Steve Case Takes On the Credit Card Giants


His new GratisCard slashes fees via Net-based transactions. But can he wrest market share from the likes of Citigroup, JPMorgan, and Bank of America?

A decade ago, America Online (TWX) co-founder Stephen Case helped bring the Internet to the masses. Now, he hopes to create a similar buzz with millions more consumers hungry for another product: credit. BusinessWeek has learned that Case's latest venture is a new payment system called GratisCard, which will use the Internet to lower transaction fees paid by retailers and, Case hopes, increase access to credit and debit cards for lower-income shoppers as well as consumers with bad credit.

Revolution, the private investment company which Case launched in 2005 with $500 million of his AOL fortune, is the largest shareholder in GratisCard, which is based in St. Petersburg, Fla. GratisCard will be formally launched in April.

Case's GratisCard aims to loosen the grip of Visa, Mastercard (MA), and their bank partners, on the payment industry. Retailers complain the card giants charge them high fees—known as interchange fees—when their cards are used in stores. In 2005, Visa and Mastercard generated $25.1 billion in fees on more than $1.1 trillion in credit card purchases, an average of 2.2% per transaction, according to The Nilson Report, a payment industry trade publication. Visa and Mastercard debit cards charged fees at a rate of 1.75%.

Confronting a Juggernaut

To entice merchants to accept GratisCard, the company plans to charge a fraction of that amount: just 0.5% of the cost of a purchase. "If you assume merchants are really irritated by interchange, you have to assume they'll have a friendly ear," says David Robertson, publisher of The Nilson Report. Case and GratisCard declined to comment.

Friendly or not, derailing the credit card industry juggernaut could be the biggest challenge of Case's post-AOL career. Last month, Washington (D.C.)-based Revolution launched Revolution Health, a Web site that provides medical data and services. Its Flexcar unit rents autos—with gas and insurance included—by the hour. And Revolution has also invested in luxury resorts.

But in credit cards, he faces banks and card associations that have existing relationships with a huge swath of U.S. consumers: Just the top three card issuers, JPMorgan Chase (JPM), Bank of America (BAC), and Citigroup (C), have nearly 330 million credit card accounts. And they can keep those customers loyal with lucrative incentives like frequent-flier miles. "They start with economies of scale," says Nilson's Robertson.

Attracting Subprime Customers

Still, the prospect of cutting transaction costs is alluring to Joe Croce, senior vice-president of sales for Comcast-Spectacor, a Philadelphia joint venture which owns the National Basketball Assn.'s Philadelphia 76ers and the National Hockey League's Flyers. In a quiet test at recent games, Croce says "several hundred" customers per night have signed up for GratisCard, enticed by 20% off their first purchase of food and beverages.

But the real attraction, Croce says, is slashing the nearly $2 million that the 76ers, Flyers, and their arena, the Wachovia Complex, paid Visa and Mastercard in interchange fees last year. "If you save half of that and use it for ticket promotion, it's still a win-win," says Croce, adding that the company does not plan to stop accepting Visa and Mastercard.

For consumers with low income or bad credit who are often charged high interest rates and fees, or denied credit altogether by banks marketing traditional credit cards, GratisCard could mean more opportunity. That's because the card plans to join with both prime and subprime banks, according to a source familiar with the matter. And lower transaction costs charged by GratisCard to retailers would make it profitable to accept the card for small purchases.

The Giants Aren't Afraid

High transaction fees charged by Visa and Mastercard are one big reason that many mom-and-pop gas stations and convenience stores set a minimum charge, often $3, to pay with a credit card. "The appetite for $50 Visa cards would probably not be very great," says a senior executive at a bank which plans to issue the GratisCard.

The big banks and credit card companies aren't afraid that a new payment system, even one backed by Steve Case, will threaten their hold on the credit business any time soon. The 10 largest credit card issuers, including JPMorgan Chase, Bank of America, and Citigroup, generated $1.7 trillion in sales on credit cards last year, up 10% from 2005, according to The Nilson Report.

And a host of banks and upstart firms are launching alternative payment systems like GratisCard, often aimed at consumers who still pay with cash. "There is still so much greenfield out there," says Tim Attinger, senior vice-president of product development at VISA USA. "Consumer spending is growing overall and, within that, cash and check is still an enormous opportunity."

One GratisCard Asset: Anonymity

Besides cheaper transaction costs, sources familiar with GratisCard say it will offer consumers and retailers another hot feature: better security. Visa and Mastercard cards are prime targets for thieves because they have an owner's name and account number stenciled on the front. GratisCard is anonymous—cards contain only a 16-digit verification number.

Transactions are encrypted and routed over the Internet. And customers have to use a personal ID number, which can be changed regularly, to authorize purchases. "I could leave a stack of cards on the counter, activated and unactivated, you could take them all and never be able to use them," says the bank executive who plans to issue the card.

Analysts say retailers would welcome cheaper payment alternatives. According to Avivah Litan, a vice-president at market research firm Gartner, a typical credit card purchase of a $100 shirt costs retailers $1.80 in fees. That eats into already thin profit margins, say retail experts. In 2003, the big card duo settled a suit filed by Wal-Mart Stores (WMT)—later joined in a class-action by 5 million other retailers— agreeing to pay back $3 billion in interchange fees.

Case's Ally: Retailers' Anger

But that hasn't soothed the ire of retailers, who contend that fees continue to rise. "It's a double-whammy. It drives up not only the cost of our goods but it becomes a hidden tax on our customers," says Mallory Duncan, general counsel of the National Retail Federation, the industry's largest trade group.

For Case and GratisCard, that lingering anger could be the opening they need. What's more, Case appears to be marshaling a team of Web-savvy entrepreneurs and industry insiders with knowledge of the credit card firms' own secrets. GratisCard is chaired by Theodore Leonsis, vice-chairman of AOL and the multimillionaire owner of the NHL's Washington Capitals. But a bigger threat may be GratisCard's chief executive, Jason Hogg. He is a founder of MBNA Canada, now part of Bank of America, and the son of a credit card veteran: His father, Russell Hogg, was chief executive of Mastercard in the 1980s.


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