Two-sided markets and competition policy

Understanding interchange fees

Sean Greenaway*IDEI conference, Toulouse

29 June 2006

* Case handler, DG Competition, European Commission. This presentation reflects only the views of its author.

Structure of PresentationStructure of Presentation

Findings of the sector enquiry on Findings of the sector enquiry on payment cards : how to square payment cards : how to square them with theory?them with theory?

An interchange fee for direct debit : what’s going on?

The sector enquiry on The sector enquiry on payment cardspayment cards

• Provides empirical evidence for low pass-through Provides empirical evidence for low pass-through rates in issuingrates in issuing

• Appears to undermine the defense of (observed) Appears to undermine the defense of (observed) interchange fees based exclusively on usage interchange fees based exclusively on usage externalitiesexternalities

• Suggests models are needed which explicitly Suggests models are needed which explicitly account for market structureaccount for market structure

– Incentives of banks as issuers Incentives of banks as issuers andand acquirers acquirers

– Governance of the networksGovernance of the networks

– Relationship with the broader banking marketRelationship with the broader banking market

Discussion of some findingsDiscussion of some findings

• Acquirers in some MS pay much higher IFs than in others Acquirers in some MS pay much higher IFs than in others

=> Size of country doesn’t appear to be relevant=> Size of country doesn’t appear to be relevant

=> Concentration of the banking sector doesn’t either=> Concentration of the banking sector doesn’t either

=> Less mature markets may show higher fees=> Less mature markets may show higher fees

=> Network ownership seems to be relevant=> Network ownership seems to be relevant• Acquirers pay much higher IFs for credit than debit cardsAcquirers pay much higher IFs for credit than debit cards

=> But no greater usage externality for credit=> But no greater usage externality for credit• Large merchants do have countervailing buyer powerLarge merchants do have countervailing buyer power

=> “Sectoral IFs” exist=> “Sectoral IFs” exist

=> Some merchants are acquired below cost=> Some merchants are acquired below cost• Inelastic demand for the transaction leads to higher feesInelastic demand for the transaction leads to higher fees

=> Presence of market power => Presence of market power

The central conundrumThe central conundrum

Rents captured in acquiring are almost Rents captured in acquiring are almost completely transferred to issuing, but completely transferred to issuing, but not subsequently competed awaynot subsequently competed away

– IF moves rents away from the more IF moves rents away from the more sheltered side of the market sheltered side of the market

– Does not look like a Nash bargaining Does not look like a Nash bargaining equilibriumequilibrium

What to conclude ?What to conclude ?

Two-sidedness theory has taught us a lot Two-sidedness theory has taught us a lot about this and other marketsabout this and other markets

However, we have neglected market structureHowever, we have neglected market structure

Collusive strategies and the desire to Collusive strategies and the desire to maintain oligopoly may explain the findingsmaintain oligopoly may explain the findings

This would merit further academic analysisThis would merit further academic analysis

An interchange fee for direct An interchange fee for direct debit?debit?

• SEPA contextSEPA context

• « Business case » for PEDD?« Business case » for PEDD?

• EPC cannot imposeEPC cannot impose

• Requires universal reachability ?Requires universal reachability ?

• Misaligned investment incentives ?Misaligned investment incentives ?

• Can an IF solve the problem ?Can an IF solve the problem ?

• Banking community wants legal certainty, whilst Banking community wants legal certainty, whilst many fear the IF will be a source of rents.many fear the IF will be a source of rents.

ThoughtsThoughts• Most platform markets are not two-sided! Two groups of Most platform markets are not two-sided! Two groups of

users with differing demand is NOT a sufficient condition.users with differing demand is NOT a sufficient condition.

• Can’t the parties reach an efficient solution bilaterally Can’t the parties reach an efficient solution bilaterally through side-transfers? (Coase theorem)through side-transfers? (Coase theorem)

• Probably yes, as concerns the usage externalityProbably yes, as concerns the usage externality

• Maybe not, as concerns the network externality BUT does Maybe not, as concerns the network externality BUT does there exist an interchange fee that « solves » the there exist an interchange fee that « solves » the problem?problem?– IF changes the investment decision for a marginal tranche of IF changes the investment decision for a marginal tranche of

banksbanks– What incentive is there for the utilities to use PEDD rather What incentive is there for the utilities to use PEDD rather

than national DD?than national DD?– Asymptotically the IF does solve the problem BUT only if Asymptotically the IF does solve the problem BUT only if

side-transfers are possible and both markets are side-transfers are possible and both markets are competitivecompetitive

Questions on an IF for Questions on an IF for PEDDPEDD

• How does it work at national level? How does it work at national level?

• It may be competitively neutral but since It may be competitively neutral but since it is unlikely to be effective, why then it is unlikely to be effective, why then does the banking community want it?does the banking community want it?

• If it won’t deliver a cost-effective PEDD, If it won’t deliver a cost-effective PEDD, what would? what would?

• Does it matter?Does it matter?