Payment Cards

In 1949, Frank McNamara was having lunch in a New York restaurant when he realized he had left his wallet at home. While waiting for his wife to bring cash to pay the bill, the idea of a payment card came to his mind. The following year, 1950, he incorporated Diner’s Club with €1.5 million of start-up capital, 14 restaurants, and a group of friends as purchasers. One year later, 42,000 card-holders and 330 merchants, mostly restaurants and hotels, accepted the card, paying a 7 percent commission to Diner’s Club? The American Hotel Association reacted in 1956 by creating its own card, and the National Restaurant Association signed on. This was an early attempt to avoid the 7 percent commission charged by the intermediary, Diner’s Club.

The payment card industry is a classic example of a multi-sided market. An intermediary (the payment card company) facilitates the interaction between merchants and purchasers. The key to the success of payment card companies is the number of users, both merchants and purchasers. The wider the use by each group, the higher the benefit for the other group. On one hand, merchants will be increasingly interested in the card as it is more widely used by purchasers. On the other hand, purchasers will be increasingly interested in a card if it is accepted by a substantial number of merchants.

Diner’s Club was the first payment card, but this did not guarantee a monopoly to the first mover, not even a leadership position, as other companies entered the market. A company created 16 years later, VISA, eventually became the market leader. Strong competition exists between payment card companies, and both merchants and purchasers usually accept more than one card, a practice called “multi-homing.”

The key benefit for both sides making use of payment cards is the reduction of transaction costs. Payment cards make payments easy and eliminate the risk of cash being stolen or lost. The payment card company has a key role as it defines the distribution of the benefits derived from the new interaction among all the players: the merchants, the purchasers and the platform itself, including the so-called interchange fees to be paid for the use of the card in each transaction. Despite competition, the distribution of the benefits created by payment cards has raised numerous conflicts. After decades of such conflicts, regulation was adopted both in the US and in the EU to set a price cap on interchange fees. This is an early illustrative example of how platforms, like intermediaries, are often subject to regulation to exclude abuses.

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