TESTIMONY OF STEVEN C. SMITH
PRESIDENT AND CHIEF EXECUTIVE OFFICER
K-VA-T FOOD STORES, INC.
AND
CHAIRMAN OF THE BOARD
FOOD MARKETING INSTITUTE
CREDIT CARD INTERCHANGE FEES
THE UNITED STATES HOUSE OF REPRESENTATIVES
COMMITTEE ON THE JUDICIARY
ANTITRUST TASK FORCE
JULY 19, 2007 

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Chairman Conyers and Members of the Committee, I am honored to appear before you
today and present information of great concern to my company, K-VA-T Food Stores,
Inc., the members of the Food Marketing Institute and American consumers.

I serve as President and CEO for K-VA-T Food Stores, Inc., a retail supermarket chain
operating 95 stores under the Food City banner in Kentucky, Virginia and Tennessee.
We are a family owned business, dating back to 1955. 16% of our company is owned
by our associates through our Employee Stock Ownership Plan and we currently
employ over 11,000 associates.

Also, I serve as Chairman of the Food Marketing Institute, commonly referred to as
"FMI". FMI is a national trade association that has 1,500 member companies made up
of food retailers and wholesalers in the United States and around the world. FMI’s
members operate approximately 26,000 retail food stores with combined annual sales
of $340 billion, representing three quarters of all retail food store sales in the United
States. FMI’s retail membership is composed of national and regional chains as well as
independent grocery stores. Our international membership includes some 200
companies from 50 countries.

I am here today to shed light on the best kept secret of the credit card industry; that is,
the great hidden tax that has been thrust upon consumers due to ever increasing
interchange fees that credit card companies charge retailers as a result of collective
price setting by Visa and by MasterCard and their respective card-issuing banks.
This collective price setting—which looks to me like price fixing under the antitrust
laws—does not occur in isolation. Rather, it is part and parcel of a system that imposes
collectively-set rules that effectively require merchants to keep the cost of accepting
cards secret from their customers. The rules also prevent merchants from refusing to
accept particular types of credit or debit cards that impose higher fees. Thus, the card
systems can, and do, increase their collectively-set interchange fees without any fear of
resistance by their card holders who remain unaware of the increased costs they are
imposing and incurring. 

My testimony today will focus on three topics: First, I would like to give you some
understanding of the supermarket industry in today's marketplace; Second, the history
of electronic payment transactions in our industry; and last, the effect of interchange
fees on the retail industry today and the hidden "tax" burden it has laid upon the
consumers.

The grocery industry is comprised of all types of businesses – from national "big box"
chain stores to the traditional "mom & pop" store on the corner. It is my opinion that this
industry serves a broader cross-section of the American public than any other retail
industry. Each of those consumers enjoys a very competitive marketplace that
exemplifies what most Americans believe their free enterprise system to be –
specifically, each member of our industry has to fight, each and every day, to offer the
consumer the best product at the fairest price in order to win them as a customer.
Because of this healthy competition, the profit margin in the grocery industry is generally
in the 1% range; that is, our operators generally only make $1 of profit for $100 of sales.
I like to say that we are a "penny" business – I know of no other industry that operates
in such a competitive, low-margin environment.

Back in the early 1990’s, supermarkets first began experimenting with credit and debit
card acceptance. When we signed on to accept credit/debit cards, the issuing banks
actually paid retailers to accept their cards and offered a variety of incentives to entice
retailers to "sign up" and join the system.

Over time, our interchange fees were increased. And even though our profit margin
was right around 1%, the same amount as our 1% introductory interchange fees, the
initial volume of credit card payments was low. The industry fully expected that the rate
charges would fall as transaction volume increased – this would be consistent with
basic economic theory and our experience with various other aspects of our business.
However, the exact opposite proved true.

Today consumer use of credit and debit cards is at an all time high, with 60-65% of all
payments in our industry made with plastic. As the credit card payment method has become more and more prevalent, and interchange fee rates have increased, our interchange fee volume began to increase exponentially -- resulting in a 700% increase in total interchange fees over the past 10 years. Today’s high rate of credit card usage
combined with the fact that credit card companies are allowed to collectively set
interchange rates leaves retailers faced with a take it or leave it system – basically it
comes down to a decision to either swallow hard and pay high fees that are set with no
competitive influences or turn your back on the 65% of your revenue from customers
who have been influenced by the card industry’s advertising to believe they are social
outcasts if they pay with actual cash. The retailer's only practical option is to "pay up"
and be forced to pass this uncontrollable expense on to consumers. 

Because of these factors, the grocery industry now faces credit card interchange fees
that can be up to 2% or more of a sale. Please recall my earlier statement that our
industry is a "penny business" or 1% of sales. Therefore, the effect is that fees set
collectively by the credit card companies are now double the industry's profit margins.

As FMI Chairman, I represent 26,000 retail food stores with combined annual sales of
$340 billion, or three quarters of all retail food store sales in the United States. These
retailers have all been put in the position of having to pass-along the costs of these
credit card interchange fees. As a result, consumers pay over $4 billion annually in FMI
member stores and because the fees remain hidden, they don’t even realize it!

To the “injury” of higher interchange fees, our members must add the “insult” of the
anticompetitive, Visa and MasterCard Operating Rules. These rules prevent stores
from setting minimum charges; require retailers to accept all cards, even premium
rewards or corporate cards which carry a higher interchange fee and are not available
to the majority of consumers; don’t permit retailers to make preferences based on card
type or even payment type; and prevent retailers from reviewing the rules of practice
without obtaining a signed nondisclosure agreement.

In the grocery industry, our very survival depends upon customer attraction and
retention amidst an intensely competitive marketplace. Every entity of the retail world
is faced with some form of competition - from the contractors that build our stores and suppliers that provide our products to our utility companies. This competition serves as a safeguard to ensure that our practices and prices remain in check.  

Yet the reverse is true of credit card companies. Visa and MasterCard, accounting for
80% of industry transaction volume, each work collectively with their members to drive
rates upward rather than maintaining a healthy balance. In their non-competitive
market, normal pressures do not apply. Visa regularly increases its collectively-set
interchange fees to encourage the issuance of its cards and MasterCard does the
same. Meanwhile, the unsuspecting consumer is the conduit for this rise in fees—
thanks in part to those collectively-set rules that prevent merchants from responding
competitively to the increased cost of particular types of cards. The only beneficiaries
are those lucky few who qualify for the premium cards packed with rewards on airline
miles, cash back, hotel rooms, etc. But even they often find that the greatly touted
rewards programs lack the promised substance.

My company operates 95 stores in 3 states. We see credit cards from every state in the
country and I have yet to find even one bank that chose to offer an interchange rate
lower than those collectively set and agreed upon by Visa or MasterCard. Fair and
rigorous competition is the foundation of our industry. We are not lobbying to deny
credit card companies their reasonable profit. We only ask that we not be faced with
costs imposed on us that have been set collectively by card systems and their member
banks, in an environment that is deliberately and collectively designed to deprive
America’s merchants of any freedom of competitive action: given Visa and
MasterCard’s market share we simply don’t have the ability to say “no” to the card
systems’ all-or-nothing proposition.

The conventional wisdom tells us that as volume grows prices should fall, but instead
credit card companies have created much greater volume AND raised fees and costs
substantially. This is contrary to the basic concepts of the American free enterprise
system. This situation is the result of card systems controlling 80% of industry volume
collectively setting prices in violation of the antitrust laws. And the great shame of it all
is that the consumer bears the costs and this fact has been effectively hidden from
them. I hope that you can work with representatives of FMI and other merchant groups to develop solutions to end the anticompetitive conduct of the major card systems. I know of no other industry which is allowed to blatantly abuse both the consumer and the retailer. Credit card companies should be required to operate in the same competitive
environment as every other facet of business throughout our nation.

Thank you for the opportunity to testify. 

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