Academic journal article Journal of Business Strategies

Sustainable Growth of Payment Card Networks: A Two-Sided Market Approach

Academic journal article Journal of Business Strategies

Sustainable Growth of Payment Card Networks: A Two-Sided Market Approach

Article excerpt

Abstract

The payment card industry is a typical "two-sided market" where two groups of agents (i.e. merchants and cardholders) interact with each other via a common network platform (i.e. a card network) and the value of participating in the network for agents in one group depends on the number of participants from the other group. The positive network externalities across the two sides create the "chicken-and-egg problem": without sufficient merchants accepting a particular card network, few consumers are willing to apply for the card," without sufficient cardholders, few merchants are willing to accept the card. While economists have addressed the issue from social welfare perspective, we focus on business strategy implications. Modeling network externalities in dynamic systems, we show that network platform owners could overcome the "chicken-and-egg problem "through strategies such as merger and acquisition, licensing, forming strategic alliance, as well as adjusting product and pricing strategies, etc. We provide a history of the U.S. payment card industry as empirical evidences to support our findings.

Introduction

The payment card network has recently attracted much attention from researchers (Chakravorti, 2003; Rochet & Tirole, 2002, 2003; Schmalensee, 2002; Wright, 2003a, 2003b, 2004) due to its special structure: two different groups of agents, the merchants and the consumers, interact with each other via the payment card networks; and the value of participating in a particular card network for agents in one group (say, merchants) depends on the number of participants from the other group (the consumers, correspondingly). For example, if more consumers carry VISA card, merchants accepting VISA card will be able to capture higher sales volume from these cardholders; on the other hand, if more merchants accept VISA card, it will be more convenient for VISA cardholders to pay for their purchases.

Such positive network effect also exists in other markets. For example, in yellow directory business, more advertising in a particular directory leads to more consumer usage, which in turn leads to more advertising in that directory (though in the next publication); in the PC industry, if more consumers use Windows operating system, more software developers would like to write application software for this system, which will make the system even more appealing to consumers. Similar phenomena can also be seen in the markets for academic journals, advertising, shopping malls, dating services and nightclubs, etc.

Markets with such cross-group network effect are termed as "two-sided markets" (Armstrong, 2004; Rochet & Tirole, 2003). The cross-group network effect is a double-edge sword: it can either lead to spiral growth of the network or create the "chicken-and-egg problem." For example, if few consumers carry VISA cards, few merchants would be willing to accept VISA, which further discourages consumers from using this type of cards. Unless the network has reached a critical mass in the number of participants, it cannot take off.

While the "chicken-and-egg problem" in two-sided markets has been discussed in the economics literature, few focus on how to overcome it from business strategy perspective. In this paper, we use a dynamic system model to provide mathematical explanations to the "chicken-and-egg problem" and explore strategies for overcoming it. Such strategies include merger and acquisition, licensing, forming strategic alliance, as well as adjusting product and pricing strategies, etc. We provide a historic account of the U.S. payment card industry to demonstrate relevance of our findings to business strategies in two-sided markets.

The paper is organized as follows. We introduce the characteristics of two-sided markets in section II, followed by a brief literature review in section III. In section IV, we present a dynamic system model of network growth and study the long-run behavior of the system. …

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