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In October, a little more than six years to the day after the Antitrust Division of the U.S. Department of Justice (DOJ) filed its lawsuit against Visa and MasterCard and three years after the district court issued its opinion, the U.S. Supreme Court decided not to review the decisions of the Southern District of New York and the 2nd U.S. Circuit Court of Appeals holding that Visa and MasterCard’s exclusivity rules violated the antitrust laws. United States v. Visa U.S.A. Inc., 163 F. Supp. 2d 322 (S.D.N.Y. 2001), aff’d, 344 F.3d 229 (2d Cir. 2003), cert. denied, 125 S. Ct. 45 (2004). The decision will have wide-ranging ramifications for credit and debit card competition and network competition, and, it portends significant competitive challenges and litigation in the credit card marketplace. Antitrust enforcement presents the opportunity for massive restructuring of a single industry. Although the decision struck down relatively straightforward exclusivity rules, its recognition of the importance of network competition and the market power possessed by the credit card networks presents a tremendous opportunity for a spur to competition. Moreover, the court’s analysis of market definition and market power signals increasing sophistication of the treatment of these issues by the courts, and likely will influence the outcomes in subsequent litigation arising in payment systems and other network industries. COMPETITION AMONG CREDIT CARD NETWORKS WAS LIMITED The general impression at the time that DOJ filed its enforcement action was that the market for credit card issuance was relatively competitive. Yet the level of network competition was less than overwhelming. Not only did just four networks compete (Visa, MasterCard, American Express and Discover), but competition among these networks was almost docile. Neither Visa nor MasterCard were seen to compete aggressively against one another. Moreover, Visa and MasterCard consistently increased interchange fees (the effective charge to merchants for handling transactions) in lock-step fashion for years. DOJ’s lawsuit resulted in two years of pretrial sparring, a trial that lasted more than six weeks, and an exhaustive opinion of more than 150 pages. The case challenged two aspects of the defendant associations’ membership rules. The first was “governance duality,” the defendants’ policy permitting members of one network to belong to the other. DOJ lost on this claim because it failed to demonstrate that duality had led to any adverse competitive effects, and because “market forces had … all but ended dual governance.” The meat of the case was the exclusivity rules of the two networks — the policy of preventing the defendants’ member banks from issuing the cards on networks other than Visa and MasterCard. Although Visa and MasterCard allowed member banks to issue each other’s cards, if a bank chose to issue an American Express card or a Discover card, that bank would lose its right to issue Visa and MasterCard products. The court deemed the exclusivity rules anti-competitive, specifically finding that by preventing banks from issuing American Express or Discover cards, they weakened competition and harmed consumers. The key to any antitrust case is whether the defendants have market power, i.e., the ability to increase prices or reduce output. In the market for the network services that support the use of credit and charge cards, the only competitors were Visa, MasterCard, American Express and Discover. The court found that both Visa and MasterCard possessed market power in this network services market, collectively in excess of 70 percent, which has typically been held sufficient to establish market (and monopoly) power. Establishing a credit card network market was not a simple proposition, since the legal precedent had always found an “all payment systems market” that included checks, cash, credit, ATM cards and debit cards. Here, the court relied both on testimony and customer surveys that suggested that credit was different from other payment mechanisms. Much of the court’s analysis of market definition and market power looked at the role of interchange fees, the fees paid by merchants to card-issuing banks for handling credit card transactions. The court observed that merchants would not switch to other payment mechanisms in the face of an increase in interchange fees. In addition, the parties’ documents showed that they primarily looked to each other’s interchange fees (and, secondarily, to American Express and Discover) in setting their own interchange fees (but they did not consider other payment mechanisms). The court also found direct evidence of market power through Visa and MasterCard’s ability to increase interchange fees to merchants without losing so much business to make the price increase unprofitable and through their ability to price-discriminate among different classes of merchants. Firms cannot be said to possess market power unless there are barriers to entry. In this case, the existence of entry barriers should be rather straightforward. The fact that there has been no entry into the network market, with the exception of Discover, in the past 20 years provided a strong argument that there are significant barriers. On its face, DOJ’s exclusivity claim seemed quite challenging. American Express and Discover are successful, profitable and very effective card issuers. Also, the market seemed competitive. But the court focused on how the exclusivity rules might adversely affect future competition, especially the emergence of smart cards and competition in the debit card market. In these areas, the court effectively found that banks were a “unique distribution source,” and the exclusivity rules had the potential to prevent a more competitive market from arising. The court based this conclusion on direct evidence that, but for the exclusionary policies, several banks would have issued American Express and Discover cards and that in turn would have led to added or enhanced available customer services. Moreover, the exclusionary policies weakened American Express’ and Discover’s ability to compete. There were no comparable distribution channels available to American Express or Discover that would permit them to achieve a sufficient scale to compete effectively against Visa and MasterCard. The court concluded that bank issuance of general-purpose cards across all networks would permit American Express and Discover to gather competitive strength, cause Visa and MasterCard to respond competitively, and ultimately increase product variety and consumer choice. In rebuttal, the defendants asserted two putative business justifications, but neither had much traction. First, the exclusionary rules were necessary to maintain the cohesion of the networks themselves. The court rejected that argument on several grounds, among them the fact that the networks had not suffered outside the United States where similar exclusionary rules were not adopted. Second, the defendants asserted that the rules alleviated free-riding concerns — concerns that American Express, for example, might take something from either association without providing compensation. The court also rejected this argument, finding that neither Visa nor MasterCard had any rules concerning their member banks’ use of their “card-issuing relationships, data, [or] information” and, based on the testimony of bank executives, that Visa and MasterCard had “no interest in the banks’ relationships with their customers” THE DECISION CREATES A NEW WORLD FOR COMPETITION The most immediate impact of the decision will be on the two excluded networks, Discover and American Express, and the banks with which they may now enter into partnerships. American Express has begun an alliance with MBNA, and Discover will acquire Pulse, the crown jewel in the debit card network market. These arrangements will be attractive for banks and the networks and may spur greater network competition. Short-term effects may generally benefit banks and networks, but what of consumers? First, in terms of network competition, one should not expect that the market will stop with just Discover and American Express. Although entering into the network-services market may seem like a daunting task now, there are numerous banks available to enter into partnerships for potential entrants. What will be intriguing is the longer term impact on consumers. Most of the growth in payment systems has been in the debit arena, where Discover and American Express have been relegated to the sidelines because of the associations’ exclusionary rules. The potential for new entry may be particularly important as the debit market continues to grow. Perhaps the most important aspect of the decision is the courts’ holding that Visa and MasterCard both possess market power. Firms that have market power must be far more careful in complying with the law. This finding will make it far more simple (and less costly) for courts to condemn the associations’ practices under the antitrust laws. The litigation gauntlet is already extraordinarily active. Discover and American Express have already filed follow-on suits to DOJ’s case. Success in these cases should be relatively straightforward since liability has already been established. Typically, firms respond to findings of antitrust liability, especially in cases brought by the government, by significantly reforming their conduct. Microsoft’s settlement of the DOJ suit and its recent settlements of private antitrust cases are prime examples of a firm adopting a new attitude of antitrust compliance. While Visa may still tout that it is “everywhere,” and MasterCard may continue to offer “priceless” opportunities, how they respond to the finality of this antitrust challenge and the new environment of antitrust scrutiny could determine much toward the restructuring of the credit card industry. David A. Balto is a partner in the Washington office of Minneapolis-based Robins Kaplan Miller & Ciresi (www.rkmc.com). 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