ANTITRUST ECONOMICS 2013
David S. Evans
University of Chicago, Global Economics Group
Elisa Mariscal
CIDE, Global Economics Group
TOPIC 16: SELECTED TOPICS – ANTITRUST OF
PAYMENT CARDS
Date
Topic 16| Part 2
23 January 2014
Overview Topic 16
2
Part 1
Antitrust and
Telecommunications
Part 2
Currency Platforms
Payment Cards
Interchange Fees
Merchant Rules
3
Currency Platforms
Currency Platforms
4
Receiver
of Funds
Platform
For payments to happen need to
have underlying currency which is
a unit of account, store of value,
and medium of exchange.
Senders and receivers both have to
be on platform in the sense that
they agree to the medium of
exchange.
Platform could be operated by
government (euro), for profit
(banks), customer (wampum),
open source (bitcoin).
Sender of
Funds
Critical Mass Problem for Payment Systems
5
All payment systems face demand
coordination issue (“chicken and egg
problem”).
Senders will use a currency that receivers won’t
take and receivers can’t be paid in a currency
that senders don’t want to use.
Governments can easily overcome the
“chicken and egg” problem by paying with
currency and making currency legal tender.
But many currencies arise because they are
able to secure critical mass of senders and
receivers including airtime, bitcoins, wampum,
and 19th Century American banknotes.
Igniting New Payment Platforms: Bitcoin
6
Bitcoins
issued in
January 2009
Protocol
invented
November
2008
Bitcoin
becomes
widely used
for “dark
web”
transactions
and by drug
lords
Mainstream
businesses
start
accepting
bitcoin
Bitcoin currency is a digital address.
Bitcoin “miners” generate finite supply (21 million BTC) of bitcoins
through solving hard math problems.
Make money from selling currency they “mine” into the market.
Public ledger of transactions where bitcoin transactions are
posted.
Exchanges convert bitcoins to other currencies but as more take
sellers bitcoin less need to convert.
7
Payment Card Platforms
8
The Birth of the Modern Payment Card
Industry
Seeds for massive business planted in
1949 in Manhattan.
Frank McNamara sees opportunity for
“general purpose payment” card
that many people could use to pay
at many different merchants.
Unlike “store cards” that were
common at time, more like “cash”
which could be used everywhere.
Ignition: Diners’ Club 1950
9
Gives “charge” cards away to few
hundred people to use to pay (free at use,
pay bill at end of month).
Signs up 13 restaurants to accept (10% of
meal bill).
Both consumers and merchants see value.
Positive feedback effects drive growth.
In 1951, a year after Diner’s Club launch,
McNamara had signed up 330 restaurants,
hotels and nightclubs, along with 42,000
cardholders.
By 1956, almost $54 million of transactions
(over $300 million in today’s dollars) on
these cards at merchants from Boston to
Anchorage to Tahiti.
Lessons for Payment System Ignition
10
Innovation reduces “transaction costs” between merchants and
consumers.
Need both consumers and merchants to see enough value to
launch.
Solving this “chicken and egg” problem is essential. Hundreds of
Diners Club competitors failed in 1950s.
Getting critical mass of both sides can result in ignition and
explosive growth.
Hilton’s Carte Blanche sputtered, American Express ignited in 1958,
as did Bank of America in 1958.
First-mover advantage and positive feedback effects don’t
guarantee permanent success: Diners Club eclipsed by American
Express in 15 years. Discover Card bought Diners for $165 million in
2008.
Three and “Four” Party Payment Card Systems
11
Three-party payment systems are “closed loop” platforms that
provide payments services directly to merchants and consumers.
American Express, Diners Club, Discover Card.
“Four-party” payment systems separate the business of serving the
merchant from the business of serving the consumer. MasterCard,
Visa.
Network provides B2B “open-loop” platform with “open entry” by
issuers and acquirers.
Card issuers connect with platform and serve consumers.
Merchant acquirers connect with platform and serve merchants.
Called “four party system” (issuer, consumer, acquirer, merchant)
but really “five-party” system including the network which is key.
Cooperative Model
12
Original “four-party” model was based on
“consumer cooperative” where bank acquirers
and issuers established and operated network.
Banks became members and received voting
rights. Appointed management.
Cooperatives received transaction fees to fund
operations including branding but otherwise
operated on break-even basis.
Partly (largely?) as a result of antitrust challenges
to collective rule making MasterCard and Visa
International adopted for-profit equity model in
2006 and 2008 respectively.
Many four-party systems around the world (Visa
Europe, and Carte Bleu, Multibanco operated as
cooperatives still).
The Structure of the Payment Card Ecosystem
13
• Own brand, recruit
issuers and acquirers,
authorize and settle.
• Usually banks, issue
cards to consumers,
pay merchant’s
agents (acquirers),
collect money from
consumer.
• Often banks, sign up
merchants, pay
merchant when
card is used, often
pay issuer
“interchange” fee
required by network.
Networks
Issuers
Acquirers/Processors
Often called “4-party” or “open-loop” systems: (consumer |issuer |
acquirer and merchant) like Visa
Versus “3 party” or “closed-loop” systems (consumer | system |
merchant) like Amex
The Payment Card Industry in Spain
14
Issuers
Networks
Acquirers
Banco Santader,
Domestic and international schemes
Banc Sabadell,
Banesto,
BBVA,
Caja Madrid,
Banco Santader,
Bankia,
Citibank,
BBVA,
Euro 6000,
Comercia
La Caixa
Grupo Banco
Popular
MBNA
Grupo Banco
Popular,
Unicaja
The Payment Card Supply Chain
15
Merchant
(Safeway)
takes
payment
on card.
Acquirer
(First
Data)
sets up
merchant
and pays
when
card
used.
POS
equipment
(Ingenico)
probably
installed
by
acquirer
takes
cards at
POS.
Merchant
processor
(First Data)
reads
signal and
switches
transaction
to network
(might be
same as
acquirer)
Network
(MasterCard)
uses card # to
figure out
which issuer
and checks
with issuer to
make sure
funds are
available
Bank Issuer
(Citi) debits
funds from
checking
account or
includes
charge of
monthly
credit-card
statement
Card Processor
(TSYS) sends
statement to
consumer and
collects money
and sends to
bank (bank
issuer may do)
Value-Added providers (PayPal) have solutions that rely on
the rest of the chain.
Integration into layers varies by country.
Innovation is occurring at all of these layers and especially valueadded.
The Payment Card Business Model
16
Merchant
(Safeway)
takes
payment
on card
Acquirer
(First Data)
sets up
merchant
and pays
when card
used
POS
equipment
(Ingenico)
probably
installed by
acquirer
takes cards
at POS
Merchant
processor
(First Data)
reads signal
and switches
transaction
to network
(might be
same as
acquirer)
Network
(MasterCard)
uses card # to
figure out
which issuer
and checks
with issuer to
make sure
funds are
available
Bank Issuer
(Citi) debits
funds from
checking
account or
includes
charge of
monthly
credit-card
statement
Card Processor
(TSYS) sends
statement to
consumer and
collects money and
sends to bank
(bank issuer may
do)

Network makes money from fees it charges acquirers and issuers

Issuer makes money from “interchange fees” acquirers pay when cards are used plus fees and
interest charges to consumers; bundled with checking account for debit

Acquirer makes money from fees on top of interchange fees it charges merchants

Merchant and card processors charge transaction fees

Equipment manufacturers sell or lease equipment to acquirers or merchants

Value-added providers charge additional fees or earn arbitrage fees
17
The Interchange Fee Controversy
Merchant Pays Model for Cards
18
Ever since the beginning of the card industry (1950 in US) most of
the costs for payment cards has been recovered from the
merchant side so merchants are the money side and consumers
are the subsidy side (see platform lectures).
Consumers have highly elastic demand for payments in part
because cash and check systems are subsidized by government.
Consumers dictate choice of instrument at merchant.
Merchants have relatively inelastic demand because they want to
please customer and make a sale.
Virtually every system, virtually everywhere in the world, has
adopted the merchant pays model because of the fundamental
two-sided economics of payments.
18
Interchange Fee
19
Interchange fee is a fee paid by one network side to the other
network side.
In payment card systems typically acquirer pays fee to issuer when
issuer’s card is used to pay at acquirer’s merchant.
Fees vary from a fraction of a percent to 4 percent across systems,
countries, card products.
Fee is typically set by the network sometimes unilaterally and
sometimes by a process agreed to by the members of the network
cooperative.
Since the acquirer passes it on in whole or in part to the merchant
and since the bank passes it on in whole or in part to the
consumer it ultimately determines the relative prices faced by
merchant and consumers just like merchant discount for threeparty system.
Interchange Fees: Is There A Problem?
20
Multi-sided platform theory shows generally that platforms “may” not
set socially optimal pricing balance.
• Should we care since many businesses may not (probably do) set
socially optimal prices and this is all blackboard economics anyway?
Payment cards may result in a market failure because:
• Consumer dictates choice but
• Merchant bears cost
• And because of either transactions costs, network rules, or both
merchant can’t signal cost minimizing choice to consumer.
• Results in consumers “overusing” cards versus other payment methods.
Merchants and some commentators argue that interchange fee
should be zero (on par) or small to cover costs.
• Multi-sided platform literature is definitive on cost-based pricing being
wrong.
• How would we come up with the “right” price?
These are all “problems” with merchant fees for three-party systems
and not just interchange fees for four party systems.
And Whose Problem Is It?
21
Antitrust
Price fixing by
cooperative members
Need to establish
efficiencies under US
(BMI) or EU (Art 101(3))
EC and EGC in
MasterCard
Recent US settlement
of Visa/MasterCard
interchange fee
litigation
Banking regulators
Is there a problem
that regulators can
deal with under
existing banking
regulation?
Reserve Bank of
Australia capped
interchange fees
based on finding
market failure
Legislature
Is there an economic,
social, or other problem
that merit new laws?
Generally economists
limit business regulation
to situations where there
is a market failure that
can be fixed.
Durbin Amendment in
US mandated costbased caps on debit
interchange fees;
proposed legislation
before European
Parliament.
Antitrust Claims Against Interchange Fees
22
Note that merchant fee charged by three-party system in general
are immune to antitrust challenge (except under excessive pricing
theory) for the same reason companies no matter how dominant
are allowed to charge whatever price they want.
Antitrust case therefore based on “horizontal restraint” theory. In
US could be per se in case but more likely rule of reason under for
efficiency-creating cooperatives. In EU collective price setting
could be ok under Article 101(3) exemption.
But MasterCard since 2006 and Visa International since 2008 have
been publicly traded corporations and not bank cooperatives.
Two-Sided Antitrust Issues
23
Market definition:
• One-sided acquirer market?
• Two-sided platform market?
Whose welfare?
• Merchants as network customers?
• Cardholders plus accepting merchants as network customers?
• All consumers regardless of whether these use cards…
What rate?
• Acquirers and issuers have to agree on some fee even if zero so court
or regulator needs to decide, but what?
Net Impact on Consumers
24
Economics of pass-through shows when firms have increases
in cost they pass part of it on to consumers and take part of it
as reduced profit generally. Question is what fraction of cost
increase is borne by consumers versus business.
When banks lose revenue from caps they can make up from
consumer (higher fees, reduced services) or by reducing
profits.
When merchants have lower costs they can pass some of
savings on to consumers and keep some as profits.
Net effect of price cap consumers therefore depends on
how much they lose on bank side versus how much they gain
on merchant side.
Consumers overall “win” if bank pass-through rate is less than
merchant pass-through rate and “lose” if merchant passthrough rate is lower than bank pass-through rate.
Economics of Pass Through
25
Estimated pass through rates vary considerably and depend on market details including
demand, cost, structure, behavior. Median pass-through from studies about 50 percent.
Whose Welfare? Again
26
Suppose lower interchange fee results in net loss for consumers
because banks pass on more of lost revenue than merchants pass on
cost savings.
Then acquirer market definition leads to result that merchants gain
from interchange fee reduction but consumers overall lose.
Two-sided market definition would consider both merchants and
consumers as customers and evaluate overall impact of interchange
fee on total price and overall output.
Market Failure and Remedy
27
Court or regulator would need to determine the “right” fee.
Theory says socially optimal fee likely to be smaller than privately set fee. But
how much smaller?
Cost-based test wrong as matter of two-sided market theory; prices do not
necessarily (and probably do not) follow cost closely for socially optimal prices.
Tourist test based on how much a merchant would be willing to pay to accept
a card from a tourist who could also pay with cash. Not robust to merchant
heterogeneity in costs and benefits.
Full econometric estimation of two-sided prices based on cost and demand.
Very difficult to do.
Question is whether “regulator” can select a price that is better than “private
actors”. Just as too high a price could be suboptimal so could too low a price.
Could “collective merchant buying power” affected through collective
lobbying for legislation or court ruling result in market failure of too low an
interchange fee in which merchants profits to themselves by banks and
cardholders?
28
Merchant Rule Controversy
Platforms Harness Externalities
29
A Place to Get Together.
• Platform provides a physical or virtual environment for different types of
customers to get together.
Ways to Connect and Create Value.
• Platform provides search and matching methods for helping customers
find “value-creating” transactions and for exchanging value.
Manage externalities.
• Platforms manage positive and negative externalities to increase value
that members can realize from the platform.
Platform Design and Rules Promote Positive
Externalities
30
Sorting Devices to Get Right Customers:
• “Exclusionary vibe” (JDate discourages Gentiles).
• “Exclusionary amenity” (Upscale anchor stores discourages lowend shoppers).
Search Diversion:
• Design rules encourage one type of agent to meet another
type of agent who really values them but may not seek out by
themselves.
• Shopping malls with anchor stores at either end.
Platforms and Bad Behavior
31
Web Businessman Sentenced for Threats
By DAVID SEGAL
Published: September 6, 2012
A Brooklyn man who terrified customers of his online
eyewear store with threats of violence, including
rape, was sentenced on Thursday to four years in
federal prison and ordered to pay nearly $100,000 in
restitution and fines.
Borker told the New York Times in 2010 that negative
publicity had vaulted his site to the top of Google’s
organic rankings. “I’ve exploited this opportunity
because it works. No matter where they post their
negative comments, it helps my return on
investment,” he explained. “So I decided, why not
use that negativity to my advantage?”
Rule to Reduce Negative Externalities
32
Rules:
• Prohibitions on actions that could harm other agents (usually those on
other side of match/transaction).
• eBay has detailed rules for buyer and seller behavior.
No misleading ads (sellers) and no multiple auctions for same good
(buyers).
Detection and Monitoring:
• Systems to determine if rules are being broken.
• Facebook has hundreds of employees looking for bad pictures and bad
language.
Enforcement:
• Platforms have and use “Bouncers Rights” to exclude violators.
• Google manually reduces ranks of websites that violate rules for 90 days
and sometimes delists websites.
Welfare Effects of Rules
33
Promoting positive externalities has costs:
• Sorting devices harm customers that can’t get on platform or don’t get
their preferred matches.
• Search diversion benefits side that gets from looks but not necessarily
side that has been diverted.
Governing bad behavior has costs:
• Customers lose benefits from violations.
• Customers also lose from false positives in enforcement.
Platform has incentives to balance benefits and costs:
• Platform can make more money by promoting positive externalities and
reducing negative ones.
• Platform value is greater and platform profit greater too.
Vertical Restraints and Platform Governance
34
Anti-steering/exclusive dealing rules:
• Might deter entry, but…
• Give customers on other side assurance that when they use the platform
they will get the platform’s products.
No surcharge rules:
• Might deter entry, but …
• Prevents opportunistic behavior and provides customers price certainty
for platform.
Platform exclusion penalties and rules:
• Might prevent alternative platform from accessing users, but …
• Punishes customers on one side from harming customers on the other
side through fraud, deception, and other bad behavior.
End of Topic 16, End of the Antitrust
Economics Course
35
Part 1
Antitrust and
Telecommunications
Part 2
Currency Platforms
Payment Cards
Interchange Fees
Merchant Rules