Reform of Credit Card Schemes in Australia: II Commissioned Report 2. Industry Overview

6. Figure A provides an illustrative schematic of the credit and charge card industry. As shown in the diagram, consumers obtain credit and charge cards from card issuers. A cardholding consumer – either a household member or business employee – can use a credit or charge card to make purchases at merchants who accept that brand of card. To do so, the merchant must have a relationship with an acquiring institution. Card issuers and acquiring institutions interact with each other through the credit or charge card system to which they both belong. At the outset, it is important to recognize that each of the Bankcard, MasterCard, and Visa systems is an association of independent corporate entities, the member banks. In contrast, American Express and Diners Club each is a single corporate entity. Bankcard, MasterCard, and Visa often are referred to as open systems, while American Express and Diners Club are referred to as closed systems.
7. An acquirer and issuer's interaction through their common card system allows them to verify that the consumer is entitled to use the card to make the desired purchase (authorization) and to ensure that payments flow to the appropriate parties (settlement). It is worth considering acquirers, issuers, and systems in more detail.

A. Card Issuance

8. A card issuer offers cards with particular features, sets the financial terms (e.g., the annual fee, interest rate on unpaid balances, grace period, and late fees), renders the bills to the consumer, extends credit, collects payments from the consumer, and provides ongoing customer service.
9. The Bankcard, MasterCard, and Visa associations do not themselves act as card issuers. Instead, the banks that are members of the associations do. Examples include ANZ and National Australia Bank. American Express and Diners Club also act as card issuers and thus compete with the issuing banks that are members of the two associations. In addition, American Express has one partner issuer in Australia, AMP.
10. The Bankcard, MasterCard, and Visa associations do not themselves act as card issuers. Instead, the banks that are members of the associations do. Examples include ANZ and National Australia Bank. American Express and Diners Club also act as card issuers and thus compete with the issuing banks that are members of the two associations. In addition, American Express has one partner issuer in Australia, AMP.^[5]

B. Merchant Acquisition And Processing

11. The activities of so-called acquirers can be subdivided into merchant acquisition and merchant processing.^[6] In this typology, merchant acquisition refers to signing up merchants, installing point-of-sale terminals, and providing any necessary training of merchant employees. Merchant processing activities include routing transaction authorization requests from the merchant to the proper card issuing institution and relaying that issuer's reply back to the merchant, handling the flow of electronic and paper receipts, settling accounts, and providing ongoing services such as repairs, monitoring, and the provision of supplies.
12. Several members of the Bankcard, MasterCard, and Visa associations engage in merchant acquisition and processing. There are significant economies of scale in merchant processing, and a merchant acquirer may outsource merchant processing activities to a so-called third-party processor, of which there are relatively few. American Express serves as the sole merchant acquirer and processor for its network in Australia.^[7]
13. Acquirers charge merchant service fees in both fixed annual amounts (e.g., terminal rental fees) and on per-transaction bases. Per-transaction charges generally are on an ad valorem basis (i.e., are levied as a percentage of the retail transaction value) but may also contain a flat amount per transaction.
14. Credit card acquiring is highly concentrated in Australia. The top four acquiring banks accounted for 90.9 percent of credit card transactions and 91.8 percent of the dollar value of credit card transactions in 2000.^[8] To some extent, this is to be expected because of the large economies of scale in this industry. The Joint Study, however, raises the possibility that this concentration is increased by restrictive membership rules of the three associations.^[9]

C. Systems Services

15. Credit and charge card systems provide services to issuing and acquiring entities that make it possible for them to offer their services and products to consumers and merchants. Core system services include authorization and settlement protocols and standards that allow systems of a large number of different issuers and acquirers to work together to provide services to consumers and merchants. The set of merchants honoring a given credit and charge card system's cards constitute that system's acceptance network and is also a core system service. The size and coverage of its acceptance network is one of the most important characteristics of a credit and charge card system. The leading credit and charge card systems also engage in extensive brand-building and other activities in support of their members.
16. Credit and charge card systems levy a variety of assessments and fees on issuers and acquirers who use their systems services. Some fees cover non-transaction-related costs, such as brand promotion and innovation. Other fees cover the costs incurred to process transactions over authorization and settlement networks.
17. As noted in the introduction, in addition to charging members for network services, the Bankcard, MasterCard, and Visa associations stipulate the payment of interchange fees. Members of the associations collectively set the default rates in Australia.^[10] Although stipulated at the network level, an interchange fee does not go to the network itself. The fee is a transfer between members: It is paid by a merchant's acquiring institution and received by the cardholder's issuing institution. American Express does not have a formal interchange fee. However, American Express and its issuing partner, AMP, have an agreement that links AMP's compensation to the merchant fees collected by American Express.^[11] This compensation is the economic analog of an interchange fee.
18. The Australian credit and charge systems market is highly concentrated. Survey data indicate that the Bankcard, MasterCard, and Visa schemes together accounted for 93.3 percent of the general purpose consumer credit and charge cards on issue in Australia in 2000. American Express and Diners Club combined had only a 6.7 percent share of cards on issue.^[12] Because American Express and Diners Club have higher average transaction values than Bankcard, MasterCard, and Visa, share measurements using the dollar value of transactions yield somewhat different results. According to Visa, about 12 percent of the dollar value of transactions is accounted for by the closed general purpose credit and charge card schemes.^[13] Thus, Bankcard, MasterCard, and Visa have an 88 percent market share, which is still highly concentrated.
19. Another notable feature of the Australian marketplace is the high degree of overlap in the ownership and governance of the three major credit card associations. Bankcard, MasterCard, and Visa are managed by full-time professional staffs and governed by their members. The four largest banks in Australia serve on the boards or executive committees of all three major open credit card schemes. ANZ, Commonwealth, National Australia Bank, and Westpac serve on the boards or executive committees of Bankcard, MasterCard, and Visa.^[14] The board or executive committee of each scheme has the authority to approve interchange fees and other policies within the scheme. This extensive overlap of system governance, coupled with highly concentrated issuing and acquiring, raises very significant questions about the degree of competition in the Australian credit and charge card industry.
20. The association structure is relevant to the analysis of the effects that various practices have on competition and consumer welfare. To date, Bankcard, MasterCard, and Visa have not been operated as profit centers.^[15] The governing members, however, generally are forprofit entities. Because issuers and acquirers control the associations, association policies can be used to effect economic agreements among horizontal rivals. And because, to date, the associations have not been operated as standalone profit centers, the exercise of association market power is not aimed at elevating the service prices charged to members in order to generate association profits. Instead, market power is exercised to allow members to earn greater profits.