Payment Card Network Rebates: Barriers to Market Entry

Research into payment card markets indicates that incumbent card networks utilize high-level rebates to issuing banks as a strategic mechanism to deter new competitors from entering the market.

The analysis explores how these rebates create a barrier to entry, contributing to a persistent concentration of power among a few large global card networks. Unlike one-sided markets, where entry deterrence can lead to lower prices or improved efficiency, the research shows that in two-sided payment markets, this strategy results in higher merchant fees.

The Mechanism of Rebate-Based Deterrence

Large card networks provide significant rebates to the banks that issue cards. This practice becomes more profitable for the dominant network when transaction benefits for consumers and merchants increase, particularly if issuing banks pass those rebates through to cardholders.

The research suggests that these rebates serve as a tool to increase switching costs for issuing banks. When banks face costs to switch their card issuance to a different network, the market becomes more blockaded, making it difficult for new or domestic card networks to gain a foothold or compete profitably.

Market Impact and Merchant Fees

The global payment card landscape is currently dominated by a small number of large networks. Policy makers have expressed concern regarding the overreliance on these services and the resulting rise in merchant fees.

A common industry assumption is that entry is blocked primarily by the high costs associated with setting up a payment system and network. However, this research highlights that the strategic use of rebates can independently prevent profitable entry by ensuring that competitors cannot match the incentives provided to issuing banks.

Additional research notes that merchants rarely engage in price discrimination based on the payment method used. This environment allows card networks, such as Visa, to use merchant fees to fund consumer rewards.

Regulatory and Competitive Implications

The lock-in effects created by these rebate structures explain why new card networks struggle to enter the market and why domestic networks are often pushed aside. These findings may have significant implications for how payment systems are regulated moving forward.

The dynamics of the market are further influenced by the two-sided nature of the network, involving both the merchants who accept the cards and the consumers who use them, with issuing banks acting as the intermediaries receiving the rebates.