"In business, I look for economic castles protected by unbreachable 'moats'." --Warren Buffett
You've heard it before: American Express's (NYSE:AXP) customers spend more money on its closed-loop network, which gives it an advantage over virtually every other credit-card network.
No one can touch its transaction volume per card. And Discover is the only other credit-card company to have a truly closed-loop network, wherein one company serves every role, from card network to banker for the card user and the merchant.
Unlike American Express, however, Discover targets spenders who are more likely to carry a balance. Discover is much more like Capital One than it is, say, Visa or MasterCard, as it earns the bulk of its income from interest and finance charges, not network fees.
The advantages of a closed-loop network are many. First, there's the simple fact that a closed-loop network stands to generate more revenue on every swipe. Theoretically, networks of this type should be able to pay more to drive transaction volume, whether that comes in the form of increased marketing spend or incentives like cash-back rewards, or both.
There are other benefits that aren't so obvious. The Department of Justice noted in its decision against American Express in an anti-trust case that the closed-loop network generates valuable data that open-loop networks simply cannot collect.
The DoJ wrote the following in its decision:
Amex's merchant value proposition relies on the network's ability to leverage its closed-loop infrastructure to deliver marketing and data analytics services to merchants that its competitors cannot match. By retaining end-to-end control of all spending data on its network, American Express is able to sell its merchants information on and analysis of its cardholders' spending behaviors, allowing the merchant to engage in more effective targeted marketing or identify new locations for geographic expansion, among other applications.
Put simply, closed-loop networks collect more data about their customers.
But for all the glowing praise from the Department of Justice, the truth is that even this advantage is being whittled away by competitors. A recent article by Reuters tells the tale of JPMorgan's (NYSE:JPM) successful entry into the network business.
Led by an ex-Amex employee, JPMorgan's credit card business is securely in the No. 2 position. The bank signed a very favorable deal with Visa in 2013 that allows it to effectively lease the network for its own use.
ChaseNet is the equivalent of a closed-loop network. When a Chase card is swiped at a merchant that banks with JPMorgan, the transaction mimics a closed-loop transaction.
JPMorgan generates transaction volume on ChaseNet with merchant incentives like lower fees, which retailers are happy to accept. The result is that it can collect all the data that Discover and American Express can collect, all with the benefit of being able to tell merchants that it has significantly lower fees than American Express.
JPMorgan has, in effect, duplicated American Express' advantage of data collection at a lower price to the merchant.
All this is to say that one of the most enduring advantages of American Express -- its closed-loop network -- is now replicated by the No. 2 credit card company, not just also-ran Discover. Its well-heeled clientele may be the single last remaining advantage, but targeting big spenders is a marketing strategy that's easily duplicated. American Express' moat is shriveling.