The Global View: Payment Cards Unbound

  For years, MasterCard and Visa pretty much determined payment card rules and pricing. Egged on by increasingly large and aggressive merchants, regulators and courts around the world are rewriting the rulebook, opening the door for new alliances, technologies and marketing strategies.
  The rules of the credit and debit card game are changing as regulators and courts around the world trim the power of Visa International and MasterCard International. That is likely to mean lower fees for merchants and less revenue for card-issuing banks, along with greater freedom for a wider variety of players to innovate in the payments arena.
  Driving the changes are big merchants, notably U.S.-based Wal-Mart Stores Inc., that are pressing for lower fees for accepting credit and debit cards. Merchants are winning most of those battles, and those victories are inspiring them to push harder for concessions from the two major payment networks, MasterCard and Visa.
  Retailers have already won rulings forcing down the fees they pay in the United States, United Kingdom and Australia, and for cross-border transactions in the European Union. The rulings have also loosened Visa and MasterCard rules that limited merchants in terms of the cards they accept and the fees they charge consumers.
  These rulings, and those likely to follow, will force Visa and MasterCard to operate and compete in new ways, some observers say.
  For instance, with greater freedom to partner with issuers, a competing network like American Express Co. could woo banks with new technology and creative marketing. AmEx already convinced Visa's largest Canadian issuer, CIBC, to issue its first smart card under the American Express brand, the Entourage card introduced last year.
  The shift in card pricing to the benefit of merchants means less revenue for issuers. And that could force them to charge consumers more. A case in point is Australia, where regulators forced down interchange by 40% last year and banks followed by raising their credit card fees an average of around 50%.
  Issuers may also cut back on costly loyalty programs, such as air miles, if interchange is forced down. Consumers may also find themselves paying fees for using a credit or debit card as rules against card surcharges are lifted, potentially putting a damper on card use.
  'Wakeup Call'
  MasterCard and Visa executives have taken note of these widespread developments.
  In a speech last June to the annual meeting of MasterCard Europe, Robert Selander, MasterCard's chief executive, warned his members that "these legal and regulatory challenges are among the most significant threats I can imagine."
  "Essentially, I was placing a wakeup call," Selander said in a recent interview with CCM's sister magazine Card Technology. "I don't believe the industry has done as good a job as we need to do in communicating the value we bring."
  He says making that case is more critical now that dominant merchants have emerged in many parts of the world that are demanding with greater force that regulators reduce card-transaction fees. "And regulators can't ignore that," Selander says.
  He says MasterCard's response has been to offer new technologies, such as radio-frequency-based contactless cards that make transactions faster at merchants like fast-food restaurants where convenience is key. And, he says, MasterCard executives "are directly engaging merchants in ways we haven't in the past and ensuring they understand the structure of interchange."
  Both MasterCard and Visa emphasize that their global payment networks-in which more than 1.6 billion Visa- and MasterCard-branded credit cards alone are accepted by more than 20 million merchants-have made payments more efficient and stimulated economic growth. A recent Visa International report, for instance, cited studies suggesting that electronic payments cut payment costs by at least 1% of a country's total economic output compared with cash and checks, and that a 10% increase in card purchases boosts consumer spending by 0.5%.
  Regulators have generally accepted the notion that the Visa and MasterCard networks increase economic efficiency and for years gave the associations wide latitude to set rules and pricing. But that is changing. Besides the pressure from merchants, there is the fact that credit and debit card networks are well-established in industrialized countries, which weakens the argument that the Visa and MasterCard rules are needed to guarantee there is enough profit in credit and debit cards to ensure needed investment in these networks.
  More regulatory rulings are coming, and most observers believe they will continue to go against Visa and MasterCard, perhaps even more forcefully than earlier decisions. As a recent report from the EuroCommerce merchant association put, "Each decision by a competition authority in turn has gone further than the last without the collapse of the system." Some regulators are even talking about eliminating interchange (box).
  And pricing is just part of the story. The rulings in various jurisdictions have struck down a series of important operating rules. Here is a snapshot of some of those rules and how the legal actions are likely to affect the market:
  * Honor All Cards. These are rules that required merchants in the United States to accept debit cards with the Visa and MasterCard logos, if they accept those brands' credit cards. They effectively forced merchants to accept debit cards that required only a cardholder's signature, in addition to the much lower-priced debit cards that are authorized with a personal identification number, or PIN.
  The rules fell victim last year to the settlements of a class-action lawsuit on behalf of U.S. retailers, led by Wal-Mart, the world's largest merchant. Following the settlements, Wal-Mart announced it would no longer accept signature-based MasterCard debit cards and negotiated a much-reduced interchange on signature-based Visa debit cards. According to analyst Kenneth Posner of New York-based Morgan Stanley, Wal-Mart's signature debit rate is on a par with PIN-based debit, a roughly 50% reduction. (Neither Visa nor Wal-Wart will discuss terms.) Posner notes other large retailers are also pursuing favorable interchange deals while some opted out of the Wal-Mart settlements and are pursuing better deals in court.
  The demise of the honor-all-cards rules also could spur merchants to challenge their obligation to accept other types of cards that carry higher fees, notably commercial cards issued by banks for corporations to handle travel-and-entertainment and procurement expenses. The European Commission, however, upheld Visa's honor-all-cards rule and other rules in its August 2001 decision that forced a reduction in Visa's cross-border interchange. Merchants are pressing for a more sweeping attack on MasterCard's rules in an important decision due this spring from the United Kingdom's Office of Fair Trading on MasterCard's U.K. interchange rates.
  * No Surcharges. The associations generally prohibit merchants from charging consumers for paying with cards, because such fees would discourage card use. The Reserve Bank of Australia rejected that no-surcharge edict in an important 2002 ruling that also forced down interchange fees substantially.
  It's not clear, however, that many merchants would risk consumer disfavor by charging for payments with plastic. Robert Hunt, an economist with the Federal Reserve Bank of Philadelphia, notes that in Sweden and the Netherlands, two countries that passed laws allowing surcharges in the past decade, only about 10% of retailers impose the fees.
  * Brand Exclusions. Visa and MasterCard have prohibited U.S. members from issuing such other brands as American Express and Discover. A federal court struck down that rule in 2001 in an antitrust case filed by the U.S. Department of Justice. That ruling was upheld on appeal, and Visa and MasterCard are taking their case to the U.S. Supreme Court.
  MasterCard's Selander says banks that will want to promote a competing brand will be "few and far between." But one of MasterCard's largest U.S. issuers, MBNA Corp., has said it will offer American Express cards if the lower-court ruling is upheld on appeal, as many observers predict.
  This ruling only applies to the United States, as AmEx can form partnerships with MasterCard and Visa issuers elsewhere. In fact, AmEx has such partnerships with about 80 issuers worldwide.
  * Only Banks Need Apply. Both Visa and MasterCard were created by banks and have limited membership to regulated financial institutions. But the Reserve Bank of Australia this year forced the associations to open their doors to nonbanks, raising the possibility of such major merchants as Wal-Mart, France-based Carrefour or the U.K.'s Tesco to becoming major players in Visa and MasterCard.
  "It seems to us there is scope for well-managed companies to come into the Australian cards market," says an official at the Reserve Bank of Australia who spoke on the condition that he not be named. "The whole point of our intervention is to make the market contestable."
  He notes that merchants have allied with major issuers to offer cobranded credit cards, such as U.K.-based Virgin Group introducing its Ozzie card last year in cooperation with Westpac, one of Australia's four dominant banks.
  "But we want Virgin and similar companies to have the option of doing it themselves," the regulator says. "This would mean that if Virgin didn't like the deal offered by Westpac they could go it alone."
  The idea of joining Visa and MasterCard, and particularly sitting on their boards where he could have full access to the cost data used to justify interchange, appeals to Nick Mourant, group treasurer of Tesco, the world's eighth-largest retailer according to Retail Forward Inc.
  "Both Visa and MasterCard are acting as a cartel," Mourant says. "We would be interested in being on the boards of the associations. It would help to provide transparency on the make-up of interchange."
  As with many of these issues, the impact of such a decision beyond Australia will vary by region, as Visa and MasterCard both have regional boards that set many of their own rules. In the United States, for instance, retailers like Target Corp., Nordstrom Inc. and others own banks, issue cards and participate in Visa and MasterCard as members.
  But, given the fact that regulators in so many markets are taking a close look at the Visa and MasterCard rules, there is no region that will be untouched by the general trends toward a bigger merchant say in pricing and more freedom for all parties in the payment card arena to set their own policies.
  How will MasterCard and Visa respond to this new, more level playing field? Top executives at both organizations emphasize plans to build on their strengths, their global networks, by expanding into merchant categories such as fast food that are mostly cash-only today, and into untapped countries, such as Russia, India and China.
  They point to the special importance of their brand when cards are new to consumers and merchants. "The trusted Visa brand, particularly in new areas, is of great value to our members," says John Elkins, executive vice president for global brand and marketing at Visa International.
  To be sure, no one believes Visa or MasterCard are going away. There are no comparable networks with their global reach. And the important role payment cards played in recent years in enabling Internet shopping-more than 95% of online purchases in the United States are made with payment cards-only reinforces the utility of such global networks.
  Fewer Restrictions
  At the same time, it's clear that Visa, MasterCard and the big issuers that are their major backers no longer dominate payments as they once did.
  "Twenty years ago, who was as big as Visa and MasterCard?" asks Hunt, the Philly Fed economist, who emphasized he was offering his own opinions, not those of the U.S. central bank. "Today, you've got some merchants big enough where Visa and MasterCard don't seem so large any more."
  The playing field is increasingly level. More players will be allowed to play with fewer restrictions. There will be fewer barriers to new technologies and marketing strategies. Let the games begin.
  Donald Davis is editor of Thomson Media's Card Technology magazine. He can be reached at don.davis thomsonmedia.com.