Locked out by loyalty: entry deterrence through rebates in payment card markets

Vera Lubbersen

Abstract

Payment card markets are globally dominated by a few large card networks, which give significant rebates to issuing banks. Policy makers are concerned about rising merchant fees and overreliance on these networks’ payment services. A common assumption is that profitable entry is blockaded by the entry costs to set up the payment system and network, resulting in a monopolistic or duopolistic market structure. This paper explores the conditions under which a card network sets rebates at a higher level such that competitors cannot profitably enter the market. Deterrence becomes more profitable for a large card network when transaction benefits increase – especially if the issuing banks pass rebates through to cardholders. At the same time, entry becomes more blockaded if issuing banks face costs to switch their card issuance to a different card network, indicating that large card networks may use rebates to increase switching costs. These lock-in effects explain why domestic card networks are pushed aside and new card networks struggle to gain ground, and they may have important implications for payment regulation.