Four essays on price, competition, and diffusion of payment cards

Résumé

The present doctoral thesis includes four research studies undertaken within the discipline of empirical industrial organisation and focusing on the subject of payment cards. It deals with three fundamental questions present in recent literature on payment cards: prices, the role of competition and the diffusion (adoption and use) of electronic payment means. A brief summary of the essays and their respective contributions now follows. Essay I: A cost-benefit analysis of a two-sided card market This first essay was written jointly with Prof. Santiago Carbó (University of Granada), Prof. Dave Humphrey (Florida State University) and Dr. Francisco Rodríguez Fernández (University of Granada). We estimate the costs and benefits of payment instruments in Spain, considering the cost incurred and income generated for the three main parties to a payment transaction: banks (including issuer and acquirer banks), merchants and consumers. Payment cards have increasingly replaced cash and cheques for point of sale (POS) transactions. Because of the way in which banks price card transactions- involving both the consumer and the merchant sides of the (two-sided) market- controversy exists over how well these prices reflect underlying payment costs and match their benefits. Using a novel dataset (based on expert opinions and judgment as well as internal cost accounting analyses), this essay provides a separate estimation of the costs and income for card-issuing and merchant acquiring banks, as well as for merchants and consumers. It illustrates the expenses incurred by banks in providing different payment services and incurred by merchants and consumers in using them. Our results are in line with the predictions of recent theoretical contributions and suggest that any policies oriented towards the regulation of prices in the payment cards industry should consider the whole set of cost and benefits for all the agents involved. More specifically, this is because the net welfare effect of using each payment instrument varies significantly in terms of costs as well as revenue. Additionally, comparisons across different users should be based on normalized transaction values. The analysis in this essay provides evidence of important scale benefits related to the use of debit and credit cards that should also be taken into account. When all these influences are jointly considered, credit cards provide the lower net welfare loss for merchants, consumers and banks. However, when the evaluation of welfare effects is exclusively based upon costs, then cash become the cheapest payment instrument for banks, while debit cards are the least costly payment method for consumer and merchants. Essay II: Price structure and willingness to pay in two sided network industries: evidence from payment cards This second essay was co-authored with Prof. Santiago Carbó and Dr. Francisco Rodriguez Fernandez. Theoretical contributions on the subject of network industries have been numerous, but there is a lack of satisfactory empirical evidence to assist both competition authorities and policymakers. One of the main developments has occurred in payment card services, which have typified industries with such interactions and network externalities, for both the banks (issuers and acquirers) and consumers involved. The contribution of this study is twofold. First, we provide evidence on the two-sided structure of payment cards markets and examine the relationship between merchant and cardholder prices. Secondly, we examine the extent to which these prices reflect the willingness of cardholders and merchants to pay for card payment services. We employ a unique database of Spanish banks that contains quarterly bank-level information on payment card transactions and supply factors such as ATMs and POS terminals from 1997:1 to 2007:4. In line with theoretical predictions, our findings show that the prices in one side depend on product differentiation and network externalities in the other side. The results also suggest that -compared to ATMs- POS devices contribute to a significantly larger extent to increase the willingness to pay for cards of cardholders. The growth in the number of cardholders is also found to significantly increase merchants adoption of POS devices. The empirical evidence in this paper suggest that any antitrust intervention ignoring the two-sided nature of payment cards markets could be misguided. Essay III: The impact of interchange fee regulation in Europe This essay was written jointly with Prof. Santiago Carbó (University of Granada) and analyses two important issues for the payment card market in the light of recent changes in the regulation of interchange fees (the fees that acquirer banks pay to issuer banks when a transaction is performed using a payment card) throughout Europe (EU-27). We use annual payment card data from 27 European countries from 1995 to 2007 and employ five different data sources (Blue Book (ECB), Red Book (BIS), Financial Structure Dataset (World Bank), Eurostat, and Bank Profitability). The two-sided nature of the payment card market makes its analysis complex, particularly so in the case of interchange fee regulation. Specifically, we test the following hypotheses: (H1) Interchange fee regulation (i.e. a mandatory reduction) can have effects which government policymakers do not predict. In other words, it is likely to have an unintended impact on intensive and extensive margins; (H2) Interchange fee investigations have affected intensive and extensive margins in the European payment card industry; and (H3) There are differences in the impact of intra-EU interchange fee regulation (mandated by the European Commission) and specific country regulation. Controlling for the social, economic and financial environment, crime and tourism, our results suggest that recent actions concerning interchange fees (mandatory reductions and investigations) have had a positive effect on intensive and extensive margins (the adoption and usage of payment cards). Interestingly, mandatory cross-border reductions (initiated by the European Commission) have encouraged cash replacement in Europe. In conclusion, our essay is a contribution to the recent debate on interchange fees, from a European perspective. Essay IV: How effective are rewards programs in promoting payment card usage? Empirical evidence Card issuers have incurred substantial costs in launching incentive programs to stimulate payments by debit and credit cards, presumably assuming such incentive schemes would significantly increase the use of these cards, based on standard comparisons. However, there is little evidence regarding the effectiveness of rewards programmes. The principal objective of this final essay, written jointly with Prof. Santiago Carbó (University of Granada), is to empirically examine both the effects of incentive programmes on payment preferences and the impact on the substitution of cash by cards. In order to address these goals, this paper uses unique survey data to investigate how incentive programmes change cardholder preferences, combining demand variables and comprehensive information on rewards programs across different merchant activities. Consequently, this essay is the first empirical study to consider different types of rewards in order to estimate the relative impact of these rewards on the preference for cards compared to cash. It offers an estimation of the aggregate economic impact of reward programs upon the use of cards across merchant activities. Furthermore, it offers novel evidence on two key issues in the payment card literature: i) it measures the impact of incentives (rewards) programmes on the use of debit and credit cards; and ii) it quantifies the economic impact of these programs in terms of the substitution of cash by cards for payment purposes. Our results may have important implications for both policymakers and card issuers, as they show that rewards may significantly modify preferences for card payments. The evidence also suggests that the economic impact of rewards programs varies significantly across different type of rewards and across merchant activities, and that on average these incentives appear to be more effective for debit cardholders than for credit cardholders. Finally, we also quantify the monetary value of the total impact of rewards in the substitution of cash transactions by card transactions. Based on 100 transactions made using cards or cash, we observe that credit cardholders who receive rewards make 8.4 times the number of transactions than those who do not. In the case of debit cards, we observe that cardholders with rewards make 7.3 times the number of transactions than those without rewards. In terms of volume, debit cardholders with rewards increase the value of purchases by 326.89 euros for every 100 transactions they make. In the case of credit cards, this extra sales value amounts to 531.1 euros.