By Philippe Bergevin
Visa and MasterCard, the two biggest credit cards companies operating in Canada, are currently targets of serious allegations. The Commissioner of Competition alleged in a recent referral to the Competition Tribunal that these companies, through rules they impose on merchants, have limited competition in the marketplace, resulting in increased costs to businesses and, ultimately, consumers.
These allegations have been vigorously disputed by the two targeted companies. Further, some of the economic arguments underpinning the legal case are, in my view, flawed and the solutions prescribed by the commissioner are unlikely to foster, and may even harm, competition and consumer choice.
The allegations refer to rules that are imposed by Visa and MasterCard, which are often incorporated into agreements between merchants and their payment processors — companies that provide terminals to merchants, among other services. One is the so-called no-surcharge rule that prevents merchants from charging consumers directly for paying with a Visa or MasterCard. Merchants, of course, pass on credit card fees to their customers in the form of higher prices — as with any costs associated with their business — but they can’t do so specifically for customers who use credit cards.
The commissioner contends that the no-surcharge rule has reduced competition among different credit card networks like Visa and MasterCard. A close look at the credit card market suggests a more nuanced assessment.
Card payment systems are two-sided markets, meaning that they compete for two types of customers: cardholders and merchants. Cardholders tend to be sensitive to prices, because they can often turn to a lower-cost payment method, such as cash. Merchants in a sense are more captive; they tend to be willing to accept a more expensive payment method, if their customers choose it, for fear of losing business.
Visa and MasterCard try to set relative credit card fees billed to merchants and cardholders so as to maximize the number and size of transactions on their systems; that’s how they make money. They take a small cut — usually a few cents — of every message that is sent among members of their payment system, for example from a merchant to the cardholder’s bank.
The no-surcharge rule is part of a strategy adopted by payment networks to ensure that merchants, not the cardholders, pay an important part of the direct costs of the system. Merchant card fees are to a large extent retained by the banks that issue the credit cards — a fee known as interchange. In turn, the fees are used by banks to support their credit card services, which, through competition, lead to higher benefits — such as travel rewards — and lower costs for cardholders.
In short, every payment network that operates on a for-profit-basis — like Visa and MasterCard — tries to adopt a pricing strategy that maximizes activity on its network — the basis of efficiency and competition. So it is difficult to see how altering Visa’s and MasterCard’s pricing strategy could enhance competition and bring about lower prices overall, for both merchants and cardholders.
There are valid public policy objectives that could be pursued in banning no-surcharge rules. One of them is fairness among cardholders and other customers, notably cash-paying customers. The idea is that since merchants tend to pass card fees on to all customers in the form of higher-priced goods and services, customers who use payment methods associated with fewer benefits, such as cash, nonetheless share the costs of payment methods associated with higher benefits, like credit cards.
But this sort of inequity is common at the retail level. For example, consumers who go to the mall by public transit subsidize, through their purchases, the parking spaces of car drivers. This is at heart a political question, an issue distant from competition policy. Furthermore, the Finance Minister decided, in imposing a voluntary code of conduct that most market participants adopted as of August last year, not to ban the practice.
The other important allegation, which takes aims at so-called honour-all-cards rules, is perhaps more serious and may have more traction for the Commissioner of Competition. In short, Visa and MasterCard require merchants who accept their cards to accept all of their cards.
Until recently, all their credit cards carried the same fee structure for a given merchant, so these rules were never really an issue. A few years ago, however, these same credit card companies started issuing more “premium cards” that provide higher benefits — for example, more travel points — to cardholders, but which impose higher fees on merchants. The strategy was to tap into the lucrative market of high-spending cardholders.
The proliferation of cards carrying higher fees is a genuine problem for merchants. For one thing, it brings uncertainty to the way merchants do business. It is harder for merchants to pass on, through higher-priced goods and services, higher fees to customers if the costs associated with Visa and MasterCard are not stable and vary from card to card. Further, it is harder to decline Visa or MasterCard services with this take all or nothing approach.
It is unclear whether this practice contravenes Canadian competition laws — that will be for the Competition Tribunal to determine. The code of conduct has attempted to address this issue by limiting the growth of premium cards. Further arrangements could be made by industry participants to smooth out price variations for merchants and enhance the predictability of their cost structures.
Overall, requiring Visa and MasterCard to change these rules is unlikely to enhance competition and consumer choice in the credit card market, or the payments market more broadly. Further, the commissioner missed an opportunity to foster more competition by declining last year a bid from Interac — the main payment network for debit card transactions in Canada — to compete on a for-profit basis. It’s not too late for the commissioner to change course.
The government — and by extension the commissioner — should encourage competition and consumer choice, not limit them. The government’s role should be to uphold transparency and disclosure standards to ensure market participants make informed decisions in a competitive market, to the ultimate benefit of merchants and consumers.
Philippe Bergevin is a policy analyst at the C.D. Howe Institute and author of Change is in the Cards: Competition in the Canadian Debit Card Market, at www.cdhowe.org.