How an Incentive Boom Could Push Visa, MasterCard into Acquiring

Locked in increasingly fierce competition with each other and with other card networks, Visa Inc. and MasterCard Worldwide are paying out higher and higher sums to issuers and merchants in the form of rebates and incentives, a trend that not only hurts the bank card networks' yield on each dollar processed but also could lead ultimately to the networks' entry into direct acquiring relationships with large merchants. That's according to research released this week by Aite Group LLC. If that were to happen, acquirers would be shut out of a merchant market where, for example, the 232 largest U.S. merchants accepting Visa account for half that network's volume. “The implications [for acquirers] would be huge,” Gwenn Bezard, research director at Boston-based Aite, tells Digital Transactions News. Bezard estimates the bank card networks paid issuers and merchants around the world almost $4.9 billion between 2005 and 2007 to encourage the issuance and acceptance of their brands. Of the sums Visa USA is committed to spend between now and 2012, some 40% will be given to merchants, Bezard says. Recipients are generally large retailers, cobranding partners, and merchants in emerging markets where the networks are trying to encourage usage, such as the bill-payment and small-ticket categories, he notes. Subsidies to merchants to pay for contactless readers, for example, are counted among merchant incentives. The Aite report says Visa USA and MasterCard Worldwide together poured out $1.5 billion in these incentives in 2007, compared with $700 million just two years earlier. A big reason for the explosion in incentive spending by the bank card companies is a U.S. Supreme Court decision in 2004 to let stand a lower-court ruling that allows banks to issue cards on the American Express Co. and Discover Financial Services Inc. networks, not just Visa and MasterCard. The incentives come with a price: As the bank card systems spend more on incentives, they risk hurting the yield they earn on each new dollar they handle, Bezard says. Another effect of all this largesse, however, is that it draws the networks closer to merchants in a way that could see Visa and MasterCard ultimately muscling aside the merchant processors that have traditionally served merchant accounts. Though the bank card networks historically have bowed to acquirers and dealt even with larger merchants primarily through these processors, negotiations over rebates and other incentives have been an exception, Bezard says. As network competition grows more intense, the networks could draw on these direct relationships to bypass acquirers on other acceptance matters, eventually entering the acquiring business themselves, Bezard says. Another factor that could push the bank card networks in this direction, he points out, is that many large merchants are also issuers that work with banks in cobranded card programs. “If I were in the shoes of the merchant acquirers, I'd be worried,” says Bezard, though he adds there's no reason for acquiring executives to lose any sleep yet. Any such move by the networks is probably at least five years off?if it happens, he says. Nor does he see Visa and MasterCard consciously formulating a strategy to move into acquiring. But with Discover and AmEx to worry about now more than ever, he says, the bank card networks may find themselves moving into tighter relationships with merchants any way. And at the same time, the networks confront larger merchants and merchant coalitions that, through market consolidation, have more negotiating clout. Visa and MasterCard could decide the only way to please these merchants is to acquire their transactions directly, a move that could allow them to undercut pricing from middlemen without giving up more in rebates. “Visa and MasterCard will have to do something to come up with packages to make themselves more attractive,” Bezard notes.