Interchange fees in Australia, the UK, and the United States: matching theory and practice.

Interchange fees are an integral part of the pricing structure of credit and debit card industries. While in recent years the theoretical literature on interchange fees, and payment cards in general, has grown rapidly, the empirical literature has not. There are several reasons for this. First,

comprehensive data are hard to obtain. Second, the industries are very complicated, and empirical models need to incorporate many industry-specific features, such as payment-card network rules and government regulations. And third, empirical studies may require a generalized empirical model since, typically, only a few payment card networks exist in a given country. However, because of the first and second reasons, generalizing empirical models may prove problematic.

This article seeks to provide a bridge between the theoretical and empirical literatures on interchange fees. Specifically, the article confronts theory with practice by asking: To what extent do existing models of interchange fees match up with actual interchange fee practices in various countries? For each of three key countries--Australia, the United Kingdom, and the United States--models that "best" fit the competitive and institutional features of that country's payment card market are identified, and the implications of those models are compared to actual practices. Along what competitive dimensions is there alignment? Along what competitive dimensions is there not alignment? What country-specific factors appear to be important in explaining deviations from theoretical predictions? The results suggest that a theory applicable in one country may not be applicable in another and that similar interchange fee arrangements and regulations may well have different implications in different countries.

The first section of the article briefly describes the mechanics of interchange fees. The second section surveys existing theories of interchange fees. The discussion focuses on assumptions regarding the degree of network competition, the degree of intranetwork (issuing and acquiring) competition, and the behavior of consumers and merchants. The third section attempts to match the theory with practice by examining in some detail interchange fee developments in the three countries. These case studies provide useful insight into interchange fee competition issues.

I. MECHANICS OF INTERCHANGE FEES

Credit and debit card industries are examples of two-sided markets. The distinguishing feature of two-sided markets is that they contain two sets of end users, each of whom needs the other for the market to operate. In the case of credit and debit cards, the two end-user groups are cardholders and merchants.

Payment card systems take one of two principal forms. They may be three-party systems: cardholders, merchants, and a single financial institution that offers proprietary network services, for example, American Express. Alternatively, they may be four-party systems: cardholders, merchants, card issuing banks, and merchant acquiring banks, using the services of a multiparty network such as MasterCard, Visa, or a domestic debit card network. In four-party systems, the interchange fee is an instrument that networks can use to achieve a desired balance of cardholder usage versus merchant acceptance across the two sides of the market, in the same way that proprietary systems can achieve directly. In other words, interchange fees are a mechanism that can be used to transfer revenues from one side of the market to the other to generate the desired level of card activity.

In most cases, interchange fees are paid by the merchant acquiring bank to card issuing banks. (1) Typically interchange fees are a component of a larger set of fees charged by merchant acquiring banks and therefore are indirectly paid by merchants.

Interchange fees are set under a variety of arrangements. In some networks, they are collectively set by the members of the network; while in others they are set by network management. In some countries, they are subject to regulatory limits. (2) Network rules, which likely affect the level of interchange fees, also exhibit considerable variation across countries. These rules include no-surcharge rules, HAC rules, and net issuer rules. No-surcharge rules prevent merchants from charging customers for the use of the network's card. Honor-all-card rules require merchants to accept the networks branded card regardless of the issuer. (3) Net issuer rules require merchant acquiring banks to issue a minimum level of cards in order to participate on the acquiring side of the market.

II. INTERCHANGE FEE THEORIES

Interchange fees and related payment card issues have been the subject of a growing body of theoretical work in recent years. (4) This section surveys a portion of this work, focusing on models that examine various factors potentially affecting interchange fees. To review this literature somewhat systematically, we group possible factors into four categories: assumptions regarding networks, assumptions regarding issuers and acquirers, assumptions regarding end users (consumers and merchants), and assumptions regarding other possible factors. A single factor, by itself, is highly unlikely to determine the level of interchange fees. Rather, interaction among factors, in some or all of these four categories, typically proves critical.

Assumptions

Table 1 presents a summary of many of the key theoretical articles on interchange fees written over the last several years. The papers, organized by the assumed level of network and intranetwork (issuer and acquirer) competition, are listed in the third column of the table. As will be discussed in the third section, use of these two categories proves to be a useful "first-step" sorting mechanism when comparing model assumptions and predictions with actual interchange fee arrangements.

The first organizational division, reflected in the first column of Table 1, is the assumption regarding network competition. Many models assume there is no competition among card networks, either explicitly, by assuming a monopolistic network, or implicitly, by not considering network competition in the setup. Other models assume there is competition among networks. In some cases, these networks are defined as identical, competing within the same payment instrument (for example, credit vs. credit or debit vs. debit). In other cases, these networks are defined as asymmetric, competing across different payment instruments (for example, credit vs. debit or PIN debit vs. signature debit), across different network schemes (three-party vs. four-party), or within the same payment instrument but facing different cost structures.

The second organizational division, shown in the second column of Table 1, is the assumption regarding intranetwork competition. A key feature of most models is the assumed degree of competition among card issuing banks and among merchant acquiring banks. This degree of competition is typically modeled with reference to the price-cost margins of issuers and acquirers. A zero margin is taken to imply perfect competition. A positive margin is taken to imply some market power. As seen in Table 1, some models assume both issuers and acquirers operate in perfectly competitive markets, some assume both issuers and acquirers have some market power, and still others assume only issuers have market power.

The remaining "Assumption" columns in Table 1 list other important factors assumed or incorporated in the respective models. Column 4 focuses on network attributes. In addition to the assumed degree of network competition, three additional network attributes are considered: whether the model in question assumes a three-party or four-party scheme; what the objectives of the networks are; and whether there is a single or multiple interchange fee structure. Possible network objectives include maximizing the number of transactions or market share; maximizing network profits (in a three-party scheme); and maximizing members' joint profits (in a four-party scheme), perhaps weighted more on the issuer or acquirer side. In addition, networks may seek to address any imbalances between the costs and revenues of issuers and acquirers, and between the demand of consumers and merchants. Finally, models may incorporate either a single interchange fee or, alternatively, multiple interchange fees that vary according to type of industry or transaction volume.

Column 5 focuses on intranetwork attributes. In addition to the assumed degree of competition on the issuing and acquiring sides of the market, three additional attributes are considered: the degree of pass-through of interchange fees from issuers and acquirers to cardholders and merchants, respectively; the relative cost structures facing issuers and acquirers; and whether issuers and acquirers are the same or different entities.

The next two columns turn to assumptions regarding the end users in payment card models. Consumer characteristics (column 6) include the demand for products (elastic or inelastic); the demand for cards (exogenous or endogenous; singlehoming or multihoming); and the demand for specific card transactions (homogeneous or heterogeneous transactional benefits). The types of fees and rewards that consumers face also vary by model.

Merchant characteristics are listed in column 7. Some models assume that merchants are strategic in their card-acceptance behavior--that is, they are competitive. Others assume that merchants are monopolistic. Models also differ according to whether merchants are assumed to derive homogeneous or heterogeneous transactional benefits, and whether they pay per-transaction fees and/or fixed fees. Finally, column 8 shows other factors that are built into various models. Chief among them are the presence or absence of assorted network rules and bylaws. These include no-surcharge and nondiscrimination rules, HAC rules, and net issuer rules.

Results

It is probably fair to say that the results of the papers summarized in Table 1 vary as much or more as the underlying assumptions in these papers. Key results are listed in column 9.

Perhaps the most important general result involves network competition. The effect of network competition on interchange fees is not uniform but varies widely depending on other factors. Some key factors include consumer and merchant demand characteristics, and the nature of intrasystem competition.

To the extent consumers are singlehoming, that is, using only one payment card, networks can act as monopolies. Thus, interchange fees are not reduced by network competition (Rochet and Tirole 2002). However, as consumers become multihoming, merchant resistance to interchange fees increases, and network competition lowers interchange fees (Rochet and Tirole 2002, 2003; Guthrie and Wright 2003).

To the extent that merchants are homogeneous, with an inelastic demand for transactions, network competition leads to a lower (or equal) interchange fee than noncompetition. However, if merchants are heterogeneous (elastic demand), the competitive interchange fee can be higher than the monopolistic interchange fee (Guthrie and Wright 2006). Network competition lowers interchange fees for both strategic (competitive) and monopolistic merchants. However, interchange fees for monopolistic merchants are lower than those for strategic merchants whether the network is competitive or not (Guthrie and Wright 2003).

Intrasystem competition is similarly influential. Several models show that differences in issuers' and acquirers' margins affect equilibrium interchange fees (Manenti and Somma 2002; Rochet and Tirole 2002; and Guthrie and Wright 2006). Differences in these margins also affect competing networks' profits (Manenti and Somma 2002).

A number of other interesting results involving network competition fallout of these models as well. These include: (1) network competition lowers the total fees charged across the issuing and acquiring sides of the market (Rochet and Tirole 2003; and Chakravorti and Roson 2006); (2) network competition may raise interchange fees if consumers hold a single card and merchant demand for transactions is elastic (Guthrie and Wright 2003, 2006); and (3) if the network is a monopoly, interchange fees can vary depending on the interaction of network objectives and issuer and acquirer margins (Gans and King 2002; Schmalensee 2002; Wright 2003, 2004; and Schwartz and Vincent 2006).

Clearly, the nature of network competition is central to many of the results of the models in Table 1. Another important role is played by the various network rules and bylaws. Most of the models, for example, explicitly assume a no-surcharge rule and implicitly assume an honor all cards rule. Relaxing these assumptions can lead to differing results. If merchants are allowed to surcharge, for example, interchange fee levels may change depending on any number of additional factors, including the effective cost of surcharging to merchants, merchant competitiveness, and the price elasticity of consumer demand for goods (Gans and King 2002; Katz 2001; Wright 2003; and Schwartz and Vincent 2006).

What one comes away with after surveying this rich theoretical literature is an appreciation for the many factors that may affect interchange fees. Even a single factor may impact interchange fees differently, depending on other factors. Determining the actual impact of such variables is, in the end, an empirical question. We attempt to take a step in this direction in the next section.

III. COUNTRY CASE STUDIES

The previous section surveyed some of the important contributions in the theoretical literature on payment card interchange fees. This section details actual market conditions in three countries--the United States, Australia, and the UK--and compares these conditions with theory. Interchange fees have been a focus of much debate in these three countries in recent years. The key question asked is" To what extent do actual interchange fee practices "line up" with model assumptions and predictions? For each country, we first characterize the credit and debit card industries by the level of network and intranetwork competition. We then try to match a country's experience with existing theory, suggesting additional assumptions and institutional features that may help explain that country's situation.

United States

Network competition exists in the United States, both within and across payment card instruments.

The United States has six credit card networks. The three largest-Visa, MasterCard, and American Express--compete aggressively with one another. Visa has the largest market share, followed by MasterCard and American Express. Visas market share has declined somewhat in recent years, as measured by purchase value, number of transactions, and number of cards (Chart 1). The remaining three credit card networks--Discover, Diners Club, and JCB--have relatively small market shares (Chart 1).

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The United States has two signature-based debit card networks (Visa Check Card and MasterCard MasterMoney) and 13 PIN-based debit card networks. Competition has been especially pronounced in the PIN debit market, especially among the four largest networks. The market share of Visas Interlink network has trended up in recent years, while those for Star, NYCE, and Pulse have fluctuated (Chart 2). These large PIN-based networks also compete vigorously with the two signature-based networks. (5)

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It is unclear to what extent credit and debit cards compete. Overall debit card market share (signature plus PIN) has been rising in recent years, and, in 2003, the number of debit card transactions exceeded the number of credit card transactions for the first time (Chart 3). However, in terms of purchase value, the difference between credit and debit cards has been stable over the last five years, suggesting perhaps that debit card transactions are largely substituting for paper-based (check and cash) transactions and not for credit card transactions (Chart 3). One can safely say, however, that there is competition within the credit card industry, within the PIN debit card industry, and across the PIN and signature debit card industries.

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Intranetwork competition also exists in the United States, as both the acquiring and issuing sides of the card market appear to be competitive. With regard to the acquiring market, although the largest acquirers' market share has increased slightly in the last ten years, acquirers' margins per transaction reportedly have been declining (Chart 4). (6)

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On the issuing side, top credit card issuers' market shares have increased significantly in the last ten years (Chart 5). Nevertheless, this market appears to be quite competitive. No annual fees, generous reward programs, and free or low introductory interest rates are typical in the industry, as issuers compete aggressively for customers. The story is somewhat different with respect to debit cards. Here, market shares of top issuers are much smaller than in the credit card market, but the degree of competition is hard to gauge (Charts 6 and 7). Because debit cards are tied to demand deposit accounts, it is costly for consumers to switch issuers. At the same time, however, many banks use their debit products as a strategic tool, providing rewards for signature card transactions and charging so-called PIN fees for PIN card transactions. On net, it is probably fair to view card issuing--both credit and debit--as a competitive environment.

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Matching theory and practice. As noted earlier, both network and intranetwork payment card competition exist in the United States. In terms of network competition, competition between Visa and MasterCard in the credit card market, and among the top networks in the PIN debit market, fits well with the identical four-party network schemes assumed in Guthrie and Wright (2003, 2006) and Rochet and Tirole (2002, 2003). Competition between Visa/MasterCard and American Express, on the other hand, fits well with Manenti and Somma (2002).

In terms of intranetwork competition, although both the acquiring and issuing sides of the market are competitive, it is difficult to judge which side is more competitive or which side experiences lower margins per transaction. Revenues (not margins) are much higher for issuers than acquirers, but their costs per transaction are unknown. It does appear that pass-through of interchange fees is 100 percent on the acquiring side, while on the issuing side it is less than 100 percent. (7,8)

On balance, network objectives are likely to be weighted more heavily toward issuers than acquirers in the United States. One reason is that even the largest nonbank acquirers do not have voting power in association networks and market share of nonbank acquirers is fairly large (Chart 8). A second reason is that large bank acquirers are typically large issuers as well. Therefore, maximization of issuer profits, number of transactions, and the weighted sum of end-user surplus with a high weight on consumers appear to be plausible assumptions in the U.S. case. These assumptions are made by Guthrie and Wright (2003, 2006) and Rochet and Tirole (2002, 2003).

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Other important factors in the United States are merchant demand for card transactions and consumer cardholding behavior. Most industries in the United States are quite competitive. As a result, merchants clearly have a strategic motive to accept cards. In addition, unlike in most other countries, interchange fees in the United States are set in a very detailed manner according to industry category and size of the merchant (Table 2). Thus, a single interchange fee applies to a relatively homogeneous set of merchants, and this industry-specific fee less likely impacts consumer cardholding behavior, which is consistent with Rochet and Tirole (2002). U.S. households typically hold multiple credit and debit cards--that is, they are multihoming. (9) However, also consistent with Rochet and Tirole (2002), these multihoming cardholders often appear to prefer a particular card over the others. (10)

Taken in sum, the assumptions in Rochet and Tirole (2002) fit the U.S. payment card market well. However, the model does not predict that network competition raises interchange fees, which, arguably, is occurring in the United States. The model also predicts that competition among issuers lowers interchange fees, which also seems to contradict the U.S. case. (11) The only model that predicts that network competition may raise interchange fees is Guthrie and Wright (2003, 2006). However, to generate this result, the model assumes that the same interchange fee is charged to different types of merchants. This assumption does not necessarily fit well with the case in the United States, where interchange fees vary by industry and size of the merchant.

Can theory and fact be reconciled? Additional considerations may help explain the U.S. situation. For example, modeling issuers' behavior may prove critical. Oligopolistic issuers may alter their card portfolio, if not change networks, according to profitability. Network competition, therefore, gives networks a strong incentive to try to attract issuers as much as possible. One of the strategies for doing so is to provide issuers with higher interchange fees. these fees allow issuers either to generate higher revenue per transaction or to provide the issuers' customers more generous rewards or both. By offering rewards, issuers may be able to stimulate their existing customers' spending on their cards or to lure customers away from their rival issuers. It is very likely that an issuer and its rival issuers are members of the same network. Then, higher interchange fees may not necessarily increase the its total transaction volume or the networks (weighted) member joint profits.

If cardholders' rewards are not just money transfers from merchants (or their customers) to cardholders but incur additional costs on issuers, the issuers' per transaction costs may not be fixed, as marly papers assume. (12) Rather, they depend on whether the cardholder per transaction fees are negative (which means issuers provide rewards) or non-negative. Whether the cardholder per transaction fees are negative may greatly depend on the level of interchange fees.

As noted, U.S. interchange fees are set by industry. As a result, modeling consumer cardholding and merchant card acceptance under a single interchange fee does not fit the U.S. case. In a given industry, perhaps the merchant's card acceptance does not influence its customers' cardholding behavior.

Australia

Network competition likely exists in Australia.

There are six credit card networks in the country. The three largest--Visa, MasterCard, and Bankcard--have a combined market share in excess of 80 percent. The remaining market is divided among American Express, Diners Club, and JCB. Individual network share data are not available for recent years, but in 2001-02, shares in terms of number of credit cards were 53.4 percent for Visa, 22.7 percent for MasterCard, 15.4 percent for Bankcard, 6.5 percent for American Express, 1.9 percent for Diners, and essentially negligible for JCB. From 2002 to 2005, the combined American Express/Diners share has increased slightly (Chart 9).

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There are two debit card networks in Australia, EFTPOS and Visa Debit. EFTPOS is PIN-based, while Visa Debit is signature-based. Based on statistics furnished by the Building Society to the Reserve Bank of Australia, EFTPOS share of the overall debit network is roughly 90 percent, while Visa Debit's is roughly 10 percent. (13) Visa Debit cards are primarily issued by credit unions and building societies that were precluded from issuing credit cards. EFTPOS cards, in contrast, are issued by all types of financial institutions.

Credit card and EFTPOS debit card transactions have exhibited an interesting growth pattern in recent years (Chart 10). In 1995, credit and EFTPOS debit transaction volumes were about the same. From 1996 to 1998, debit volume exceeded credit volume, but, from 1999 to 2004, credit volume exceeded debit volume. In 2005, volume for the two instruments has essentially been the same again. This may imply that, in Australia, credit and EFTPOS debit are relatively close substitutes, and hence credit card networks and the EFTPOS network see each other as competitors.

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Intranetwork competition. Both the acquiring and issuing sides of the card market appear to be competitive in Australia.

While the acquiring market is highly concentrated, a large portion of recent interchange fee reductions has been passed through to lower merchant service charges (MSC). The four largest banks in Australia acquire about 95 percent of transaction volume and 85 percent of transaction value. (14) However, according to the Reserve Bank of Australia, the average MSC for four-party networks in Australia has declined from 1.46 percent prior to regulation to 0.97 percent since regulation. This roughly 50-basis-point decline is in line with the decline in interchange fees pre and post regulation.

The four largest banks issue 55 percent of the number of cards and account for 70 percent of transaction volume. (15) Although many banks reportedly have cut reward-program benefits as a response to lower regulated interchange fees, they still provide rewards to their cardholders. This may imply that a portion of interchange fee revenue remains passed through to cardholders and that credit card issuing is competitive. Also indicative of competition is the fact that two of the four largest banks now issue and promote American Express cards as well as Visa and MasterCard cards.

Regarding EFTPOS debit card issuing, the combined market share of the four largest banks is large. Issuers typically charge per-transaction fees to their cardholders after a certain number of free transactions. Issuers seem to compete by using the per-transaction fees or free transactions as their strategic tools.

Matching theory and practice. As suggested above, the Australian payment card market probably can be characterized as exhibiting both network and intranetwork competition. In light of this, which theoretical model(s) best "lines up" with Australian interchange fee practices?

None of the models appears to closely fit the Australian market over a large number of parameters. For example, competition between Visa and MasterCard, between Visa/MasterCard and Bankcard, and between credit cards and EFTPOS can all be characterized as four-party scheme network competition. Although the competition between Visa and MasterCard can be regarded as identical, the other two competitive relationships cannot. A number of important papers adopt four-party schemes, but all of them assume either identical networks or symmetric network competition (Guthrie and Wright 2003, 2006; Rochet and Tirole 2002, 2003). Chakravorti and Roson (2006) assume asymmetric network competition but they adopt either a three-party scheme or an issuer-controlled four-party scheme. EFTPOS cannot be regarded as issuer-controlled because interchange fees flow from issuers to acquirers in this market. (16) And most important, of course, interchange fees are now regulated in Australia, which likely has fundamentally changed pricing dynamics. This "new regime" must be taken into account in analyzing current Australian conditions.

Other factors to consider in addressing the Australian situation include differences in acquirer and issuer margins, merchant strategy, consumer cardholding, and surcharging. Acquirers appear to maintain a constant margin regardless of interchange fee levels, while issuers' margins appear to be influenced by the level of interchange fees. Most models assume constant margins on both sides of the market; only Wright (2004) considers interchange fee pass-through.

Regarding merchant strategy, it is generally believed that the Australian retail industry is more concentrated than that in the United States. It is unclear, however, how competitive Australian merchants are in practice. Merchants likely have a strategic motive to accept cards. Unlike in the United States, each network sets a single interchange fee for a typical point-of-sale transaction--that is, interchange fees do not vary by industry. This implies that heterogeneous merchants face a single interchange fee, consistent with Guthrie and Wright (2003, 2006); Rochet and Tirole (2003); Chakravorti and Roson (2006), Schmalensee (2002); and Wright (2004). Consumers typically pay an annual fee for credit cards with an interest-free period. To join a reward program, an additional annual fee is charged. Such endogenous cardholding with a fixed cost is assumed by Chakravorti and Roson (2006), Katz (2001), and Wright (2003).

Merchants were not allowed to surcharge prior to credit card reform. Since then, surcharging has been permitted, but few merchants reportedly have elected to do so. According to a recent survey, however, nearly half of Australia's merchants plan to apply surcharges to credit card transactions in 2006. (17) To sufficiently capture developments in the Australian payment card market, future models will probably need to explicitly assume the option of merchant surcharging as well as interchange caps for four-party schemes.

United Kingdom

Network competition. It is unclear to what extent network competition exists in the UK. Whether the two dominant networks, Visa and MasterCard, compete against each other in both credit and debit markets, in just one market (likely debit), or whether Visa focuses on credit and MasterCard focuses on debit, is an open question.

There are five credit card networks in the country. The two largest, Visa and MasterCard, together have a more than 90 percent market share. (18) In addition, the number of Visa and MasterCard credit/charge cards has been increasing in recent years, while the sum of those of other networks (American Express, Diners, and JCB) has not. Purchase values show the same trend (Chart 11).

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In the debit card market, the two networks, Visa and MasterCard, have essentially equal (50-50) market shares (Chart 12). A typical UK bank is a member of both the Visa and MasterCard networks, but in issuing debit cards banks choose one brand or the other. According to Cruickshank (2000), Switch's (now MasterCard) interchange fee was considerably lower than Visa's in 2000, suggesting that, on revenue grounds, Visa would be more attractive. However, potentially offsetting this is the fact that MasterCard's debit card, Maestro, is more popular throughout Europe.

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Two other facts make the UK card market interesting. First, unlike in most other European countries, debit cards have not markedly outstripped credit cards in terms of usage (Chart 13). Second, unlike in Australia, credit card-debit card network competition is subtle, if it exists at all, because there is no third network equivalent to EFTPOS.

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Intranetwork competition. Both the acquiring and issuing sides of the card market are competitive in the UK.

The acquiring market is relatively concentrated. In 2002, the top two acquirers had 40 percent and 30 percent market shares, respectively. However, it is likely that the market share of the top three acquirers has declined recently, and the difference between MSCs and interchange fees in the UK is comparable to the average difference in the United States. (19)

The issuing market is clearly competitive. With respect to credit cards, no annual fees, free or low introductory interest periods, and cash rebates are broadly used. In addition, several U.S. issuers, including Capital One, Citibank, and MBNA, have entered the UK market in recent years, and their combined market share now accounts for 20 percent of credit cards issued. Smaller UK banks have also entered the market. With respect to debit cards, banks' debit card market shares correspond closely with the current account market shares.

Matching theory and practice. As noted above, the degree of network competition in the UK is difficult to gauge. Intranetwork competition, on the other hand, exists.

To the extent Visa and MasterCard compete in the credit card market, it can be characterized as an identical four-party scheme (Guthrie and Wright 2003, 2006; Rochet and Tirole 2002, 2003). To the extent Visa and MasterCard compete in the debit card market, competition is again four-party, but it may or may not be identical network competition. According to Cruickshank (2000), Visa debit and Switch (MasterCard) interchange fees were quite different in 1998: The Visa debit interchange fee was at least twice as much as the Switch interchange fee. However, the more recent European Payment Cards Yearbook (2004-05) reports that the average interchange fee on Visa debit is thought to have fallen sharply from the figure reported in Cruickshank (2000). Depending on how close the two networks' interchange fees now are, they may be regarded as almost identical. If they are not identical, Chakravorti and Roson's (2006) asymmetric network competition model may fit well. Although their model assumes a three-party scheme, it can also accommodate an issuer-controlled four-party network. Since Visa debit issuers typically are not Switch issuers, an issuer-controlled four-party assumption may be valid.

In terms of intranetwork competition, it is hard to judge which side is more competitive or which side receives higher margins. However, in the UK, all networks are still subject to so-called "net issuer rules"--only issuers can be acquirers. In addition, many aspects of merchant acquiring, such as transaction processing and recruitment of retailers, are outsourced to third-party service providers who do not have voting power. Therefore, a networks objective is likely to be weighted more on the issuer side. As a result, maximizing members' (weighted) joint profits (with a higher weight on the issuers), maximizing the number of transactions, or maximizing a weighted sum of end-user surplus (with a higher weight on the consumer side) is a plausible assumption. These assumptions are made in Guthrie and Wright (2003, 2006) and Rochet and Tirole (2002, 2003), with network competition; and in Rochet and Tirole (2002), Wright (2003, 2004), Schwartz and Vincent (2006), and Schmalensee (2002), without network competition.

There are additional factors to consider as well. One, although the degree of competition among merchants is unknown, merchants likely have a strategic motive to accept cards. If they did not have such a motive, they may not have complained about credit card interchange fees to the Office of Fair Trading in the early 1990s. Two, credit and debit card interchange fee schedules are not publicly available. However, according to Cruickshank (2000), credit card interchange fees vary according to a number of factors, including whether a transaction is domestic or cross-border, whether it is a face-to-face or a mail order transaction, and on the level of information about the transaction that is provided to the issuer. Visa's pricing in the UK may therefore be somewhat similar to Visas pricing for EU cross-border transactions and, unlike in the United States, a single rate may typically apply to retail Point of Sale (POS) transactions in the UK. This implies that heterogeneous merchants largely face a single interchange fee, as assumed by Guthrie and Wright (2003, 2006), Rochet and Tirole (2003), Chakravorti and Roson (2006), Schmalensee (2002), and Wright (2004).

In addition, there are consumer factors to consider. Consumers can hold credit cards with no annual fees, so endogenous cardholding with no fixed fees might be an apt description in the UK credit card market (Guthrie and Wright 2003, 2006; Gans and King 2002). On the other hand, since the debit card is a demand deposit account product, debit card holding might be exogenous.

There are other factors to consider as well. UK merchants are prohibited from surcharging debit card transactions, but they are permitted to surcharge credit card transactions. However, most merchants choose not to surcharge for credit card transactions; surcharging may require some costs to merchants. Thus, interchange fees are not neutral, unlike the Gans and King (2002) prediction.

On balance, the assumptions in Guthrie and Wright (2003, 2006) appear to fit UK payment markets well if Visa and MasterCard compete against one another. The model predicts that with competition among heterogeneous merchants, network competition may raise interchange fees if networks place more weight on consumer surplus than on merchant surplus. Since credit card reward programs are very popular in the UK, consumer surplus is likely weighted more heavily than merchant surplus. However, unlike the model's prediction, UK credit card interchange fees have been declining. The decline in interchange fees may not be a result of market equilibrium but may be due instead to regulatory pressure from the Office of Fair Trading.

If, on the other hand, Visa and MasterCard do not compete in the UK, assumptions in Rochet and Tirole (2002) may fit well with the UK debit card market and assumptions in Wright (2004) may fit well with the UK credit card market. While credit card interchange fees likely have been lowered because of regulatory pressure, debit card interchange fees have not been subject to regulatory concerns. As Rochet and Tirole (2002) predicted, debit card issuers' competition may have lowered interchange fees of Visa debit.

IV. SUMMARY

This article has sought to provide a bridge between the theoretical and empirical literatures on interchange fees. Specifically, the article confronts theory with practice by asking: To what extent do existing models of interchange fees match actual interchange fee practices in various countries? For each of three countries--Australia, the UK, and the United States--models that "best" fit the competitive and institutional features of that country's payment card market are identified, and the implications of those model are compared to actual practices.

Not surprisingly, the models examined--while certainly yielding insight into developments in these countries--are limited in their applicability and predictive power. This reflects the fact that country-specific factors are typically very important. The next step, of course, is to try to gather comprehensive data that capture these institutional features as well as interchange structures and prices, so that analysts can conduct rigorous econometric analysis.

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--, and Robetto Roson. 2006. "Platform Competition in Two-Sided Markets: The Case of Payment Networks," Review of Network Economics, vol. 5, pp. 118-43.

Cruickshank, Don. 2000. Competition in UK Banking: A Report to the Chancellor of the Exchequer, HMSO, Norwich, March.

Dove Consulting. 2002. Debit Card Survey: Cardholder Fees and Industry Outlook.

--. 2001. 2001 Study of Consumer Payment Preferences.

Evans, David. 2003a. "The Antitrust Economics of Multi-Sided Platform Markets," Yale Journal on Regulation, vol. 20, pp. 325-81.

--. 2003b. "Some Empirical Aspects of Multi-Sided Platform Industries," Review of Network Economics, vol. 2, pp. 1-20.

--, and Richard Schmalensee. 2006. "The Economics of Interchange Fees and Their Regulation: An Overview," Interchange Fees in Credit and Debit Card Industries: What Role for Public Authorities? Federal Reserve Bank of Kansas City, pp. 73-120.

--. 2005. Paying with Plastic: The Digital Revolution in Buying and Borrowing. Cambridge, Mass.: MIT Press, 2nd ed.

Executives Meeting of East Asia-Pacific Central Banks and Monetary Authorities. 2002. Payment Systems in EMEAP Economies, EMEAP Working Group on Payment and Settlement Systems.

Federal Reserve System. 2004. 2004 Federal Reserve Payments Study.. Analysis of Noncash Payments Trends in the United States: 2000-2003.

--. 2002. 2001 Retail Payments Research Project: A Snapshot of the U.S. Payments Landscape.

Frankel, Alan S. 1998. "Monopoly and Competition in the Supply and Exchange of Money," Antitrust Law Journal, vol. 66, no. 2.

Gans, Joshua, and Stephen King. 2003. "The Neutrality of Interchange Fees in Payment Systems," Topics in Economic Analysis & Policy, vol. 3, no. 1.

--. 2002. "A Theoretical Analysis of Credit Card Regulation," Melbourne Business School Working Paper No. 2002-11.

Guthrie, Graeme, and Julian Wright. 2006 (forthcoming). "Competing Payment Schemes," Journal of Industrial Economics.

--. 2003. "Competing Payment Schemes," University of Auckland, Department of Economics, Working Paper No. 245.

Hayashi, Fumiko. 2006. "A Puzzle of Card Payment Pricing: Why Are Merchants Still Accepting Card Payments?" Review of Network Economics, vol. 5, pp. 144-74.

--, Richard Sullivan, and Stuart E. Weiner. 2003. A Guide to the ATM and Debit Card Industry, Federal Reserve Bank of Kansas City.

Hunt, Robert. 2003. "An Introduction to the Economics of Payment Card Networks," Review of Network Economics, vol. 2, pp. 80-96.

Katz, Michael. 2001. "Reform of Credit Card Schemes in Australia II: Commissioned Report," Reserve Bank of Australia Public Document, August.

Manenti, Fabio, and Ernesto Somma. 2002. "Plastic Clashes: Competition Among Closed and Open Systems in the Credit Card Industry," mimeo.

MBNA. 2002-04. Annual Report(s).

Nilson Report. 1991-2005. Various issues.

Reserve Bank of Australia. 2005. Reform of the EFTPOS and Visa Debit Systems in Australia: A Consultation Document, Sydney, February.

--. 2002. Reform of Credit Card Schemes in Australia, IV" Final Reforms and Regulation Impact Statement, Sydney, August.

--. 2001. Reform of Credit Card Schemes in Australia, I: A Consultation Document, Sydney, December.

--. 1999-2004. Payments System Board Annual Reports, Sydney.

--, and Australian Competition and Consumer Commission. 2000. Debit and Credit Card Schemes in Australia: A Study of Interchange Fees and Access, Sydney, October.

Rochet, Jean-Charles. 2003. "The Theory of Interchange Fees: A Synthesis of Recent Contributions," Review of Network Economics, vol. 2, pp. 97-124. --, and Jean Tirole. 2004a. "Defining Two-Sided Markets," Toulouse, France: IDEI, mimeo, January.

--. 2004b. "Two-Sided Markets: An Overview," Toulouse, France: IDEI, mimeo, March.

--. 2003a. "Platform Competition in Two-Sided Markets," Journal of the European Economics Association, vol. 1, pp. 990-1029. --. 2003b. "An Economic Analysis of the Determination of Interchange Fees in Payment Card Systems," Review of Network Economics, vol. 2, pp. 69-79. --. 2002. "Cooperation Among Competitors: Some Economics of Payment Card Associations," RAND Journal of Economics, vol. 33, pp. 549-70.

Roson, Roberto. 2005. "Two-Sided Market: A Tentative Survey," Review of Network Economics, vol. 4, pp. 142-60.

Schmalensee, Richard. 2003. "Interchange Fees: A Review of the Literature," The Payment Card Economics Review, vol. 1, pp. 25-44.

--. 2002. "Payment Systems and Interchange Fees," Journal of Industrial Economics, vol. 50, pp. 103-22.

Schwartz, Marius, and Daniel Vincent. 2006. "The No Surcharge Rule and Card User Rebates: Vertical Control by a Payment Network," Review of Network Economics, vol. 5, pp. 72-102.

Weiner, Stuart, and Julian Wright. 2005. "Interchange Fees in Various Countries: Developments and Determinants," Review of Network Economics, vol. 4, pp. 290-323.

Wright, Julian. 2004. "Determinants of Optimal Interchange Fees in Payment Systems," Journal of Industrial Economics, vol. 52, pp. 1-26.

--. 2003. "Optimal Card Payment Systems," European Economic Review, vol. 47, pp. 587-612.

ENDNOTES

(1) In Australia, interchange fees of EFTPOS, a domestic PIN-based debit card scheme, go in the opposite direction.

(2) Weiner and Wright (2005).

(3) Before the so-called Wal-Mart settlement, the HAC rule in the United States required merchants who accept a networks credit card to also accept that networks signature-based debit cards. Currently, networks require merchants to accept both consumer and corporate cards and accept both nonreward and reward cards.

(4) Other surveys are provided by Schmalensee (2003), Evans and Schmalensee (2006), Roson (2005), and Weiner and Wright (2005).

(5) For discussion of PIN vs. signature debit competition, see Hayashi and others (2003).

(6) According to the Star's fee structure, a processing fee is around 3 cents per transaction and according to the FMI, the acquirer's processing charge is between 2.5 cents to 6.5 cents per transactions, these fees have declined slightly in the last several years.

(7) A typical merchant fee consists of three components, an interchange fee (to the issuer), a processing fee (to the acquirer), and a switch fee (to the network).

(8) According to a large credit card issuer's annual report, the average growth rate of interchange fee income (after deducted the costs of reward program) exceeds the average growth rate of transaction value. This suggests that interchange fee does not pass-through 100 percent on issuing side.

(9) According to the BIS, the number of debit cards and credit cards issued in the U.S. in 2002 were 260.4 million and 709 million, respectively. The U.S. population in the same year was 288.2 million.

(10) Some studies pointed this out. For example, the 2004 Preferred Card Study by Edgar, Dunn, and Company concluded that "rewards dominate the reasons to use a specific credit card for 6 in 10 Americans."

(11) See, for example, Hayashi (2006) for the trends of U.S. interchange fees.

(12) This is very likely. Some issuers outsource their reward program administration to third-party service providers.

(13) Building Society Comments on RBA Draft Standards for Visa Debit and EFTPOS (April 29, 2005).

(14) Reserve Bank of Australia and Australian Competition and Consumer Commission (2000)

(15) Authors' calculation from Nilson Report.

(16) On the other hand, competition between four-party scheme and three-party scheme may fit well with Manenti and Somma (2002).

(17) See, for example, American Banker vol. 170, no. 148.

(18) European Payment Cards Yearbook (2004-05).

(19) According to the 2002 MSC Survey by Payment Systems Europe Ltd, average credit card MSC in UK has been stable around 1.5-1.6 percent from 1995 to 2002. According to Cruickshank (2000), average credit card interchange fee was 1-1.1 percent. In the United States, average MasterCard and Visa credit card MSC is reportedly around 2 percent and average interchange fees are around 1.5 percent.

Fumiko Hayashi is a senior economist at the Federal Reserve Bank of Kansas City. Stuart E. Weiner is a vice president and director of Payments System Research at the bank. The authors thank Nathan Halmrast, Jean-Charles Rochet, Julian Wright, and seminar participants at the European Central Bank and at the "Competition and Efficiency in Payment and Security Settlement Systems Conference," co-sponsored by the Bank of Finland and the Center for Economic Policy Research. The article is on the bank's website at www.KansasCityFed.org.

Table 1
KEY ASSUMPTIONS AND RESULTS IN PREVIOUS LITERATURE

Assumptions

Network       Intranetwork
Competition   Competition       Paper

     1               2                3

No network    Both issuers      Katz (2001)
competition   and acquirers
              are
              perfectly
              competitive

                                Rochet and
                                Tirole (2002)
                                (Section l-4)

              Acquirers are     Wright
              perfectly         (2003)
              competitive &
              issuers involve
              some market
              power

                                Schwartz
                                and
                                Vincent
                                (2006)

              Both issuers      Gans & King
              and acquirers     (2002)
              involve
              me market         Schmalensee
              power             (2002)

                                Wright
                                (2004)

              Both issuers      Guthrie and
              and acquirers     Wight
              are perfectly     (2006)
              competitive

Competition   Acquirers are     Rochet and
              perfectly         Tirole
              competitive &     (2002)
              issuers           (Section 5)
              involve some
              market power      Manenti and
                                Somma
              Both issuers      (2002)
              and acquirers
              retain            Guthrie and
              certain per       Wight
              transaction       (2003)
              margins
                                Rochet and
                                Tirole (2003)

              Intrasystem       Chakravorti
              competition is    and Roson
              not considered    (2006)

Assumptions

Network                          Intranetwork
Competition, Scheme,             Competition, Pass-through
Objectives, IFs                  Costs, Entities

              4                                    5

* Competition is not             * Issuers and acquirers are
  considered                       perfectly competitive
* 4-party scheme                 * 100% pass-through IF
* No assumption on the           * Fixed costs for card issuing
  network objectives               and per transaction cost for
* Single IF                        both issuing and acquiring
                                   sides
                                 * No assumption on entities

* Competition is not             * Acquiring is perfectly
  considered                       competitive and issuing involves
* 4-parry scheme                   some market power
* Maximize issuers' profits =    * 100% pass-through IF on
  set highest IF that induces      acquiring side
  merchant card acceptance       * Per transaction cost is fixed
* (Multiple IFs are possible)      and no fixed costs
                                 * No assumption on issuing
                                   and acquiring entities

* Competition is not             * Acquiring is perfectly
  considered                       competitive and issuers can
* 4-party scheme                   be monopoly or symmetric
* Maximize issuers' profits        Cournor oligopoly
* Single IF                      * 100% pass-through IF on
                                   acquiring side
                                 * Fixed costs for card issuing
                                   and per transaction cost for
                                   both issuing and acquiring
                                   sides

* Competition is not             * Acquirers are identical and
  considered                       perfectly competitive and
* 4-party scheme                   issuers are identical and calclude
* Maximize issuers' profits        in pricing to card users
* (Multiple IFs are possible)      (competitive card issuers are
                                   considered in section 6)
                                 * 100% pass-through IF on

* Competition is                 * Issuers and acquirers are
  not considered                   competing perfectly or
* 4-party scheme                   imperfectly (two-part
* Maximize members' joint          pricing and linear pricing)
  profits                        * Per transaction cost is fixed
* Single IF                        and no fixed corn exist

* Competition is not             * Both bilateral monopoly
  considered                       and multiple issuers &
* 4-party scheme                   acquirers considered
* Maximize members'              * Per transaction cost is fixed
  weighted                         and no Fixed costs exist
  likely join, profits           * Different entities in the
  (issuers hold more               case of bilateral monopoly
  voting power than                and no assumption in the
  acquirers)                       case of multiple issuers and
* Single IF                        acquirers

* Competition is nor             * Multiple symmetric issuers
  considered                       and symmetric acquirers
* 4-part scheme                  * Pass-through IF is
* Max members'                     considered
  (weighed) joint profits        * for transaction cost is fixed
* Single IF                        and no fixed costs exist

* Identical network              * Both issuing and acquiring
  competition                      are perfectly competitive
* 4-party scheme (3-party        * 100% pass-through IF on
  schemes also considered as       herb sides
  extension)                     * Per transaction cost is fixed
* Maximize weighted sum of         and no fixed costs
  end-user surplus               * No assumption on issuing
* Single IF in a network           and acquiring entities

* No assumption on whether       * Acquiring is perfectly
  competing two networks           competitive and issuing
  are identical                    involves some market
* 4-parry scheme                   power
* Maximize issuers profits =     * 100% pass-through IF on
  set highest IF that induces      acquiring side
  merchant card acceptance       * Per transaction cost is fixed
* (Multiple IF, are possible)      and no fixed costs
                                 * No assumption on suing
                                   and acquiring entities

* Competition between a          * Per transaction margins to
  not-for-profit network           issuers and to acquirers are
  jointly run by members and       proportional to net costs
  a proprietary network          * Per transaction cast is fixed
* Networks compete                 and no fixed costs
  according to the Hotelling     * Issuers and acquirers are
  model                            different entities
* Maximize total profits
* Single IF

* Identical network              * Multiple symmetric issuers
  competition                      and symmetric acquirers
* 4-party scheme                 * Per transaction margins to
* Maximize members' joint          issuers and to acquirers are
  profits = maximize the           constant (and rend to be
  number of transactions           zero).
* Single IF                      * 100% pass-through IF
                                 * Per transaction cost is fixed
                                   and no fixed costs exist
                                 * No assumption on issuing
                                   and acquiring entities

* Competition between            * Per transaction margins to
  networks with symmetric          issuers and to acquirers are
  consumer demand                  constant and the same for
* Both 4- party scheme             both networks
  and 3- party scheme            * Both issuers and acquirers
  are considered                   join only one network
* 4-parry schemes maximize       * 100% pass-through IF on
  the number of transactions       both sides
  and 3-parry schemes            * Per transaction cost is fixed
  maximize profit                  and with and without fixed
* Single IF                        costs are considered
                                 * No assumption on issuing
                                   and acquiring entities

* Both symmetric and             * Intrasystem competition
  asymmetric competition are       does or exist
  considered                     * Fixed costs for card issuing
* 3-party scheme                   and per transaction cost for
* Maximize, profits                acquiring side
                                 * Costs may vary by network
                                   (asymmetric competition)

Assumptions

End Users

Consumers                              Merchants

                 6                                    7

* Endogenous cardholding               * Monopolistic merchants
  and a fixed card Fee is              * Homogeneous in card
  charged                                benefits
* The card provides no                 * Pay per transaction fee
  transactional benefits but
  makes some transactions
  possible
* Receive per transaction
  rebate
* Elastic demand for goods

* Cardholding and card usage           * Strategic merchants
  are not distinguished                * Homogeneous merchants
  (exogenous cardholding)
* Card benefits are drawn
  from density function h
  (and do not vary by
  network)
* Pay per transaction fee
* Inelastic demand far goods

* Endogenous cardholding               * Monopolistic merchants
  and a fixed card fee is                and competing merchants
  charged                                according to Bertrand are
* Heterogeneous in card                  considered
  benefits                             * Homogeneous in card
* Pay per transaction fee                benefits
* Inelastic demand for goods           * Pay per transaction fee

* Exogenous cardholding                * Monopolistic merchants
  (some fraction of consumers          * Homogeneous in card
  hold a card)                           benefits
* Cardholders use only cards           * Pay per transaction fee
  and pay/receive per
  transaction fee/rebate
* Elastic demand for goods

* Exogenous cardholding                * Monopolistic merchants
  (possibly pay a fixed card           * Homogeneous in card
  fee)                                   benefits
* Homogeneous in card                  * Transactional benefits
  benefits                               decrease as more
* Transactional benefits                 transactions made by cards
  decrease as more                     * Par per transaction fee and
  transactions made by the               fixed fee
  card
* Pay per transaction fees
* Elastic demand for goods

* Cardholding and card usage           * No strategic motive to
  are not distinguished                  accept cards
  (exogenous cardholding)              * Merchants (partial)
* Consumer (partial)                     demand for transaction is
  demand for transaction is              decreasing merchant fee
  decreasing in cardholder
  per transaction fee
* No assumption on consumer
  demand for products

* Exogenous cardholding                * Both, strategic merchants
  with no costs (all                     and monopolistic
  consumers hold a card)                 merchants are considered
* Card benefice arc drawn              * Merchants in a given
  front density function h               industry arc homogeneous
* Per transaction fee (rebate)           in card benefits but each
  charged (received)                     industry has different card
* Inelastic demand for goods             benefits, which are drawn
                                         from density function g

* Endogenous Cardholding *              * Strategic merchants
  (whether to hold two cards,          * Both cases where
  one, or none) and no costs             homogenous and
  of holding a and                       heterogeneous in and
* Card benefits are drawn                benefits with a single IF
  from density function h                are considered
  and do not vary by network           * Card benefits do not vary
* Per transaction fee is                 by network
  charged
* Inelastic demand for goods

* Cardholding and card usage *         * Strategic merchants
  are not distinguished *              * Homogeneous merchants
  (exogenous cardholding)
* Card benefits are drawn
  from density function h
  (and do not vary by
  network)
* Per transaction fee is
  charged
* Inelastic demand for goods

* Cardholding and card usage *         * No strategic motives
  are nor distinguished (make          * A fixed fee is charged (not
  only one transaction)                  per transaction fee)
* A fixed card fee is charged          * Merchants maximize their
  (no per transaction fee)               utility (not profits)
* Hold at most one card *              * Merchant's taste for the
* Consumer taste for the                 network is uniformly
  network is uniformly                   distributed over an interval
  distributed over an interval
* Inelastic demand for goods

* Endogen cardholding                  * Both strategic merchants
  decisions (whether to hold             and monopolistic
  two card, one card, or                 merchants are considered
  none) and no costs of                * Both cases where homogenous
  holding a card                         and heterogeneous in
* If consumers obtain                    card benefits with a single
  positive intrinsic benefit             IF are considered
  from holding cards,                  * Card benefits do not vary
  multi-homing is                        by network
  equilibrium,
  otherwise consumers hold
  at most one card
* Card benefits are drawn
  from density Function h
  and do not vary by network
* Pay per transaction fee
* Inelastic demand for goods

* Cardholding and card usage           * No strategic motives
  are not distinguished                * Heterogeneous in card
  (exogenous cardholding)                benefits with a single IF
* Three types of consumers             * Card benefits do not vary
  (marquee, captive, and                 by network
  multihoming) are
  considered
* With and without fixed fee
  are considered (With a
  fixed fee, a consumer holds
  at most one card)
* Heterogeneous in card benefits
* Card benefits vary by
  network
* Pay pert transaction fee
* Inelastic demand for goods

* Endogenous cardholding               * No strategic motives (each
  and a fixed card fee is                merchant sells an unique
  charged                                good)
* Hold at most one earl                * Heterogeneous in card
* Heterogeneous in card                  benefits
  benefits                             * Card benefit, vary by
* Card be-fit, vary, by                  network
  network                              * Pay per transaction fee and
* No per transaction fee                  no fixed cost

Assumptions    Results

Others

     8                           9

* Effects of   * Under NSR, card is likely
  NSR is         overused if rebate is
  considered     provided to card users

* NSR          * Card issuers competition
* HAC            likely lowers
                 interchange fees

* Effects of   * With monopolistic merchants
  NSR is         NSR is preferred by both the
  considered     network and the regulator,
* HAC            since it increases card demand
               * With competitive merchants
                 both network and regulator is
                 indifferent between surcharge
                 and no-surcharge

* Effects of   * If rebates to card users are not,
  NSR is         feasible, NSR reduces total
  considered     consumer surplus
* (HAC)        * Card user rebates raise IF and
                 total consumer surplus, but
                 reduce cash users' surplus

* Effects of   * Under NSR and linear
  NSR is         pricing, the profit-
  considered     maximizing IF increases as
* HAC            acquirer competition increases
                 and issuer competition
                 decreases.
               * Under the  same condition,
                 the cost-minimizing. IF is
                 independent of acquirer
                 competition but decreases as
                 issuer competition increases

* NSR          * Under bilateral monopoly, the
* HAC            weight the issuer has in
                 the network's objective
                 function, the higher the inter
                 change fees
               * Under bilateral monopoly,
                 when, consumer and
                 identical, the
                 necessary condition for profit
                 maximization is satisfied
                 when interchange fee is set to
                 equalize issuer and acquirer
                 unit costs
               * If consumer's and merchant's
                 partial demand for
                 transactions are linear and
                 have the same slope, and if
                 acquiring side competes more
                 intensely than issuing side, it
                 is profit maximizing to raise
                 interchange fee above the
                 output-maximizing level

* NSR          * If higher interchange fees
* HAC            increase per-transaction profit
                 to issuers more than they
                 decrease per-transaction profits
                 to acquirers, (pass-through
                 costs to user fees is higher on
                 the acquiring side than the
                 issuing side), profit
                 maximizing IF is higher than
                 out-put maximizing IF
               * When merchants compete
                 according to Hotelling model,
                 and issuers and acquirers pass-
                 through costs at the same
                 rare, profit-mas IF will be
                 higher than welfare-mas IF if
                 the average transactional
                 benefit over all those
                 merchants who accept cards is
                 lower roan the fee they pay at
                 the profit-max IF

* NSR          * Intersystem competition may
* HAC            raise IFs with heterogeneous
                 merchants but not with
                 homogeneous merchants

* NSR          * 4-party scheme network
* HAC          competition has no impact on
               IF if consumers hold at most
               one card. Otherwise, it
               increases merchant resistance
               and thus lowers IFs

* HAC          * When intranetwork
                 competition is symmetric
                (ratios of issuer and
                 acquirer prices to their net
                 costs are the same),
                 equilibrium networks' profits
                 are independent of the inter-
                 change fee
               * If acquirers margin (relative
                 to the net costs) is greater
                 than issuer's, the proprietary
                 network's profit increases with
                 the nonprofit network's
                 interchange fee

* NSR          * Greater intersystem competition
* HAC            may raise IFs if most
                 merchants accept multiple
                 cards and consumers typically
                 carry a single card (heterogeneous
                 merchants).
               * Greater intersystem competition
                 may lower IFs if most
                 consumers hold multiple
                 cards and merchants will
                 reject the more expensive
                 card

* NSR          * As more cardholders become
* HAC            multihoming, merchant fee
                 decreases and cardholder fee
                 increases
               * The presence of buyers
                 generating a high surplus on
                 the merchant side raises
                 merchant fees and lowers
                 cardholder fee
               * Captive cardholders tilt the
                 price structure to the benefit
                 of merchants

* NSR          * Total fees charged across both
                 sides are always lower in
                 duopoly than in monopoly
                 network (symmetric
                 competition)
               * Under asymmetric competition,
                 a network with the
                 lower consumer fixed fee
                 always has the high.
                 merchant per transaction fees

Table 2
U.S. INTERCHANGE CATEGORY BY SELECTED BRAND

Visa                            MasterCard

Credit, Signature Debit         Credit                 Signature Debit

Retail (#,+)                    Merit III (#,+)        Merit III (#)
Supermarket (#,+)               Supermarket (#,+)      Supermarkets (#)
Automated fuel dispenser (+)                           Petroleum
Service station (+)             Convenience (+)        Convenience
Hotel & car rental (+)          Travel industries *    Travel industries
                                Passenger transport    Passenger
                                                       transport
Passenger transport (+)                                Restaurant
Restaurant (+)                                         Small ticket
Small ticket                                           Emerging market
Retail 2 (Emerging)             Warehouse club (#,+)   Warehouse
                                                         club (#)
                                                       Public sector
                                Public sector          Service
                                                         industries
                                Service industries     Merit I
                                Merit I (+)

e-Commerce basic (+)
e-C Hotel & car rental (+)
e-C Passenger transport (+)
e-C retail (+)

Standard                        Standard (+)           Standard
Electronic
Card not present (+)
Key entry (+)                   Key entered (+)        Key entered

Visa                            Star

Credit, Signature Debit         PIN Debt

Retail (#,+)                    Grocery & wholesale
Supermarket (#,+)               Club (#)
Automated fuel dispenser (+)    Petroleum (#)
Service station (+)
Hotel & car rental (+)

Passenger transport (+)
Restaurant (+)                  Small ticket
Small ticket
Retail 2 (Emerging)

                                Medical
                                QS restaurant
                                All other retailers (#)
e-Commerce basic (+)
e-C Hotel & car rental (+)
e-C Passenger transport (+)
e-C retail (+)

Standard
Electronic
Card not present (+)
Key entry (+)

(#): tiered fee structure

(+): varies by consumer credit card type

Sources: Greensheets, Star 2005 Fee Schedule