such as competitive needs to boost acceptance in emerging markets?have over recent years set interchange at substantially different rates for different merchant categories, Litell says. Litell concedes that merchants may legitimately raise questions about interchange that reflects a “premium” for cards laden with rewards points for consumers, another key point merchants make against current interchange pricing, since the premium benefits consumers and issuers. “Overall, as a fraction of the total interchange costs, the rewards program 'premium' is relatively small,” he says. “Of course, merchants can always question the cost vs. value received from the overall interchange structure, and can also assert that there is a large, hidden component of rewards-program offset?or other issuer 'rent premium'?in the base interchange structure.” Given that issuers incur costs and liabilities in issuing premium cards, he says, the question remains open whether consumers or merchants should pay those costs. Others, including merchants, have argued issuers should bear the costs of rewards plans, since they are marketing expenses unrelated to network costs. But, at bottom, Litell argues that there is no reason interchange must be a negotiable matter, separate from any haggling acquirers may do with merchants. “Who says that prices must be negotiable any way?” he asks. “Have these merchants tried to negotiate prices with their phone company, their electric company, or their gas company?”