Regulatory changes and the initial
public offerings of MasterCard and Visa are changing the
competitive landscape for card networks in the US. A battle for
issuer business has broken out between the major bank networks,
American Express and Discover. Charles Davis
reports on the potential outcomes.

The US card market could be entering a new era of competition, as
the changes wrought by the 2004 decision by the US Department of
Justice to repeal rules that kept Visa and MasterCard members from
using other networks, combined with the associations’ initial
public offerings (IPOs), mean that the major bank networks are
vying with American Express and Discover for issuers.

A new report by Gwenn Bézard, director of research at financial
services consultancy Aite Group, The Future of Card Networks:
Gauging Battle-Readiness for a Post-Visa IPO World, predicts that
American Express will emerge as a powerful competitor with Visa and
MasterCard in the US.

Bézard traces the fast-moving changes ushered in following the
Justice Department’s repeal of the exclusionary rules preventing
Visa and MasterCard members from using other networks. The rules
change meant that the major bank networks were suddenly competing
directly for issuers’ business with American Express and

Interchange war

The most immediate consequence of the ruling, Bézard said, was an
interchange war between the networks: Visa and MasterCard raised
their rates in 2005 in a bid to fend off issuers’ defection to
American Express. The higher interchange rate, in turn, further
infuriated the merchant community, prompting a series of lawsuits
challenging the nature of the interchange rates. Concern over the
potential litigation liabilities gave rise to a growing number of
banks warming to the idea of turning over their card networks to
the public markets – and the rest is history.

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Since then, MasterCard went public in 2006, and Visa followed with
a major reorganisation and later announced its intention to become
public in 2008. Morgan Stanley finally spun off its Discover
Financial Services subsidiary, which became traded on the New York
Stock Exchange in 2007.

By early 2008, this means that most American consumers should be
using card brands operated by four publicly traded card networks –
Visa, MasterCard, American Express and Discover. The change will
not mean much to those shoppers, but it could have long-lasting
effects on the issuance side.

Bézard wrote that although the business models of Visa and
MasterCard are nearly identical, Amex and Discover are very
different. “Visa and MasterCard make most of their money by
enabling issuers to leverage their networks and global brand: they
don’t issue cards themselves, and seldom acquire merchants
themselves,” Bézard wrote. “In contrast, American Express is a card
issuer at heart, and is very picky about which customers it
targets. American Express makes most of its money by delivering
affluent cardholders to merchants and charging high transaction
fees for that service; incidentally, it uses its own network and
brand to that effect.”

While Discover’s roots also are in card issuing, and while it also
typically uses its own network and brand for its credit
card-issuing business, Bézard noted, that’s where the similarities
end. Unlike Amex, which is focused on the upper end of the card
market, Discover focuses on targeting credit card revolvers and
making money from their card balances.

One thing in common

Despite differences in their core business models, all four
companies have one thing in common: they all compete for issuers’
business today. Visa and MasterCard, which make most of their money
from issuers, square off against one another while fending off
incursions by Amex and Discover, which make most of their money
from their proprietary credit card business. The challenge, then,
is to grow third-party issuers’ use of their networks, notably in
the US, where they generate a significant portion of their

The competition for issuers’ business is incumbents Visa’s and
MasterCard’s to lose, but consolidation is making those players
increasingly vulnerable to the risk of a major customer defecting.
Five major MasterCard issuers accounted for 34 percent of the
company’s revenues in 2006, for instance.

While a relative upstart in third-party issuing in the US, Amex
gained valuable experience abroad before the rules were repealed,
opening the domestic market. Amex has already managed to attract
selected portfolios of some major issuers, including Bank of
America, Chase and Citibank.

To date, Discover has not been much of a player in the third-party
issuing market, but Bézard expects that to change as the US market
tightens. “Leveraging the network and brand Discover once strictly
used for the benefit of its proprietary issuing business to serve
other banks seems the natural path to long-term growth,” Bézard

Risky move

For Visa and MasterCard to counter Amex and Discover, Bézard found,
one option would be for them to turn themselves into issuers,
becoming more like American Express and Discover. Such a move would
not be without risks, however. While Visa and MasterCard would
likely be in a strong position from a branding standpoint to start
their own issuing business, they would risk damaging relationships
with their issuers. Given their increasing reliance on a few large
issuers, upsetting just a few major customers could spell
significant trouble for them.

Another option for Visa and MasterCard would be to expand in
merchant acquiring. This is a less likely scenario, as intense
competition and consolidation among larger merchants is squeezing
profit margins. The networks would also risk alienating their
acquiring partners, pushing them to further encourage adoption of
Amex and Discover.

Aite Group believes Visa and MasterCard will stick to their core
proposition and focus on building their network business. This
would build on the association’s core competencies, allow them to
continue to capitalise on the volume of switching that is done
outside Visa’s and MasterCard’s networks around the world, and
allow them to leverage their unique global processing and
acceptance capabilities.

Bézard concluded that a major wildcard affecting the strategy of
Visa and MasterCard is likely to be the approach taken by other
major networks, including China UnionPay and JCB, the domestic
networks dominating a number of countries, and many other card as
well as non-card payment networks.