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Pricing payment cards

Author Info

  • 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.

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File URL: http://static.esmt.org/publications/workingpapers/ESMT-10-005.pdf
File Function: First version, 2010
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Paper provided by ESMT European School of Management and Technology in its series ESMT Research Working Papers with number ESMT-10-005.

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Length: 38 pages
Date of creation: 11 Aug 2010
Date of revision:
Publication status: Published in American Economic Journal: Microeconomics 5(3): 206–231.
Handle: RePEc:esm:wpaper:esmt-10-005
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Keywords: payment card networks; interchange fees; merchant fees;

Other versions of this item:

Find related papers by 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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  1. 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.
  2. Stuart E. Weiner & Julian Wright, 2005. "Interchange fees in various countries: developments and determinants," Payments System Research Working Paper PSR WP 05-01, Federal Reserve Bank of Kansas City.
  3. Jean-Jacques Laffont, 2001. "Internet Interconnection and the Off-Net-Cost Pricing Principle," Theory workshop papers 357966000000000085, UCLA Department of Economics.
  4. 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.
  5. Jean-Charles Rochet & Jean Tirole, 2003. "Platform Competition in Two-Sided Markets," Journal of the European Economic Association, MIT Press, vol. 1(4), pages 990-1029, 06.
  6. Mark Armstrong & John Vickers, 2010. "Competitive Non-linear Pricing and Bundling," Review of Economic Studies, Oxford University Press, vol. 77(1), pages 30-60.
  7. 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.
  8. repec:reg:rpubli:105 is not listed on IDEAS
  9. 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.
  10. Schmalensee, Richard, 2002. "Payment Systems and Interchange Fees," Journal of Industrial Economics, Wiley Blackwell, vol. 50(2), pages 103-22, June.
  11. Julian Wright, 2004. "The Determinants of Optimal Interchange Fees in Payment Systems," Journal of Industrial Economics, Wiley Blackwell, vol. 52(1), pages 1-26, 03.
  12. 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.
  13. 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 541-88, October.
  14. Armstrong, Mark, 2001. "The theory of access pricing and interconnection," MPRA Paper 15608, University Library of Munich, Germany.
  15. Graeme Guthrie & Julian Wright, 2003. "Competing Payment Schemes," Departmental Working Papers wp0311, National University of Singapore, Department of Economics.
  16. Hendrik J. Brouwer & Chair, 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.
  17. 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.
  18. 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.
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Cited by:

  1. Marc BOURREAU & Marianne VERDIER, 2010. "Cooperation for Innovation in Payment Systems: The Case of Mobile Payments," Communications & Strategies, IDATE, Com&Strat dept., vol. 1(79), pages 95-114, 3rd quart.
  2. James McAndrews & Zhu Wang, 2008. "The economics of two-sided payment card markets: pricing, adoption and usage," Research Working Paper RWP 08-12, Federal Reserve Bank of Kansas City.
  3. Economides, Nicholas & Henriques, David, 2011. "To surcharge or not to surcharge? A two-sided market perspective of the no-surchage rule," Working Paper Series 1388, European Central Bank.
  4. Reisinger, Markus, 2014. "Two-part tariff competition between two-sided platforms," European Economic Review, Elsevier, vol. 68(C), pages 168-180.
  5. Anna Creti & Marianne Verdier, 2011. "Fraud, Investments and Liability Regimes in Payment Platforms," EconomiX Working Papers 2011-31, University of Paris West - Nanterre la Défense, EconomiX.
  6. Bolt, Wilko & Schmiedel, Heiko, 2009. "SEPA, efficiency, and payment card competition," Working Paper Series 1140, European Central Bank.
  7. Julian Wright, 2012. "Why payment card fees are biased against retailers," RAND Journal of Economics, RAND Corporation, vol. 43(4), pages 761-780, December.
  8. Wilko Bolt & Sujit Chakravorti, 2010. "Digitization of Retail Payment," DNB Working Papers 270, Netherlands Central Bank, Research Department.
  9. Kay, Benjamin S. & Manuszak, Mark D. & Vojtech, Cindy M., 2014. "Bank Profitability and Debit Card Interchange Regulation: Bank Responses to the Durbin Amendment," Finance and Economics Discussion Series 2014-77, Board of Governors of the Federal Reserve System (U.S.).
  10. Weyl, E. Glen, 2009. "Monopoly, Ramsey and Lindahl in Rochet and Tirole (2003)," Economics Letters, Elsevier, vol. 103(2), pages 99-100, May.
  11. Verdier, Marianne, 2012. "Interchange fees and inefficiencies in the substitution between debit cards and cash," International Journal of Industrial Organization, Elsevier, vol. 30(6), pages 682-696.
  12. Alexander White & E. Glen Weyl, 2010. "Imperfect Platform Competition: A General Framework," Working Papers 10-17, NET Institute, revised Nov 2010.
  13. Reisinger, Markus, 2010. "Unique Equilibrium in Two-Part Tariff Competition between Two-Sided Platforms," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 308, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
  14. Andre Veiga & E. Glen Weyl, 2011. "Multidimensional Heterogeneity and Platform Design," Working Papers 11-33, NET Institute, revised Nov 2011.

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