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Pricing and welfare implications of payment card network competition

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  • Fumiko Hayashi

Abstract

This paper examines how competition among payment card networks three-party scheme networks and four-party scheme networks affects pricing as well as the welfare of various parties. A competing network has an incentive to provide rewards to its card users. By providing more generous rewards than its rival networks, the network can increase its own card transactions because multihoming cardholders who hold multiple networks cards choose to use its card instead of using its rivals. Although a monopoly network does not have such an incentive, in a monopoly four-party scheme network, competition among card issuers likely makes issuers provide rewards. Due to rewards, the merchant fees under competition can be higher than the merchant fees set by a monopoly network, unless the majority of cardholders are multihoming. Generally, cardholding consumers are better off under network competition. In contrast, non-cardholding consumers are better off only when network competition reduces merchant fees lower than those under monopoly. The results suggest that policies that simply encourage network competition will likely increase cardholder rewards but will not necessarily lower merchant fees in the U.S. payment card market. Several empirical indicators may possibly tell which direction the U.S. payments system needs to go.

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File URL: http://www.kansascityfed.org/PUBLICAT/PSR/RWP/Hayashi_Pricing.pdf
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Bibliographic Info

Paper provided by Federal Reserve Bank of Kansas City in its series Payments System Research Working Paper with number PSR WP 06-03.

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Date of creation: 2006
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Handle: RePEc:fip:fedkpw:psrwp06-03

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Keywords: Competition ; Credit cards ; Debit cards ; Payment systems;

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References

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  1. Jean-Charles Rochet & Jean Triole, 2002. "Platform Competition in Two Sided Markets," FMG Discussion Papers dp409, Financial Markets Group.
  2. Andrew Ching & Fumiko Hayashi, 2006. "Payment card rewards programs and consumer payment choice," Payments System Research Working Paper PSR WP 06-02, Federal Reserve Bank of Kansas City.
  3. Hayashi Fumiko, 2006. "A Puzzle of Card Payment Pricing: Why Are Merchants Still Accepting Card Payments?," Review of Network Economics, De Gruyter, vol. 5(1), pages 1-31, March.
  4. Fabio M. Manenti & Ernesto Somma, 2002. "Plastic Clashes: Competition among Closed and Open Systems in the Credit Card Industry," Industrial Organization 0211012, EconWPA.
  5. Graeme Guthrie & Julian Wright, 2003. "Competing Payment Schemes," Departmental Working Papers wp0311, National University of Singapore, Department of Economics.
  6. Chakravorti Sujit & Roson Roberto, 2006. "Platform Competition in Two-Sided Markets: The Case of Payment Networks," Review of Network Economics, De Gruyter, vol. 5(1), pages 1-25, March.
  7. Fumiko Hayashi & Stuart E. Wiener, 2006. "Interchange fees in Australia, the UK, and the United States : matching theory and practice," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 75-112.
  8. Fumiko Hayashi, 2005. "Network competition and merchant discount fees," Payments System Research Working Paper PSR WP 05-04, Federal Reserve Bank of Kansas City.
  9. Jean-Charles Rochet & Jean Tirole, 2002. "Cooperation Among Competitors: Some Economics Of Payment Card Associations," RAND Journal of Economics, The RAND Corporation, vol. 33(4), pages 549-570, Winter.
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Cited by:
  1. Fumiko Hayashi, 2008. "The economics of payment card fee structure: what drives payment card rewards?," Research Working Paper RWP 08-07, Federal Reserve Bank of Kansas City.

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