AmEx never leaves home without its arbitration clause

Merchants have been grousing about American Express credit cards for more than forty years. Some retail stores, hotels and restaurants dislike the cards because American Express charges a higher transaction fee to process a sale. Their customers, though, love the cards and in a consumer-driven market, this tends to be the deciding factor.

The contractual agreement between American Express and the merchants requires that disputes be resolved through arbitration and specifically notes that, “there shall be no right or authority for any Claims to be arbitrated on a class action basis.”

The U.S. Supreme Court has now ruled in favor of that arbitration clause in a case that hinged on a fairly narrow legal argument but a novel view of economic damages.

The case, American Express Co. et al. v. Italian Colors Restaurant et al, began as a class-action suit claiming that American Express had violated federal antitrust laws when it used its monopoly power to charge 30 percent more per sale transaction than competing credit cards such as Visa and MasterCard.

The merchants’ lawsuit also claimed that the arbitration clause did not apply because under the antitrust laws the economic damages to any single merchant would be lower than the legal costs of recovery. Expert testimony for the merchants estimated that the costs would be at least several hundred thousand dollars and “might exceed $1 million” while even the triple damages recoverable would only total $38,540. Only a class-action process would allow an equitable remedy.

The underlying reason for the great disparity between damages and costs is that the merchants’ argument is based on a novel approach. They based their economic damages claim on the idea that American Express, in violation of federal antitrust laws, used its monopoly power to charge about 30 percent more than competing bank credit cards. Proving and quantifying monopoly power is an expensive process, though, with lots of analysis and expert testimony — certainly beyond what an individual merchant could reasonably expect to recover.

From an economic theory standpoint it is almost too bad that the case was decided on the narrow issue of whether the cost disparity warranted a judicial override of the merchant-American Express contract to allow class actions. A market-based economy like ours could certainly use a learned argument over the roles and boundaries of market participants.

The whole purpose of “branding,” for example, is to obtain a form of monopoly power in a commodity market. A seller cannot dominate the market for a commodity like shoes, but it can exert a total monopoly over the sale of, say, “Hyper-fitted Foot-long” shoes.

Economists call this “product differentiation” and while it is a seller’s effort to escape the profit-squeezing prison of a commodity market, it rarely rises to the level of monopoly power that would show up on antitrust radar.

American Express operates in a very competitive market and its business model relies heavily on product differentiation. It has focused its marketing efforts toward the more affluent portion of the population, a strategy which results in somewhat higher service and per-transaction operations costs that it makes up in part with higher merchant fees.

None of this is secret information and merchants are aware of this when they sign the contract, open an account, and agree to honor the cards. An argument can be made that this antitrust case was, in effect, an effort to renegotiate that contract in the courts so that merchants could obtain the same product at a lower cost.

Outside of this particular case it is easy to sympathize with the merchants’ situation. They operate in a market that today isn’t just competitive in the usual sense; they are besieged on all sides by suppliers, regulators, shoplifters, tort lawyers and tax-hungry government authorities. Still, this case seemed to have little merit and even though the Supreme Court’s decision prompted loud whining from the consumer advocacy and class-action lawyer industries, its impact on consumer rights is probably minimal.

Class-action lawsuits remain a powerful consumer force in the marketplace, even though their financial benefits are often consumed in the process and only a small fraction actually reaches the injured parties. They represent only one of the forces in today’s markets, though, and it is far from clear that they are the most effective way to improve either the efficiency or the fairness of those markets.

Much the same could be said of another major market force, government regulations, which are costly to taxpayers and our economy and often effective more in intent than in fact. What would be more helpful to our economy would be less emphasis on regulations and more effort on improving market information so that sellers and buyers are on an equal footing.

James McCusker is a Bothell economist, educator and consultant. He also writes a monthly column for the Herald Business Journal.

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