Electronic money and the network externalities theory: lessons for real life

Abstract

The aim of this paper is to show that the network externalities theory provides a useful framework to analyse the introduction and further development of the new electronic payment instruments currently being launched. To that end the paper presents a pragmatic (and selective) reading of the network externalities literatures i.e., it screens the literature in search of both theoretical insights and empirical results which can be transposed to the case of electronic payment instruments. In so doing, the paper concentrates on the so-called electronic money products and, especially, on electronic purses. Specifically the paper shows that the network externalities literature provides a number of useful insights concerning consumer reactions to the introduction of electronic purses (and the ways in which card issuers can anticipate these reactions) and concerning the strategies card issuers may follow in a competitive market with incompatible electronic purses. All this is substantiated by multiple references to real-life situations. The first section of the paper defines the concept of network externalities. The third section demonstrates that payment cards in general are indeed network goods. It also points out which kind(s) of network effects apply to the electronic purses currently available. The paper then goes on to answer five questions in depth. Firstly, what can we learn from the network externalities literature as far as the ‘chicken-and-egg’ problem is concerned? – the problem being: merchants will not invest in terminals without a sufficient number of potential users, while the general public will not use electronic purses unless there is sufficient acceptance. Secondly, is there room for more than one incompatible electronic purse, or is the electronic purse market prone to ‘tipping’ and ‘lock-in’? Thirdly, can an electronic purse issuer gain a (decisive) first-mover advantage by entering the market before others do? Fourthly, under which conditions will card issuers be inclined to make their electronic purses compatible? And finally, what is the optimum pricing strategy for an electronic purse issuer?