Working Paper

Network competition and merchant discount fees

Abstract: Pricing in two-sided markets has not been fully understood yet. Especially, investigations of how competition in these markets affects the price structure or levels are still underway. This paper takes the payment card industry as an example of two-sided markets and examines whether two networks? competition lowers one of the prices in the industry, merchant discount fees, and if it does, how much it lowers equilibrium merchant fees compared with the fee set by a monopoly network. If some cardholders hold only one card and the other cardholders hold two different cards, whether network competition lowers the fees and by how much the fees will be lowered depends on various factors, such as the share of multihoming cardholders in the total cardholder base, the merchants? transactional benefit, each network?s net transactional benefit to its card users, the difference in the two networks? cardholder bases, and the share of cardholders in the total customer base. Numerical examples with various parameter values suggest that typically, if the share of multihoming cardholders is 20 percent or less, networks can act as if they are monopolies; and if the share is around 50 percent, the average equilibrium merchant fee is reduced from the monopolistic merchant fee by 25 percent.

Keywords: Competition;

Bibliographic Information

Provider: Federal Reserve Bank of Kansas City

Part of Series: Payments System Research Working Paper

Publication Date: 2005

Number: PSR WP 05-04