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Impact of interchange fees on consumers and merchants

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Impact of interchange fees on consumers and merchants Powered By Docstoc
					Interchange fees and innovation
   in retail payment systems
  Marc Bourreau,Telecom ParisTech




                                    1
Introduction
   Slow pace of innovation in retail payment systems
    for decades…
    ◦ Paper check for 700 years, plastic card for 50 years
    ◦ Role of the interchange fee (IF): allocation of costs
      between the acquiring and the issuing sides, etc.
   … but acceleration of innovation due to the
    development of web and new digital devices
    ◦ At POS: contactless cards (Visa PayWave), mobile
      phone as payment card (NFC), mobile phone as POS
      terminal (Square), etc.
    ◦ E-commerce: web checkout (Paypal), telephone bill as
      payment account, …
    ◦ P2P: SMS-based money transfers, …

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                                                                                    Introduction




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                                   technologies, per year




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                                   Patent Office (EPO) for “payment”




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                                   Patents submitted to the European




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                                                                        Year 2000




3
Introduction
 Question   addressed in this presentation:
  What is the impact of IF on innovation in
  retail payment systems?
 Main message: the IF affects innovation
  in payment systems through two
  different (but related) channels,
 ◦ Issuers’ and acquirers’ (and potential entrants’)
   incentives to invest in innovative payment
   solutions
 ◦ Merchants’ and consumers’ incentives to adopt
   innovative payment solutions


                                                       4
Innovations in payment systems
   Innovation = product innovation (introduction
    of new payment services) + process
    innovation (cost reductions + quality of service
    improvements)
   Cost reductions:
    ◦ security/reduction of fraud
    ◦ transaction costs, etc.
   Quality of service improvements:
    ◦ convenience, simplicity
    ◦ customer relationship management
    ◦ possibilities of differentiation, etc.

                                                       5
Innovation in payment systems
   Two-sided nature of retail payment
    systems
    ◦ Membership and usage externalities between
      two distinct groups of users: consumers and
      merchants
    ◦ Implies adoption externalities: the innovating
      firms might have to solve the “chicken and
      egg” problem
   Economies of scale and network effects
    ◦ Strong incentives for standardization and
      cooperation between competitors
                                                       6
             A model of innovation (B&V 2011)

              Interchange       payment system      Interchange


Incentives      competition                       competition
    to        between issuing                       between
innovate?         banks                          acquiring banks
                            consumer fee                 merchant fee
Incentives to
  adopt the         consumers       retail   merchants
 innovation?                        prices

                                                   adoption externality   7
Adoption incentives
   Adoption externality between consumers
    and merchants
Consumers’ adoption       Merchants’ adoption
incentives depend on…     incentives depend on…
• the price of the new    • the merchant fee,
payment instrument,       • the adoption cost of the
• its quality,            innovation,
• the number of           • the number of
merchants who adopt the   consumers who adopt the
innovation                innovation


                                                       8
                 Adoption incentives
                      Short-term perspective: the innovation has been
                       developed. Effect of a lower IF on users’ adoption
                       incentives?
                             consumers                           merchants
                       Price effect (higher                Price effect (lower
                       consumer fee):                      merchant fee):
                       adoption                           adoption 
                       Externality effect (higher          Externality effect (lower
                       # of merchants):                    # of consumers):
                       adoption                           adoption 

example with a                Consumer adoption…             Merchant adoption…
uniform distribution     for low degrees of externality
of merchants            (if IF not too high)                          
                         otherwise                                                    9
Innovation incentives
    Long-term perspective: the innovation has to be
     developed. Effect of a lower IF on issuers’ incentives to
     innovate (= invest in quality improvements)?
    Example with           Low degree of          High degree of
    uniform                adoption               adoption
    distribution           externality            externality

    Effect of a lower IF
                                     -
    on quality                                           +
                           (if IF not too high)
    investments

• Low externalities: a high IF softens competition
• Strong externalities: a low IF stimulates merchants’
  adoption
                                                                   10
Cooperation and Innovation
   Historical examples of cooperation between
    banks to create common networks (e.g.,
    Visa)
   Many recent examples of partnerships or
    Research Joint Ventures for the development
    of new payment solutions:
    ◦ JV MasterCard + Smart Hub (MNO), 2010
    ◦ Alliance Visa + Monetise, 2009
 Should cooperation for innovation be
  encouraged in retail payment systems?
 What is the effect of the IF on the incentives to
  cooperate for innovation in payment solutions?
                                                      11
Cooperation and Innovation
   Should we encourage cooperation for
    innovation in retail payment systems?
    ◦ Yes, if strong adoption externalities between
      consumers and merchants  higher
      investments in quality of service with
      cooperation compared to no-cooperation
   Effect of IF on incentives to cooperate?
    ◦ With a high degree of adoption externalities
      between consumers: incentives to cooperate
      increase with the IF
                                                      12
Conclusion
 Acceleration of innovation in payment services,
  driven by the development of digital devices
  (computers, smartphones, tablets, etc.)
 Effect of IF on innovation in payment systems?
    ◦ Short-term perspective (effect on adoption
      incentives) vs. long-term perspective (effect on
      innovation incentives)
    ◦ Effect depends on the magnitude of adoption
      externalities between merchants and consumers
 Cooperation socially desirable if strong adoption
  externalities
 Incentives to cooperate higher with high IF

                                                         13
References
 Bourreau & Verdier (2011), “Cooperation
  or Competition: Innovation in Payment
  Systems,” work in progress.
 Bourreau & Verdier (2010), “Cooperation
  for Innovation in Payment Systems: The
  Case of Mobile Payments,” Communications
  & Strategies.



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