Debit or Credit

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					     Debit or Credit?
      (Why “Model”
Consumer Payment Choice)
   FRBBOS Retail Payments Conference
          Jonathan Zinman
          Dartmouth College
          October 28, 2005
   “Modeling” Consumer Choice
• Why social scientists “model” human
  – Get to essence/drivers of choices
  – Explain, and ultimately predict behavior
  – That’s why we’re here today!
   “Modeling” Consumer Choice
• How we model:
  – Behavior very complex
    • Hard to identify what causes what
  – Our tools (math and statistics) have
    “bandwidth” limits
  – So: we simplify by making assumptions
    • Makes problem tractable
    • Permits focus on what really matters
         Empirical Social Science
•   Ask an interesting question
    –   I.e., formulate a hypothesis
•   Build or modify a model that makes realistic
    simplifying assumptions
•   Find/collect/generate the right data for testing
    your model
•   Test it

My paper does not satisfy all 4 criteria!
  Two Views of Consumer Choice
      and Payment Choice
#1. Homo economicus (“rational” man)
  – Recognizes when a choice needs to be made
    (i.e.., no confusion)
  – Makes a choice (i.e., no procrastination)
  – Chooses based on:
     • Stable preferences (i.e., I know what I want)
     • Full/adequate info (i.e.., know what I’m choosing)
  – Sticks to choice (i.e.., no self-control problem)
    View #1: Economic Model of
    Consumer Payment Choice
• “Cost is king”:
  – Including implicit costs, not just fees, but:
  – Finance charges, foregone interest
  – Time/hassle costs
   View #2: Psychological Model
   of Consumer Payment Choice
• Homo consumaloticus (“psychological man”)
  – Lots of things drive payment choice
  – How I pay impacts how much I spend
  – In particular, credit leads me to spend more
     • Perhaps more than I want to in more reflective moments
  – Other payment media, including debit, help me control
    spending by helping me:
     • “Feel the pain” (salience)
     • Track spending (mental accounting)
            Psychological Model
• Thought experiment to show how this works:
   – Randomly assign debit cards to a pool of credit users
   – If “salience” dominates
       • debit users’ overall spending will fall
       • debit used at times/places where temptation is greatest
   – If “mental accounting”
       • debit users’ spending falls
       • payment choice varies systematically with what is being purchased
         (conditional on transaction size, acceptance)
• This seems to be the conventional framework for
  explaining debit use (at least relative to credit)
   – Trade press
   – Popular press
       What My Paper Does
• Test whether choice between debit and
  credit is consistent with economicus model
  – In coarse but nationally representative data
• Fairly convincingly rules out widespread
  indifference among payment choices
• Casts doubt on primacy of spend-control
  motives for choosing debit over credit
        What Paper Does Not Do
• Nothing to say about choice mechanics
   –   Not solving calculus….
   –   Intuition
   –   Rules-of-thumb?
   –   Trial-and-error?
• Little to say about why debit has grown
• Paper can not directly rule out spending-control motives
   – Merely questions their importance
• Paper’s findings should not shift your prior beliefs
   – Only question them
   – Motivate you (bank/issuers) to give me data needed for direct
     testing of psychologicus explanations
             How Paper Tests
           Economic Model: Data
• Survey of Consumer Finances (SCF)
  – Only nationally representative data, with decent
    sample size, that knows anything about both debit
    and credit use
  – But doesn’t know much
     •   Do use debit regularly
     •   Good measure of credit card holding
     •   Decent measures of credit revolving and utilization
     •   Nothing on rewards, cash back, acceptance, etc.
     •   Nothing on transactions
  – And only a snapshot
     • Most recent survey in 2001 (2004 out soon)
How Paper Tests Economic Model:
    Focus on Debit v Credit
• No data on cash or check use SCF
• Debit and credit very similar re: most
  – acceptance (at least by 2001)
  – portability
  – security
  – time at POS
• So can focus in on costs as driver of
  Testing the Economic Model
3 key predictions on who’s most likely to
   use debit:
  •   Those lacking a credit card
      •   otherwise float and get miles, except…
  •   Revolvers more likely to use debit
      •   to minimize costs from “borrowing-to-charge”
  •   High intensity revolvers even more likely
            Results of Tests
• All economic predictions borne out
• Correlations are big
• Robust to controls for:
  – Demographic characteristics
  – Spending patterns (rough proxies)
• All this despite data limitations that work
  against finding support for the model’s
        Other Data/Findings
  Cast Doubt on Spending Control
• Most important/provocative:
  – May 2004 Survey of Consumers (“Michigan Survey”
    used to measure consumer confidence, etc.)
  – Asked open-ended questions: “Why do/don’t you use
    debit to make purchases?”
     • 5.8% of debit users said something related to spend control
     • 5.5% of nonusers said something related to spend control
• See Borzekowski, Kiser, and Ahmed 2005 for
  this & more interesting results
        Some Food for Thought:
    From Modeling to Business Apps
• What’s (irr)rational consumer behavior? Be
• Example. Free checking:
  – Not necessarily irrational (Stavins)
  – Intense transactors should choose min balance option
  – (Not necessarily irrational for banks either.)
• Example. Slow e-payments adoption.
  – Small benefits to adoption
  – (Perceived) big downside risk
  – High cost of getting info to accurately assess
    downside risk
  – Inertia may be rational/optimal
 From Modeling to Business Apps:
    Learning About Customers
• How do we ask them?
  – Survey responses depend greatly on how you
    ask/frame questions (psych wins here!)
    • May explain difference between market research
      and Survey of Consumers on spending control
  – Will customer’s responses to hypothetical
    questions have useable content?
    • General concern in social science
    • Particularly so here: stakes of payments decision
      are small for most consumers (maybe $10 a month
      on average)
   From Modeling to Business Apps:
   How Much Should the Consumer
• Not much, necessarily
  – Rational to devote little energy/attention to
    payments choice in face of small stakes
• So… how to communicate with or
  “educate” consumers
  – Less is more
     • “Information overload” with debt, saving, jam(!),
       doctor’s Rx choices (psych wins again)
     • Be especially careful in payments– small stakes
                  Going Forward
• With richer data:
   – From bank/issuer
   – With deposit/debit and credit customers (account-level info)
   – Transaction level data
• Direct tests of spending-control models
• Finer tests of economicus model:
   – Impact of rewards
   – Impact of credit pricing
   – Time costs vs. (implicit) pecuniary costs
• Insight into choice mechanisms:
   – Adoption
   – Learning
• Understanding of “rational” behavior must be
  nuanced. Impacts how we:
  – Develop, market, and price products
  – Collect and interpret info on customers
  – Communicate info to customers
• Paper’s findings not rich enough to change your
  mind on what drives debit use
  – But re-examine your beliefs and model(s)
• We can reach a deeper understanding of what
  drives consumer (payment) choice
  – Analytic framework in place
  – Just give me the data!

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