Discover Financial Services, the No. 5 domestic credit card issuer, took a major step in November to begin playing in the U.S. debit card market. By announcing plans to buy the Pulse EFT Association for $311 million, Discover hopes to use Pulse's extensive financial-institution connections to compete with Visa USA and MasterCard International for issuance of signature-based (offline) debit cards.
With the nation's largest issuers firmly entrenched in Visa and MasterCard, however, small to mid-size financial institutions likely would experience the biggest impact of the increased competition, observers say.
Over the past few years, as other electronic funds transfer networks were being bought by publicly traded companies, Houston-based Pulse marketed itself as a financial institution-owned network that answered to banks and credit unions, not Wall Street. However, Stan Paur, who would stay on as Pulse's president and chief executive, says times have changed. And that is why Pulse's board, composed mostly of financial-institution members, approved the deal with Discover, which is owned by Morgan Stanley, a publicly traded company whose biggest businesses are investment banking and retail securities brokerages.
"The marketplace has changed," Paur says. "Increasingly, financial institutions, both large and small, have suggested that the ownership proposition is not as meaningful as it was in the past." He notes that under the terms of the Discover deal, financial institutions would continue to have product oversight and influence over network rules and policies.
David Seim, Dallas regional president of PlainsCapital Bank in Dallas and a Pulse board member, says the board in recent months had become concerned that competitive pressures could affect Pulse's ability to grow and serve its members appropriately.
"This decision was not taken lightly," he says. "At the end of the day, general consensus was that this was the best course of action to take to benefit not only large financial institutions, but also smaller member banks and credit unions."
As such, Seim believes Pulse's members will welcome the planned sale. "Once the members know the facts, they will come to the same conclusion the board came to, which is that this is in the best interest of all of us," he says. "I have a hard time understanding a downside risk to it."
If approved, Riverwoods, Ill.-based Discover would offer Pulse's members the opportunity to issue Discover-branded, signature-based debit and credit cards, says David Nelms, Discover chairman and CEO. Discover also would promote to financial institutions prepaid cards, and it would work to add Pulse acceptance at any of its 4 million U.S. merchant locations that do not accept personal identification number-based debit cards.
In March, Pulse had an 11.4% share and was the third-leading PIN-based point-of-sale debit network behind First Data Corp.'s Star and Visa's Interlink, according to CCM sister publication ATM&Debit News. Including automated teller machine transactions, Pulse was the fourth-largest EFT network overall, following Star, Interlink and Metavante Corp.'s NYCE.
Historically, Visa and MasterCard have had a virtual lock on the U.S. offline debit market. The U.S. Supreme Court, however, in October opened the market to greater competition when it let stand lower-court decisions that Visa's and MasterCard's rules that allowed banks and credit unions to issue the two associations' branded cards, but not any derived from agreements with Discover or American Express Co., violated federal antitrust laws.
Nelms says the court actions will help add innovation in the debit market. "We're just very excited about this and the potential to truly enhance the industry and bring about competition and choice," he says.
Though Discover issues 1.2 million Morgan Stanley-branded MasterCard cards in Europe, the Pulse deal would affect only the U.S. market, Nelms says.
The bank card associations' response to the Discover/Pulse deal was muted. MasterCard deferred comment until it gets feedback from its members. In a statement, Visa noted that the Discover/Pulse announcement represents another example of the changing debit landscape.
"As the marketplace evolves, Visa considers it a competitive advantage to offer our members, merchants and cardholders the benefits of global acceptance, a bank-governed network, as well as a customizable payments platform that delivers superior value," the statement reads.
Discover's entry into the offline debit market would come at a time of continued growth. Through Sept. 30, financial institutions had issued 209.3 million Visa- and MasterCard-branded offline debit cards. The cards were used to initiate 8.35 billion signature-based purchases during the first nine months of 2004, up 17% from 7.12 billion during the same period in 2003.
The management at Pulse, which would become a wholly owned Discover subsidiary, would remain intact under the proposed deal, and Pulse would stay based in Houston. Discover and Pulse say they will not make any changes to their pricing or operating platforms.
Industry observers agree that Pulse faced pressures that required action. "They realized they were up against increasingly stronger competition by way of Star/First Data, Visa and to some extent MasterCard," says David Lott, a director at Collective Dynamics, an Atlanta-based consultancy.
Because Visa and MasterCard have provided the largest card issuers with significant deals, Discover likely would find difficulty attracting their interest, according to Lott.
"Besides, you don't want to have all your business concentrated in a couple of institutions," he says. "If they make a switch or get involved in a purchase, it could modify your whole business structure. So there are benefits to having many smaller bank members, though it is a tougher business."
Other observers note that Discover's acquisition of Pulse comes at a time when there are so few EFT networks left to make a debit play.
And Paul Tomasofsky, president of Two Sparrows Consulting in Montvale, N.J., and a former NYCE executive, says the deal may make for "a great recipe" on paper, but now Discover has to make it work.
"The key is going to be in the execution, can the players put that recipe together and make a cake that financial institutions want to eat," Tomasofsky says. "I'm not saying they can or can't, but on paper it looks like a wonderful combination."
The Discover/Pulse deal, which its backers expect to be finalized soon, requires regulatory approvals and also needs the OK from Pulse's 4,100 member financial institutions.
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