Vertical MFN’s and the Credit Card

This paper presents a theory of vertical most favored nation clauses (MFNs) and then applies the theory to the credit card industry. A vertical MFN is a restraint that an upstream supplier imposes on a retailer that prevents the retailer from charging more for the supplier’s product than for the products of rival suppliers. In the market for credit card services, this restraint takes the form of a no-surcharge rule: that retailers not surcharge for purchases made with a particular credit card compared to purchases made with other credit cards, cash or debit. Vertical MFN’s are observed in markets other than credit cards, such as tobacco, and holiday travel packages. We investigate the impact of the vertical MFN restraint on competition among upstream suppliers selling through a common set of competing retailers. An upstream supplier faces many dimensions of competitive discipline against raising its wholesale price when merchants are free to surcharge. Two are likely to be most significant: the ability of consumers to choose another product as the wholesale price increase is reflected in a higher retail price; and the ability of retailers to drop the product. We start by setting aside the ability of retailers to ∗We are grateful to Andre Boik, Jim Brander, Tom Ross, Roger Ware and Kairong Xiao for helpful comments and to Navid Siami for excellent research assistance. Carlton and Winter have each worked adverse to credit card companies on competition policy matters. †Carlton: Booth School of Business, University of Chicago; Winter: Sauder School of Business, UBC The restraint is sometimes known as a “price parity” restraint.