Post-IPO, the Bank Card Networks Open up To Go for Volume

This is the fifth installment of a six-part series exploring the growing economic tensions and structural conflicts between acquirers and issuers in the bank card business.

Once upon a time, the idea of non-bank access to the Visa Inc. and MasterCard Worldwide networks for payment innovations was about as far-fetched as a woman or a black person running for president. Today, both paradigms have shifted.

Some of the early signs that have emerged since the bank card associations became quarter-to-quarter public-reporting companies suggest they are focusing more and more on driving new transaction volumes in emerging markets for electronic payments than preserving the closed and clubby nature of their brands. Once-sacrosanct access to their networks is opening up to all parties, and, increasingly, one transaction to them looks as good as another.

MasterCard is clearly leading the way toward network ubiquity. The best example of this new operating philosophy: the MasterCard bug going on Capital One Financial Corp.'s incipient (and controversial) decoupled debit card. A little more than a year ago, in a hail of publicity, Cap One proposed issuing a front-end transactional debit card, with a generous loyalty program included, to any and all comers, and thereby set their own interchange with merchants in the process.

Consumers just had to sign up for the card (merchants or third parties could also be issuers), register their existing demand-deposit account (DDA) for payment, and make a transaction. Cap One would use the MasterCard network for authorization, and settle the transaction via an automated clearing house debit to the customer's DDA (Digital Transactions News, June 7, 2007). Instead of receiving point-of-sale interchange income, the financial institution holding the DDA gets the cost of an ACH debit.

“MasterCard told us that this transaction looks the same to them now as any other transaction,” a Cap One executive said privately at an industry conference late last year. “As long as they get their nickel, they're happy.”

HSBC's Tempo network works in a similar fashion: Consumers sign up for the ACH-based debit card for integration with a merchant's store/loyalty card, and accepting merchants get a low-priced, guaranteed transaction. The issuing merchant can even earn interchange when its card is used at other locations.

What has big and small banks alike worried is the potential for a decoupled debit card issuer to eventually poach the DDA account?the crown jewel of retail banking profitability.

Further signs of the junior bank card association's emerging “go-for-volume” strategy appear in a number of other payment-product innovations: –MasterCard (and Visa) bugs are on multitudes of third-party-issued cards from the likes of Green Dot and NetSpend in the fast-growing prepaid debit card market; –MasterCard has 'bugged' PayPal's eBay seller's debit card, and now its one-time-password-generating plug-in, which gives PayPal's business model acceptance at any Web site that accepts MasterCard; –MasterCard's new Integrated Processing Solutions (IPS) debit-processing platform for card issuers handles everything from ATM and signature- and PIN-based debit card transactions to prepaid cards.

Visa, on the other hand, is still much more of an unknown quantity. Evidence of a similar volume-oriented philosophy post-IPO is perhaps indicated in an S-1/A registration statement filed with the Securities and Exchange Commission early this year. In it, the network declared outstanding commitments for “volume and support incentives for card issuance, marketing and program support” approaching $4.5 billion?in effect, pricing concessions Visa makes to keep network usage growth rates from declining further.

“We have increased our use of incentives such as upfront cash payments and fee discounts in many countries, including the United States,” Visa reported. “In order to stay competitive, we may have to continue to increase our use of incentives. Such pricing pressure may make the provision of certain products and services less profitable or unprofitable and materially and adversely affect our operating revenues and profitability.”

Some industry observers also speculate that Visa cut a special deal with Wal-Mart Stores Inc. to get its merchant acceptance brand on the prepaid MoneyCard issued by the giant retailer. Even with such possible concessions, Wal-Mart's use of a hybrid network approach (the card also traverses GE Money for processing and Green Dot for loading) drives operating costs up and fails to offer much in the way of Wal-Mart's usual bargain rates for consumers?at rates of $8.94 to purchase a card and $4.94 to load it.

What is clear is that network access is getting commoditized in favor of higher volume growth, and pricing is now a market mover for the associations. This has been borne out by special pricing for the top national retailers (a subject covered in the first installment of this series), which has a material negative impact on the interchange collected by mostly big bank card issuers.

Meanwhile, there's a lot of talk in the industry about the associations trying to increase their various network access charges and assessments to acquirers and their merchants, as they have overseas in recent quarters. “We continue to believe that we are able to adjust prices in the roughly 200-basis-point range per year as we did over the last couple of years,” Martina Hund-Mejean, MasterCard's chief financial officer, said at an investor meeting in May. “But keep in mind that we will have to demonstrate value to our customers for such price changes.”

Like Visa, Hund-Mejean also said that rebates and incentives paid to issuers and merchants would be an important restraint on revenues. “This is a very competitive industry, and we continue to negotiate” such deals, she said.

And so the battle is engaged, with acquirers being asked by the associations to help pay?through higher prices?for the concessions they are making to issuers and merchants. In the upcoming September issue of Digital Transactions magazine, the final installment of this series plots the strategies of the big processors for gaining the upper hand and a more equitable balance in who gets compensated in card payments going forward.–Steve Mott