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From The Economist print editionWHEN finance is not being blamed for wrecking the economy, it is being attacked for profiteering. Earlier this month the 7-Eleven chain of convenience stores in America presented a petition with more than 1.6m signatures to Congress, calling for a reduction of the fees levied by payment-card firms and their member banks each time a purchase is made using plastic. The House of Representatives is mulling a bill that would cap these “swipe fees”, known in the industry as merchant-interchange fees. In America these are 1.5-2% of the price of an average purchase, which is high by rich-world standards. Retailers grumble that the charges inflate their costs, which they are forced to pass on to consumers—even those who choose to pay by cash.
Similar complaints have already prompted regulatory action elsewhere. Visa and MasterCard, the payment-card giants, are fighting an attempt by the European Union to limit swipe fees to 0.3% of a transaction’s value whenever a credit card issued in one EU country is used in another. (Until two years ago the EU’s competition authorities had been pacified by Visa’s pledge to bring average interchange fees down to 0.7%.) In Australia, where regulators set charges in relation to the payment system’s running costs, the average swipe fee has fallen to around 0.4%.
The case for tight regulation seems strong, at first glance. In rich countries, where paying by plastic is now commonplace, the firms that run card-payment systems look like other utilities, which have long been subject to price caps. Visa and MasterCard are associations run on behalf of their member banks. Competition officials are usually wary of such shared ventures but accept that it is more efficient for rival banks to band together in one network in order to process payments and settle accounts. A common fee structure stops members from abusing the rule that retailers must take all cards issued with the association’s brand. It also obviates the need for countless bilateral deals between thousands of banks. Even so, regulators still fret that banks might use their combined heft to overcharge.
They need to tread carefully. Judging how much credit-card firms ought to charge for their services is trickier even than setting the right price for water or energy supplies. That is because the payment-card system is a “two-sided” market. What sets this type of enterprise apart is that it caters to two distinct groups of customers and each sort benefits the more custom there is from the other sort. Consumers will sign up for a credit-card brand if it is widely accepted as a means of payment. Merchants will more willingly accept a card if lots of consumers use it.
Building up a two-sided market, and balancing the needs of each side, require pricing strategies that would make little sense in more traditional, one-sided industries. Charges may have little relation to costs and often lean to one side of the market. For instance, outfits that act as matchmakers for lonely hearts (dating clubs, singles bars, and so on) often levy higher charges on men than on women. They judge that single men will be keener to join clubs that are visited by lots of women. Computer operating systems make more money from users than from software developers. Most media outfits rely on a mix of charges to both sides of the market that is tilted towards advertisers. Broadcast networks and some local newspapers provide their wares free and charge advertisers for access to consumers. Others are now opting for a one-sided business model, without advertisers, where consumers pay directly for news and programmes.
Skewed pricing is one solution to the central challenge of two-sided industries: how to lure one set of clients with the promise of custom from the other. In its early days, the Diners Club card took a hefty 7% cut of the tab from restaurants that accepted it. They did so because the eateries were given privileged access to the wealthy New Yorkers who had been given the card free. With one side on board, Diners Club found it easier to charge the other. As a rule, the side that bears more of the cost of bringing both sides together is the one that is least reluctant to pay—the side that Jean-Charles Rochet of Toulouse University, an expert in two-sided markets, describes as “caught”. But because finding the right mix of charges is so crucial to a successful two-sided business, regulating prices could upset a delicate balance. It is hard for firms to know what the “right” prices are in two-sided markets. Cut charges on one side and it will raise them on the other, chasing customers away and making the business shrink.
Not going Dutch
Trustbusters are nevertheless suspicious of a credit-card business model, where one side covers all of the running costs. That looks sinister on two counts. First, in mature markets merchants may have little choice but to take the main credit cards. If so, it may allow the big brands to overcharge, pushing merchants’ profits down and consumer prices up. Second, to the extent that card issuers use some of their excess profits from interchange fees to compete for cardholders—through lower fees, loyalty schemes and other benefits—a hefty swipe fee could distort the payments markets by favouring credit cards over other forms of settlement, such as debit cards, cheques or cash.
Even so, that does not add up to a compelling case for regulation, since it is hard to see how consumers could be made better off. The tentative evidence from Australia is that caps on interchange fees for retailers have not been offset by any gain in the form of lower consumer prices. If interchange fees merely shift economic rents from merchants to card firms, then that is not a concern for competition policy (especially if some of the rents end up washing back to cardholders). It is true that interchange fees facilitate credit-card usage, which can encourage indebtedness with all its attendant problems. That makes them a tempting target for crisis-burned regulators. But if consumer debt is the problem, tinkering with swipe fees is the wrong way to tackle it.
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