Pricing of card payment services in Scandinavian banking

Abstract

Pricing of card payment services includes many considerations of cost and revenue in an environment of changing payment technology, network effects in two-sided markets and price bundling. This paper describes the consumer pricing methods for card payment services by Scandinavian banks and evaluates their explicit pricing methods. The main findings suggest that Scandinavian banks in general are more interested in earning revenue from implicit prices than in encouraging the use of more cost efficient technology by charging explicit transaction fees. However, the pricing methods applied may vary, depending on the country and a bank's service supply.

Keywords:

• payment pricing
• debit card
• credit card
• ATM
• banking
• Scandinavia

Acknowledgements

The author wishes to acknowledge Bankforskningsinstitutet for financial support. In addition, many grateful thanks to comments by colleagues at the School of Business, Economics and Law, Göteborg University, where special thanks are dedicated to Professor Ted Lindblom, Dr Björn Lantz and Professor Marianne Frisén. Additional acknowledgements to Professor Mats Bergman, Södertörn University College, for constructive comments that greatly improved the quality of the paper. Finally, thanks to the comments from two anonymous reviewers.

Notes

Network effects are implied when demand considers some value beyond the intrinsic value of using a network. For a one-sided network, such as ATMs, this requires a critical mass of users as the benefit of the network increases with size. In a two-sided network, like a card payment network, there are network effects as well as interdependence between two user categories. This is a chicken and egg problem, where the demand of consumers depends on the volume of merchants attached to the card payment network, and vice versa. Rochet and Tirole (2002) provides a good description of the differences between one-sided and two-sided networks).

Transaction fees are also intended to charge users their fair share of costs and thus to reduce the risk of subsidisation among various consumer groups (van Hove, 2004). However, this does not affect the analysis here, which is concerned with the profit goals of a bank's pricing strategy.

The need to be certain of its costs also favours transaction fees since they can assure that increased total costs, from increased number of transactions, will be covered by higher total revenue (Drake & Llewellyn, 1995).

The network externalities associated with two-sided networks makes scale effects greater. Lower participation from one user category will also reduce the benefit to the other user category (Chakravorti & Roson, 2006; Guthrie & Wright, 2007).

For a payment network, there are also differences between a membership and user benefit (Rochet & Tirole, 2006). The pricing, by either fixed fees or variable fees, reduce the net benefit of the network membership or network usage, respectively. Consequently, both fixed fees and transaction fees reduce the payment network's net benefit and may jeopardise its existence.

Other payment methods can be electronic or paper-based giro payments, credit cards and cash. Checks are nowadays rarely used as a means of payment in point-of-sale payments in the Scandinavian countries.

Savings banks and cooperative banks may be involved in the commercial banks' payment systems through the interchange fees paid between card issuing banks and acquiring banks. Thus, these banks' customers can use the infrastructure provided by commercial banks and vice versa.

To operationalise the data set, a full-service bank is defined as a bank that also provides Giro services. A bank that holds a Giro service generally provides a broad spectrum of other services to the customers, whereas a bank that does not holds a Giro service generally only provide a limited variety of banking services.

Some minor data adjustments were needed in order to make payment services comparable. For instance VISA did not provide any debit function to their standard visa card in Iceland. Instead another debit card service, similar to the standard specification in the other countries, was considered.

Cash may also be withdrawn at merchants, but then in connection to purchases made by a debit or a credit card.

The composition of the two-part tariff arises from a transaction fee per ATM withdrawal and the fixed fee for the debit card. The numbers regards pricing of withdrawals from the bank's own ATM networks, but only when these exist. If the bank does not provide any own network, the prices for any ATM withdrawal is used.

The banks varied what regards to payments' transaction frequency as well as to interest margins and merchant fees. Complete data on such differences were not publicly available.