Breaking Up The Old Credit Card Game?

Following its Microsoft win, Justice plans to take on the Visa-MasterCard duopoly

In 1992, executives at MasterCard International Inc. decided to go head-to-head with Visa USA Inc. Until then, they had soft-pedaled the rivalry, never publicly criticizing the No. 1 credit-card company. But this time, the MasterCard team was advised by marketing consultants that the only way to thwart a widespread misperception--that MasterCard was not as commonly accepted as Visa--was to go into attack mode. So the company ordered up a television spot to set things straight. "No credit card is more widely accepted. Not Visa. Not American Express," it announced.

Don't remember it? That's because it never aired in the U.S. MasterCard's board, made up of a consortium of banks--almost all of which also issue Visa cards--didn't want its two brands competing. So it overruled MasterCard's management and nixed the campaign.

To the U.S. Justice Dept., the torpedoed ad is indicative of too much coziness between the two tightly intertwined companies that dominate the credit-card business. In the next big antitrust campaign since its triumphant battle against Microsoft Corp., Justice is scheduled to take on Visa and MasterCard on June 12 in a federal courthouse in Manhattan. Expect a long, bruising, and highly entertaining trial. Whereas the Microsoft case had only 24 witnesses, this battle could have twice that many--including such industry luminaries as American Express Co. CEO Harvey Golub, AmEx heir apparent Kenneth I. Chenault, Visa CEO Carl F. Pascarella, his MasterCard counterpart Donald L. Boudreau, and outgoing Citigroup Co-CEO John Reed.

Justice will try to use its witnesses to tell the story of how Visa and MasterCard, which jointly control 75% of the business, have worked together to bully competitors and harm the American public. Specifically, the agency will argue that the two companies have stamped out useful but threatening innovations such as the "smart card," a high-powered version of the traditional credit card that contains a computer chip. If the feds win the case, they're likely to seek nothing less than legal separation of the Visa-MasterCard duopoly and a decree banning business practices that have allowed them to dominate the industry. That could boost the fortunes of long-beleaguered rivals American Express and Discover (a division of Morgan Stanley Dean Witter-Discover).

But Visa and MasterCard are waging a wide-ranging counterattack. In private pretrial meetings with news organizations and in a public hearing at the Senate banking subcommittee on May 25, the two companies have been airing their battle cry: that Justice is simply bailing out a group of rivals that couldn't win in the marketplace. Defense lawyers will also make a strong case that there isn't much direct evidence of consumer harm. No price-gouging. No wild swings in fees or interest rates. No lack of services. That's why many experts think Justice could have a tough time. "This definitely presses the outer reaches of antitrust law," says Ernest Gellhorn, an antitrust expert at George Mason University Law School.

Indeed, it's going to be hard for the government team even to explain how the credit-card industry works. Visa and MasterCard are not traditional companies. Instead, they're nonprofit joint ventures supported by the banks, thrifts, and credit unions that issue the cards. These financial institutions kick in an annual fee in exchange for advertising and a variety of support services. Although the two companies are headquartered on different coasts (Visa in San Francisco and MasterCard in New York), their owners are almost identical: Of the 7,000 financial institutions participating in the Visa joint venture, almost all are also involved in MasterCard. These institutions control the credit-card companies through their membership on the board of directors and have instituted many complementary policies, Justice says. So long as such joint ownership remains intact, the agency believes the two cards will never compete. "All [the owners] would be doing is shifting profits from one card brand to the other," says a source close to Justice. (Because the case is so close to trial, officials have refrained from discussing the details of the suit in public.)

TAWDRY TALES. In an increasingly cashless society, credit cards' power can hardly be overstated. Some 510 million credit cards are used by U.S. consumers. Thanks to incentive programs linking plastic to free travel, Visa and MasterCard are becoming common payment for nearly anything. Outstanding credit-card debt, now hovering at more than $600 billion, has nearly tripled in the past decade, and it is 11 times its 1980 level. "Some people would accuse them of having a chokehold on the payment system because they are the payment system," says Robert E. Litan, a former Justice Dept. antitrust lawyer now at the Brookings Institution.

Just as it did in the Microsoft case, Justice is hoping to win the case by telling a series of unsavory stories about the defendants' past. One episode we're sure to hear a lot about is the demise of the smart card. Because they can store so much more information than cards with a magnetic strip, smart cards could become an extremely powerful tool in the Digital Age. For example, they could store medical information to be used in case of an emergency, check out library books, serve as a security card at work, or be a universal payment system for subways, trains, and toll roads

Convinced that these supercards would give them an advantage over Visa, a group of MasterCard executives in 1987 asked the board to approve a rollout. But its board balked, Justice asserts, for exactly the same reason that it killed the ad: Its members were beholden to Visa. In this case, however, the board allowed the developers of the smart card to appeal directly to Visa. This led to the odd spectacle of MasterCard executives flying to California to ask Visa's permission to introduce a joint product. Not surprisingly, it wasn't granted.

To support this and other similar tales, the government plans to enter more than 100 depositions and copious notes, e-mail messages, and other documents from Visa and MasterCard officials. It hints broadly that these will contain the kind of damning death-to-competitors statements that advanced its case against Microsoft. For their part, Visa and MasterCard claim the smart card was an idea whose time had not yet come. The two companies had just pumped billions of dollars into a system of central computers linked to "swiping" machines that could instantly check a cardholder's creditworthiness, and they saw no reason to abandon this for a different system. "There just wasn't a good business case for smart cards," says Paul Allen, Visa's corporate counsel.

Justice is also going to argue that the credit-card duopoly retarded the development of Internet security technology. In late 1995, Visa announced it had reached an agreement with Microsoft to produce one of the first encryption standards that allowed Web users to encode their credit-card numbers to buy online. The system, called secure encryption technology, is commonplace now, but then it was in its infancy. After the Visa-Microsoft announcement, MasterCard sent out a message to banks saying it had no choice but to respond in kind and offer a competitive plan.

But the banks that own the two credit-card companies quickly quashed the budding competition between them, Justice claims. Many of the banks called Visa and asked it to back down. Visa and MasterCard say the idea was killed for legitimate reasons: Banks did not want two proprietary systems but rather one "open" approach. But that hasn't always been their line. Shortly after the episode, Bennett R. Katz, Visa's former counsel, told the Federal Trade Commission that, if it had not been for the overlapping control of the two organizations, the encryption technology would have been available to consumers sooner. "This thing would have been out there already," he said.

NIRVANA? What Justice is really after is a ruling that unravels the overlapping ownership of the two associations. The agency also wants to shoot down rules that prevent member banks from issuing American Express or any other credit cards. It believes this would create a world in which MasterCard, Visa, AmEx, Discover, and whatever else comes down the pike would be cast into the same market for the allegiances of individual banks. This competition would force them to provide attractive offers, better services, and innovative products that the banks would then pass on to their customers.

But where Justice sees a kind of consumer nirvana, Visa and MasterCard see an overly active imagination on the part of a few government lawyers and economists. There is no evidence the new system proposed by Justice would lead to more competition, says Visa economic consultant David S. Evans. What's more, he says, the Justice Dept. would impose this new world without showing what was wrong with the old one. "To Justice, there's the way the industry is organized, and there's the way they think it should be organized," says Evans. "And they say their way is better. End of story."

Visa will argue that the closeness of the companies is nothing to make a federal case over. It insists that the separation Justice wants is starting to happen anyway. Banks can negotiate better terms by putting the lion's share of their credit card in one camp or another. So Citigroup and Chase Manhattan, for instance, issue mostly MasterCard products. And Bank of America and First Union issue mostly Visas. As this process continues, the companies argue, the market will take care of Justice's concerns.

Is a settlement possible? Sources close to Visa say it labored intensely to make a deal that they say would have separated the two companies, but Justice didn't think the proposal went far enough. So for now, no peace treaty appears to be in the works. This means that Visa and MasterCard will soon be at war with the Justice Dept. in the courtroom--and as Microsoft can attest, that's not a very comfortable place to be.

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