Surcharge Rules | Reform of Credit Card Schemes in Australia: II Commissioned Report-Equilibrium In The Presence Of No (2024)

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82. When merchants are forbidden to surcharge, the neutrality result discussedin the previous section may no longer hold, which raises questions of thewelfare effects of interchange fees and the determination of optimal interchangefee levels.

A. Equilibrium For A Given Interchange Rate

83. The presence of a no-surcharge rule breaks the logic of the interchange neutralityargument presented in the previous section. But even with a no-surcharge rule,neutrality still holds when merchants are perfectly competitive. To see thisfact, suppose that card-based transactions are more costly to merchants thanare other transactions. Then under a nosurcharge rule, individual merchantswill specialize. Some merchants will accept credit and charge cards and willcharge relatively high prices. Other merchants will accept only cash and willcharge relatively low prices. Any merchant that tried to set a common pricefor both card and non-card transactions would lose all non-card sales unlessit set the same price as the noncard stores. But then it would fail to coverits card acceptancecosts.^[64]
84. When there are economies of scale at the retail level and merchants offer differentiatedproducts, it may not be economically viable for retailers to specialize interms of which payment mechanisms are accepted. For example, suppose a smalltown has four restaurants, each offering a different cuisine. Given the economiesof scale involved in operating a restaurant, the town's market might notbe large enough to support eight, twelve, or more restaurants offering thesame four cuisines, but some accepting only cash, others accepting only creditand charge cards, and still others accepting only debit cards.
85. The remainder of this section maintains the assumption that economies of scaleand merchant differentiation make it economically infeasible to have separatestores for each different type of payment mechanism. In this case, a singlemerchant will accept multiple payment mechanisms and charge the same pricefor all types of transaction under a nosurchargerule.^[65]A profit-maximizing merchant sets this common price based on the average marginalcost of a transaction, where the average is taken over types of transaction.Merchant pricing behavior can no longer ‘undo’ the effects ofinterchange rates because there is no way to distinguish between card usersand non-card users.

86. In theory, a no-surcharge rule thus makes it possible to use the interchangefee as a means of internalizing network effects. But, at the same time, therule takes away surcharges as a means of internalizing network effects. Becauseof the no-surcharge rule, consumers no longer face retail price signals thatconvey the net benefits or costs incurred by merchants due to the use ofdifferent payment mechanisms. As Professors Gans and King have nicely summarized,

    Under the no-surcharge rule, the customer chooses the level of credit cardtransactions according to their [sic] own marginal costs and benefits. They[sic] ignore the marginal costs and benefits of credit card purchases tothemerchant.^[66]

    Hence, no-surcharge rules substitute one mechanism for the other. Which oneperforms better? The market outcome under a no-surcharge rule depends criticallyon the cardholder benefits net of any fees they pay to issuers or rebatesthey receive from them. These fees and rebates, in turn, depend on the levelof the interchange fee.

B. Economic Analysis Of Efficient Interchange Fees

87. In principle, the interchange fee could be set to reach an efficient balanceof the costs and benefits realized on the two sides of a card-based transaction.There are two central questions. First, what is the socially optimal interchangefee? Second, will economic self interest lead to privately chosen interchangefees that are at least approximately socially optimal?
88. An early and classic analysis of interchange fee setting was provided by ProfessorBaxter.^[67]Recall that the efficiency effects of an interchange fee derive from its effectson merchant service fees and cardholder fees, which in turn affect merchantacceptance and consumer card use. Professor Baxter found that the sociallyoptimal interchange fee is one that results in a card use fee to consumersequal to the total social costs of a card-based transaction (i.e., the sumof the acquirer and issuer's transactions costs measured relative to thetransactions costs of the next best payment mechanism) minus the merchant'smarginal transactionsbenefits.^[68]This price ensures that, when a consumer compares his or her private benefitof card use with the price of card use, he or she will be comparing the sumof merchant and consumer benefits with the social costs of card use, and thuswill make the socially efficientchoice.^[69]
89. Professor Baxter compares the setting of interchange rates on an issuer-acquirerpair basis with the collective setting of rates at the system level. He arguesthat ‘collective institutional determination of the interchange feeis both appropriate and desirable,’ and that ‘individual establishmentof the interchange fees will almost certainly produce chaotic results, suchas higher fees and instability within the cardsystems.’^[70]
90. Although, if accepted, this finding indicates that the collective setting ofinterchange fees is preferable to a decentralized system, this finding doesnot establish that the interchange rate will collectively be setat the economically efficient level. Moreover, Professor Baxter's analysisof whether private parties will set the interchange fee at the efficient levelis based on a flawed assumption. Specifically, Professor Baxter adopted theassumption that merchant willingness to pay for card acceptance can be takenas a measure of the transactions benefits that merchants enjoy from cardacceptance.^[71]
91. This assumption matters because it affects the degree to which market forces–inparticular merchants' willingness to ‘resist’ card acceptance–willdrive a card system to set an efficient interchange fee. As Rochet and Tirolepoint out, as a consequence of this assumption, Baxter's model generically‘overstates merchant resistance by ignoring that card acceptance isa competitiveinstrument.’^[72]The reason is that a merchant may be willing to accept cards for the increased-salesbenefits, in addition to the transactions benefits. And, as discussed above,an individual merchant's increased-sales benefits may not be social benefits.Because each merchant acting alone may be willing to pay more than the socialvalue to accept credit and charge cards, merchants may accept cards even whenthe interchange fee and resulting merchant service fees are set inefficientlyhigh
92. In a more recent and technically sophisticated paper, Professor Richard Schmalenseeformally models the private setting of interchange rates and compares theequilibrium interchange rates with the socially optimal ones. Professor Schmalenseefinds that, if merchants collectively have a linear demand curve for cardacceptance, consumers collectively have a linear demand curve for card use,and acquiring and issuing each is monopolized, then the interchange fee thatmaximizes total issuer and acquirer profits also maximizes both card use anda measure of economicwelfare.^[73]He also finds that, when demands are linear but issuing and acquiring arenot each monopolized, both the profit-maximizing value of the interchangefee and the welfare-maximizing value depart from the card-use-maximizing valuein the samedirection.^[74]
93. An important and fundamental criticism of Professor Schmalensee's analysisconcerns the measure of economic welfare on which his results are based. Headopts the assumption that merchant willingness to pay can be taken as a measureof social benefits. Professor Schmalensee is careful to observe that thisassumption deserves scrutiny because merchants' demand for card acceptancederives from consumers' demand to usecards.^[75]As he points out, his welfare measure ignores distortions that might arisewhen merchants exercise market power and set prices abovecosts.^[76]A more important criticism, however, is that merchants' demand for cardacceptance may be a very misleading measure of economic welfare. Specifically,there may be very little connection between an individual merchant's incentives to accept credit and charge cards and the overall effects of card acceptance on merchant and social welfare.^[77]
94. This point is essentially the same one made in Rochet and Tirole's critiqueof Baxter's analysis. Nevertheless, it is worth exploring further. Thefollowing stylized example illustrates the dangers of Professor Schmalensee'sassumption. Consider a market served by two merchants. Some consumers preferone merchant, other consumers prefer its rival, but each consumer is willingto patronize either merchant depending on the relative prices. Suppose thateach consumer purchases exactly one unit of the good sold in this market,so that the only question about a consumer's purchase behavior is fromwhich merchant he or she will make apurchase.^[78]Because total consumer purchases are fixed, one immediately sees that, from the perspective of merchants as whole,acceptance of credit cards has no effect on total sales. Yet, merchants maystill have individual incentives to accept credit cards because an individualmerchant may garner increased sales through card acceptance. Summing up individualmerchants' acceptance incentives, without accounting for the harm to othermerchants, overstates the benefits of carduse.^[79]
95. The fact that merchants' willingness to pay for card acceptance can bea very misleading measure of economic welfare raises serious doubts aboutthe validity of Professor Schmalensee's conclusions about the relationshipbetween privately and socially optimal interchange fees. There may be modelsof merchant behavior under which Schmalensee's conclusions are correct,but the existence (and relevance) of any such models should be treated asan open question at this point. In short, Professor Schmalensee's modeldoes not provide a rigorous basis for concluding that privately set interchangerates will be efficient.
96. Rochet and Tirole model merchants' acceptance incentives based on fundamentalparameters. They assume that acquiring is competitive and consider a varietyof market structures for issuing. When issuers are perfectly competitive aswell, the optimal interchange fee iszero.^[80]When issuers are less than perfectly competitive, Rochet and Tirole find thata positive interchange fee can promote efficiency.
97. In the Rochet and Tirole model, the role of the interchange fee is notto internalize network effects or other externalities. Instead, the interchangefee compensates for the pricing distortions introduced by the exercise ofissuer market power. Rochet and Tirole find that subsidizing issuers withmarket power will induce them to reduce their prices, partially compensatingfor the standard monopoly output restriction. This finding suggests that policiesaimed at increasing issuer competition would reduce both the loss of economicwelfare due to issuer market power and the need for an interchange fee. Moreover,it raises the public interest question of whether it is desirable to elevatethe prices paid by non-card users (through interchange fees and no-surchargerules) in order to pay issuers not to exercise their market power with respectto card users.
98. Rochet and Tirole also compare privately and socially optimal interchange ratesand find that an ‘issuer-controlled’ association may choose aninterchange fee that leads to ‘overprovision’ of credit cardservices.^[81]This finding is one illustration of a more general result:In the presence of no-surcharge rules, setting relatively high interchange fees can promote inefficiently high levels of credit and charge card usage.

99. Professors Schwartz and Vincent also find that the combination of a privatelyoptimal interchange fee and a no-surcharge rule can lead to the overuse ofcredit and charge cards. They find that a monopoly card network with a monopolyissuer may use rebates to create incentives for excessive card use, leadingSchwartz and Vincent to make the following observation:

    It might be thought that card issuer rebates to cardholders … is evidenceof strong competition for cardholders. These results show, instead, thatrebates may be a pricing tactic by a monopolist, designed to increase theimpact of the [no-surchargerule]!^[82]

100. Dr. Wright extends the Rochet and Tirole model to allow for heterogeneousmerchant transactions benefits from card use. (Rochet and Tirole assume thatall merchants enjoy the same benefits per transaction.) He shows that thedetermination of the socially optimal interchange fee is more complex thanis suggested by the Baxter analysis. Wright examines how the interchangefee can balance merchant and consumer incentives to participate in a cardsystem, and how the weights in that balancing depend on the benefits thatone party's participation in the system generates for the party on theother side of a transaction. He establishes that socially and privately optimalinterchange fees typicallydiverge.^[83]

101. Dr. Wright also argues that merchants' socially excessive acceptance incentives(due to the beggar-thy-neighbor aspect of increased-sales benefits) give riseto an efficiency argument for higher interchangefees.^[84]The logic is that merchants are willing to remain on a card network even ifthe merchant service fee exceeds their transactions benefits, while consumerswill drop off if the price of card use exceeds their transactions benefits.As an argument for a positive interchange fee, this logic hinges on the assumptionthat the net transactions benefits that would be enjoyed by merchants if merchantservice fees were equal to acquirer transaction costs are positive so thatthere is a positive external effect in need ofinternalization.^[85]
102. Professors Gans and King consider the case of a monopoly merchant in theirbaseline model. Like other authors, they explore the role of interchange feesin balancing the costs and benefits enjoyed by two sides of a transaction.For their baseline model, Gans and King find that the socially optimal interchangefee is sensitive to the relative marginal benefits enjoyed by consumers andmerchants from card-basedtransactions.^[86]They also find that the socially optimal interchange fee depends on the degreeof issuer competition (the fee helps offset the reduction in card use dueto issuer market power) but not the degree of acquirer competition, becauseconsumers (not merchants) choose the paymentmethod.^[87]
103. Summarizing the findings on socially optimal interchange rates, there are situationsin which it is optimal to use interchange fees to rebalance the costs andbenefits enjoyed by the two sides of a card-based transaction. The sociallyoptimal fee level depends on the nature of merchant, issuer, and acquirercompetition, as well as consumer characteristics. As a general matter, whenno-surcharge rules are in effect, there is little reason to believe that itis optimal to set the interchange fee equal to either an issuer's marginalcosts of a card transaction or zero.
104. The findings on the relationship between the interchange rate chosen by a rationallyselfinterested association and the socially optimal interchange fee can besummarized as follows. In general, they can be expected to differ from oneanother. One source of the divergence is that private parties will respondto merchants' willingness to accept cards, which may be a poor measureof the overall effects of card acceptance on merchant welfare. Because ofthis distortion in acceptance incentives, privately optimal interchange feesmay promote socially excessive card use.

C. Current Practices

105. Economic theory notwithstanding, an important question is: How do the associationsand their members actually set interchange fees? Even if there were fullydeveloped models establishing conditions under which privately optimal interchangerates are socially optimal, the question of whether the associations conformto these models would remain. To date, there is little hard evidence on howthe associations actually set their interchange fee levels in Australia. Moreover,the processes that have been attributed to them in various responses to theJoint Study do not conformto the recommendations of the various economic models that have been cited.
106. Neither the associations nor their members provide much detail regarding theircurrent procedures for determining interchange fees inAustralia.^[88],[89] Instead,each association asserts that competition among payment mechanisms ensuresthat there cannot be a problem with interchange fees. For example, MasterCardargues that they have set the fee at an appropriate level because if it hadbeen set

     too high or too low in relation to what benefits the system can deliver toall its participants – then the participants will behave (accordingto incentives created by the inappropriate interchange fees) in such a waythat the four party systems are rendered notviable.^[90]

     This argument, however, fails to account for either the possibility of creditcard system market power or the divergence between an individual merchant'sprivate acceptance incentives and social benefits.

107. Although both MasterCard and Visa point to competition as a guarantee thatinterchange will be set efficiently, the premise of competition is suspect.As noted earlier, there is overlapping ownership and governance of Bankcard,MasterCard, and Visa, and both issuing and acquiring are concentrated markets.In his widely cited paper arguing in favor of collectively setting interchangefees, Professor Baxter stated that

     antitrust and banking authorities should be alert to ensure that the numberof payment systems is as large as the attainment of economies of scale permits.Though unbridled autonomy within a system cannot be attained, unbridled rivalrybetween a multiplicity of systems should beencouraged.^[91]

     The current system of governance and ownership does not encourage full competition.At a minimum, this finding highlights the importance of policy makers'understanding the process by which the associations set their interchangefee levels.

108. According to the Australian Bankers' Association (ABA), the MasterCardmethodology is based on the recovery of specific issuer costs attributableto the provision of services to merchantacquirers.^[92]According to the ABA, the interchange cost comprises a pertransaction elementto cover processing costs and a percentage element to cover risk and fundingcosts. In determining actual interchange fees, the interchange cost may beadjusted to take into account the fees charged by other schemes, the needto encourage adoption of new technologies, and the need to improve merchantacceptance in certainsegments.^[93]
109. According to the ABA, under the Visa methodology all costs attributable tothe ‘payment functionality’ of credit cards are allocated to issuersand acquirers based on cardholder and merchant demand for thatfunctionality.^[94] Interchangeis then the difference between the issuers' allocated costs and actualcosts. Interchange fees in this methodology may be adjusted based on thesetter's commercialjudgment.^[95]
110. As described by the ABA, MasterCard and Visa's processes of basing interchangefees on allocations of cost components between merchants and consumers basedon functionality do not conform to any of the economic analyses that havebeen cited in this matter. In all of the models, the optimal merchant servicefees and consumer card services charges depend only on the sum ofthe marginal costs of providing service and the conditions ofdemand.^[96] Tothe extent that the formulas for optimal interchange fees depend on the individualcomponents–issuer marginal cost and acquirer marginal cost–itis because those components affect the pricing decisions separately madeby issuers and acquirers.
111. Dr. Wright, who has served as a consultant for Visa, briefly describes Visa'sinterchange methodology in one of his papers analyzing issues raised by theJoint Study. He characterizes the Visa Australia fee-setting processas ‘the balancing of profitability between acquiring and issuing banks,where profits are scaled byrevenue.’^[97]
112. When issuers and acquirers have constant unit costs (which need not be thesame for issuers and acquirers), this rule is equivalent to an equal markuprule. Hence, the rule ascribed to Visa indicates that, if issuers are lesscompetitive than acquirers and tend to have higher markups, then the interchangefee should be lower than otherwise if this will lower issuer markups relativeto acquirer markups. This is the opposite of what is indicated by the analysesof Professors Gans and King, Professors Rochet and Tirole, and Dr.Wright.^[98] Indeed,if acquirers were perfectly competitive, and thus earned zero average markups,the process described by Dr. Wright could lead to negative interchange feesdesigned to make issuers' net costs so high that even with the exerciseof market power they would not earn positive economic profits. This is arather perverse feature of the process, and it strongly suggests that itdoes not promote efficiency.
113. Although several parties have made representations about the process by whichthe associations' members set interchange fees in Australia, it is myunderstanding that no respondent has provided contemporaneous documents showingthe actual processes used to set current interchange levels. Moreover, thereare questions whether the associations and their members possess the knowledgeneeded to follow some of the processes that they are said to follow or aspireto follow. For example, the interchange formulas cited by Visa as justifyingunconstrained private rate setting depend in part on the price elasticitiesof consumer and merchant demand for cardholding andacceptance.^[99]Yet Visa has provided no evidence that it explicitly takes into account theseprice elasticities. Indeed, it is my understanding that no respondent hassubmitted elasticity estimates. Further, in the United States, but not inAustralia, Visa has interchange fees that vary across merchant categories.This difference raises the question of whether costs and elasticities aremore uniform in Australia than in the U.S., or suggests that Visa uses differentmethodologies in different countries. If the latter is the case, then threeimportant policy questions are: (1) what explains the differences; (2) isthere a reason that Visa follows an optimal policy in one country but notthe other; and (3) is Australia the country in which Visa and its membersare not pursuing the optimal policy? Finally, Visa's Australian memberslast updated the interchange rate in 1993, which raises the question of whetherthe relevant market conditions have remained unchanged since then or if Visais pursuing a different approach than laid out in responses to the Joint Study.

D. Proposals For Future Rate Setting

114. There are benefits from allowing collective rate setting rather than havingeach issuer-acquirer pair negotiate separately. At the same time, it doesnot follow that private parties will collectively choose the interchange feelevel that is optimal in terms of its effects on economic efficiency and consumerwelfare. The possible divergence between social and private incentives hasseveral implications:
     • It is desirable to promote inter-network competition broadly.
     • Transparency is valuable, so that competition policy and banking authoritiescan monitor the interchange fee-setting process for signs of trouble.
     • There may be scope for public intervention to improve matters. This interventioncould take the form of mandatory procedures to ensure transparency, implementationof policies designed to increase competition in the credit and charge cardindustry, the imposition of ceilings on interchange fee levels, or directfee setting, for example.
     • An assessment of the value of intervention must consider not only the problemswith the current outcome, but also the possible adverse consequences ofintervention.
115. Several proposals have been put forward for ceilings or caps on interchangefee levels:

     • In its Avoidable Cost methodology, the ABA proposes that, rather than prescribingan explicit methodology for setting interchange fees, key principles shouldbe set to which any interchange methodology mustconform.^[100]The key pricing principle is that the interchange methodology used recovers

       in aggregate no more than the stand alone economic costs of sustainably deliveringthe ‘buy now, pay later’ payment functionality only –with differentiation of fees allowed where appropriate on thebasis of significant cost differences among classes oftransactions.^[101]

     • Professors Gans and King appear to suggest that setting an interchange feethat equalizes issuers and acquirers' net marginal costs of a transactionmay be a reasonable approach in the face of incomplete information aboutunderlying consumer and merchantbenefits.^[102]
     • MasterCard asserts that the interchange fee should redress any imbalancebetween issuer costs and revenues; issuers should be compensated for costsin providing certain services to merchants, namely, the payment guarantee,funding of delayed payment (by the cardholder), and transaction processing.

       The interchange fee is then established by taking these costs as a startingpoint and taking into consideration other factors, including the need toprovide incentives for widespread issuance and for merchants to acceptcards or deploy technology and the level of competitors'fees.^[103]

     • In Europe, Visa International recently agreed to reduce the level of theinterchange fees charged on intraregional credit transactions over a periodof severalyears.^[104]Visa also proposed that an ‘objective benchmark’ consistingof the sum of three cost components be used as a ceiling on the association'sinterchange fee.^[105]The costs to be included, in whole or in part, in thebenchmark are those associated with transactions processing, financing ofcardholder float, and guarantee of payment to themerchant.^[106]
116. An immediate difficulty with the ABA proposal arises from the need to figureout what it actually says. It could be read as saying the interchange feeis subject to a cap equal to the average unit costs of a card-issuing operationnot part of a larger organization (i.e., an issuer that derived no economiesof scope from related operations). This cap does not appear to have been derivedfrom any of the economic analyses cited by respondents to the JointStudy.^[107]The ABA does not provide an economically sound basis for concluding that its proposedapproach would promote consumer welfare or efficiency.
117. The MasterCard and Visa approaches also do not appear to be based on economicanalyses. In each case, the approach attempts to allocate costs based on functionality,with only vague reference to demand conditions. As the economic analysis ofcredit and charge card markets demonstrates, however, card-based transactionsmay have costs and benefits for both sides of the market simultaneously, manycosts are common, and efficient pricing must be based in part on demand conditions.
118. Only the Gans and King ‘proposal’ stems from an explicitly statedmodel. However, as the authors note, it is a rule of thumb based on a specialcase that may be a plausible starting point. Moreover, as discussed in theTechnical Appendix, the model itself is a specializedone.^[108]
119. The ABA's proposed approach would include loyalty program expendituresin the calculation of issuers' standalone costs. The treatment of rebatecosts in determining costbased interchange rates has been a contentious issue.The Joint Study asserts that the costs of loyalty programs shouldnot be included in calculating a cost-based interchangerate.^[109]The ABA argues that loyalty program costs should be included in any cost-basedinterchange calculation because loyalty programs are a resource cost and ameans of promoting credit cards and attracting cardholders to a specificissuer.^[110]
120. The relevant policy question is not whether issuer expenditures on loyaltyprograms constitute economic costs to issuers. The policy question is whetherincluding rebate expenditures in a (partially) cost-based cap promotes efficiencyand consumer welfare. Although rebate expenditures are an economic cost fromthe issuer's perspective, one has to be careful about their treatmentin setting caps on interchange fee levels. If the costs of rebate and rewardprograms are included in the calculation of a cap or safe harbor for interchangefees, then public policy might place little limit on the ability of issuersto use inefficiently high interchange fees to support inefficiently high rebatesand rewards for card use. The reason is that raising the interchange fee tofund increased rebates and rewards would raise the cap. Under market conditionswhere merchants accept credit and charge cards even at inefficiently highmerchant service fees, issuers might thus be able to set a relatively highinterchange rate to exploit the incentive problems created by no-surchargerules that can lead to socially excessive carduse.^[111]
121. There is also the practical question of how rebate and reward costs would beincluded in the calculation of a cap, given that these costs differ widelyacross different cards. Lastly, it is notable that the formal economic modelscited by respondents to the Joint Study do not include rebate costsin their analyses ofoptimality.^[112]

E. Will Public Intervention Distort Competition?

122. Visa raises a number of objections to public policy intervention with respectto interchange fees based on the claim that such intervention will distortcompetition between open and closed credit and charge cardschemes.^[113]
123. Visa characterizes designation of Bankcard, Mastercard, and Visa as ‘differentialregulation based purely on differences in organizational form.’^[114]However, this claim ignores the fact that Bankcard, MasterCard, and Visa have overlappingownership and governance and collectively dominate the credit card systemsmarket in Australia, and thus designation can be viewed as intervention basedon the extent of marketpower.^[115]
124. Visa recognizes the general argument that policy intervention with respectto one competitor may–through market forces–induce other competitorseffectively to abide by the samepolicies.^[116]Visa asserts, however, that this general argument does not apply to the specificcase of the Australian credit and charge card schemes.^[117],[118] Ironically,Visa's argument that American Express would have unfair and inefficientadvantages if Visa's interchange fee were regulated is based on identifyingdistortions that follow from card-user rebates, merchants' inabilityto surcharge, and the fact that merchants garner individual increased-salesbenefits of card acceptance even if there are no collective merchant benefits.

125. Moreover, Visa appears to be of two minds on the efficacy of inter-systemscompetition and American Express market power. At one point, Visa assertsthat

     One card with quite low penetration among merchants is American Express.

     There would seem to be two possible reasons for this low penetration rate.The first is that merchant service fees for American Express are too high,so merchants select lower cost methods, such as VISA. Alternatively, onemight argue that merchants do not feel as much need to accept American Expressbecause there are fewer cardholders for this card. Both of these reasonsare likely to have some validity. [footnote omitted asserting that merchantsare less willing to pay the American Express merchant service fee becauseit has fewer cardholders than otherschemes.]^[119]

     Yet, Visa also declares:

     The decision by merchants to accept a particular type of card depends notso much on the number of cardholders that the system has, but rather on theadditional cost of accepting the card versus the margin they earn on additionalcustomers attracted by accepting the card (as well as other benefits obtainedthrough card acceptance). [footnoteomitted]^[120]

     and asserts that high merchant service fees are unlikely to drive away merchantswhen these fees can be used to finance cardholder loyaltybenefits.^[121]

     See Also

     Visa Surcharge Changes: Effective April 15th, 2023How to Explain a Service Charge to a Customer - CustomersFirst AcademyHow truck drivers can use fuel surcharge to their advantage - OptymApply for a U.S. Visa | Frequently Asked Questions (FAQ) - Morocco (English)

126. Another claim made by Visa is that designation will impair the associationand its members' ability to maximize the number of card transactions.For this claim to be of policy relevance, Visa would have to establish thata designated system would try to maximize the number of card transactionsabsent designation and that maximizing the number of transactions would bein the public interest.
127. With respect to the first point, Visa assumes that, absent public intervention,an association would set its interchange fee at the level that maximizes thecard transactions volume. Visa points to the Schmalensee and Rochetand Tirole models to provide theoreticaljustification.^[122]However, this result is sensitive to the specific models used and the association'sobjective function. For instance, in Professor Schmalensee's analysisof the linear demands case cited by Visa, he finds that an association choosesthe transactions-maximizing interchange fee when the system's goal isto maximize the sum of issuer and acquirer profits, but he finds that an issuer-controlledsystem sets the interchange rate above the transactions-maximizinglevel.^[123]Moreover, the following argument demonstrates that an association can have incentivesto set the interchange fee higher than the transactions-maximizing levelmore generally. Suppose the association seeks to maximize some weighted sumof issuer and acquirer profits and that the correspondingly weighted sumof issuer and acquirer margins is an increasing function of the interchangerate.^[124]Suppose, counterfactually, that a system set the interchange fee below the transactions-maximizinglevel. Then the system could choose a higher fee that both raised the numberof transactions and their weighted margins. Hence, weighted profits wouldrise, contradicting the private optimality of the original choice. Similarly,starting at the transactionsmaximizing fee level, there is no first-orderloss of quantity from a small increase in the fee, but there is a first-orderincrease in weighted margins. Hence, profits would rise here too.
128. With respect to the second point, as has already been discussed, setting theintechange fee to maximize the use of credit and charge cards may not be sociallyoptimal. Instead, it may promote the overuse of cards.
129. Lastly, Visa asserts that policy restrictions on interchange fees could leadlarge banks to set up their own credit cardschemes.^[125]As Visa points out, one should take into account any increases in organizationalcosts and the possible loss of networkbenefits.^[126]Visa fails to point out, however, that increased inter-systems competition resultingfrom new schemes might generate static and dynamic efficiency gains.