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Pricing payment cards

Author

Listed:
  • Özlem Bedre-Defolie

    (ESMT European School of Management and Technology)

  • Emilio Calvano

    (Bocconi University)

Abstract

Payment card networks, such as Visa, require merchants' banks to pay substantial "interchange" fees to cardholders' banks, on a per transaction basis. This paper shows that a network's profit-maximizing fee induces an inefficient price structure, over-subsidizing card usage and over-taxing merchants. In contrast to the literature we show that this distortion is systematic and arises from the fact that consumers make two distinct decisions (membership and usage) whereas merchants make only one (membership). These findings are robust to competition for cardholders and/or for merchants, network competition, and strategic card acceptance to attract consumers.

Suggested Citation

  • Özlem Bedre-Defolie & Emilio Calvano, 2010. "Pricing payment cards," ESMT Research Working Papers ESMT-10-005, ESMT European School of Management and Technology.
    • Handle: RePEc:esm:wpaper:esmt-10-005
    as

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    References listed on IDEAS

    as
    1. Graeme Guthrie & Julian Wright, 2007. "Competing Payment Schemes," Journal of Industrial Economics, Wiley Blackwell, vol. 55(1), pages 37-67, March.
    2. Schmalensee, Richard, 2002. "Payment Systems and Interchange Fees," Journal of Industrial Economics, Wiley Blackwell, vol. 50(2), pages 103-122, June.
    3. David S. Evans & Richard Schmalensee, 2005. "The economics of interchange fees and their regulation : an overview," Proceedings – Payments System Research Conferences, Federal Reserve Bank of Kansas City, issue May, pages 73-120.
    4. 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.
    5. Chakravorti Sujit, 2003. "Theory of Credit Card Networks: A Survey of the Literature," Review of Network Economics, De Gruyter, vol. 2(2), pages 1-19, June.
    6. Gans Joshua S & King Stephen P., 2003. "Approaches to Regulating Interchange Fees in Payment Systems," Review of Network Economics, De Gruyter, vol. 2(2), pages 1-21, June.
    7. Jean-Charles Rochet & Jean Tirole, 2014. "Platform Competition in Two-Sided Markets," CPI Journal, Competition Policy International, vol. 10.
    8. repec:reg:rpubli:105 is not listed on IDEAS
    9. Hendrik J. Brouwer, 2005. "General discussion : Weiner-Wright : Interchange fees in various countries : developments and determinants," Proceedings – Payments System Research Conferences, Federal Reserve Bank of Kansas City, issue May, pages 65-72.
    10. Mark Armstrong & John Vickers, 2010. "Competitive Non-linear Pricing and Bundling," Review of Economic Studies, Oxford University Press, vol. 77(1), pages 30-60.
    11. Baxter, William F, 1983. "Bank Interchange of Transactional Paper: Legal and Economic Perspectives," Journal of Law and Economics, University of Chicago Press, vol. 26(3), pages 541-588, October.
    12. Graeme Guthrie & Julian Wright, 2007. "Competing Payment Schemes," Journal of Industrial Economics, Wiley Blackwell, vol. 55(1), pages 37-67, March.
    13. Weiner Stuart E. & Wright Julian, 2005. "Interchange Fees in Various Countries: Developments and Determinants," Review of Network Economics, De Gruyter, vol. 4(4), pages 1-34, December.
    14. Laffont, Jean-Jacques & Marcus, Scott & Rey, Patrick & Tirole, Jean, 2003. "Internet Interconnection and the Off-Net-Cost Pricing Principle," RAND Journal of Economics, The RAND Corporation, vol. 34(2), pages 370-390, Summer.
    15. Alan S. Frankel, 2005. "Interchange fees in various countries : developments and determinants : commentary on Weiner and Wright," Proceedings – Payments System Research Conferences, Federal Reserve Bank of Kansas City, issue May, pages 51-64.
    16. Julian Wright, 2004. "The Determinants of Optimal Interchange Fees in Payment Systems," Journal of Industrial Economics, Wiley Blackwell, vol. 52(1), pages 1-26, March.
    17. Armstrong, Mark, 2001. "The theory of access pricing and interconnection," MPRA Paper 15608, University Library of Munich, Germany.
    18. Gans Joshua S & King Stephen P, 2003. "The Neutrality of Interchange Fees in Payment Systems," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 3(1), pages 1-18, January.
    19. Rochet Jean-Charles, 2003. "The Theory of Interchange Fees: A Synthesis of Recent Contributions," Review of Network Economics, De Gruyter, vol. 2(2), pages 1-28, June.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    payment card networks; interchange fees; merchant fees;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • L42 - Industrial Organization - - Antitrust Issues and Policies - - - Vertical Restraints; Resale Price Maintenance; Quantity Discounts
    • L31 - Industrial Organization - - Nonprofit Organizations and Public Enterprise - - - Nonprofit Institutions; NGOs; Social Entrepreneurship
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation
    • K21 - Law and Economics - - Regulation and Business Law - - - Antitrust Law

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