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Module 101 Managerial Economics

GROUP ASSIGNMENT Visa and MasterCards Association Potentially Anticompetitive

Group number: 3 Name of students: 1. Nguyen QuocBao 2. Le Van Thanh 3. Cong ThiThuy ID: 1830910 ID: 2544474 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. 2. 3. Michael Porter The five competitive forces that shape strategy .......................................... 3 Overview of the case Visa and MasterCards Association potentially anticompetitive ...... 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

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 MasterCards Association potentially

The case Visa and MasterCards 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 banks 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. 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. 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 MasterCards 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 consumers 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 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 consumers 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 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 MasterCards 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. Visa and Master dominate the Market:




VISA 50 53




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 doesnt 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 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 - Divide Market share for another smaller range of products: commercial cards, competitors travelers cheques, stored value cards Widen business network and as: American Express,


partnership; Discover/Novus Additional






consumer acceptance widespread - Lower cost cause of Visa member banks issuing card.

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 = 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 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 Visas and MasterCards corporate structures, a member bank in eitherassociation has the right to issue cards bearing the associations trademark and to offer card acceptance services for the associations 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 associations 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 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 Expresss and Discover/Novuss 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. Visas 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 dont 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 Internationals President and Chief Executive Officer proposed that each of banks would issue prospectively only one GPC brand Visa or MasterCard. , Visa U.S.As 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 Express or Discover/Novus networks. Bylaw 2.10(e) prohibits Visas member banks from issuing cards on any network that is deemed competitive by Visas Board. But Visas Board

has not deemed MasterCard to be a competitor, and Visas 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 Internationals 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 consumers benefits has been abandoned, delayed, suppressed and consumer choices have been reduced. The strength of the competitiveness also affects price, cost, and the investment including price discounting, new product introduction, advertising campaigns, and service improvements. Its testified that in 1992, Visa Internationals

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 Internationals 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.