No-surcharge Rule Research Articles

The no surcharge rule and its welfare implication

This paper investigates the welfare implications of banning the no surcharge rule (NSR) in credit card markets. Conventional wisdom indicates that banning the NSR may increase or decrease social welfare. This paper finds that lifting the NSR unambiguously decreases social welfare in a closed system and in an open system when Visa and MasterCard privatize. In a closed system, the unambiguous welfare implication is due to the fact that the distortion of Merchant internalization (MI) fully offsets the distortion of market power, and the monopolistic credit card company acts as a social welfare maximizer when it maximizes its own profit. The credit card service is always optimally provided under the NSR, and lifting it, which eliminates the distortion of MI, always leads to an under-provision of credit card service and a decrease of social welfare. In an open system, the credit card service is always under provided under the NSR, because the market power of issuing banks works as another distortion in addition to those in a closed system. Banning the NSR will further drive down the card usage and social welfare decreases.

Do No-Surcharge Rules Increase Effective Retail Prices?

Do No-Surcharge Rules Increase Effective Retail Prices?

Do Premium Payment Methods Increase Effective Retail Prices?

In this paper, we determine how premium payment methods impact effective prices (prices that include any consumer payment rewards). This question is fundamentally related to policy, and we provide a robust answer by considering how a variety of retail market structures are impacted by multiple payment methods. We find that, with a no-surcharge rule applied to the premium payment method, effective prices are often higher across all payment methods. In this case, the no-surcharge rule protects a double marginalization effect where the premium payment method inserts an additional margin that harms all consumers and all merchants. We show that this loss in welfare can be rectified by allowing merchant surcharging across payment methods. Our results are robust across merchant market structures, suggesting that protected premium payment methods are generally harmful, except for the payment industry.

Missed Sales and the Pricing of Ancillary Goods*

Firms often sell a basic good as well as ancillary ones. Hold-up concerns have led to ancillary good regulations, such as transparency and price caps. The hold-up narrative, however, runs counter to evidence in many retail settings where ancillary good prices are set below cost (e.g., free shipping or limited card surcharging in countries where the “no-surcharge rule” was lifted). We argue that the key to unifying these conflicting narratives is that the seller may absorb partly or fully the ancillary good’s cost so as not to miss sales on the basic good. A supplier with market power on the ancillary good market then takes advantage of cost absorption and jacks up its wholesale price. Hold-ups occur only when consumers are initially uninformed or naive about the drip price and shopping costs are high. The price of the basic good then acts as a signal of the drip price, since a high markup on the basic good makes the firm more wary of missed sales. Regardless of whether consumers are informed, uninformed but rational, or naive, mandating price transparency and banning loss-making on the ancillary good leads to (i) an efficient consumption of the ancillary good, and (ii) a reduction of its wholesale price, generating strict welfare gains.

Vertical Most-Favored-Nation Restraints and Credit Card No-Surcharge Rules

AbstractA vertical most-favored-nation (vMFN) restraint prohibits a retailer from charging more for one supplier’s product than for rivals’ products. For credit card services, this restraint takes ...

Cards on the Table: Efficiency and Welfare Effects of the No-Surcharge Rule

Abstract In Electronic Payment Networks (EPNs), the No-Surcharge Rule (NSR) requires that merchants charge at most the same amount for a payment card transaction as for cash. In this paper, I use a three-party model (consumers, local monopolistic merchants, and a proprietary EPN) with endogenous transaction volumes, heterogeneous card use benefits for merchants and network externalities of card-accepting merchants on cardholders to assess the efficiency and welfare effects of the NSR. I show that the NSR: (i) promotes retail price efficiency for cardholders, and (ii) inefficiently reduces card acceptance among merchants. The NSR can enhance social welfare and improve payment efficiency by shifting output from cash payers to cardholders. However, if network externalities are sufficiently strong, the reduction of card payment acceptance affects cardholders negatively and, with the exception of the EPN, all agents will be worse off under the NSR. This paper also suggests that the NSR may be an instrument to decrease cash usage, but the social optimal policy on the NSR may depend on the competitive conditions in each market.

Vertical MFN's and the Credit Card No-Surcharge Rule

A vertical MFN prohibits a multi-product retailer charging more for a supplier's product than for the products of rival suppliers. In the market for credit card services, this restraint takes the form of a no-surcharge rule: that a retailer not surcharge for transactions with a particular credit card. This paper sets out a general theory of the vertical MFN restraint and then applies the theory to credit cards. In a symmetric, differentiated duopoly, the vertical MFN raises price from the Bertrand equilibrium value to a level greater than the fully collusive value. In a monopoly-competitive fringe model, the restraint can allow the dominant firm to leverage its power to extract surplus from the entire set of consumers. The theory applies directly to the credit card market. Contrary to accepted wisdom and an important legal case, the two-sided nature of the credit card market does not mandate new economic foundations.

Wait a minute: the efficacy of discounting versus nonpecuniary payment steering

Merchants who accept credit cards face payment processing fees. In most countries, the no-surcharge rule prohibits them from using surcharges to pass these fees on to customers.

Price differentiation and menu costs in credit card payments

Purpose – The purpose of this paper is to model a credit card market where the retailers may charge differential prices depending on the instrument of payment used by the consumer. According to the research agenda proposed by Rochet and Wright (2010), the authors find conditions for the existence of differential prices equilibrium and analyze the effects of that price differentiation on the consumer’s welfare. Design/methodology/approach – This is done when the consumer has also the store credit as an alternative of payment. The equilibrium prices are computed assuming a Hotelling competition among retailers in both scenarios, when the cost of the store credit provided by the retailer is greater than that provided by the credit card and vice versa. Findings – From this, the authors prove that the average price under the price differentiation is lower than the single price under the no-surcharge rule; nevertheless, the retailer’s margins remain the same in both situations. Furthermore, some cross-subsidies are expunged when price differentiation is allowed. The authors also conclude that the consumers’ welfare is greater when the no-surcharge rule is abolished. Finally, if the retailers face menu costs whenever they differentiate prices, the authors provide sufficient conditions for differential prices remain as equilibrium. Practical implications – This is an important input for discussions among regulators and players of the credit card market. Originality/value – From the analysis the authors can conclude that price differentiation, according to the instrument of payment, is a welfare improving policy. The authors explicitly determine the average price in that setting and the differentiated prices even in presence of costs that arise from price differentiation. The obtained theoretical results can be used as an input for econometric modeling purposes.

Competition Policy and Regulation in Credit Card Markets: Insights from Single-Sided Market Analysis

This paper reexamines the economics of two common features of credit card networks: the interchange fee paid by merchant banks, or acquirers, to cardholder banks, or issuers; and the restraint commonly placed on merchants against surcharging for credit card transactions. We show that the parallels with the economics of conventional one-sided markets offer insights that have been overlooked in the credit card economics literature, which stresses the two-sided nature of the market. The characterization of the optimal interchange fee is equivalent to the Dorfman-Steiner theorem from conventional price theory. The principle that the interchange fee maximizes output when an optimum exists and the possibility of interchange fee neutrality also have precise parallels in one-sided markets with promotion. Our analysis shows that the no-surcharge rule is equivalent to a retail MFN constraint. The no-surcharge rule raises prices to merchants due to a competition-suppression effect as well as a cost-externalization effect. The market condition underlying interchange neutrality (when surcharging is allowed) eliminates the impact of the no-surcharge rule in the case of a credit-card duopoly. Yet the same condition magnifies the impact in the presence of cash customers.

Competition within Payment Card Associations and the Role of Interchange Agreements

The paper presents a model of a payment card association which provides payment cards as well as ATM services. Consumers are able to substitute cards by cash and regard cash as an inferior substitute for a debit card. I analyze the role of some widely accepted interchange agreements, such as the no-surcharge rule and collectively set interchange fees in this enriched setup. In the absence of ATM interchange fees banks-members of an association tend to set too high merchant discount causing a bias toward overprovision of card services. Introduction of ATM interchange fees makes provision of ATM services profitable, and may result in the excessive equilibrium share of cash payments and the over-optimal level of ATM quality. The effect of banning the no-surcharge rule is ambiguous.

Upstream Competition with Non-Linear Pricing and Contracts that Reference Rivals

The competitive effects of a number of vertical restraints, such as no-surcharge rules (common in the credit card industry) and market-share requirements (common in many other industries), have been at the center of a recent policy debate. This paper develops a model of bilateral vertical contracting in successive duopolies to study the effects of these restraints on the intensity of upstream competition. When suppliers offer menus of non-linear tariffs and are sufficiently differentiated, both downstream firms purchase inputs from both suppliers, who charge input prices above marginal cost to soften downstream competition. In such equilibria, vertical restraints such as no-surcharge/no-steering rules or market-share and/or minimum volume requirements soften upstream competition and lead to higher prices. Selective bans on only one type of restraint may, however, have unintended consequences. For example, a ban on minimum volume requirements may reduce welfare when no-surcharge rules or share requirements are allowed or when it results in exclusive equilibria.

The No Surcharge Rule and Merchant Competition

We analyze the no surcharge rule (NSR) and its impact on merchant competition by comparing different surcharging regimes. Any constraint on surcharging, including the NSR is shown to be a competition-softening device. A NSR may induce socially excessive card use. Allowing imperfectly competitive merchants to surcharge may lead to socially too little card use. Under a NSR, increased cost of card acceptance increases all prices, even the prices of a merchant not accepting cards. Under the NSR cards yielding no social surplus may be viable. This is not the case without the NSR. Card-use rewards may hurt consumers.

To Surcharge or Not to Surcharge? A Two-Sided Market Perspective of the No-Surcharge Rule

In Electronic Payment Networks (EPNs) the No-Surcharge Rule (NSR) requires that merchants charge the same final good price regardless of the means of payment chosen by the customer. In this paper, we analyze a three-party model (consumers, merchants, and proprietary EPNs) to assess the impact of a NSR on the electronic payments system, in particular, on competition among EPNs, network pricing to merchants and consumers, EPNs profits, and social welfare. We show that imposing a NSR has a number of effects. First, it softens competition among EPNs and rebalances the fee structure in favor of cardholders and to the detriment of merchants. Second, we show that the NSR is a profitable strategy for EPNs if and only if the network effect from merchants to cardholders is sufficiently weak. Third, the NSR is socially (un)desirable if the network externalities from merchants to cardholders are sufficiently weak (strong) and the merchants' market power in the goods market is sufficiently high (low). Our policy advice is that regulators should decide on whether the NSR is appropriate on a market-by-market basis instead of imposing a uniform regulation for all markets.

Perfect surcharging and the tourist test interchange fee

Two widely discussed pricing benchmarks in the literature on payment card markets are the “tourist test” interchange fee ( Rochet and Tirole, forthcoming), which internalizes usage externalities in payment card markets, and “perfect surcharging” by merchants ( Rochet and Tirole, 2002). This paper shows that these benchmarks are allocatively equivalent. Implications for the regulatory treatment of interchange fees and no-surcharge rules are discussed.

To Surcharge or Not to Surcharge? A Two-Sided Market Perspective of the No-Surcharge Rule

In Electronic Payment Networks (EPNs) the No-Surcharge Rule (NSR) requires that merchants charge the same final good price regardless of the means of payment chosen by the customer. In this paper, we analyze a three-party model (consumers, merchants, and proprietary EPNs) to assess the impact of a NSR on the electronic payments system, in particular, on competition among EPNs, network pricing to merchants and consumers, EPNs’ profits, and social welfare. We show that imposing a NSR has a number of effects. First, it softens competition among EPNs and rebalances the fee structure in favor of cardholders and to the detriment of merchants. Second, we show that the NSR is a profitable strategy for EPNs if and only if the network effect from merchants to cardholders is sufficiently weak. Third, the NSR is socially (un)desirable if the network externalities from merchants to cardholders are sufficiently weak (strong) and the merchants’ market power in the goods market is sufficiently high (low). Our policy advice is that regulators should decide on whether the NSR is appropriate on a market-by-market basis instead of imposing a uniform regulation for all markets.

Incentives at the counter: An empirical analysis of surcharging card payments and payment behaviour in the Netherlands

In card payment systems, no-surcharge rules prohibit merchants from charging consumers extra for card payments. However, such rules are prohibited in the Netherlands. Dutch retailers are allowed to surcharge consumers for debit card use. This setting permits an empirical analysis of the impact of surcharging card payments on merchant acceptance and consumer payment choice. Based on consumer and retailer survey data, our analysis shows that surcharging steers consumers away from using debit cards towards cash. Half of the observed difference in debit card payment shares across retailers can be explained by this surcharge effect. Removing debit card surcharges may induce cost savings of more than EUR 50 million in the long run.

Optimal pricing of payment services

Payments are increasingly being made with payment cards despite the fact that the cost of clearing a card payment usually exceeds the cost of transferring cash. We examine this puzzle through the lens of monetary theory. We consider the design of an optimal card-based payment system when cash is available as an alternative means of payment. We find that a feature akin to the controversial “no-surcharge rule” may be necessary to ensure the viability of the card payment system. This rule states that merchants cannot charge a customer who pays by card more than a customer who pays by cash.

Payment Networks in a Search Model of Money

In a simple search model of money, we study a special kind of memory that gives rise to an arrangement resembling a payment network. Specifically, we assume that agents can pay a cost to access a central database that tracks payments made and received. Incentives must be provided to agents to access the central database and to produce when they participate in this arrangement. We also study policies that can loosen these incentive constraints. In particular, we show that a no-surcharge rule has good incentive properties. Finally, we compare our model with that of Cavalcanti and Wallace.

Optimal Pricing of Payment Services When Cash is an Alternative

Payments are increasingly being made with payment cards rather than currency-this despite the fact that the operational cost of clearing a card payment usually exceeds the cost of transferring cash. In this paper, the authors examine this puzzle through the lens of monetary theory. They consider the design of an optimal card-based payment system when cash is available as an alternative means of payment, and derive conditions under which cards will be preferred to cash. The authors find that a feature akin to the controversial no-surcharge rule may be necessary to ensure the viability of the card payment system. This rule, which is part of the contract between a card provider and a merchant, states that the merchant cannot charge a customer who pays by card more than a customer who pays by cash. ; Also issued as Payment Cards Center Discussion Paper No. 07-15