Credit Where It's Due

Is the credit card market insufficiently competitive?


In 1970, National BankAmericard Inc. emerged from the accumulating red ink of BankAmericard, the world's first bank card, which was struggling in a fiercely competitive and quickly evolving marketplace. The company that would later be renamed Visa is structured so that its member banks (also its owners) compete with each other for customers, innovating the services and terms of individual credit cards. Through their joint ownership of Visa, these banks cooperate on issues such as merchant payment systems, fraud protection and brand promotion.

"Visa has elements of Jeffersonian democracy, it has elements of the free market, or government franchising–almost every kind of organization you can think about," Dee Hock, Visa's founding CEO, told Fast Company magazine in 1996. "But it's none of them."

Visa may soon add one more element to its mix: Bill Clinton's Department of Justice. On October 7, the DOJ filed antitrust charges against Visa and MasterCard in federal court, alleging the two credit card giants, which have overlapping ownership in an arrangement referred to as a "duality," conspire to squash competition and limit innovation.

On its face, the claim that America's credit card market lacks competition is absurd. More than 6,000 banks alone compete to provide consumers with Visa. Leave town for a week, and the pile of mail awaiting you upon your return will consist of catalogs and credit card solicitations, most pre-approved with low introductory interest rates or no annual fees. "Anyone can get a credit card," says American University business historian Thomas DiBacco, "even dogs."

True to Hock's vision, banks compete vigorously to provide consumers with spending power. They vie not only with each other but also with other credit-issuing institutions. When I bought a laptop computer recently, my Visas, MasterCards, and Discover card stayed in my wallet; Best Buy financed my purchase for a year, interest free. I now have a Best Buy card to add to my Macy's, Nordstrom, and Ann Taylor store cards.

Even if you grant the DOJ's claim that Visa and MasterCard, for practical purposes, operate as a single entity, there are still plenty of sources of competition and innovation. American Express is accepted by 2.1 million merchants, and Discover by 3.1 million, just 10 percent fewer than accept Visa and MasterCard. And with a deluge of solicitations, the only reason someone doesn't carry Discover or American Express cards is because she chooses not to.

But the Clinton Department of Justice doesn't see it that way. "American consumers have lost out," Attorney General Janet Reno said upon filing the suit. "They have lost the benefit of vigorous competition between the two largest credit card networks, which means that they have not enjoyed the innovation that competition brings."

Short on innovation? My grocery shopping earns me frequent flier miles on a card I pay nothing to use. I amassed a down payment on a G.M. car I never bought with my G.M. card while subsidizing my motorcycle's gas with my Shell MasterCard. Several of my cards will insure my car rentals.But the DOJ brushes these issues aside. It has decided that Visa and MasterCard haven't come to market with the right innovations–smart cards, commercial cards, and secure transactions over the Internet. While it does not dispute that banks compete for consumers in what it labels the "downstream market," Justice contends that the cooperative governance in Hock's concoction limits innovation at the network level. The same banks now own both Visa and MasterCard, which between them have 75 percent of the market–50 percent Visa and 25 percent MasterCard. The DOJ maintains that the two titans enjoy a détente, a contention it supports with a series of executive quotes such as this one from a MasterCard executive: "It is clear that because of duality you don't see MasterCard and Visa in the marketplace attacking each other."

DOJ has also zeroed in on Visa and MasterCard's bank contracts that prohibit institutions that issue either or both cards from also issuing Discover or American Express, a practice known as exclusive dealing.

It's unclear that consumers are actually hurt. And even if we are, in some abstract sense, it is even more unclear how the government is going to improve our lot. This becomes apparent when examining the DOJ's proposed remedies: "that banks governing an association be dedicated to one particular network" and the "removal of exclusionary rules."

If the problem is exclusive dealing, then the solution is to allow banks to own or contract for any card they want, the second of the government's remedies. Exclusive deals aren't evil per se; a person's right to contract is also the right to exclude. And the economy is rife with exclusive deals. Anheuser-Busch distributorships won't deliver Coors. Nor is one likely to find Coke and Pepsi flowing from the same fountain. But exclusive deals can be anti-competitive. In fact, the government took this position in the early 1970s, when it refused to support Visa's prohibition of member banks issuing MasterCard. That this position led to the current "duality" is irony lost in the current DOJ filing.

But in the government's eyes, the real problem afflicting consumers seems to be the lack of innovation, which results from a lack of exclusive dealing. Since banks can offer both cards, Visa and MasterCard have a chance to collude. The government's solution can't be to let Discover and American Express join the collusion club. That would defeat the whole purpose.

The solution, as recognized in the DOJ's filing, is a form of exclusive dealing: Make each bank choose a card and stick with it, or at least restrict its management interests to one card. This is pregnant with unintended consequences, the most portentous of which is making Visa, which now accounts for half the market, become even more dominant, as banks choose to stick with the industry leader. That, of course, would invite more government supervision, as Visa might soon find itself in Microsoft's market-share territory.

"For the life of me I can't figure out how this is pro-consumer," David Robertson, president of the Nilson Report, which tracks the credit card industry, told The New York Times. "This is a fabulous time for card holders right now."

In the end, the suit is not pro-consumer but pro-government and pro-American Express and Discover, which long to form their own partnerships with banks and which feel that their innovations–the gold card in American Express' case and rebates in Discover's–are unfairly co-opted by the giants. The government's solution, muddled in its purpose, would only prepare the field for more government intervention. For Clinton's antitrust technocrats, who seem to know what innovations the market should produce, that may be the point.