Global not-for-profit joint ventures between commercial entities: an interview with Broox W. Peterson, former Senior Vice President and Assistant General Counsel, Visa International and Visa U.S.A.
Q: Visa and MasterCard used an intriguing form of joint venture, the global not-for-profit joint venture, to introduce credit card products that have become familiar to nearly everyone. I'd like to discuss this with you. What is a "global not-for-profit joint venture"?
A: Don't forget the "between commercial entities" part, since it is an important distinction. There are many non-profit joint ventures between non-profit entities like hospital groups and other affiliations of charitable organizations, but not that many between commercial entities. Any commercial entity can be structured and operate as a non-profit entity, just as any non-profit entity can participate in activities that for-profit commercial businesses do.
Q: What type of business model do commercial entities use for global not-for-profit joint ventures?
A: Perhaps the prime models for the kind of joint venture I am talking about have been MasterCard and Visa, the credit and debit card associations, although they are both moving away from that model now. This has also been used in professional sports, publishing, and other lines of business.
Q: How would you describe the model chosen by MasterCard and Visa?
A: Both MasterCard and Visa were established as Delaware membership associations owned by their customers, the banks around the world that issued MasterCard or Visa Cards. These membership associations were operating companies in themselves, providing system operating rules, product development, marketing services, and an electronic global payments communications and processing network that enabled any card issued by any member bank to be used at any merchant around the world signed up by a member bank. They were governed by a Board of Directors comprised of representatives of the member banks, who approved budgets for the association which were funded by fees-for-services approved by the Board of Directors, and paid by the member banks using those services. Neither association was operated on a for-profit basis, although some capital was accumulated to fund risks such as a member bank failure preventing daily settlement for cards issued by that bank.
Q: Why was this operating model adopted?
A: Lots of reasons, of course, but a very significant factor was the nature of the credit card business. When the associations were formed in the early 1970's, no one bank could put together a nationwide, much less global, payment system like Visa or MasterCard. In fact, in the U.S., banks were not permitted to operate across state lines until the early 1990's. The card business is a scale business, and real success requires lots of issued cards and lots of accepting merchants. Actually, Visa was formed in 1970 due to the inability of Bank of America to expand its proprietary BankAmericard system outside of California. Bank of America needed licensees in other states in the U.S. and countries outside of the U.S. to issue BankAmericards and sign merchants to accept those cards, but those relationships proved contentious and ultimately unworkable. Visa was formed to tie together--with common interest and ownership--all banks around the world that wanted to be in the card business, and to provide the infrastructure that would integrate the individual member banks into one system.
Q: What were the other reasons you mentioned?
A: The banks that wanted to participate in Visa and MasterCard also wanted to retain control of their relationships with their customers, individual and business, by issuing the cards directly to their customers under license from the card associations. In addition, they wanted to be able to put their bank trademarks on the cards, and to set and collect their fees directly from their customers. The membership association form of organization for this operating entity enabled the member banks to fund jointly the systems and other common infrastructure required for the credit card business to succeed, while permitting the member banks to compete with each other for cardholders and merchants. It also limited the cooperative activities of these competitors strictly to those functions that needed to be centralized for the business to succeed, which was an important part of defending the member banks against claims of anti-competitive behavior.
Q: How did this model minimize complaints of anti-competitive behavior?
A: Well, any time you have competitors coming together in a joint venture you have concerns about restraints of trade and other anti-competitive behavior. In the early 1980's, Visa successfully fought a price-fixing challenge in the United States to the so-called interchange reimbursement fee. This fee was established by the Visa Board of Directors and paid by the member bank that signed up the card-accepting merchant, called an Acquirer, to the member bank that issued the card, called an Issuer. MasterCard had a similar fee. The fee was needed to reallocate revenue generated by Acquirers to the Issuers since they incurred relatively more costs than Acquirers did per dollar of revenue, and the reallocation ensured that that there were member banks willing to perform each function. A court found that this was not price-fixing, and that since the system would not be successful without the fee, it was a reasonable practice under the anti-trust laws in the U.S. The decision was a legal blessing of sorts by the courts in the U.S. of the bank association joint venture model.
Q. You have mentioned that the members of the joint venture were free to compete with each other for cardholders and merchants. Was it really a global free-for-all?
A: Not really. The card associations adopted jurisdictional rules from the beginning, limiting the rights of member banks to issue cards and sign merchants outside their home country. Remember, the global, ubiquitous card business of today started from nothing. In each country cards had to be marketed and issued, and merchants signed to accept them. Both of these endeavors had to be successful for the business to succeed in that country, and the success of one endeavor was dependent on the success of the other. It was the old chicken and egg conundrum, and it took a lot of marketing investment and leg-work to solve that puzzle.
The card association rules favored indigenous Issuers and Acquirers, since it was believed, correctly in my opinion, that an indigenous member was better positioned and motivated to build both halves of the business than an outsider that might be tempted merely to cherry-pick without making the investment necessary for the market to be developed properly. These jurisdictional restrictions benefited every member in the system by maximizing the development of country markets, and thus the global utility of any card issued by any member. There were also provisions permitting non-indigenous members to come into a country if there was no indigenous member in that country, or if the indigenous members in that country approved. Obviously, the indigenous members in a country had to comply with local legal restrictions when giving or withholding this approval.
Q: You mentioned at the beginning that Visa and MasterCard are moving away from the association joint venture model. The Visa and MasterCard businesses have been extremely successful as they are, so why change?
A: While the card association model was incredibly successful in propagating the card business worldwide, it became a victim of its own success, to some extent self-inflicted. Merchants today have no choice whether to accept credit and debit cards; they have to, because consumers expect them to. As more and more of merchants' sales are paid for with cards, the merchants have come to resent the fees they pay for that privilege. This resentment has been stoked over the years by a creep upwards in those fees, due to increases in the amount of the interchange reimbursement fee paid by Acquirers to Issuers for every transaction, which the Acquirer passes along to the merchant.
Due to mergers and consolidation of banks worldwide in the past 20 years, it came to be that a small number of very large banks controlled the card associations. Since these member banks were also very large Issuers, they began to view the interchange reimbursement fee not as a revenue reallocation mechanism to ensure success of the system, but as a demand-driven pricing scheme to collect as much revenue from merchants as the market would bear.
Unfortunately for the Issuers, the merchants haven't borne it very well, and in the U.S., Visa and MasterCard, and their member banks, have been sued by groups of merchants on the grounds that the interchange reimbursement fee constitutes price-fixing or other anticompetitive behavior, seeking to overturn the court precedent from the 1980's finding that it was not. It is not unreasonable to believe that they could succeed, since much of the rationale on which the court upheld the interchange reimbursement fee in the 1980's is out-of-date in today's circumstances. There are also regulatory investigations underway in the European Union apparently seeking to reduce significantly the fees paid by merchants for accepting cards.
Q: It seems that you are saying that these legal challenges are causing the card association model to be abandoned by the member banks. If so, why?
A: The member banks are concerned that their control of the process of setting the interchange reimbursement fee exposes them to potential liability and also makes the fee harder to defend. MasterCard has already restructured itself as a public stock company no longer controlled by the bank members. Visa is not far behind. By giving up control of MasterCard and Visa, the banks hope to preserve the lucrative interchange revenues from the card business while insulating themselves from antitrust challenges. Of course, given the myriad of legal challenges to interchange fees, there is a distinct possibility that they will be at least substantially reduced, and now also might have seemed a good time for the banks to monetize some of their considerable investment in the card systems while the value of the systems are at their peak.
Q: Besides the legal difficulties you describe, are there other drawbacks to the competitor joint venture model, at least with the card associations?
A: The great strength of the card associations was the agreement of fierce bank competitors to cooperate to build an infrastructure platform that any member bank could use to compete with other members in card issuance and merchant signing. Actually, "fierce banker" may be an oxymoron. Anyway, the great weakness of the card associations was that large member banks resented the fact that the common infrastructure that they helped fund helped their competitors as well, both large and especially small. During the early years the diffuse ownership structure of the associations kept the large banks from doing much about their resentment, particularly since they needed and benefited from the common infrastructure as much as any of the other members. However, over time a few very large members grew their card businesses to the point where a relative handful of large banks controlled the associations, and began to stifle innovation.
Another difficulty with the global association structure was that national and regional resentments and pride played an extraordinarily large role in the business and organizational decisions of the associations. In the case of Visa, what began as a centralized organization that had focused on the global business evolved over time as a result of these forces, and splintered into regional, semi-autonomous divisions, with a greatly weakened headquarters function, and incessant internal negotiations trying to achieve a global consensus. Interestingly, MasterCard evolved from a different direction. Until recently, the European MasterCard business was actually a separate business affiliated with MasterCard, with the same inter-regional politics as Visa experiences now. But after 2000, MasterCard bought out the European company as part of a global restructuring into a centralized organization. However, national and regional resentments and pride are a constant distraction in a global card association, regardless of structure.
Q: Now that MasterCard and Visa seem to be leaving the not-for-profit joint venture model behind, do you see the model having any use in the future?
A: I do, in businesses where development and operation of a common infrastructure by competitors will enable the creation and success of a business that needs the infrastructure for success. This is very common in the sports business where "leagues" and "associations" are common. Media networks and similar industries can also benefit from this. There are even associations dedicated to approaches like this, such as the Midlantic Association of Not-For-Profit Organizations. There are always situations in which creative business minds can use the non-profit model for competitive success. For example, suppose that instead of having the interstate highway system built with federal tax dollars, the automobile companies had been left to build, market, and operate the interstate system as a non-profit joint venture. Maybe the oil companies could also have participated. Since a large part of the success of these competitors depended on the necessary infrastructure being present for the use of their products to be maximized, there are parallels to the card association experience. Obviously there are large differences, as well, but as new technologies in transportation or other areas emerge, perhaps new uses for non-profit joint ventures of competitors will be found.
Interviewed by L.V. Kurylo
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|Publication:||Review of Business|
|Date:||Mar 22, 2007|
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