Case Study visa case

Case Study visa case - Transcript

Visa and MasterCard s Association Potentially Anticompetitive

Michael Baye and Patrick Scholten prepared this case to serve as the basis for classroom discussion rather than to represent economic or legal fact The case is a condensed and slightly modified version of the public copy of the Complaint filed in United States of America v Visa U S A Inc et al dated October 7 1998 No 98 civ 7076

OVERVIEW OF MARKET FOR GENERAL PURPOSE CARD SERVICES Visa and MasterCard compete in the market for general purpose card network products and services General purpose cards which include credit cards and charge cards are payment devices that enable consumers to make purchases from unrelated merchants without immediately accessing or reserving funds Visa and MasterCard are the two largest general purpose card networks Together they account for over 75 of all purchases made with general purpose cards in the United States Visa and MasterCard are joint ventures or as they call themselves associations created owned governed and operated by and in the interests of their member banks These banks use the associations products and services either to issue cards to consumers provide card acceptance services to merchants or both The same large banks control both associations by simultaneously serving on the board of directors of one and on important committees of the other In addition each of these banks issues significant numbers of both Visa and MasterCard cards The control of the two associations by banks that have significant interests in both known in the industry as duality has possibly substantially lessened competition between Visa and MasterCard because these banks seem to have been and continue to seem to seem to be significantly less willing to fund and implement competitive initiatives that would cause consumers to switch their business from one association to the other In addition both Visa and MasterCard on behalf of and in collaboration with the banks that govern them have adopted rules and policies that might restrict the ability of all member banks to do business with American Express Discover Novus or any other network that the controlling banks deem to be competitive Importantly Visa and MasterCard do not apply these rules to one another Banks can therefore do business with the two largest general purpose card networks but not with smaller competitor networks These exclusionary rules and policies might eliminate certain forms of competition among the Visa and MasterCard member banks and might have effectively precluded American Express and Discover Novus from competing to enlist banks in the U S to issue their cards Through their common control of both Visa and MasterCard the largest banks might have stifled competition between these two networks and might have thwarted competition from smaller competitor networks This possible reduction in competition among general purpose card networks might have hindered and delayed the development and Managerial Economics and Business Strategy 5e Page 1

implementation of improved network products and services and might have lessened consumer choice If allowed to continue the possibly anticompetitive structure and practices of the associations could threaten competition in the development and marketing of new general purpose card products such as products that integrate credit debit and stored value functions Since the mid 1960s Visa and MasterCard have operated general purpose card networks throughout the United States They provide card network products and services in and those products and services affect a substantial amount of interstate commerce In 1997 transaction volume on the Visa and MasterCard networks exceeded 600 billion

RELEVANT MARKET
General purpose cards are payment devices that a consumer can use to make purchases a from unrelated merchants and b without accessing or reserving the consumer s funds at the time of the purchase There are two principal types of general purpose cards credit cards such as Visa and MasterCard Classic and Gold cards the American Express Optima card and the Discover card that usually permit the cardholder to either i pay all charges within a set period after a monthly bill is rendered or ii pay only a portion of the charges within that time and pay the remainder in monthly installments including interest and charge cards such as the American Express Green Card that require the cardholder to pay all charges within a set period after a monthly bill is rendered



General purpose cards do not include cards that can be used at only one merchant e g department store cards or cards that immediately access funds on deposit in a checking or savings account e g debit cards General purpose cards provide a consumer with a combination of convenience widespread acceptance security and deferred payment options that are not effectively replicated by any other form of payment For a significant number of consumers and types of transactions other forms of payment are not a close substitute for general purpose cards Competition to provide general purpose cards occurs at two levels First Visa and MasterCard compete with American Express Discover Novus Diners Club and Japan Credit Bureau JCB in an upstream market hereinafter referred to as the general purpose card network market Second individual Visa and MasterCard member banks compete with each other and with American Express Discover Novus Diners Club and JCB in two downstream markets the card issuing market the market for issuing general purpose cards to consumers the card acceptance market the market for providing the services that enable merchants to accept general purpose cards for the purchase of goods or services Michael R Baye

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The Visa and MasterCard associations compete only in the upstream network market Their member banks with the exception of Citibank which owns Diners Club compete only in the two downstream markets American Express Discover Novus Diners Club and JCB are integrated entities that compete in all three markets Product Market Certain functions essential to the acceptance and use of general purpose cards are most efficiently performed by general purpose card networks often because the functions require broad coordination across the network For example among these functions all general purpose card networks Invent develop and implement systems and technologies including systems to authorize and settle card transactions and reduce fraud Develop market advertise and promote their brand names among consumers and merchants Invent develop implement standardize market and advertise types of card products Develop and implement rules and standards to govern their networks Set fees and assessments for use of the network s products and services including the interchange fee that accounts for the largest part of the price that merchants pay for the right to accept general purpose cards and Extend card acceptance to merchant segments that have not accepted cards in the past



The products and services provided by general purpose card networks form a network market which is relevant product market Banks and other entities that issue cards and provide card acceptance services to merchants rely on general purpose card networks to provide a core set of these products and services for which there is no cost effective alternative Card issuers and banks that provide card acceptance services to merchants thus cannot substitute other products and services for the products and services provided by general purpose card networks in an amount sufficient to deter the exercise of market power in the network market In addition consumers do not substitute other forms of payment and merchants do not stop accepting general purpose cards in amounts sufficient to deter the exercise of market power in the network market The products and services provided by general purpose card networks are critical inputs to the entities that issue cards to consumers and provide card acceptance services to merchants Card issuers compete for cardholders with respect to interest rates annual cardholder fees payment terms and conditions card enhancements and customer service Entities that provide card acceptance services to merchants compete with respect to their fees and the quality of service they provide This competition among Visa and MasterCard member banks in the card issuing market and the card acceptance market is not a substitute for and does not replace competition at the network level Competition at the downstream levels Managerial Economics and Business Strategy 5e Page 3

thus cannot protect consumers from the anticompetitive effects of the exercise of market power by general purpose card networks Competition among card issuers does however ensure that if network competition is vigorous the benefits of that competition will be passed on to consumers Geographic Market The United States is the relevant geographic market for each relevant product market Almost all of the general purpose cards issued by banks based in the United States are issued to domestic cardholders and these consumers use their cards predominantly at merchants located in the United States Most general purpose card transactions with merchants located in the United States are made using cards issued in the United States and most merchants would not consider networks operating outside the United States to be a substitute for networks operating in the United States Visa and MasterCard consider the United States to be a separate geographic market as demonstrated in part by their establishing separate Boards of Directors for and separate rules governing the operation of their card networks in the United States For example the Visa and MasterCard rules permitting the member banks to issue Visa and MasterCard but no other network s cards apply only in the United States VISA AND MASTERCARD HAVE MARKET POWER IN THE NETWORK MARKET Visa and MasterCard s questionable actions related to anticompetitive effects occur primarily in the network market Visa and MasterCard together have and exercise market power in the network market Visa and MasterCard are the two largest general purpose card networks in the United States Their only significant competitors are the American Express and Discover Novus networks and entry into the network market is extremely difficult Visa and MasterCard Dominate the Market In 1997 Visa accounted for approximately 50 of the dollar volume of transactions on all general purpose cards in the United States and approximately 53 of the number of general purpose cards issued In 1997 MasterCard accounted for approximately 25 of the dollar volume of transactions on all general purpose cards in the United States and approximately 33 of the number of general purpose cards issued Together Visa and MasterCard account for approximately 75 of general purpose card dollar volume and approximately 86 of the number of general purpose cards issued In the United States approximately 3 4 million merchant outlets accept both Visa and MasterCard Practically every merchant that accepts Visa also accepts MasterCard and vice versa This common merchant base is significantly larger than the base of any other network competitor In 1997 American Express accounted for approximately 18 of dollar volume and 5 of general purpose cards issued in the United States Cards on the American Express network were accepted at approximately 2 5 million merchant outlets in the United States In 1997 Discover Novus accounted for approximately 6 of dollar volume and 8 5 of general purpose cards issued in the United States Cards on the Novus network were accepted at approximately 3 1 million merchant outlets in the United States Page 4 Michael R Baye

There are two other general purpose card networks that compete in the United States Diners Club Carte Blanche Diners which is owned by Citicorp the bank that has issued the largest number of Visa and MasterCard cards and JCB a network based in Japan that issues cards in the United States primarily to Japanese expatriates

Both networks have competitively insignificant market shares and limited merchant acceptance in the United States Competition among Card Issuers is Not a Substitute for Network Competition Card issuers may compete on interest rates fees enhancements and customer service This competition however cannot cure the harm to consumers arising from a lack of competition among card networks nor does it prevent the Visa and MasterCard member banks from collectively exercising power in the network market to the detriment of consumers There Are Significant Barriers to Network Entry The prospect of entry by new card networks does not prevent Visa and MasterCard from exercising market power in the network market Entry is extremely difficult because establishing a new general purpose card network requires large investments to develop both cardholder and merchant bases Coordinated development of both cardholder and merchant bases is critical because the utility of a particular card product to cardholders and merchants depends not only on the cost and features of the card but also on the ubiquity of its acceptance and use Since Visa and MasterCard were formed in the mid 1960s only one network has successfully entered the relevant market In 1985 Sears created that new network then called Discover and now known as Novus by building on the infrastructure and the cardholder and merchant bases of the Sears single retailer card system At the time Sears was one of the largest retailers and card issuers in the United States In the early 1980s Citicorp the largest issuer of Visa and MasterCard cards and at the time a large provider of card acceptance services to merchants unsuccessfully attempted to enter the network market Other companies that considered entering the network market concluded that the high cost of building a merchant and cardholder base made entry too difficult For example in the late 1980s AT T considered forming a new general purpose card network After analyzing the Discover and Citicorp experiences however it decided not to enter the network market AT T instead entered only at the card issuing level by becoming a member of Visa and MasterCard Visa and MasterCard have adopted and maintained possible anticompetitive rules and policies that further increase an entrant s cost of developing cardholder and merchant bases By virtue of their dominant market shares and the difficulty of entry into the highlyconcentrated network market Visa and MasterCard together have potential power to injure competition in that market As described below they might have exercised that power to the detriment of consumers by reducing competitive investments in the innovation development

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and marketing of improved network products and services and maybe by restraining the competitiveness of smaller networks THE SAME BANKS HAVE TAKEN CONTROL OF BOTH VISA AND MASTERCARD Both Visa and MasterCard are organized as membership corporations that ostensibly operate on a not for profit basis Their activities are financed through fees and assessments levied on their members Both card networks permit a variety of financial institutions to become members including commercial banks thrifts credit unions and entities that are engaged primarily in the card business commonly known as non bank banks or monoline banks From here on all types of financial institutions that are eligible to become members of Visa and MasterCard are referred to collectively as banks and all financial institutions that are members of Visa and or MasterCard are referred to collectively as member banks Under Visa s and MasterCard s corporate structures a member bank in either association has the right to issue cards bearing the association s trademark and to offer card acceptance services for the association s cards Most member banks including all of the largest ones also become owners of the association and receive a bundle of rights similar to those of a shareholder in a corporation These rights include the opportunity to vote for a board of directors participate in the governance of the association and share in the association s assets upon dissolution Voting and dissolution rights are apportioned according to the dollar volume of transactions that the bank has transmitted through the network Member banks also agree to abide by the associations bylaws rules regulations and policies Visa and MasterCard Began As Entirely Separate Systems Prior to 1970 Visa and MasterCard were controlled by different groups of banks In 1970 one of Visa s member banks Worthen Bank of Arkansas sought to become a cardissuing member of both networks MasterCard did not object but Visa responded by adopting a bylaw that prohibited member banks from issuing any other network s cards Worthen then sued Visa and the district granted summary judgment for Worthen The Eighth Circuit however reversed and remanded for trial While the case was awaiting trial Visa asked the Department of Justice to express its views pursuant to a Department procedure called a Business Review on the legality of a more restrictive bylaw that would have prohibited Visa members from both issuing cards and providing card acceptance services for any other card program presently existing or which may develop The Department responded that it would not object to a bylaw that restricted Visa members to issuing Visa cards exclusively to the extent it is necessary to insure continued intersystem competition But the Department expressed concern that Visa s proposed prohibition on banks providing card acceptance services to merchants for both networks might well handicap efforts to create new bank credit card systems and may also diminish competition among the banks in various markets The Visa and MasterCard Governing Banks Adopted Duality Notwithstanding the Business Review Letter the member banks on Visa s Board of Directors over the objections of Visa s General Counsel voted to permit Visa member banks to own and participate in the governance of MasterCard and to permit MasterCard members Page 6 Michael R Baye

to own and participate in the governance of Visa MasterCard s Board of Directors also permitted MasterCard member banks to become owners and governors of Visa and Visa members to become owners and governors of MasterCard This overlapping ownership and governance structure has become known in the industry as duality Since 1975 virtually all significant card issuing banks have become owners of both Visa and MasterCard Almost all of the largest card issuing banks have representatives on one of the associations boards of directors as well as have representatives on the important committees that influence policy for each network For example MasterCard s Business Committee and Visa s Marketing Advisors Committee advise their respective network s professional staff and management on key strategic and competitive issues In 1996 twelve of the twenty one banks represented on Visa s Board of Directors were also represented on MasterCard s Business Committee Seventeen of the twenty seven banks on MasterCard s Business Committee had representatives on Visa s Marketing Advisors Committee Seven of the twenty two banks represented on MasterCard s Board of Directors also were represented on Visa s Marketing Advisors Committee In total as of year end 1996 approximately nineteen banks including Chase Manhattan Citibank First Chicago Bank of America and NationsBank had a representative on the board of directors of one association and on at least one important committee of the other association Despite this overlap in ownership and governance neither Visa nor MasterCard enforces the safeguards necessary to prevent one association from obtaining confidential competitive information about the other In 1992 MasterCard International s Executive Vice President and General Counsel wrote in a letter to the Department of Justice that when one board acts with respect to a matter the results of those actions are disseminated to the members who are members in both organizations As a result each of the associations is a fishbowl and officers and board members are aware of what the other is doing much more so than in the normal corporate environment

VISA AND MASTERCARD POTENTIALLY RESTRAIN COMPETITION Visa and MasterCard on behalf of and in collaboration with their governing banks make competitive decisions that a possibly restrain competition between the two associations and b possibly restrain competition from other networks and eliminate certain forms of competition among the member banks As a result of this potentially anticompetitive behavior certain possible competitive initiatives that would have benefited consumers have been abandoned delayed suppressed and diluted consumer choices have been reduced and competition among general purpose card networks has been restrained substantially Duality Possibly Restrains Competition between Visa and MasterCard The common control of both Visa and MasterCard by banks with significant financial interests in both networks possibly restrains competition between those two general purpose card networks Duality Possibly Lessens the Associations Incentives to Compete Against One Another Managerial Economics and Business Strategy 5e Page 7

The banks that govern Visa earn substantial profits from issuing MasterCard cards For example as of year end 1997 Visa U S A s Board of Directors included representatives of First Union Corporation and Associates First Capital Corporation both of which had issued nearly 40 of their general purpose cards on the MasterCard network The banks that govern MasterCard earn an even greater percentage of their profits from issuing Visa cards For example as of year end 1997 at least five banks that placed directors on the MasterCard board for the United States Region issued more Visa cards than MasterCard cards The most pronounced examples among MasterCard s 1997 board members were Providian Bancorp Inc and Capital One Bank which had issued more than 95 and more than 66 of their cards on the Visa network respectively Because of these significant overlapping financial interests the banks that govern each association have possibly rejected investments in and implementation of competitive initiatives that might lead consumers to switch from one association s brand of card to the others From the banks perspective these innovations would merely shift their profits from cards issued on one of their networks to cards issued on the other Because the same banks control the associations the overlapping interests of the governing banks possibly substantially restrain the ability of the separate managements of Visa and MasterCard to compete Visa and MasterCard Top Executives Admit that Duality Restrains Competition Officials at the highest levels of Visa and MasterCard have acknowledged repeatedly publicly and under oath that the common ownership and governance of Visa and MasterCard significantly limit competition between the two associations In 1992 Visa International s President and Chief Executive Officer testified Q So you believe consumers would be better off without duality A Yes He explained that Visa was a better organization before its owners acquired an interest in MasterCard It created more it was more innovative and it was more vital and more imaginative The real creativity ingenuity desire to develop and support from members that made Visa what it is today came before duality because there were groups of banks who wanted to support Visa to go beat up on MasterCard and there were groups of banks in MasterCard who wanted to support MasterCard to go beat up on Visa And they weren t sitting there as shareholders of both organizations not really caring who beat up on whom or if they didn t beat up on anyone or not caring who won If you ve got one foot firmly placed on both sides of the street who cares and I think that not only would the banks have benefited had they gone this way without duality but ultimately the consumer would too In 1992 Visa International s Executive Vice President and General Counsel testified that it is very difficult for us to take a step an aggressive step that hurts MasterCard because the same banks who sit there on the board who are in Visa are also in MasterCard In response to the question whether duality has led to a decrease in intersystem competition between Visa and MasterCard he replied Absolutely and when asked whether duality Page 8 Michael R Baye

harmed consumers he answered I think in the long run they would be better off without duality In 1992 MasterCard International s Executive Vice President and General Counsel wrote in a letter to the Department of Justice that Visa s and MasterCard s members which necessarily underwrite the networks costs view the associations as complementary and are displeased when one attempts to enhance itself at the expense of the other MasterCard and Visa simply do not compete in any conventional business sense In January 1997 the President of MasterCard International s U S Region testified It is clear that because of duality today you don t see MasterCard and Visa in the marketplace attacking each other The owners don t want us attacking the other thing they own Also in January 1997 the President and Chief Executive Officer of Visa U S A testified that you can t compete in certain areas if you re co owned He emphasized that Visa would seek to differentiate its network services from MasterCard s to a greater extent if Visa were not owned by the same banks that own MasterCard Proposals to Roll Back Duality Were Rejected Recognizing that duality blunts competition between the associations each network s staff and management have sought at various times to increase their network s independence and enhance network competition The banks that control Visa and MasterCard have resisted these efforts In 1991 Visa International s President and Chief Executive Officer proposed eliminating the overlap between the two networks Under the proposal each member bank would issue prospectively only one general purpose card brand Visa or MasterCard and would participate exclusively in the governance of the system on which it chose to issue cards Also in 1991 Visa s U S Executive Planning Committee considered the advantages and disadvantages of phasing out duality According to an internal Visa document an anticipated benefit of eliminating duality was to create real competition with MasterCard The Visa Board rejected these proposals voting instead to continue to permit a bank to govern Visa regardless of the extent of the bank s interest in MasterCard Similarly throughout the 1990s MasterCard s professional staff repeatedly urged the network s Chief Executive Officers to end the practice of providing member banks with equal access to MasterCard network services regardless of the banks interests in Visa In 1992 a MasterCard staff memorandum reported that MasterCard s innovative ideas are totally neutralized in a dual world Then in 1994 a MasterCard management team advised MasterCard International s then new President and Chief Executive Officer about the tyranny to issuer duality and the drive to homogenize that resulted in no meaningful difference in the network products and services offered by MasterCard and Visa In 1996 a high ranking MasterCard executive again emphasized that increasing the revenues collected by card issuers advertising more effectively and increasing overall efficiency are matters that become marginalized in a dual world with a larger competitor As one of these memoranda concluded The cure is in a core of dedicated issuers dedicated not dual Under these staff proposals new MasterCard innovations would have been made available only to member banks that agreed to favor MasterCard over Visa Managerial Economics and Business Strategy 5e Page 9

Despite these proposals MasterCard like Visa continued to permit banks to govern MasterCard regardless of their interest in Visa Duality Has Potential Anticompetitive Effects on Brand Development Brand development is an essential aspect of establishing and developing a general purpose card network A network promotes and differentiates its brand in order to attract consumers merchants and banks to use its brand rather than a competing network s brand Advertising campaigns such as Visa s ubiquitous they don t take American Express advertisements are an important component of network competition because they educate consumers and merchants about important attributes of the network In recent years advertising has accounted for approximately a quarter of all expenses for both Visa U S A and MasterCard s U S region Because consumers value the ability to use their cards to make purchases whenever and wherever they want a card network must offer widespread merchant acceptance In the United States virtually all merchants that accept any credit card accept both Visa and MasterCard Yet studies have long shown that consumers wrongly perceive that Visa is accepted by significantly more merchants than MasterCard In 1992 MasterCard management was advised by its advertising consultant that MasterCard must name Visa in its advertisements in order to combat this misperception As a result MasterCard management proposed that MasterCard institute an advertising campaign proclaiming No other card is more accepted Not Visa Not American Express Bank representatives on the MasterCard Business Committee objected on the ground that this advertisement would harm Visa MasterCard s U S Region President responded to these objections by assuring member banks that MasterCard s acceptance claim comparison to Visa would be used only if it did not negatively impact Visa During the same time period MasterCard faced a similar perceived acceptance gap vis vis Visa in Canada where duality does not exist There MasterCard s Canadian Region ran the advertising that was rejected in the United States It used the tag line No card is accepted in more places worldwide than MasterCard Not Visa Not American Express Within two years MasterCard s Canadian Region concluded that the use of this tag line has helped improve acceptance imagery as well as reduce the Visa brand awareness advantage One study showed a drop in the perceived acceptance gap in Canada from 15 to 4 during a one year period in which MasterCard named Visa in its advertisements Notwithstanding the success of this campaign MasterCard has not named Visa in a comparative acceptance advertisement in the United States Surveys continue to show that consumers in the United States wrongly perceive that Visa is significantly more widely accepted than is MasterCard Similarly Visa does not name MasterCard in its U S advertising But in the non dual Canadian market Visa has named MasterCard For example in one advertisement Visa highlighted a Canadian merchant that only accepted Visa A Visa executive testified that Visa management never proposed running the Canadian advertisement in the U S because we knew that they the banks wouldn t accept it He further testified that when Visa s U S Marketing Advisors Committee was shown the advertisement their reaction clearly was don t you show that in the U S on U S television Page 10 Michael R Baye

Duality Has Possible Anticompetitive Effects on Product Development The overlap in control of Visa and MasterCard constrains each association s professional staff and management from proposing competitive initiatives likely to lead consumers to switch from one brand to the other In 1991 a Visa executive testified that member banks opposed Visa initiatives against MasterCard because they had a vested interest on that side too and this was an ongoing problem in almost everything we did and continue to do He added that Visa s managers often don t even propose them competitive initiatives because we know they are unacceptable to members The possible anticompetitive effects of duality exceed what can be readily observed because many products services and innovations that would have emerged in a competitive environment were never even considered by the associations or their managements Nevertheless there are several instances in which the controlling banks seem to have restrained critical competitive initiatives developed by the managements of Visa and MasterCard

Smart Cards In the 1980s MasterCard developed and extensively tested smart cards A smart card differs from the cards in widespread use in the United States in that it can store information on an integrated circuit instead of or in addition to a magnetic stripe Integrated circuits are capable of storing significantly more information than magnetic stripes This additional data storage capacity would enable a card network to enhance its products by among other things storing cash and personal information such as airline and hotel preferences identification numbers and medical data Smart cards would also enable issuers to reduce their costs by providing superior fraud and credit risk control In 1987 MasterCard s staff concluded that introducing this product would give MasterCard a significant advantage over Visa and sought board approval to introduce smart cards Bank representatives on the MasterCard Board s Executive Committee refused however to approve the initiative without Visa s agreement MasterCard then approached the Visa Board and the two networks hired a consultant to consider whether to introduce this new product jointly After several banks represented on Visa s Board of Directors expressed their opposition to the introduction of the smart card Visa notified MasterCard that it would not introduce the product MasterCard s Board then refused to permit MasterCard to move forward and the planned development was shelved After a decade of delay Visa and MasterCard are now finally testing separate smart card options although with full knowledge of each other s strategic plans Commercial Cards In 1993 Visa staff concluded that prohibiting Visa member banks from issuing both Visa and MasterCard commercial cards i e corporate cards and other cards issued to businesses rather than consumers would enable Visa to innovate and differentiate its Managerial Economics and Business Strategy 5e Page 11

commercial products from MasterCard s more effectively than if duality were permitted Based on Visa management s recommendation its Board initially adopted a resolution that would have required Visa member banks to decide by early 1996 whether to issue Visa or MasterCard commercial cards exclusively Visa then planned to promote its commercial cards aggressively and allocated a substantial budget to the initiative Widespread bank opposition led Visa to reverse its decision and allow banks to issue both MasterCard and Visa commercial cards Soon after the decision to permit banks to issue both associations commercial cards Visa scaled back its investment in developing commercial card products Visa s former Executive Vice President of Market Development testified that the amount of money that Visa spent on the commercial card was reduced because it became apparent that it was going to be a dual world Secure Transactions over the Internet The member banks also delayed Visa s introduction of the first system to provide secure general purpose card transactions over the Internet and thereby prevented Visa from gaining a competitive advantage over MasterCard In October 1995 Visa and Microsoft jointly announced the specifications for a system to provide secure transactions over the Internet Visa intended to use Microsoft encryption software to implement the announced standard In a message to member banks MasterCard stated that it had no choice but to respond competitively to the Visa Microsoft alliance and it began to form alliances with other software providers The member banks pressured Visa to abandon its agreement with Microsoft in favor of a cooperative effort with MasterCard to develop a standardized approach Visa complied with the banks wishes In a 1995 presentation to the Federal Trade Commission on joint ventures Visa International s Executive Vice President and General Counsel blamed duality for the delay in introducing the Internet security system He stated that if we had our group of banks and MasterCard had their group this thing would be out there already In 1997 Visa U S A s President and Chief Executive Officer testified that this was yet another case in which Visa had an opportunity to get out ahead of MasterCard and had to come back work again with MasterCard Also in 1997 Visa U S A s former Executive Vice President of Market Development testified in regard to Internet security that the Visa staff and management deserve d the opportunity to either prove that we were right or to fail Standardizing things too quickly in new emerging products and markets from my experience as a marketing person has the capability of stifling innovation Visa and MasterCard Possibly Restrain Competition from Other Networks and Prohibit Certain Forms of Competition among Their Member Banks In addition to restraining network competition between themselves Visa and MasterCard on behalf of and in collaboration with their governing banks have adopted and maintained rules and policies that might prohibit all member banks from doing business with other general purpose card networks such as American Express and Discover Novus These rules might restrain competition a between the bank controlled Visa and MasterCard networks and the general purpose card networks not so controlled and b among the Visa and MasterCard member banks Page 12 Michael R Baye

Prior to the mid 1980s Visa and MasterCard did not compete directly with other networks At that time other general purpose card networks such as American Express issued charge cards intended primarily for use in the travel and entertainment sectors In contrast Visa and MasterCard cards were targeted for use in the general retail sector By the mid 1980s Visa and MasterCard had expanded into travel and entertainment American Express had expanded into the retail sector and Sears had entered the network market with the Discover network now called Novus These changes brought the bankcontrolled Visa and MasterCard networks into direct competition with American Express and Discover Novus Visa and MasterCard on behalf of and in collaboration with their governing banks responded to this competitive threat by adopting rules that possibly lessened the ability of those networks to compete effectively a with Visa and MasterCard in the network market and b with the associations member banks in the downstream card issuing and cardacceptance markets Visa and MasterCard both exempt each other and the Citicorp owned Diners Club network from these exclusionary rules enforcing them only against American Express and Discover Novus By adopting and maintaining these possibly discriminatory exclusionary rules Visa and MasterCard preserve and extend their jointly held market power As MasterCard explained to its members in a 1991 document discussing competition among Visa MasterCard American Express and Discover Visa and MasterCard form a segment of the credit card market a market where MasterCard and Visa together are fighting to maintain their dominance and minimize incursion of non bank or competitive quasi bank products Emphasis in the original Visa and MasterCard Potentially Impede the Ability of Other Networks to Convince Merchants to Accept Their Cards One difficulty that a network faces in convincing merchants to accept its cards is that merchants strongly prefer to use a single card acceptance terminal to process transactions for all brands of general purpose cards Processing transactions involves transmitting transaction data from a merchant s terminal to a central computer that directs the information to the appropriate card network for authorization and settlement Visa and MasterCard permit banks to process transactions for both networks through a single merchant terminal enhancing the ability of both networks to convince merchants to accept their cards In the mid 1980s Visa MasterCard and their member banks used their control of merchant terminals to hinder American Express s and Discover Novus s efforts to build merchant bases In response to these practices American Express and Discover Novus developed their own card acceptance terminals capable of handling all card transactions American Express and Discover Novus then entered into agreements with a few Visa and MasterCard member banks that were willing to permit American Express and Discover Novus to process those banks Visa and MasterCard transactions through terminals that accepted all card brands Other banks complained to Visa and MasterCard about these agreements and the associations then adopted new regulations that prohibited any member bank from permitting American Express or Discover Novus to process Visa and MasterCard transactions These Managerial Economics and Business Strategy 5e Page 13

regulations which were an exception to the existing rules that permitted the banks to contract with third party processors substantially hindered American Express s and Discover Novus s ability to persuade merchants to accept their cards Eventually because of strong merchant demand for a single terminal Visa and MasterCard agreed to modify their regulations to permit banks to link their processing services to American Express and Discover Novus Under the modified regulations any network could place a terminal with a merchant as long as all transactions on the terminal that involved another network s cards were diverted to that other network for processing American Express then began to divert transactions in accordance with the modified Visa and MasterCard regulations and by offering card acceptance services at low prices American Express placed terminals with a number of merchants This prompted several Visa and MasterCard member banks to again complain about American Express s pricing practices to Visa and MasterCard In response Visa and MasterCard adopted additional rules effectively requiring merchants to pay a higher fee for Visa and MasterCard transactions if they used a card acceptance terminal placed by American Express According to Visa s Executive Vice President and General Counsel these discriminatory fees were adopted to make it more difficult for Amex to price our member bank acquirers out of the marketplace and remained in effect until at least 1991 Visa and MasterCard Impede the Ability of Other Networks to Provide Cash Advances A valuable feature of any general purpose card network is the ability to provide cardholders with convenient access to cash advances most importantly through automated teller machines ATMs Visa and MasterCard each own one of the two worldwide ATM networks Plus and Cirrus respectively Visa s rules permit member banks that issue MasterCard cards to use the Plus system to provide cash advances on MasterCard cards Similarly MasterCard s rules permit member banks that issue Visa cards to use the Cirrus system to provide cash advances on Visa cards As a result any member bank can enable its cardholders to use general purpose cards to obtain cash advances worldwide at over 200 000 locations To obtain access to these ATMs a bank merely needs to agree to pay a fee to the ATM operator whenever one of its cardholders obtains a cash advance and to agree to accept cards issued by Cirrus or Plus member banks at its own ATMs Visa stated in its 1988 Corporate Strategic Plan that The successful consolidation of regional ATM switches into a unified bank owned and operated national network will deprive Discover and American Express of the opportunity to chip away at a major strategic advantage by the banking industry through the progressive creation of a national network of their own Visa and MasterCard will not permit American Express and Discover Novus to use Cirrus or Plus to provide cash access to their cardholders As a result of Visa s and MasterCard s exclusionary practices American Express and Discover Novus have had to negotiate individually with scores of regional ATM networks and banks to secure ATM access for their cardholders often at access prices higher than those paid by member banks The cash access networks that American Express and Discover have assembled through these individual negotiations are smaller more geographically uneven and more

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costly to maintain than those that Visa and MasterCard make available to each other s member banks Visa and MasterCard Impede the Ability of Other Networks to Contract with Issuers In the last few years American Express and Discover Novus have attempted to expand their networks by convincing other entities including banks to issue cards on their networks In the United States those efforts have been stymied by Visa and MasterCard rules that prohibit all member banks from issuing cards on the American Express and Discover Novus networks

Visa Adopts Bylaw 2 10 e In 1991 Visa U S A s Board of Directors adopted Bylaw 2 10 e which states that the membership of any member shall automatically terminate in the event it or its parent subsidiary or affiliate issues directly or indirectly Discover Cards or American Express Cards or any other card deemed competitive by the Board of Directors Visa has asserted that it adopted Bylaw 2 10 e to prevent Discover Novus and American Express from becoming card issuing members of Visa by acquiring member banks as Discover attempted to do in 1990 As written however the bylaw also prohibits all independently owned Visa member banks from issuing cards on the American Express or Discover Novus networks Bylaw 2 10 e prohibits Visa s member banks from issuing cards on any network that is deemed competitive by Visa s Board But Visa s Board has not deemed MasterCard to be a competitor and Visa s member banks may thus issue cards without restriction on the MasterCard network The bylaw applies only to American Express and Discover Novus the networks not controlled by the member banks By 1994 American Express and Discover Novus had begun to pursue a number of competitive initiatives to strengthen their networks including arrangements with certain banks in the United States to issue cards on the American Express or Discover Novus networks in addition to the Visa and MasterCard networks Visa U S A s Bylaw 2 10 e has effectively precluded member banks in this country from issuing American Express or Discover cards MasterCard Adopts Competitive Programs Policy In May 1996 American Express through its Chairman publicly announced its intention to contract with banks to issue American Express cards Unlike Visa MasterCard at that time had no rule that prohibited its member banks from issuing cards on other networks American Express thus focused its efforts on banks that primarily issued MasterCard Many banks expressed interest in American Express s proposal and within a month discussions commenced between American Express and a number of banks MasterCard learned of some of these negotiations At its June 1996 meeting the MasterCard U S Board adopted a policy that mirrored the Visa bylaw MasterCard s policy on competitive programs provides that

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With the exception of participation by members in Visa which is essentially owned by the same member entities and Diners Club and JCB members of MasterCard may not participate either as issuers or acquirers in competitive general purpose card programs At the meeting in which MasterCard adopted the policy the board considered the American Express proposal to partner with member banks and concluded that the newly adopted policy would prohibit member banks from issuing American Express cards

The Exclusionary Rules Restrain Competition in the United States Following adoption of the MasterCard policy those banks that had been negotiating with American Express terminated the discussions The banks were not interested in issuing American Express cards if doing so would require them to forfeit their right to issue both Visa and MasterCard the two dominant general purpose card brands In addition Visa s Bylaw 2 10 e and MasterCard s competitive programs policy would prohibit a bank that issued American Express or Discover cards from accessing the wide array of other Visa or MasterCard products and services including the Plus and Cirrus ATM systems and the associations point of sale debit cards that can be used to make purchases from merchants with funds deducted directly from the cardholder s bank account In these ways the rules raise the cost to a member bank of issuing American Express or Discover Novus credit cards to high levels and make it practically impossible for American Express and Discover Novus to convince banks the most experienced and skilled card issuers and the only entities that hold the demand deposit accounts of most consumers to issue cards on their networks The current presidents of both Visa U S A and MasterCard s U S Region have said that were it not for the exclusionary rules some of their member banks in the United States would issue American Express cards In addition in 1997 the former Chairman of MasterCard International and then Chief Executive Officer of a bank that was among the top ten general purpose card issuers testified that eliminating Visa s and MasterCard s exclusionary rules in the United States would force MasterCard and Visa to compete more intensely for the affection of the members This increased competition between the networks for banks card issuing resources as well as competition among the banks to offer additional card brands would spur the development and implementation of higher quality and lower priced network products and services In addition consumer choice would be enhanced by eliminating the exclusionary rules Consumers would have access to new general purpose cards that would combine the network attributes of American Express or Discover Novus with the card issuing attributes of individual banks For example a consumer would have the option of obtaining American Express and Discover Novus network cards from an institution that also offers other banking products such as a demand deposit checking account or a Visa or MasterCard card Finally eliminating the exclusionary rules would benefit consumers by enhancing the competitive effectiveness of Visa s and MasterCard s smaller network competitors thereby enabling those networks to compete more vigorously against Visa and MasterCard For example Visa U S A s former Executive Vice President of Market Development testified in Page 16 Michael R Baye

1997 that issuing through banks would help a competitive network to obtain additional volume and thereby realize lower costs and better economies of scale Without ubiquitous merchant acceptance of its cards a card network cannot compete fully and effectively with Visa and MasterCard To ensure ubiquitous acceptance throughout the United States a card network needs a substantial market share Without issuance by some Visa and MasterCard member banks a network could not as a practical matter maintain the necessary minimum market share Visa s internal documents reveal that allowing competitive networks to issue cards through Visa member banks would increase competition For example Visa documents state that the member banks are a huge and effective distribution network that through partnerships with Visa member banks competitor networks would threaten to rapidly erode Visa s merchant acceptance advantage and banks issuing a competitor s cards would strengthen the competitor s other products commercial cards traveler s cheques stored value cards MasterCard s internal documents similarly acknowledge the importance of banks to the effectiveness of competition from other networks For example MasterCard documents state that member banks possess powerful distribution channel capabilities for new products and that by issuing through banks competitor networks would obviously build revenue to reinvest back into the business probably continuing to open up new acceptance channels that they do not perceive Visa or MasterCard to be dominating Competition Has Increased Outside the U S Where the Exclusionary Rules Do Not Apply In 1996 both Visa and MasterCard responded to American Express s worldwide effort to convince banks to issue cards on the American Express network Both associations considered whether to adopt a worldwide rule mirroring Visa U S A s Bylaw 2 10 e that would prohibit member banks from issuing cards on the American Express and Novus networks Visa s management concluded that Visa could compete effectively without an exclusionary rule and told Visa s International Board member banks that it was not necessary to prohibit banks from issuing competitive cards MasterCard s management reached a similar conclusion and both international boards then delegated authority to each region to decide for itself whether to prohibit member banks from issuing cards on the American Express and Discover Novus networks Aside from the United States and Canada where each bank may issue only one card brand no Visa or MasterCard regional board has adopted a rule prohibiting banks from issuing other networks cards In several countries where the rule has been considered competition authorities have objected to the rule and expressed concern that such a rule would have anticompetitive effects In more than a dozen foreign countries American Express has successfully contracted with Visa and MasterCard member banks to also issue cards on the American Express network In many of these countries Visa and MasterCard have responded by introducing new products and services For example Visa International s European Region implemented an aggressive set of competitive initiatives shortly after its regional board rejected an exclusionary rule analogous to Bylaw 2 10 e These initiatives included product Managerial Economics and Business Strategy 5e Page 17

enhancements increased network support for the Visa Gold card and co branding deals and improved merchant services MasterCard responded in a similar fashion after Puerto Rico s largest bank Banco Popular decided to issue American Express cards Puerto Rico is part of MasterCard s Latin American Region which rejected a strict prohibition on banks issuing American Express cards After Banco Popular informed MasterCard of the bank s deal with American Express the President of MasterCard s Latin America Caribbean Region told a Banco Popular executive that MasterCard will strive try even harder to be competitive by improving the service and attention provided to Banco Popular in order to assure that the bank continue s the expansion of its MasterCard business Visa and MasterCard Potentially Impede Other Networks Ability to Provide New General Purpose Card Products Visa Bylaw 2 10 e and the MasterCard competitive programs policy also could reduce network competition in developing new general purpose card products These products which will retain the core characteristics of ubiquitous acceptance and deferred payment options will integrate additional functionalities such as debit and stored value A strategy document presented to the MasterCard Executive Committee explained that By utilizing a multi application operating system our members also have the ability to use the chip technology to create relationship cards allowing their customers to have credit debit and stored value resident on a single card with a choice of payment type at the point of sale In a 1995 proceeding before the Federal Trade Commission Visa International s Executive Vice President and General Counsel agreed stating that The payment engine I foresee is a chip card which will have all your relationships on it As a practical matter only banks that hold consumers demand deposit accounts can provide this type of general purpose card Such a card is likely to play a critical role in network competition in the future The associations rules might substantially diminish competing networks ability to develop general purpose card products including products that incorporate debit or stored value functionality For example a consultant for one bank that was considering whether to issue American Express cards reported that American Express is not positioned to tap into the burgeoning debit card market and it faces an increasing challenge in the rapidly evolving payment systems industry factoring in the reach of thousands of Visa MasterCard issuers But With its platform of core deposit relationships the report concluded the bank could assist American Express in establishing successful debit card programs

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Michael R Baye