The Sudden Onset of Price Competition in the US Credit Card Industry

By Schumann, Hans O. | Academy of Banking Studies Journal, January-July 2013 | Go to article overview

The Sudden Onset of Price Competition in the US Credit Card Industry


Schumann, Hans O., Academy of Banking Studies Journal


INTRODUCTION

Up until the early 1990s, The American Credit Card industry has attracted a significant amount of academic interest and articles published in economic journals. Academics, led by Ausebel (1991), Calem (1992), and others, focused on the fact that for decades the industry showed very little of the competitive price competition that one would expect from of an industry with thousands of firms selling an essentially homogeneous product (1). In 1992, the competitive market-defying interest rate "Stickiness" abruptly changed. Almost overnight, the industry became a fiercely contested market using interest rate pricing as its main competitive weapon. The purpose of this article is to explain the unique factors that all converged in 1992 to cause this momentous shift. There were three forces that worked together to change the competitive paradigm--The unique characteristics of the 1990-1992 recession; the U.S. presidential election campaign with its focus on health care reform; and the variable interest rate structure that had previously been adopted by some issuers including First Chicago Corporation and AT&T Universal Card. The catalyst that provided the spark that changed this industry was the health care insurance reform debate which was part of the 1992 presidential campaign. The net result of all these forces, triggered by the health care debate, was an awakening of the cardholders' recognition of their true financial situation. This directly resulted in the fundamental reformulation of the consumers' desire to negotiate and shop for credit cards with lower interest rates. During the year 1992, credit card interest rates ceased being "sticky" and serious price competition entered this industry where it had never been before.

HISTORY OF THE INDUSTRY

The general purpose credit card industry has a long history in the United States. Merchant credit has been extended in one way or another since the nineteenth century. Early in the twentieth century hotels and department stores began issuing identification cards for their best customers, thereby alerting the merchants' staff that these customers should be extended credit if requested. Diners Club in 1949 developed the first general purpose charge card. Together with American Express, they focused primarily on relatively wealthy customers and enabling travel and entertainment purchases. In the late 1950's Bank of America launched the bank-run credit card industry we know today with the BankAmericard. By franchising this concept to banks in other geographic regions, Bank of America created an organization that would later morph into what is now known as Visa, USA. Their principle competitor, MasterCard, then known as MasterCharge, was established in 1966 (2).

By the 1980s, the American general purpose credit card industry consisted of over 4,000 banks and bank-owned credit card issuers offering products through two industry associations, VISA and MasterCard. The largest bank card issuers included most major US money center banks: Citicorp, Chase Manhattan and Bank of America. In 1986, Sears Roebuck & Co. entered the general purpose credit card industry by creating its own Discover brand card and merchant card acceptance network. One year later, American Express entered the credit card industry with their Optima credit card utilizing their American Express Charge Card's merchant network. In 1990, the US telephone giant AT&T through a partnership with Total Systems Corporation entered the industry and began issuing MasterCard and Visa Cards. General Motors in a partnership with Household Finance entered the industry late in the fall of 1992.

This is an industry selling an almost identical product with a very large number of firms and a proven ability for new entrants to enter. In other words, this is an industry that economists would normally expect to classify as "pure competition." Yet despite all of this competition, the credit card interest rates, as measured by the Annualized Percentage Rate (APR), remained high throughout the 1980s. …

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