Their pricing power is under attack, American Express is luring banks, and processors threaten to siphon card transactions. Can Visa and MasterCard meet the challenges? Here, CCM and Card Technology assess the U.S. situation.
A flurry of regulatory and competitive blows over the last few years have loosened Visa USA and MasterCard International's tight grip on the U.S. payments market. Measures that give merchants freedom to choose the card products they will accept, and a slashing of some interchange fees, have torn apart association pricing models and operating rules. And if current court challenges to Visa and MasterCard mandates on processing and card issuance succeed, the U.S. credit and debit operating platform could be drastically altered.
"Politically, the traditional association market dominance is under attack," says Tom Dailey, a Chicago-based payments consultant and former Discover senior vice president. "At issue are interchange pricing practices, lack of innovation and anticompetitive practices, such as exclusion of alternative networks. The end results of these challenges are pretty predictable: anticompetitive practices are being stripped away like so many chips in the Berlin Wall."
And a decade from now, the roles of Visa and MasterCard in the payments market may be radically different. In an e-mail survey conducted by Credit Card Management and Card Technology magazine to gauge the industry's sentiments on what the card associations would be like in 2014, nearly half of the 621 respondents indicated that the organizations would lose transaction volume to First Data Corp. and other processors. A nearly equal number believe interchange rates will decline by 20% (chart, page 38).
Perhaps the strongest jolt thus far to Visa's and MasterCard's foundations was last year's settlements of a seven-year-old class-action antitrust lawsuit brought by merchants against the associations. The agreements resulted in the slashing of signature-based debit interchange rates, and the cutting of transaction revenue streams for card issuers, the associations' principal owners and customers.
As part of the settlements, credit card-accepting retailers now have the option to either accept or decline the associations' offline (signature-based) debit products. Visa also agreed to pay retailers $2 billion over 10 years to settle its suit. MasterCard is paying $1 billion.
Rivals American Express and Discover also are putting more pressure on the associations. Wilmington, Del.-based MBNA Corp., the second-largest U.S. issuer of Visa/MasterCard credit cards, plans to be the first U.S.-based bank to issue AmEx-branded credit cards. MBNA will own the loans and service the accounts, but transactions will flow through AmEx's merchant network.
Discover Financial Services Chief Executive Officer David Nelms told bankers in May that Discover, too, was seeking bank partners to issue its cards.
MBNA's move follows a 2001 ruling in an antitrust lawsuit brought by the U.S. Department of Justice that ordered Visa and MasterCard to drop rules that prohibited member banks from also issuing AmEx and Discover cards. The associations are appealing to the U.S. Supreme Court.
Many observers predict the Supreme Court will not take the case. Yet, Robert Selander, MasterCard CEO, says he doubts many issuers will offer AmEx cards if given the opportunity.
"Financial institutions are interested in building their brand, and are not likely to want a competing brand on their products," he says.
Threats to the associations also are coming from third-party transaction processors. Most prominent is Greenwood, Village, Colo.-based First Data Corp.'s First Data Net initiative. First Data sought to leverage its connections with issuers and acquirers to create a closed-loop processing system, and enable clients that send Visa transactions through First Data Net to bypass Visa's VisaNet authorization, clearing and settlement system and avoid some of the association's fees.
Visa sued First Data in 2002, claiming such transactions were at greater risk for fraud and other problems. First Data countersued charging anticompetitive practices, breach of contract and trade libel. The litigation has not been settled.
Despite such attacks, few analysts doubt that Visa and MasterCard will remain major players in the payments sector for years to come. The CCM/CT survey findings also support that (chart). But just how lofty their positions will be a decade from now depends in great part on how they adapt to the changing playing field.
"Visa will remain a dominant force in electronic payments because of its brand, financial resources, and the loyalty of its big credit card-issuing banks," says Stan Paur, president of Houston-based Pulse, the third-largest electronic funds transfer network. "MasterCard, on the other hand, is unlikely to survive without partnerships or a major structural change. The MasterCard brand still will exist, but it will be a question of who owns or controls the organization."
MasterCard's ability to withstand strong competitive threats, Paur says, is hampered by its dearth of large-bank members and a relatively small debit card base. Indeed, Thomson Media's ATM&Debit News reports that in 2003 the Visa check card controlled about 80% of offline debit card charge volume compared with only 20% for MasterCard.
The anatomy of both entities, however, may be significantly different in 10 years. MasterCard became a private, for-profit company in 2002 with its stock held by member-owners, and Visa still operates as a non-profit association. But the organizations could eventually go public in order to generate more capital for operations, and income for their owners.
"MasterCard going private was the first step to it becoming a public corporation," says John Gould, director of consumer lending and bank cards for TowerGroup, a Needham, Mass.-based financial industry research and consulting firm that MasterCard bought this year. "MasterCard would have made a $200 million profit last year if not for its lawsuit settlement, and they look real good to eventually do an initial public offering."
Indeed, Jerry D. Craft, president and CEO of Atlanta-based InfiCorp, a Visa and MasterCard issuer, agrees that it is likely that one or both of the associations eventually will go public within the next decade. "They both have value as a brand and as a network," he says. "If they do go public, the likely (majority) owners will be their current owners."
But Selander says his organization does not need to go public to raise funds. "We're well-capitalized and I'd feel comfortable if I went to our shareholders and said I need additional money," he says.
Dan Tarman, Visa USA senior vice president, says his association has no plans to change its structure. "We're focusing on delivering value to our shareholders and not returns to Wall Street," he says.
As a public company, Visa would have difficulty investing large amounts of funds in projects that do not promise quick paybacks, such as global processing networks, Tarman says. "Now we can drive long-term value and not focus on short-term results," he adds.
Yet, both organizations still will evolve from primarily functioning as card associations to becoming more-rounded payments companies, predicts Debra Rossi, executive vice president of Business Internet Services for San Francisco-based Wells Fargo & Co., a leading merchant acquirer and debit and credit card issuer. Rossi expects the associations to eventually support much heavier volumes of stored-value and smart card transactions, as well as recurring payments.
"Visa and MasterCard will have to be open to new payment opportunities to have their brands remain strong," Rossi says. "But they also have to continue looking at the entire operating model, and balance the needs of the cardholder and merchant."
Paramount to this balancing act is an equitable setting of interchange, the transaction fees set by the associations and paid by the merchant acquirer to the card issuer. Acquirers pass along such fees to merchants in their discount rates.
The associations' signature-based debit rates were cut by about one-third last August as part of the merchant lawsuit settlements, and retailers now have leverage to drop offline debit acceptance if they are not satisfied with the fees. Visa and MasterCard recently set new signature-based debit rates that give further breaks to high-volume merchants, but raise costs for smaller retailers though rates remain below pre-settlement levels. Credit card interchange, meanwhile, still is rising.
But some sector participants expect increasing competition and regulatory mandates to result in reduced credit and debit interchange rates by 2014.
"Interchange will be 40% lower in the future," says Paul Garcia, president and chief executive of Global Payments Inc., an Atlanta-based merchant processor. "Rates will go down because merchants are going to be offered opportunities to accept less-costly payments, such as direct automated clearinghouse debits from checking accounts, or a payment that is tied to some biometric. The world is going the way of Wal-Mart because today's rates are dangerously high."
Wal-Mart Stores Inc., leader of the merchant lawsuit, ceased accepting debit MasterCard in February following the elimination of the associations' honor-all-cards rules. Analysts say Wal-Mart also is paying lower-than-listed debit interchange to accept the Visa check card.
This decline in debit rates, coupled with credit fee increases, is causing more retailers to consider accepting debit cards in lieu of credit, and is making the associations more vulnerable to competition from American Express, Discover and others, says Bill Apker, electronic banking officer at Community Bank, a Santa Fe, N.M.-based debit MasterCard issuer and merchant acquirer.
A Narrowing Gap?
"Many merchants won't take AmEx because those rates still are more expensive," he says. "But if that gap narrows, Visa and MasterCard are leaving the door open to more competition. They will squeeze things as far as they can."
Nevertheless, Apker does not expect the associations to lose much, if any, market share over the next decade, "as long as they keep the perspective that they are the least expensive card. They have a ways to go before they blow it."
Andrew Hoffman, card services specialist for Boise-based Farmers & Merchants State Bank, adds that the sheer size of Visa and MasterCard also makes it unlikely that they will be severely impacted by competitors.
"Consumers have proven again and again that they will remain loyal to the two biggest associations, and they drive the market," he says.
Yet, greater threats from processors such as First Data could potentially cut into association revenues. Processors that are not owned and controlled by banks not only are in a position to divert volume and income from the associations, but also can contribute to a weakening of brands by offering competitive products.
Consultant Dailey notes that the ability of First Data to route transactions internally as "on-us" between its processing clients that are both issuers and acquirers not only is financially attractive, but theoretically allows the processor to provide customized loyalty programs, special pricing outside of "inflexible" interchange schemes and other innovations not generally available through traditional networks.
And in an April report on the U.S. card market, Kenneth Posner and Athina Meehan, stock analysts for New York-based Morgan Stanley, said that First Data might be able to direct a sizeable flow of transactions away from Visa if it prevails in its suit. Merchants, they noted, might be able to negotiate separate interchange agreements with large banks, especially in instances where First Data also is the institutions' processor.
Global Payments' Garcia, however, doubts that First Data Net will take hold. "It's based on fallacious logic," he says. "The three-legged stool that has been established by very thoughtful people-which creates an association, an issuer and an acquirer-is a very sound model and the payments world has been served very well by it. Saying 'no, we're going to control it all,' maybe creates an efficient or effective environment for First Data, but nobody else."
Either way, Charles T. Fote, First Data chairman and CEO, said his company's conflicts with Visa, and the ensuing competition, will result in more product innovations. "The challenge First Data is having with Visa is good for the industry," he said at the Electronic Transactions Association's 2004 Annual Meeting & Expo in Las Vegas in April.
To strengthen their ability to counter threats from First Data and other processors, and compensate for an eventual leveling of card transaction growth, Visa and MasterCard will need to eventually support non-traditional payments on their systems, some analysts say.
"The associations are tied in to almost every point-of-sale terminal on the planet and they have tremendous influence on what they can do with their networks," says Peter Quadagno, a West Chester, Pa.-based payments consultant. "But if they fail to leverage and exploit these assets in an evolving world, (their positions as major networks) eventually will be gone."
However, it will up to the member institutions to decide if Visa and MasterCard should stretch beyond payments, says Beverly Wells, president and CEO of Vital Processing Services LLC, a Tempe, Ariz.-based merchant processor that is co-owned by Visa USA and Total System Services Inc. (TSYS).
"The Visa and MasterCard role will be defined by the banks that own them, and where issues are of common significance," she says. "They have built a brand which is synonymous with what they do. The associations view themselves as a derivative of the financial institutions and they would only participate in areas that create benefits in a non-competitive format across the industry."
MasterCard's Selander, meanwhile, says his organization is continuing to focus on supporting the payments of regulated financial institutions, and is not looking to move into other types of transaction handling.
At the same time, he says one of the organization's key strategies is to continue strengthening its brand. In 2003, 30% of MasterCard's $2.8 billion in operating expenses went for advertising and market development, up $157 million, or 23%, from 2002.
Such a tactic is important, analysts state, because the associations' brands could be weakened if large institutions, particularly those with a global presence, seek to bolster their own card identities.
"Most brand people will tell you a brand is something that decays pretty rapidly, and you would be disinvesting in your asset if you didn't continue to invest in it," Selander says. "To stop advertising or walk away from that would be unacceptable to our customers because we continue to drive utilization."
However, with the exception of MasterCard issuer Citigroup Inc.-a financial powerhouse that strongly promotes its own brand-most institutions will face a great challenge if they attempt to supersede the associations' marks with their own. Linda Eckard, president and CEO of Arlington, Va.-based ICBA Bancard, a processing cooperative of the Independent Community Bankers of America, notes that the struggle and cost for a bank to promote its own brand is huge, and most institutions probably would leverage the associations' brands until exposure of their proprietary mark is increased.
But association brand identity also could be enhanced as debit volumes keep increasing, and the organizations continue their support of both signature and personal identification number-based products. Visa reports that volume for each of its debit products was up more than 25% during the first quarter.
"There will continue to be both PIN and signature debit cards, but the popularity (of each) will change as PIN is growing faster than signature," says David Lott, a director at Collective Dynamics LLC, an Atlanta-based management consulting firm. "There will always be two products because a lot of people don't like using or trying to remember a PIN."
Likewise, analysts expect both Visa and MasterCard to be permanent fixtures of the U.S. payments sector. But with association rules on pricing, competition and processing still under siege, the degree of power and prominence the two organizations will maintain in 10 years remains an open question.
Richard Mitchell is a freelance writer based in Wilmette, Ill. He can be reached at rmitchell72
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