The Antitrust Wars

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					   Credit card industry is quite competitive.
   Competition inside Visa and Master can be described as
    product differentiation.
Product Differentiation
   Card Features
      Credit line, Credit limit

      membership rewards program

         e.g. airline mileage rewards program

      Affinity card, co-branded card

   Fees
      Annual fee

         Low annual fee or even zero annual fee

      Interest rate
Product Differentiation

Extra features –
  cash-back bonus, purchase discount, purchase protection,
  price protection, frequent flyer miles …

Affinity partnerships have become popular
  E.g. Airlines Optima card has the largest co-branded
  airline program, with 2.8m cards issued by end of 1997
 Affinity partnerships have become popular since the
  later 1980s
    E.g. Airlines Optima card has the largest co-
     branded airline program, with 2.8m cards issued by
     end of 1997
        Dimensions Along Which Payment Cards Differ

 Special Card Features

 Issuers offer services besides payment and credit
  became increasingly popular during the early 1990s
    Example Features – cash-back bonus, purchase
     discount, purchase protection, price protection,
     frequent flyer miles …
AT & T
   Nature of business : Telecommunication

   Benefits offered
        Telephone calling card
        Discount on AT & T calling
        Extended warranty
General Motor ( GM )
   Nature of business: Auto motor industry

   Benefits offered
        Credit toward buying a car
        Getting discount in changing a new car
    Dimensions Along Which Payment Cards Differ

               3. Service Fees (con’t)

Service Fees                                    Variation (Min – Max)

Annual Fee                                      $0 - $88

Late Fee                                        $20 - $29

Cash Advance Fee (in %)                         2% - 4% min

Cash Advance Fee (in $)                         $2 - $4 min

   * American Express Green Card has no limit
 Dimensions Along Which Payment Cards Differ

     Amount of Credit Provided

All credit cards come with a limit on the amount that the
cardholder can charge
Larger credit lines are more valuable to consumers but
riskier for issuers
Issuers may attempt to differentiate their card offers by
extending relatively higher lines of credit than other issuers

   e.g. Platinum card developed in 1990.
         Dimensions Along Which Payment Cards Differ

              Interest Rates in 1998

Interest Rates Variety
Fixed interest rates range from 13.99% to 18.9%
Prime rate + fixed rate (from 2.9% to 11.55%)
Grace Period
From 20 to 30 days
Finance charges dominate
bankcard issuers' revenues

                            4% 2%



   Finance charges      Interchange fees    Late and other fees
   Cash advance fees    Annual fee
I. Product Differentiation

 Heavy Marketing

 Difficult for consumers to learn about and compare
  alternative card products
                           Credit Cards Advertising Spending in 1996

  USD in Million




                         Visa     MasterCard       AE        Discover   Citibank
                                               Card Issuer
Paradox of Credit Card Lending

   Credit card lending is a very competitive market
   According to Economic theory, when in a
    competitive industry,
      All firms should earn zero profit

      and price (credit card interest rate) should be

       close to production cost (the market interest
   Reality
      Very sticky and high interest rate

      rates of return for credit card operations are

       quite high.
   Is a credit card industry a Competitive Market ?
High and Sticky Interest Rate
   Credit card interest rates are usually higher than interest rates on other types of
    consumer loans

Types of consumer loans                            Interest rates (percent%)
Credit Card                                        16

Forty-eight-month automobile loan                  8.7

Home mortgage loan                                 7

Twenty-four-month personal loan                    13.5
Sticky Interest Rates
   The interest rates on credit card loans were sticky to some
   Tended to respond slowly to cost changes
   If cost of fund changes, credit card rates will change by
    only about 1/12
High Interest Rates
   Reasons
      Riskier than other consumer loans

      Require a higher interest rate to compensate for higher

      In ordinary consumer loans, assets could be seized if

       the consumer defaulted on loan, but credit card loans
       are not secured by assets.
      Adverse selection
Sticky Interest Rates
   Interest rates are not the only consumer prices that are
          Adding features

          Increase overall quality

   Credit card interest rates help cover many costs of offering
    credit card services.
   Total price = finance charge + annual fees
   Annual fees fall
   Total price remains the same.
Facts and illusion
   Price did not change
       Annual fees was replaced by Services fees
       Services fees are less visible than annual fees to consumers
       People only focus on annual fees which only accounted for <10%
        of the average price

   Profit made
       Nature of business
       Product differentiation
Dimensions Along Which Payment Cards Differ

              3. Service Fees

                       Trend of Service Fees Charging

                                  Service Fee               Annual Fees






             83   84    85   86   87   88       89     90     91    92    93   94   95   96

Credit card
   Late 1980s
       High profits
       Rates of return is 3 to 5 times over bank operations overall
       Attracted many firms into credit card lending
   1990s
       Not as attractive as the past decade
       AT&T sold its increasingly unprofitable credit card operation to
The myth of high profits
   Questions
       Are the worst of times as bad as and the best of
        times as goods as the profit measurement?

       NO!
    Biases in Accounting rates of return

   Reason
       Initial high fixed investment or high risk
       Examples
          Credit card industry
          Oil industry
Case: Discover card
    Risky credit card lending
   Is 22% rates of return high or low?
       If not risky, extremely high
       If risky, only a marginal business
   Credit card lending is risky!
       Because of uncertainty over new cardholders
   so credit card lender is not the money machine, it has not
    violate the economic principle of competitive market

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