Why merchants suffer just as much as consumers do (Part I)

Around the turn of the century, American Express began putting into place more aggressive strategies of extrapolating data and massaging it to "paint any picture" it preferred. This is a serious threat not only to the consumer, but also to the accepting merchants of the card.

American Express has a unique advantage in the credit card world—as does Discover to a smaller extent—because it generally operates in a "closed loop" business environment.  Unlike American Express, however, VISA and MasterCard rely on banks for issuance of cards, merchant acceptance, and processors to capture data.  This dependency severely weakens their ability to model consumer spending. Simply put, because American Express owns the card member relationship, the merchant relationship, and the data processing through its own infrastructure (no third party processor reliance), it is able to track spending and build behavioral models from all angles of the business.

This unique ability has long been a major threat to the merchant base which American Express charges a premium on transaction fees—well above the VISA/MasterCard threshold. In general, the merchants either have to accept the high fees associated with American Express cards, or refuse to accept the cards and risk isolating the consumer relationship. Therefore, the merchant pays excess fees to accept a card product whose company, in turn, analyzes data with results that are harmful to the merchant and to the card member alike. In a declining economy where shoppers are changing their spending habits drastically, this is even more of a lose-lose situation. 

We will have the technical/mathematical breakdown in part II. 

Response to comments below [Added Feb. 5, 2009]:

While it is true that banks can now issue American Express cards, there remains a distinct advantage for American Express over VISA and MasterCard: American Express continues to own all customer and merchant data collected.

Think of its infrastructure as being similar to the vertical integration model practiced by many manufacturers. American Express creates its product, distributes it through the banks, processes the transaction at the merchant level, passes the information back to the card-issuing bank, and collects a processing fee from the merchant and the bank.  Through the entire process, American Express owns the data collected. This is very different from VISA and MasterCard since these organizations do not own the banking or merchant relationship; they simply collect a fee from both for providing their brand. Capturing the data is between the processor, the bank, and the merchant. The arrangements between each entity can be very different. The overall impact of this detour from the closed loop is that American Express has now expanded its customer base and extended its reach through the banks, making the banks somewhat dependent on American Express for processing. This is a new revenue stream for American Express and an avenue of new business that VISA and MasterCard do not enjoy.

CapitalOne and other card issuers of VISA and MasterCard own the card relationship with its customers only. Unlike American Express, it has no singular relationship with the merchants because the merchants can choose any processor they want. The various processors do not coordinate their data amongst each other nor do they share the data amongst the various issuing banks. This is an "open-end" model that has difficult challenges regarding how to summarize consumer data under one roof like American Express can do.

While the banks do own the liability of the American Express cards they issue, in essence this gets American Express off the hook regarding credit risks. While the banks may set their own credit standards and lines, they still depend on the data going through the American Express network, which is how the consumer data is captured and thus controlled by American Express. The banks may receive this information too, but they cannot make a linkage across the merchant base because those merchants have their merchant account with American Express—not the bank. American Express has no obligation to share that part of the data in any summary form with the banks. The banks know only what their card customers are doing and know nothing about the competing bank's customers. Moreover, they know nothing about the merchants themselves, making it nearly impossible to market their customers to merchants who do not have an account with them.

Comments

[Jackie A., Columbia, Missouri]

I am a member of Costco and certainly prefer its business practices and where it sends its money politically far more than the alternative, Sam's Club. I think rather than quit Costco, we all should let Costco know that they need to rethink their relationship with Amex!

[Srinivas Annadi]

I am also not going to use Amex card like Terry. This is really painfull for customer, who has been in good standing with all his/her abilities, still increasing the interest rates dramatically without even a single notice to the customer.

When Amex does this cheap trick, either customer has to pay the excess interest or pay off the loan in difficult times. I have been a constant visitor to the Costco, where these guys allow only Amex. I am even trying to quit visiting Costco. How does that sound?

[Terry S.]

Whether they use behavioral modeling or not, will not change my decision to get rid of the American Express cards. Obviously, a good paying history and excellent credit did not factor into their behavioral modeling when they decided to cut my credit lines and increase my interest rates.

[Daniel B.]

Chandler Hill,

The Amex cards issued by other banks simply and only use the Amex network. The issuing banks sets their own credit standards and lines. Amex has nothing to do with these cards. Amex only acts as the middle man and collects a commission for Bank of America, USAA, etc for using their network. It may say "American Express" on the card but really it is just a Bank of America card, etc.

[Chris]

How does CapitalOne work? Don't they operate under a "closed" system? I am still not understanding how these companies differ and what their true capabilities are when it comes to intrusive data mining. Can you break it all down?

[Chandler Hill]

Banks can now issue Amex cards, yes? In fact, with bank mergers and consolidations, there are times when the owner of a Visa card from Bank ABC is reissued an Amex card when that bank merges with Bank XYZ. What its the impact of this detour from the closed loop?