P Competition and Innovation in the Consumer e - Payments Market ?

for helpful comments. Special thanks to Ed Green for discussions on the market contestability and models of innovation portions of this paper and to Patricia Rozaklis for research support as an intern. The views presented in this paper are those of the authors' alone and do not necessarily represent those of the Federal Reserve Bank of Chicago or the Federal Reserve System. Public Policy Studies series. The series includes working papers on various policy issues that are generally less mathematical and more appropriate for a wider audience than academic working papers. These papers may not go through as extensive a review process as associated with some journals in the interest of sharing information, analysis, and work in progress on a more timely basis. Executive Summary Significant debate has occurred over the last several decades regarding whether there is adequate competition and innovation in the non-recurring consumer payments segment of the banking industry. The Department of Justice and some retailers have sued Visa and MasterCard for limiting competition and innovation. There has also been a host of high profile product " failures " in the consumer e-payment market place (e.g., e-cash and smart card products). Meanwhile, some researchers have suggested that consumers are irrational and unresponsive to marketplace incentives (for instance, see Ausubel (1991)). Despite anecdotal reports which imply to some that " there's something wrong " in this market, we find strong, though not yet scientifically conclusive evidence, that there is increasing competition, strong innovation, and customers who respond to market stimuli in the non-recurring consumer payments market. As a result, this paper argues that going forward, public sector involvement in the consumer non-recurring payment market will be less warranted. Based on the analysis of a unique 1,300 person survey, documentation and analysis of recent private sector-led developments, and a Federal Reserve payments benchmarking study, this paper discusses several of the demand-side, supply-side, consumer protection, and competition policy dimensions influencing this market. Four general lessons may be of particular interest to public policy makers and private sector firms. First, this paper provides strong support for Hirschman (1982)'s " bundle of attributes (consumer rationality) " theory. It also provides strong evidence that there are important supply-side phenomena such as differences amongst community and national banks and the importance of market-size which influence market incentives. Second, the paper proposes the beginning of a model of substitution and innovation, which helps not only …