Back in the E.U.S.S.R.

Fifteen years after the demise of the Soviet Union, Europe still yearns for the good old days.

All across the Continent, west of the old Berlin Wall, economies are stagnant, GDP growth is anemic, and the powers that be persecute successful companies with malice aforethought. One wonders whether there's a connection there.

In the latest example of Europe's anti-free market bent, the European Commission issued an ultimatum to the credit card companies last week: Lower your prices or face fines of as much as 10% of your annual revenue. The reason: Competition Commissioner Neelie Kroes says card providers such as MasterCard, Visa, and American Express (NYSE: AXP  ) are earning "outrageous" profits and must be brought to heel.

In support of the Commission's charges, Ms. Kroes cited a slew of pretty bad-sounding statistics:

  • Fees average 2.5% of the $1.6 trillion spent on card-facilitated purchases last year.
  • Fees charged to one country's retailers can be as much as six times those charged in another country.
  • Fees charged to one country's cardholders can be as much as 12 times those charged in another country.
  • Small- and medium-sized retailers are sometimes charged as much as 70% more per transaction as are large retailers.

Up to that point, I was nodding along in agreement with Ms. Kroes. Although I'm sure there's reason to give large retailers volume discounts on fees for the amount of business they generate, a 70% differential does seem kind of wide. Likewise, it seems strange that the putative "United States of Europe" would have one and the same service priced at $1 in one country, and up to $2 to $6 in another.

Define "outrageous"
But after reading all these numbers the Commission is bandying about: "$1.6 trillion," "six times" this, and "12 times" that, I notice that nowhere have I read -- in any of the press reports on the Commission's witch hunt -- an actual number being put to these "outrageous" profits.

So I turned to Capital IQ, the Oracle of financial data we use here at the Fool, to find out, and it turns out that American Express nets just 6% of its revenues as profit. MasterCard earns a 9% net margin. Only the 14% margin that Visa boasts even shares a zip code with "outrageous."

Don't get me wrong. Fourteen percent is certainly respectable, but I was sure there were companies out there making better margins than that. With a few more clicks, I dug up a handful:

  • Coca-Cola (NYSE: KO  ) : 21% net margin
  • Intel (Nasdaq: INTC  ) : 22%
  • eBay (Nasdaq: EBAY  ) : 24%
  • Google (Nasdaq: GOOG  ) : 24%
  • Microsoft (Nasdaq: MSFT  ) : 32%

Now, these companies all have a couple things in common -- both with each other and with the major card providers as well. First, they've all been targeted for criticism by European authorities in recent years -- Coke for out-competing other pop vendors for shelf space, Intel for controlling too much market share, eBay for failing to do the European Community's tax collecting for it, Google for getting too inventive with its advertising, and Microsoft seemingly for everysinglethingitdoes.

And the second thing they have in common: They're all American companies.

A bridge too far
The problem with the Eurocrats is that they can't seem to quit when they're ahead to let a good argument stand on its merits. They always have to go one step too far and show their real motives for overregulation and interference in the market: Euro-jingoism.

If Ms. Kroes' (and her Commission's) real motivation is simply to stamp out alleged price gouging and flatten the market for financial services across European borders, then explain this portion of her statement:

"We need a European card payment system that can rival Visa and MasterCard.Those companies are welcome in Europe, as long as they conform to European competition rules, but there is evidence that [they] appear to be abusing the system at the moment."

"Those companies." As in "those American companies that try to earn profits in our Europe?"

What is Europe's real motivation here? Is it to protect the consumer from price gouging or shut out foreigners in favor of a local "champion" that will probably be guilty of the same gouging?

Two final points
I'm almost at the end of my rant here, but I have two final points before I close. First, on the subject of timing. With none of the existing card providers earning profits that are truly excessive today, one wonders why the Commission is raising a ruckus at this particular time. I suspect the answer has something to do with the fact that MasterCard is planning an IPO any day now. The last thing any company wants is bad press at its coming-out party, so now is an excellent time to try and extract concessions from this weak link of the card industry.

My second point is on economics. For the head of an agency directly responsible for ensuring a free market in Europe, Ms. Kroes seems woefully ignorant of the function of the profit motive. If Europe truly does "need a European card payment system that can rival Visa and MasterCard," then its best bet is to permit the existing companies to earn as much profit as possible.

As Adam Smith teaches, excessive profits inevitably attract competition. Leave Visa and MasterCard to their business, and if their profits are truly "outrageous," a local competitor will inevitably arise to claim a portion of those outrageous profits for itself. (And incidentally, its arrival will create the very competition needed to deflate profit margins.)

On the other hand, if you cap Visa's and MasterCard's profits today, only one result is certain: With no outrageous profits to be claimed, no local champion will ever arise to claim them.

Coca-Cola and Microsoft are Motley Fool Inside Value picks, while eBay is a Motley Fool Stock Advisor pick. Take the newsletter that best fits your investing style for a 30-day free spin.

Fool contributor Rich Smith does not own any of the companies named above. The Motley Fool has a disclosure policy.


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