Moving Money: The Future of Consumer Payments

6. Competition Policy Issues in the Consumer Payments Industry

At the completion of a sale, money changes hands. Money changing hands could be in cash or checks, and, for the last few decades, also be in electronically transmitted funds or a guarantee of prompt electronic payment to the merchant. Such electronic payments could come from a company that provides credit to customers (such as a bank organized under the Visa or MasterCard trade names1 ), from one that facilitates transactions but typically does not provide credit (such as American Express), or directly from the bank where the customer has demand deposits.2 The payment system intermediary facilitates the payment to the merchant by guaranteeing that the merchant receives the money, and at the same time can also offer a variety of services to the cardholder, ranging from credit services to frequent flyer miles. Credit and other bank cards facilitate transactions between merchants and consumers. Card networks collect significant fees from merchants to facilitate those transactions.3 The market for facilitation is dominated by the Visa and MasterCard networks. Visa had a 42 percent share of the U.S. credit card market in 2007, MasterCard 29 percent, American Express 24 percent, and Discover 5 percent.4 6 Competition Policy Issues in the Consumer Payments Industry nicholas economides 113 I thank Bob Litan and participants in the Future of Consumer Payments Conference at the Brookings Institution. 06-0277-1 CH 06:06-0277-1 CH 06 5/23/12 5:07 PM Page 113 Both Visa and MasterCard charge fees (primarily to merchants) that are significantly above costs—some report that total card costs are only 13 to 15 percent of the fees charged and that total fees are about $30 to $48 billion per year.5 This combination of fees that are significantly above cost and high market shares suggests that current fees reflect market power.6 Setups of Three- and Four-Party Card Networks The intermediation of American Express involves three parties, the cardholder , the merchant, and American Express, hence the name threeparty card network. The basic structure of this setup is presented in figure 6-1. It is important that the network (American Express) can charge fees on both sides of the market, or can charge only one side and subsidize the other. This two-sidedness is a fundamental feature of network structure and can be exploited to support high transaction fees. In a multiparty credit card association, such as Visa or MasterCard, merchants deal directly with acquiring banks that intermediate transactions to issuing banks that issue cards to consumers and ultimately send them bills as well. A transaction between a customer and a merchant conducted through Visa or MasterCard is intermediated by both the acquiring bank and the issuing bank. Figure 6-2 shows the intermediation in a Visa or MasterCard network where the functions of acquiring (a merchant) and issuing (a card to a customer) can be handled by different banks. Thus, in this setup we have four parties: the merchant, the acquiring bank, the issuing bank, and the cardholder.7 The two-sidedness remains important in more complex networks such as those of MasterCard and Visa. In four-party networks, such as MasterCard and Visa, three markets are connected in sequence in each transaction, and the surplus of each end-to-end transaction is divided among the markets (figure 6-3). The three markets are between the issuer and the consumer (market 1), between the acquirer and the issuer (market 2), and between the merchant and the acquirer (market 3). 114 Nicholas Economides 06-0277-1 CH 06:06-0277-1 CH 06 5/23/12 5:07 PM Page 114 The interchange fee is the amount an acquiring bank pays an issuing bank when a merchant accepts a Visa or MasterCard for a purchase, that is, the fee that changes hands in market 2. The acquiring bank pays the merchant the amount of the transaction less both the interchange fee and an additional fee that the acquiring bank keeps for itself. Visa and MasterCard set maximum interchange fees, and almost no banks deviate from them.8 Interchange fees in the United States are approximately 1.8 percent on average.9 The transaction fees the merchants pay are at Competition Policy Issues 115 Figure 6-1. A Three-Party Card Network American Express Merchant Consumer Goods worth $100 $100 $97 Figure 6-2. A Four-Party Card Network Merchant Consumer $100 Acquiring bank Visa...