The Rise of Payment Cards
Buying goods on credit goes back many years - religious prohibitions against usury in the Christian Bible and regulation on money lending in the Code of Hammurabi are evidence that it is centuries-old.
Traditionally, credit was borrowing a fixed sum for a specific purchase, with a specific plan for repayment. It was generally offered on high-ticket items such as vehicles, farm equipment, furniture, and other goods as service from the seller.
Payment cards trace their roots to consumer credit at grocery stores and general merchandisers for the "average" consumer, as well as the accounts extended to wealthy customers by hotels, department stores, and even oil companies. With few exceptions, the line of credit was associated with a specific vendor.
The Birth of the Payment Card
One of the key innovations that lead to the rise of payment cards was establishing acceptance among merchants. The first organization to do so was Diners Club (circa 1950), which arranged to issue a card to its members that would be accepted at many different establishments across the country - first restaurants, then hotels, then retail stores.
Following their success, a number of local banks attempted to create payment card systems in local markets, enabling consumers and merchants who had accounts with the banks to move money among accounts. The difficulty of providing such a service outweighed its value in attracting customers, so most died quickly.
1958 was a watershed year: American Express, Carte Blanche, Bank of America, and Chase Manhattan bank all entered the industry. The first two firms were true "charge cards," in that the holder was not required to maintain a deposit account with the issuer. By 1960, over 40 large banks also had their own card programs. However, most did not grow beyond the local market.
At this time, few merchants accepted payment cards, the population was not very mobile, banks were reluctant to issue cards to any but their wealthier customers, and there was a wide incidence of fraud - all of which prevented the use of payment cards from being perceived as necessary or useful by the mass market.
The Infancy of the Card Associations
Thought the 1960's, as population became more mobile, banks began to form associations and networks to enable customers to use their cards more broadly, particularly when wealthier customers and even members of the burgeoning middle class began to travel more extensively (for business and leisure).
This gave rise to the giants: the Interbank Card Association became Interbank, then Master Charge, then MasterCard in 1980. Bank America Card became the National Bank Americard, which became Visa in 1976.
The card associations themselves became independent of the banks, though each was run by a board of directors elected by their member banks who voted on the terms of the network agreement. In general, they were eager to recruit new members, as widespread acceptance of a card by merchants mean that the card was of greater value to the consumer. Also, it was not uncommon for the associations to charge fees of new members to cover the cost of operating the association - and the members generally passed the charges along to merchants as a commission.
Early Policy Issues
By the start of the 1970's, there were essentially two kinds of cards: charge cards (which accumulated charges to be paid in full when the bill arrived) and credit cards (which provided a standing line of credit with flexible payment options). Two policy issues, duality and usury, had significant effects on the industry:
Duality
Until 1976, credit cards could insist on exclusivity - as a condition of the agreement with Visa, a bank could not offer any other card - though the backed down from this (voluntarily) for fear of antitrust lawsuits.
On the bright side, this increased competition and compelled cards to be more reasonable in their fees. But on the other hand, many consumers were marketed multiple cards - and a customer who accepts several offers has the potential to accrue far more debt than they are reasonably capable of paying off.
Usury
Card issues rely on the spread between the interest rate they offer their customers and the interest they earn on the cash they must hold to meet their obligations. If they set their interest rate too high, customers leave (or charge less), too low and they may be unprofitable (or lose money). This problem is compounded by fluctuations in interest rates.
Also, maintaining card limits within the limit permitted by usury laws made it difficult for card issuers to do business across state lines - until the 1978 Marquette case, in which SCOTUS ruled that banks could charge interest based on the sate in which they were located (regardless of a customer's state of residence).
As a result, nationally chartered banks moved their card operations to states with less restrictive usury laws; states in turn relaxed their usury laws to attract these businesses (and gain the tax revenue).
Also, a national market was created: banks could easily market their card to any consumer in the US - and by 1992, over 100 companies were marketing their cards nationally.
As with duality, this created competition to keep the industry in check, but also gave the consumer the ability to open a plethora of accounts with different banks.
The 1980s Spending and Debt Spree
The payment card industry grew dramatically in the 1980's - consumer credit outstanding increased by nearly 50% over this period, while consumer spending nearly doubled.
The number of cards outstanding more than doubled, and companies began to resort to gimmicks to "sell" their cards: customized cards, "rewards" programs, cash-back incentives, etc.
Numerous non-bank companies also joined the fray - AT&T, Ford, General Electric, and other firms began to market cards under their own names. These cards were backed by major issuers, but the affinity company made a cut of the profits.
The 1990s and the New Millennium
A significant industry trend in the 1990's was the creation of securities backed by credit card receivables: credit card issuers were able to create and sell bonds, backed by their expected revenues from cardholders. This was a significant boost to card-issuing companies, who often have no assets other than the receivables on outstanding card balances.
The 1990's also marked the debut of the debit card in the United States, when banks leveraged the ability to integrate debit card technology into their customers' ATM cards. With a decade, the number of debit transactions increased almost twenty-fold, as 230 million ATM cards were converted into payment cards.
Risk, Innovation, and Investment
While much attention is paid to the four companies that rose to the top in the payment card industry, there are thousands who failed along the way. Even today, attempting to launch a payment card brand is fraught with perils.
Entrepreneurial Risk
A payment card program requires a board roll-out and a great deal of marketing: you must be able to provide a significant cardholder base to be attractive to merchants, and a significant number of merchants to be attractive to cardholders - building this level of demand, even in a local area, is expensive and risky.
Business Risk
There is also significant risk in operating a credit card business - primarily, the risk of fraud, which can come from third-parties (stolen or forged cards) as well as legitimate customers, or even merchants. In the early years, fraud was estimated at 15%
There is also the risk that a business faces in maintaining adequate capital to support credit card lending - to make payments to merchants while awaiting payments from customers required them to borrow money with the hope of making enough from their customers to repay it.
Competitive Risks
Competition also poses significant risk in the card payment industry: there is little customer loyalty. Customers often carry several cards and will move their balance to the one that charges the lowest rate. Various other "incentive" programs have been attempted, but there is no evidence that they have had significant success.
In addition to getting a card into the wallets of consumers, a card issuer must also enter into agreements with merchants to accept the card, which translates into an equipment and training expense, plus making the acceptance of a "new" card compatible with their information systems and business procedures.
For retail establishments, the use of a payment card as a system to build customer loyalty is also no longer effective: customers have a decided preference for cards that can be used in an array of locations, and few retailers can match (or beat) the rates offered by national card issuers while absorbing the cost of managing their own program.
Regulatory and Legal Risks
Credit card issues were, and always will be, vulnerable to regulation and the legal climate. Before the Marquette decision, card issuers often ran afoul of usury laws. Even after it, issuers remain at the mercy of state legislatures, who have the ability to change the maximum interest rate at a whim.
Furthermore, the major issuers have all faced antitrust litigation over time, as well as laws that compel them to issue cards to customers who are not credit-worthy and limit their ability to collect the debts owed them.
Financial Risk
A card issue faces considerable financial risk: they must maintain capital reserves to pay debts top merchants, while having little control over the time at which they will be paid by their own customers. Often, card issuers are leveraged, borrowing money to pay their obligations or securitizing their debt.
Federal law also leaves the card issuer holding the bag in case of fraud, and having little power to pursue consumers who default on their loan.
EN: The book does not mention the recent (2008) credit crisis and the effect it has had on card issuers, but I would suspect that defaults on consumer debt have had a significant impact, especially since they are obligated to pay securitized debts even while customers are defaulting on their debt.