A Shakeup in Australia's Card Market

  Regulators and card companies around the world are closely watching the Reserve Bank of Australia's reform of the country's credit card market. Yet the results so far are perhaps not what the central bank originally intended.
  New RBA rules are designed to make the costs of credit card acceptance more transparent for merchants ("Interchange Under Attack," November 2002). Since Jan. 1, merchants have been allowed to surcharge customers for credit card transactions in a reversal of Visa International's and MasterCard International's rules banning surcharges. Yet few retailers seem prepared to risk alienating customers by imposing surcharges.
  Also, banks are pushing up credit card annual fees in compensation for the 40% cut in interchange fees that the RBA will introduce in October. Finally, there has been very little interest from non-banks in the RBA's new rule allowing them to join the card associations and issue credit cards.
  In fact, the biggest gainers could be American Express Co. and Diners Club, which have largely escaped unscathed from the RBA's reforms, along with foreign entrants and smaller domestic issuers which are not hamstrung by the costly loyalty schemes that the big banks run.
  "The reforms may result in consumers making increased use of cash or debit cards at the expense of credit cards," says Grant Halverson, managing director of Australia's McLean Roche Consulting Group. "Also, as issuers put up card membership fees, consumers are likely to rationalize the number of credit cards they hold."
  With a population of almost 20 million, 10 million credit card accounts and about 14 million credit cards in issue at the end of 2002, Australia is the sixth-largest credit card market globally. Credit cards represent an attractive method of payment for Australians as most domestic cards are linked to frequent-flier schemes.
  Aussies Like Credit Cards
  "People tend to put as much of their spending as possible on their credit cards to maximize their points," says Alastair Hunter, an analyst at Australian brokerage JB Were. "Also, in Australia, consumers pay a 25 to 50 Australian cent transaction fee every time they use a debit card, while there is no charge for using a credit card, apart from an annual membership fee."
  About 8% of credit cards are issued under the Bankcard domestic brand, which is owned by the Big Four banks: Westpac, ANZ, Commonwealth Bank of Australia (CBA) and National Australia Bank (NAB). The Visa and MasterCard brands account for the remainder of the market.
  AmEx now has 1.3 million charge cards in issue in Australia, while Diners has 320,000. Japan-based JCB has merchant locations in cities visited by Japanese tourists, but it does not issue cards in Australia.
  The RBA's removal of the no-surcharging rules only applies to Visa and MasterCard. AmEx and Diners voluntarily agreed to remove their bans on surcharging, while Bankcard does not restrict merchant pricing.
  The RBA plans to cut the interchange rates set by Visa and MasterCard from around 0.95% of the sale at present to 0.55% to 0.60%. It also intends to scrutinize debit card interchange fees.
  The RBA says merchant service fees (MSFs, or discount rates) on credit cards currently cost retailers A$1.5 billion a year, with interchange fees totaling around A$750 million in 2002.
  "The RBA's move to cut interchange by 40% is drastic, especially when compared with the European Commission's ruling that Visa EU must gradually reduce interchange on cross-border credit card transactions from 1% in 2001 to 0.7% by 2007," says Helen Smith, a card-industry analyst at Datamonitor in London.
  The interchange cut is expected to result in lower MSFs that the RBA hopes will, in turn, result in lower prices in stores. However, Visa and MasterCard are challenging the RBA's action in court. A hearing in Australia's Federal Court is set for May.
  "We see the reduction in interchange as giving a significant advantage to AmEx, which has come out of this process unregulated as regards to interchange and can continue to charge retailers what it likes," a Visa Australia spokesperson says. "Also AmEx will be able to tempt Visa member banks with the prospect of swapping their Visa cards for AmEx cards because of the higher interchange on AmEx transactions. The banks have made no secret of the fact that they are talking to AmEx."
  American Express Australia Chief Executive John Steward is bullish about his firm's prospects in the new operating environment, noting that AmEx added a record number of new Australian cardholders in 2002. He sees additional growth in 2003 through new partnerships with companies and professional organizations.
  Visa believes that Diners and store card operators also could gain an unfair advantage from the RBA as they, like AmEx, are exempt from its ruling on interchange.
  In January, Visa took out advertisements in Australian newspapers to alert consumers to their rights in the new era of credit card surcharges. It also has produced an ad for merchants telling them what they are legally required to do if they decide to surcharge.
  Risks
  Visa worries about a backlash against credit cards by consumers unwilling to pay a surcharge. "Our research suggests that consumers are strongly opposed to surcharging," the Visa spokesperson says. "Almost 70% of the consumers we spoke to say they would avoid fee-charging merchants. We have a clear message to merchants: consumers do not like surcharges. If merchants do decide to surcharge, they risk losing their customers."
  Yet Visa may not need to fret. An AC Nielsen survey published in mid-January revealed that only 3% of 1,400 survey respondents had been surcharged for using their credit cards since Jan. 1. The survey did find that 39% of credit card holders would prefer to pay by cash if a fee for credit cards applied, but only 4% of cardholders said they would pay by debit card or check.
  While some observers believe retailers in smaller cities and rural areas might surcharge because of lack of competition, Mike Ebstein, principal of Australian cards consultancy MWE Consulting, disagrees.
  "Many retailers have stated that they will not pass on a surcharge as they don't want to jeopardize possible transactions," he says. "In reality, most retailers appreciate that the net cost of accepting credit cards is somewhat less than the fee applied by their bank. The absence of bad debts, same-day settlement, generation of impulse sales, higher average ticket sizes, and no need to count the cash and do the banking are recognized as benefits of credit card payments."
  JB Were's Hunter disputes the RBA's claim that retailers will respond to lower credit card MSFs by cutting prices. "The logical step would have been for retailers to offer a discount for people paying cash," he says. "In practice, consumer prices will not fall as a result of the RBA's changes, but merchants will keep the surcharge without removing the cost of card services that is already built into their prices."
  Warning to AmEx
  Hunter speculates that small retailers may offer discounts for cash, as they typically face higher MSFs than larger retailers. "Small businesses get hit for a 2% to 5% fee on credit cards," he says.
  The Visa spokesperson says that, "in general, the major retailers won't surcharge, and the smaller ones will wait and see. One sector which will definitely surcharge is travel agents."
  Both Woolworths and Coles Myer, Australia's largest retailers, say they would rather not surcharge. "Our preference is not to surcharge our customers, but we'll watch with interest what unfolds in the marketplace," a Coles Myer spokesperson says.
  But a spokesperson for the Woolworths supermarket and discount department-store group suggests that non-bank issuers such as AmEx and Diners, which are not subject to the RBA-mandated interchange cut, might face surcharging if there is too much of a gap between their MSFs and those charged by banks. Woolworths cites research indicating that 70% of AmEx cardholders in Australia also have another type of credit card.
  'Softer Approach'
  "This means that they do have an alternative to AmEx," the spokesperson says. "Also, people tend to use their debit cards for grocery shopping, so surcharging shouldn't be much of an issue in our supermarkets. The problem will mostly arise in our discount department stores, where people typically use credit cards for buying more expensive items."
  Meanwhile, Caltex, one of Australia's top four oil companies, said in early January that it would surcharge at its gas stations. But following an outcry in the press, Caltex backed off and said it would not impose surcharges at its own gas stations, although franchisees could. As of mid-February, it was unclear how many had done so.
  Last November, the Qantas airline, which holds 80% of Australia's air-travel market, announced that it would surcharge credit card customers. "Now Qantas seems to be taking a softer approach, as it says it is reconsidering the issue and will make a decision as to whether to surcharge," the Visa spokesperson says. "Qantas does have a captive market, who will have no choice but to put up with surcharges if it does decide to go this route. This is because it does a lot of its business over the Web and the phone, which are channels where you cannot use a debit card."
  The Australian Financial Review said in January that "there are early signs that retailers intend to use new powers to surcharge credit card users selectively to drive card spending onto the retailers' own card products." This could mean Qantas exempting holders of its cobranded Qantas ANZ Visa card from surcharges imposed on other cards, for example.
  Starting in July, non-banks will be able to register as specialized credit card issuers and join Visa, MasterCard or Bankcard. No non-bank entity has so far admitted to any plans to issue credit cards in its own right, although Coles Myer and Telstra, Australia's largest telecom operator, had lobbied the RBA for the right to do so.
  Woolworths already has a credit card through its EzyBanking partnership with CBA, which runs the card program. GE Capital issues private-label cards for Coles Myer, but Macquarie Research Equities analyst William Ammentorp believes the retailer is interested in a cobranded product.
  Compounding the pressure on financial institutions, Qantas is now charging banks more for buying miles for their loyalty programs.
  "The impact of reductions in interchange revenue and increases in the cost of frequent-flier points will cut ANZ's Australian credit card net after-tax profit by around A$40 million per annum from fiscal 2004," says an ANZ spokesperson.
  Hunter estimates that the impact of the reforms on CBA will be to reduce that bank's net after-tax profits by A$25 million a year. The effect on NAB will be around A$20 million a year.
  A Westpac spokesperson says that the bank expects to see an A$30 to A$40 million annual cut in net post-tax income from 2004 as a result of regulatory changes to its income from credit and debit card interchange. Westpac has yet to decide whether to increase annual fees.
  ANZ and CBA, Australia's two largest credit card issuers, raised annual fees starting Jan. 1. ANZ has increased fees by an average of 48%, while CBA has put up fees by around 32%. In addition, ANZ has introduced an A$55 fee for add-on Qantas ANZ Visa cards.
  In January, ANZ lost a major revenue source when Qantas appointed CBA as its domestic merchant acquirer in a four-year deal worth A$100 million. The Australian Financial Review claims that CBA and Qantas are also talking about launching a cobranded credit card.
  One impact of the RBA's reforms is likely to be consolidation among smaller players in Australia's credit card market. Gordon Wheaton, executive vice president for Visa Australia and New Zealand, says that he recently was told by several members-believed to be credit unions with small card portfolios-that they were likely to withdraw from the credit card business because of the RBA's reforms.
  Small issuers can expect to obtain a premium for their portfolios, judging by the price paid by AmEx for fund manager and insurer AMP's Australian and New Zealand credit card business in January. AmEx paid A$326 million for AMP's portfolio of 162,000 AmEx-branded cards, A$30 million above book value.
  Growth Slows
  Even before the RBA's reforms take full effect, the credit card market had begun to experience a slowdown in growth (chart, page 20). Halverson of McLean Roche Consulting warns that the issuers most under pressure are those with expensive loyalty programs, particularly because many cardholders are transactors-people who do not revolve their balances and therefore, do not pay interest.
  "In 2001, credit card spending totaled A$106 billion, while receivables were only A$21 billion," he says. "The costs to issuers of maintaining credit card rewards programs have increased three-fold since 1991."
  Halverson also notes that after September 2001, when Australian airline Ansett collapsed, Qantas diluted the value of the frequent-flier points awarded to credit card customers by 28% and introduced blackout periods for major holidays.
  Faced with devalued loyalty points, changes in credit card rewards, increases in annual fees and possible surcharging, Australian consumers seem poised to review their use of credit cards.
  "It is very unlikely that Australian consumers will continue their high use of credit cards as transaction vehicles," Halverson says. "In 2003, I would expect to see reduced credit card spending and lower credit card numbers as cardholders rationalize their cards. This will be offset by increased debit card use by consumers and increased cash and check use by small and medium businesses.