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DOJ Gets No Credit For Visa Complaint: Case Will Stifle Bank Card Innovation

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The specter of the U.S. Department of Justice as "social engineer" -- seeking to shape markets into a narrow and static mold of competition -- is threatening consumer welfare.

Antitrust advocates claim to be protecting consumers from anti-competitive practices. Yet consumers benefit from creative institutional and technological change and are likely to be injured by politically imposed restrictions on such change, especially when the restrictions favor particular competitors. Trustbusters' vision of the market as a static snapshot of yesterday could well frustrate the creative search for innovations tomorrow.

In its recent antitrust actions, the DOJ seems to be focusing its attention on firms that operate in dynamic and rapidly changing markets, have innovative distribution systems, and are technology-based in their products and services. Increasingly, too, satisfying the demands of competitors, at the expense of consumers, seems to be a principal factor governing antitrust suits.

With all the attention focused on the antitrust suit against Microsoft, last month the DOJ dealt a blow to another type of system heavily dependent on technology: It charged two major credit card systems, Visa and MasterCard, with antitrust violations.

The suit, filed Oct. 7, 1998, alleges that the two networks of credit card issuers cooperate rather than compete, and that, by not allowing their members to offer cards of rivals, American Express and Dean Witter Discover, they are locking out competition in the credit card industry, restricting consumer choice, and deliberately blocking innovations that could benefit consumers. The DOJ charges that consumers are hurt because they don't have a broader range of credit card choices and because they haven't been provided with product and service innovations quickly enough.

Yet consumers actually are benefiting from intense competition that has "democratized" consumer credit, and the DOJ's micromanagement of the card market is likely to have widespread unintended consequences that could disrupt the continuation of these consumer benefits.

The concerns of the DOJ, if valid, cry out for private solutions rather than the heavy hand of government trustbusters.

What's ironic about the DOJ's charge that there's not enough consumer choice in the credit card market is that bank card issuers are regularly castigated for providing consumers with too many choices. Last year, about three billion credit card solicitations were sent to consumers --- a marketing technique that some consumer groups termed excessive.

During the recent debate on bankruptcy reform legislation, for example, consumer groups assailed card issuers for creating the problem by making credit card too available. On Dec. 16, 1997, the Consumer Federation of America headlined a press release: "Credit card debts escalate in 1997, burdening many Xmas shoppers --- aggressive marketing and credit extension a key reason."

In fact, competition is alive and well in the credit card industry, despite the DOJ's claims.

Nearly 7,000 credit card issuers compete aggressively to gain new customers and to retain their current ones. Every day the mailboxes of average Americans are stuffed with card offers that promise lower interest rates, no annual fees, special rebates, frequent flier miles, and other enhancements. On the high end, application forms for gold and platinum cards try to show why those prestige cards have greater value.

As of the end of June 1998, credit card debt outstanding totaled $527.5 billion. Twenty-five years ago, in the fledgling years of bank card systems, that amount was about $10 billion, and fewer than 2,000 banks offered those plans.

Distorted View

The DOJ also alleges that since Visa and MasterCard have the same financial institutions as members and share the same banks in their governing structure, they don't really compete against each other. Their joint market share of the credit card industry is about 75 percent --- a level that shows market concentration, the DOJ says.

But this charge reflects a distorted view of credit card competition. Consumers don't get their bank cards from Visa or MasterCard but from thousands of financial institutions that compete aggressively in offering significantly different products and services under the emblems of the card systems.

That distinction between card issuers and card systems is a critical one. In the U.S. today there are four main general purpose charge card systems --- Visa, MaterCard, American Express, and Dean Witter Discover Card. These are the systems that provide the technology and networks to authorize, validate, and process transactions; provide security for the transactions; sign up merchants to accept the cards; and promote the brand names, among many other things.

But there is a difference among these four systems. While American Express and Discover Card operate their own systems, they also issue cards and market them directly to consumers. In contrast, Visa and MasterCard are systems only. They provide the networks for their member financial institutions, including marketing the brand names. It is those banks, credit unions, and savings and loans (community banks) that design specific attributes of their cards, set credit criteria, and directly market and issue their credit cards to individuals.

Currently, more than 6,000 financial institutions are members of the Visa system, and MasterCard has about the same number. Many of the banks belong to both organizations and issue both MasterCard and Visa cards, a concept known as "duality."

Thus, in terms of showing that the structure and operations of Visa or MasterCard are limiting consumer choice, the DOJ charge is ludicrous.

Axes to Grind

The DOJ, however, has further access to grind. It notes that the bylaws of the two bank card systems do not allow the card system rivals to join with Visa or MasterCard member banks in offering their cards. To do so would mean that the member banks would forfeit their bank card system membership.

That provision causes much pain to American Express and Dean Witter Discover. Discover went to the courts, but failed to get the rule struck down, while American Express has gone to member banks to try to convince them that joint marketing of American Express cards would be good for them.

American Express' CEO Harvey Golub has put it bluntly to banks: They would make more money, he says, if they could issue his company's card.

Since the main American Express card is a "convenience" card, not a credit card, the balance must be paid in full when the bill is received.

At a May 2, 1996, forum in Atlanta, Golub told banks that by offering the American Express card, they could get rid of those card users who don't carry a credit balance, and thus the banks could reap higher profits. Said Golub to the bankers: "[Y]ou would realize the economic benefit of shifting your convenience customers to a network designed to meet their needs. Convenience spending has always been significant in size and a loss economically for banks." One can only speculate the banks' higher profits would come from the pockets of those convenience users as a result of the higher annual fee that American Express charges.

It's clear why rivals of Visa and MasterCard may want to join up with banks, not only for the larger distribution system and more customers for their cards, but also to take part in the debit card explosion and the rollout of "smart" cards.

But since the bank members of Visa and MasterCard are also the owners of those systems, if they want to change the bylaws so that they could offer other branded cards, they probably can do so.

Even if the two systems are "dominated" by large bank card issuers, as is charged by the DOJ and American Express, a successful revolt against the bylaws shouldn't be difficult. Banks that consider themselves disadvantaged can try to change the rules with Visa and MasterCard. Private solutions should be tried before enlisting the trustbusting might of the Justice Department.

A further argument of the Justice Department is that entry into the card system market is extremely difficult and costly. A firm would have to establish a technology network for processing, sign up merchants to accept the card, and market the card to individuals and groups. That claim is belied by the fact the Dean Witter's Discover Card was a start-up operation only about 14 years ago, and already has more merchant establishments that accept it in the United States than does American Express. With an estimated 3.1 million merchants, the "new kid on the block" is closer to the 3.4 million merchants that accept Visa and MasterCard than to Amex's 2.5 million merchant outlets.

Of course, when Discover was introduced, it was owned by Sears, Roebuck & Co., which had a huge base of its own retailer's credit cards to mine and market. That did give Discover an edge. Yet in today's world of financial mergers and acquisitions and the sophisticated systems technology in the financial sector, it's likely that mergers and joint ventures will produce new competing systems.

And what about possible unintended consequences on consumers if the Justice Department prevails? Since banks with large credit card portfolios would essentially have to choose between the Visa and MasterCard systems, and since Visa has the largest volume, it's possible that more large banks will move to Visa. This could result in fewer options and choices for consumers and a less vibrant credit card market.

Justice Department lawyers argue that the two bank card systems could have innovated much more than they did, as noted in Item 83 of the suit: "The 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 management."

Hmm. That's an interesting argument --- that the DOJ knows that Visa and MasterCard are guilty of anti-competitive behavior because unknown products and services didn't emerge. Now, if unknown products did emerge, how would the lawyers recognize them?

Justice lawyers also contend that the two systems' cozy relationship deliberately held them back from developing competing "smart" cards, secure systems for Internet transactions, and corporate cards. Other plausible explanations --- such as complex technological problems and government encryption restrictions --- are not considered. Also omitted is the argument that the bank systems' knowledge that American Express held about 70 percent of the corporate card market probably had a somewhat chilling effect on the development of their own corporate cards.

Another example the DOJ cites to show anti-competitive effects is that Visa and MasterCard did not attack each other in their advertising, while they did attack American Express. This kind of charge is silly. Both bank card systems advertise extensively. According to the DOJ complaint, advertising represents about one-fourth of the expenses of each association in the United States, and advertising itself is a form of competitive behavior. For the Justice lawyers to decide what types of messages the systems should use in their ads represents a big stretch of government involvement in business decisions.

Underlying its complaint is Justice's assumption that the future of the credit card market is shaped by present trends. The DOJ focuses on the critical need for issuers to become part of the evolution of the credit card to a multipurpose card and thus to be able to take part in the payments system of tomorrow. Is that the look of the future? Possibly. With the mushrooming growth of electronic commerce and the innovative players that it has already spawned, however, the future could be entirely different. Payments systems are about transfers of information, not transfers of paper. The Internet already deals with the storage and flow of massive amounts of information. And those information flows don't recognize institutional boundaries.

It's likely that the future evolution of the payments system could be led by players not yet in the game. It's not clear what the world of tomorrow will look like, as the barriers to development of alternative payments systems are dropping dramatically. As David Murray of the Washington-based Statistical Assessment Service noted in another context: "The path to the future always looks clear to the nearsighted. But we never know what potholes and detours lie just over the horizon."

These are some of the reasons why the Justice Department action against Visa and MasterCard is misguided and myopic. Consumers are the ones who benefit from the vibrant competition that exists in the credit card industry. They are the ones who would suffer if the government disrupts that market through antitrust action to mold its own view of the future. The nature and speed of institutional and technological change is misunderstood. Predicting where electronic payments systems will go in the future is a task for markets, not antitrust lawyers.