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

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

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

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

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

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

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.