INTERNATIONAL SEPT PROGRAM, UNIVERSITY OF

LEIPZIG

Module 101 Managerial Economics

GROUP ASSIGNMENT“Visa and MasterCard’s Association

Potentially Anticompetitive”

Group number: 3

Name of students: 1. Nguyen QuocBao ID: 1830910

2. Le Van Thanh ID: 2544474

3. Cong ThiThuy ID: 2182079

4. Pham Phuong Linh ID: 2541089

Module number: 101 – Managerial Economics

Supervisor: Dr Nguyen Tai Vuong

Date submission: Sept 26th 2011

Table of Content

1. Michael Porter – The five competitive forces that shape strategy...........................................3

2. Overview of the case “Visa and MasterCard’s Association potentially anticompetitive”.......3

3. Analyze the case.......................................................................................................................4

A/ Analyze the case by using Five forces tool.............................................................................4

1/ Barrier to entry.....................................................................................................................4

2/ Power of consumers.............................................................................................................5

3/ Industry concentration..........................................................................................................6

4/ Substitutes and Complements............................................................................................10

B/ Analyze the nature and extent of the cooperation between Visa and MasterCard................11

1/ The nature of the cooperation between Visa and MasterCard is overlapping ownership and governance structure which is known as duality.............................................................11

2/ The extent of the cooperation between Visa and MasterCard...........................................11

C/ Has the consumer been hurt? What is the evidence? Would the consumer be better served if duality were prohibited?.............................................................................................................13

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1. Michael Porter – The five competitive forces that shape strategy

The Five Forces model, which is created by Michael Porter, the Guru in the field of

competitive strategy, is considered to be the most effective tools in industry analysis. Five forces

included:

- Rivalryamongexistingfirms

- Threatofnewentrants

- Threatofsubstituteproducts

- Bargainingpowerofbuyers

- Bargainingpowerofsuppliers

This model was introduced the first time in 1979 in the articles “How competitive forces

shape strategy” of Harvard Business Review. It is also included in one of the 25 best seller books

of Michael Porter “Competitive strategy: Techniques for analyzing Industries and Competitors”

Though the Five forces tool is simple, but it is considered the most useful tool to understand

and analyze the current competitive position and the future competitive position that the business

is moving on. By understanding clearly about where the strength power lies, the manager could

find the advantage situation, reduce the weakness of the firm, and avoid taking wrong decision.

The tool is used to identify the potential and the profitable of a product or service.

2. Overview of the case “Visa and MasterCard’s Association potentially

anticompetitive”

The case “Visa and MasterCard’s Association potentially anticompetitive” is prepared to

serve as a class discussion by Michael Baye and Patrick Scholten. This case presented detail

about the general purpose card services, as its market, network and competition.

In general, Visa and MasterCard are the services which enable consumers to make purchases

with the bank’s money in a period of time. They are joint venture or people can call them

association. Through their member banks, they issue cards to consumers and they accept for

merchandise.

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The control of this association makes benefit for both Visa, MasterCard and banks – known

as industry as “Duality” which can reduce the competition between the two brand names and

avoid the transition of consumers to other services. In addition, both Visa and MasterCard have

set rules and policies that might moderate the ability of all bank partners to do business with

American Express, Discover or other networks which supposed to be competitive.

The largest banks could have restrained and prevented competition between the two networks

or smaller competitive networks under the control of Visa and MasterCard. This could lead to the

decreasing in competition among general purpose card networks and postpone the progression of

enhance networks products and services which can restrict consumer choice.

3. Analyze the case

By using the five forces tools, members of group 3 will analyze four sectors that affected the

profit for Visa and MasterCard, which included:

1/ Barriers to entry

2/ Power of consumers

3/ Industry concentration

4/ Substitutes and Complements

In addition, group 3 will focus to answer the nature and extent of the cooperation between

Visa and MasterCard and the benefit of customer when using these services while the duality is

prohibited.

A/ Analyze the case by using Five forces tool

1/ Barrier to entry

The first sector is “Barriers to entry”. Conventionally, the barriers to entry have contributed

to raise the profit of Visa and MasterCard for reasons.

Firstly, Visa and MasterCard have built up barriers which are extremely difficult for new

entry card network. Establishing new general purpose card network demands for huge capital

investments in order to develop both cardholder and merchant bases.

Secondly, the utility of card to cardholder and merchants is not only relies on the cost and

characteristics of the card, but also depends on its popular of acceptance and use.

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These two reasons have helped to prevent competitors to entry the market and becoming the

potential danger for both Visa and MasterCard in the first time they appeared in the market. As a

result, since the public of Visa and MasterCard in mid-1960s, only Discover (also known as

Novus) issued by Sears was successfully entered the relevant market by investing on the

infrastructure and the card holder and merchant bases. And in the early 1980s, even though

Citicorp - the largest establisher of Visa and MasterCard, and the large supplier of card

acceptance services to commercial was failed to join the market. Other companies complained

that the high required capital of creating cardholder and merchants bases caused entry difficulty.

The reality showed that without competitors, Visa and MasterCard freely demonstrated their

features to consumers and increase their profit. In addition, Visa and MasterCard have set the

anticompetitive rules and policies that further contribute a raise up of the entrance cost. After all,

the benefit Visa and MasterCard have received is together they have power to injure competitors

in that market thanks to their morality of their controlling market share and the hardly entrance

for rivals.

Moreover, consumers value the capability of their purchasing card whenever and wherever

they want, so the card should be popular around global and widespread merchant approval.

MasterCard and Visa has taken the advantage and advertised their services as the most

convenient purchasing card and made it like monopoly service in all over the world and increase

profit significantly. For example, in 1992, the MasterCard’s Canadian Region ran the advertising

“No card is accepted in more places worldwide than MasterCard. Not VISA. Not American

Express” which helped to develop the image of MasterCard and reduce the influence of Visa.

From these activities, Visa and MasterCard can benefit a lot from consumers, who they can raise

the belief and therefore increasing the profit time to time.

2/ Power of consumers

The second sector is “Power of consumers”.The consumer’s power is not strong affect the

profit of Visa and MasterCard. It can be considered in some of aspects as below:

Firstly, the market share of Visa and MasterCard is too high against their competition. These

two groups are largest general purpose card network. Together, they accounted for over 75% of

all purchase made with general purpose card in United Stated. Particularly, in 1997, Visa

accounted for approximately 50% of the dollar volume of transactions on all general purpose

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cards in the United States and approximately 53% of the number of general purpose cards issued

while MasterCard accounted for approximately 25% and 33% respectively. Totally, Visa and

MasterCard account for approximately 75% of general purpose card dollar volume and

approximately 86% of the number of general purpose cards issued.

Secondly, the duality mechanism brings customer lesser choice. Whether consumer chooses

to use Visa or MasterCard, they still contribute to these “association” benefits while the

representative for these two associations is member banks.

Thirdly, the duality characteristic creates barrier entry for competitors. This lead to less

competition, less providers and less product and service are supplied.

As a result of this potentially anticompetitive behavior, certain possible competitive

initiatives that would have benefited consumers have been abandoned, delayed, suppressed, and

diluted. Consumer choices have been reduced, and competition among general purpose card

networks has been restrained substantially.

3/ Industry concentration

As for five forces of Michael Porter, industries is in which competition actually takes place is

important for good industry analysis, not to mention for developing strategy and setting business

unit boundaries. The boundaries of an industry consist of two primary dimensions.

The first dimension is the scope of products or services. For example, Visa and MasterCard

provide general purpose cards (GPCs) network that a consumer can use to make purchase from

unrelated merchants and without accessing or reserving the consumer’s fund at the time of

purchasing.

The second dimension is Geographic scope. Most industries are presented in many parts of

the world. However, is competition contained within each state or is it national. Does

competition take place within region or is there a single global industry? The five forces give the

basis tool to resolve these questions. If industry structure for two products is the same or very

similar, then the products are best treated as being part of the same industry. If industry structure

differs markedly, the two products may be best understood as separate industries.

Following to the case of Visa and MasterCard that The United States is the relevant

geographic market for each relevant product market. Visa and Master consider the United States

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to be a separate geographic market, as demonstrated in part by their establishing separate Boards

of Directors for and separate rules governing the operation of their card networks in the United

States. The Visa and MasterCard’s rules permitting the member banks to issue Visa and Master

card, but no other networks’ cards, applied only in the United States. Differences in the five

competitive forces also reveal the geographic scope of competition.

Based on the rivalry forces Economist measured rivalry by the indicators of industry

concentration. The concentration of firms in an industry is of interest to economists, business

strategists, and government agencies. Here, we discuss two commonly-used methods of

measuring industry concentration: the Concentration Ratio and the Herfindahl-Hirschman Index.

The concentration ratio indicates the percentage of market share owned by four the largest

firms (Usually Four). A high concentration ratio indicates that a high concentration of market

share is held by the largest firms - the industry is concentrated. With only a few firms holding a

large market share, the competitive landscape is less competitive (closer to a monopoly). A low

concentration ratio indicates that the industry is characterized by many rivals, none of which has

a significant market share.

The concentration ratio can be expressed as:

CRm  =  s1  +  s2  +  s3  +  ... ... +  sm

where  si  =  market share of the ith firm.

If the CR4 were close to zero, this value would indicate an extremely competitive

industry since the four largest firms would not have any significant market share.

In general, if the CR4 measure is less than about 40 (indicating that the four largest firms

own less than 40% of the market), then the industry is considered to be very competitive,  with a

number of other firms competing, but none owning a very large chunk of the market. On the

other extreme, if the CR1 measure is more than about 90, that one firm that controls more than

90% of the market is effectively a monopoly.

Visa and Master card are two the largest general purpose card networks in the United States.

Their only significant competitors are the American Express and Discover/Novus networks, and

entry into the network market is extremely difficult. Therefore, Visa and MasterCard dominate

the market.

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Visa and Master dominate the Market:

CARDS % DOLLAR VOLUME

TRANSACTION

% NUMBER OF CARD

ISSUED

VISA

50 53

MASTER CARD

25 33

AMERICAN EXPRESS

18 5

DISCOVER/NOVUS

6 8.5

However, high rivalry limits the profitability of an industry. It depends on the intensity with

which companies compete and on the basis on which they compete.The strength of rivalry

reflects not just the intensity of competition but also the basis of competition. The dimension on

which competition takes place and whether rivals converge to compete on the same dimension,

have a major influence on profitability.

In the five forces, also indicates the intensity of rivalry is greater if:

- Competitors are numbered or are roughly equal in size and power. In such situation,

rivals find it hard to avoid poaching business. Without an industry leader, practice

desirable for the industry doesn’t enforce as a whole. But Visa and MasterCard operate as

duality that possibly restrains competition between Visa and MasterCard, and possibly

restrain competition from other networks and eliminate the competition among the

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member banks. As a result of anticompetitive behavior, competition among general

purpose card networks has been restrained substantially

- Rivalry among existing competitors takes many familiar forms, including price

discounting, new product introduction, advertising campaign, and service improvements.

Rivalry is especially destructive to profitability if it gravitates solely to price because

price competition transfer profit directly from and industry to its customer. Therefore, the

increased competition between networks for banks card issuing resources as well as

competition among the banks to offer additional card brands – would spur the

development and implementation of higher quality and lower price network products and

services by enhancing the competitive effectiveness of Visa and MasterCard and smaller

network competitors are able to compete more vigorously against Visa and MasterCard.

Issuing through banks would help competitive networks to obtain additional volume and

thereby realize costs and better economic scale. To promote their profit in this

competitive situation when the market has been shared, each of associations has possibly

expanded their capacity in large increment to outside the region and possibly cost down.

The gains and losses from industry concentration of Visa and MasterCard

Gains Losses

- Create innovation of their GPC with a

range of products: commercial cards,

traveler’s cheques, stored value cards…

- Divide Market share for another smaller

competitors as: American Express,

Discover/Novus…

- Widen business network and

partnership; American Express,

Discover/Novus

- Additional volume revenue and

consumer acceptance widespread

- Lower cost cause of Visa member

banks issuing card.

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4/ Substitutes and Complements

In the market we have many kinds of product relate together. Economic theory divides them

to two kind of product: Substitute and Complement product. To identify what kind of relate a

product to other we use Cross Price Elasticity.

For example: We have 2 products X and Y. When Price of X change ∆Px make quantity of

Y change ∆Qy and Px is average of price of X, Qy is quantity of Y

Cross price elasticity of X to Y (Ex,y): Ex,y = dQydPx

PxQy

Ex,y> 0, that mean they are substitute and when price of X increase, quantity of Y increase also

Ex,y< 0, Mean they are complement and when price of X decrease, quantity of Y will be increase

Base on this theory, we will know how it affects each other if price or quantity of a goods or

service change and analyze the substitutes and complement services in the case of Visa and

MasterCard.

Upstream market: First level, Visa and MasterCard compete with

- American Express Optima Card

- Discover Card

- Diners Club

- JCB (Japan Credit Bureau)

Downstream market: Within individual bank, member of Visa and MasterCard and other in

the market.

- Card-issuing market: the market for issuing general purpose cards to customers

- Card-acceptance market:the market for providing the services that enable merchants to

accept general purpose cards for the purchase of goods or services

Base on theory of substitute and complement product, we see that in upstream market:

American, Express Optima Card, Discover Card, Diners Club, JCB are substitute service,

compete with Visa & MasterCard. That mean when customer choice V&M service, they will not

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use other service in market. Other way, when the price of Visa and MasterCard service increases,

quantity of using other service will also increase. To evaluate what level it affects they use cross

price elasticity index. In this case, Visa and MasterCard have broad of accounts, so competitors

can not affect on its benefit so much.

In downstream market, card issuer and card acceptance are complement product and service

of Visa and MasterCard. Card issue service reduce price, card merchant is more popular make it

become easier for customer approach and use general purpose network, Visa and MasterCard

benefit will be increase. Visa and MasterCard service have big market share in this sector so they

can earn more benefit than other in this case.

B/ Analyze the nature and extent of the cooperation between Visa and MasterCard.

1/ The nature of the cooperation between Visa and MasterCard is overlapping ownership

and governance structure which is known as duality.

Visa and MasterCard are joint ventures - or, as they call themselves, “associations” -

created, owned, governed, and operated by and in the interests of their member banks. These

banks use the associations’ products and services either to issue cards to consumers, provide card

acceptance services to merchants, or both.

Under Visa’s and MasterCard’s corporate structures, a member bank in eitherassociation has

the right to issue cards bearing the association’s trademark and to offer card acceptance services

for the association’s cards. Most member banks - including all of the largest ones - also become

owners of the association and receive a bundle of rights similar to those of a shareholder in a

corporation. These rights include the opportunity to vote for a board of directors, participate in

the governance of the association, and share in the association’s assets upon dissolution. Voting

and dissolution rights are apportioned according to the dollar volume of transactions that the

bank has transmitted through the network. Member banks also agree to abide by the associations’

bylaws, rules, regulations, and policies.

2/ The extent of the cooperation between Visa and MasterCard

As the nature of cooperation is duality under this might restrain outsider competitors. It is

typically strong in United State market. In this market, both Visa and MasterCard apply very

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strict policy with their member banks to avoid the entry of current players and potential new

comers.

Since 1960s, Visa and MasterCard have operated general purpose card networks throughout

United States, providing card network products and services in those products. They are joint

venture and operated by and in the interests of their member banks. As an association, Visa and

MasterCard collaborate with banks to adopt rules and policies that might restrict the ability of all

member banks to do business with other competitors: American Express, Discover/Novus or any

other networks that the controlling banks deem to be “competitive”. These exclusionary rules

and policies might eliminate the competition among Visa and MasterCard member banks. The

purpose has been stifled competition from these two networks and thwarted smaller competitors.

In the mid 1980s, Visa and MasterCard and their member banks use their control of

merchant terminals to hinder American Express’s and Discover/Novus’s effort to build merchant

bases. In response, American Express and Discovery/Novus enter into agreements with a few

Visa and MasterCard member banks that permit them process those bank transaction through

terminals accepting all card brands. Because of strong merchant for a single terminal, V&MA

permit banks to link their processing services to A.E and D/N.

In 1988, Visa and MasterCard own one of two worldwide ATM networks, Plus and Cirrus.

Visa’s rule permits member banks that issue MasterCard to use the Plus on MasterCard. And

MasterCard also do like that with Visa member banks. And they don’t permit A.E and D/N use

Plus and Cirrus. Then few years, they have attempted to convince other entities, including banks

to issue cards on their networks.

In 1991, Visa International’s President and Chief Executive Officer proposed that each of

banks would issue prospectively only one GPC brand Visa or MasterCard. , Visa U.S.A’s Board

of Directors adopted Bylaw 2.10(e), which states that “the membership of any member shall

automatically terminate in the event it, or its parent, subsidiary or affiliate, issues, directly or

indirectly, Discover Cards or American Express Cards, or any other card deemed competitive by

the Board of Directors.” Visa has asserted that it adopted Bylaw 2.10(e) to prevent

Discover/Novus and American Express from becoming card-issuing members of Visa by

acquiring member banks, as Discover attempted to do in 1990. As written, however, the bylaw

also prohibits all independently owned Visa member banks from issuing cards on the American

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Express or Discover/Novus networks. Bylaw 2.10(e) prohibits Visa’s member banks from

issuing cards on any network that is “deemed competitive” by Visa’s Board. But Visa’s Board

has not deemed MasterCard to be a competitor, and Visa’s member banks may thus issue cards

without restriction on the MasterCard network. The bylaw applies only to American Express and

Discover/Novus, the networks not controlled by the member banks

In 1992, Visa and MasterCard consider their operation as duality.

In 1993, Visa prohibited Visa member banks from issuing both V&MA commercial cards

would enable Visa innovate and differentiate from MasterCard

In 1995, Visa and Microsoft jointly announced to provide secure transaction through

internet. MasterCard immediately form alliances with other software providers to pressure Visa

abandoning its agreements with Microsoft.

In 1996, the MasterCard U.S. Board adopted a policy on “Competitive program”.

MasterCard adopts competitive Program Policy. With the exception of participation by members

in Visa, which is essentially owned by the same member entities, and (Diners Club and JCB),

members of MasterCard may not participate either as issuers or acquirers in competitive general

purpose card programs.At the meeting in which MasterCard adopted the policy, the board

considered theAmerican Express proposal to partner with member banks and concluded that the

newly adopted policy would prohibit member banks from issuing American Express cards

In more than a dozen foreign countries, American Express has successfully contracted

with Visa and MasterCard member banks to also issue cards on the American Express network.

In many of these countries, Visa and MasterCard have responded by introducing new products

and services. For example, Visa International’s European Region implemented an aggressive set

of competitive initiatives shortly after its regional board rejected an exclusionary rule analogous

to Bylaw 2.10(e). These initiatives included product enhancements, increased network support

for the Visa Gold card and co-branding deals, and improved merchant services.

C/ Has the consumer been hurt? What is the evidence? Would the consumer be better served if

duality were prohibited?

As for analysis, duality may cause the consumer’s benefits has been abandoned, delayed,

suppressed and consumer choices have been reduced. The strength of the competitiveness also

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affects price, cost, and the investment including price discounting, new product introduction,

advertising campaigns, and service improvements. It’s testified that in 1992, Visa International’s

President and Chief Executive Officer explained “Visa was a better organization before

acquiring interest in MasterCard. It created more, it was more innovative and it was more vital

and imaginative”. Also Visa International’s Executive Vice President and General Counsel

response to the question whether duality harmed consumers, he answered “ I think in the long

run they would be better off without duality” and consumer will get the better services from

spurring the development and implementation of higher quality and lower price network

products and services. In addition, consumer choice would be enhanced by eliminating the

exclusionary rules. Consumers would have access to new general purpose cards that would

combine the best services and convenience on demand.

Finally, consumer could be served better when the market is the completed competition with

the best services, price and quality of products. The competition also makes the firm to be more

initiative and innovation together to make their firm provide the best services and solution to the

market.

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