After decades of contention, Visa and Mastercard are reportedly ironing out another settlement with merchants over interchange fees.
According to the Wall Street Journal, the two companies may agree to incrementally lower credit card interchange fees merchants pay—from current rates of roughly 2% to 2.5% to about 0.1% over several years.
While that reduction would be significant, another aspect of the proposed settlement could have even greater implications: it would allow merchants to decline certain credit cards—namely high-fee rewards cards—at the point of sale, when they were previously required to honor all cards.
“The core value proposition of the Visa and Mastercard brands is the ability to unite many issuers and merchants under a common brand,” said Don Apgar, Director of Merchant Payments at Javelin Strategy & Research. “The brand mark tells consumers that you can use your card here, you don’t have to worry if the merchant accepts only Chase or Citibank cards.”
“Splitting the Visa and Mastercard brands into rewards and non-rewards will create confusion among cardholders about which type of cards that a merchant accepts—the exact issue the brands were created to avoid,” he said. “Will merchants need new signage that says which kinds of cards they accept?”
The Price of Milk
This uncertainty could rapidly become disruptive because rewards cards have shifted from being the outlier to becoming the norm. Visa and Mastercard initially introduced rewards cards to compete with American Express for high-income customers.
Because Amex charged merchants more to fund its rewards program—roughly 3.5%—Visa and Mastercard issuers followed suit, introducing their own rewards cards with higher interchange fees. At first, the limited number of rewards programs meant the share of transactions subject to higher fees was small, so the impact on merchants was nominal.
“What nobody saw coming was a war among issuers racing to get in on the action, building up to where 90% of cards now are rewards cards,” Apgar said. “Even though the interchange rates haven’t gone up per se, the effective cost to the merchant has increased steadily as more of the cards they accept qualify for the higher rewards interchange.”
However, the higher transaction fees are also one of the reasons American Express has not been as widely accepted as Visa and Mastercard. Now, those same companies are facing similar pushback from merchants.
“Nobody expected the rewards market to get so big, but how do you get the toothpaste back in the tube?” Apgar said. “I think Visa and Mastercard are betting that merchants won’t opt out of rewards card acceptance, and they’ll get merchants to accept a compromise they can’t use. That’s a risky strategy in my opinion, as there are merchants ready to do that. Costco has one foot in that direction—where they accept Visa, but the only Mastercard they accept is the Costco Mastercard.”
“I go back to Econ 101: the price of milk must be low enough so that consumers will buy it, yet high enough that farmers will produce it,” he said. “That’s when the market is in equilibrium. The interchange seesaw has tipped too far, and merchants generally agree that the cost of card acceptance is too high. Farmers aren’t selling milk—they are turning it into cheese.”
A Shift of Control
The question for Visa and Mastercard and their issuers is how to restore equilibrium—where merchants view interchange fees as fair and consumers can still enjoy the rewards they value.
While there may not be an immediate answer, any settlement between the credit card companies and merchants would still require court approval—a stage where previous proposals have stalled. Still, credit card issuers should prepare for a sea change.
“In the new world, consumers will need to know if a merchant will accept their specific card,” said Brian Riley, Director of Credit and Co-Head of Payments at Javelin Strategy & Research. “The situation can get very complicated if the card is an enhanced product such as Mastercard World Elite or Visa Infinite. There is a shift of control at the acceptance point, from the card issuer to the merchant.”
“The big deal to watch is whether cardholders will lose confidence in their card,” he said. “Consumers may need to have multiple cards in their wallets or purses to ensure the merchant will accept the product. For some large issuers that have strong merchant relationships, this might be a positive. But expect chaos for small issuers who might just issue one type of a credit card.”
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