Study On Platform Pricing And Welfare Analysis In China’s Bank Card Market Based On Two-sided Market Theory

Two-sided market theory is a discipline which began to introduce and develop until the21st century. As it covers many emerging markets such as bank cards, video games, operating systems with a strong explanatory power to realistic problems, it has now attracted more scholars, including the widespread concern of the Chinese scholars, and has become one of the hotspots of the industrial organization theory. Two-sided markets generally include two main aspects:one is that two different types of users conduct transactions through the platform; the other is the existence of indirect network externalities between the two types of users, namely, the user’s utilities on one side of the platform increase or decrease with the rising number of users on the other side. In order to attract more users into the trading platform and internalize the indirect network externalities between users to gain the maximum profit, pricing to both sides of the users becomes the focus of platform research. Therefore, platform pricing is the core of the two-sided market theory. Rochet and Tirole (2006) give a relatively precise definition of the two-sided markets, that is in the two-sided markets, not only the general price of the platform will affect the platform trading volume, more importantly, the price structure made by platform to users on both sides will also affect the trading volume.It is generally believed that bank card markets are typical two-sided markets.In the bank card markets, platform is the bank card organization (such as China UnionPay); two types of users respectively refer to consumers and business, who can complete the transaction by credit card. More importantly, the bank card holders benefit from the credit card payment or their utilities will be impacted by the number of bank card merchants, at the same time, the utilities of the receiving bank card merchants will be also affected by the number of bank card holders, which reveals the indirect network externalities between consumers and merchants.Since the first bank card issued in1985, the bank card markets in China have gone through the initial stage, the Golden Card Project stage and China UnionPay stage. During the20years of rapid development, they now have begun to take shape. By the end of2010, while there are287issuers joining the China UnionPay card issuers, totally issuing2.415billion bank cards of various types, the merchants through the inter-bank card payment system networking also reached2.183million,3.334million units of the networked POS machines,271million ATMs. Compared with2009, the amount of consumption increased enormously with a total of10.43trillion yuan. However, behind these glamorous figures, it can be vaguely seen this or that problem for bank card markets in China. In fact, the development of China’s bank card markets does not like to imagine it successfully. For example, in late2003and early2004not long after China UnionPay was established, in Shenzhen, Chongqing, Shanghai and other large supermarket chains, it explored the bank card strike to lower the bank card settlement fees, which reveals explicitly undoubtedl contradiction between holders and merchants. Followed in early2004, China UnionPay advanced the UnionPay card international brand strategy, and opened the acceptance markets in Hong Kong and Macao regions. UnionPay first goes out of the mainland in China, toward the road for international development. But meanwhile, including VISA, MasterCard, JCB, a large number of foreign bank card organizations also accelerate the pace to enter the Chinese markets. International bank card industries add increasingly more obvious impact on China’s bank card markets and thus the penetration and fusion between markets, mutual cooperation between institutions, competing with each other would be gradually formed.Just against this backdrop, this dissertation uses theoretical research and empirical research methods to investigate in-depth the operational mechanism of China’s bank card markets, the pricing strategy of the bank card industry structure and welfare analysis based on the bilateral market theory. it is divided into seven chapters, organized as follows: Chapter1introduces some problems encountered in the process of pricing and development for China’s bank card markets and described the background and practical significance of this study. Besides, it mainly summarized the recent literature review in the main aspects of foreign two-sided market theories, such as platform pricing, indirect network externalities, multi-homed, price discrimination, empirical research results. It finally introduces the research methods and the main content. Chapter2described the tow-sided market definitions, characteristics and classification, and mainly focuses on the basic theory of the tow-sided markets, namely, platform pricing theory mainly related to two classical literature of Rochet and Tirole (2003) and Armstrong (2006). It finally sums up the differences of the two literature. Chapter3is the current situation on the bank card markets in China, which gives the definitions, classification and role of bank cards, and the tentative definition of the bank card markets. On the basis of the development process, it analyzes the current status and operation mechanism for China’s bank card markets, and finally using the Granger causality test method to verify the existence of indirect network externalities of China’s banking card market, which is an important prerequisite of the research. Chapter4studies and compares the optimal pricing formula of interchange fees under different market structures like, the profit and non-profit monopoly platform, competing platforms, singhoming, as well as competing platforms and multihoming. Chapter5first analyzes through the establishment of a theoretical model the impact of the platform competition between bank card associations on the platform price level, price structure and profit, and then uses the data from the bank card markets in China from2000to2010and the GMM method to conduct an empirical analysis to consumers, business households card behaviors and platform trading volumes, to verify the conclusions of the theoretical model. Chapter6is mainly related to common multi-homing behaviors of users in the bank card industry. It first explores the endogenous multihoming and then analyzes the marekt share competition between China UnionPay and VISA, concerning multihoming. Chapter7advances the conclusions and policy recommendations.The main conclusions are as follows:(1) According to the classification of tow-sided markets, the bank card market is a demand coordinated two-sided market, which means the platform can meet the mutual needs of the users on both sides, with this demand displaying more indirect network externalities. Therefore, whether to exist indirect network externality in China’s bank card markets is a critical issue. This dissertation conducts a research using the annual data from special merchants and card volumes in China’s bank card markets through the Granger causality test. The results show that changes in the number of accepted merchants is the Granger cause for cardholder volume changes, meanwhile, changes in the number of cardholders consumers is also the Granger cause for the changes in the numbers of accepted merchants, which demonstrates that between the merchants and consumers on both sides of China’s banking card markets exists strong indirect network externalities.(2) Rochet and Tirole(2006) divided the indirect network externalities into membership externalities and uses externalities. Based on the study of the pricing strategy of the bank card associations, it argues that the externalities of the banking markets display uses externalities, based on that, advancing the optimal interchange fees in four different bank card market structure. Studies find that, in the profit-maximizing monopoly platform case, the interchange fees by issuing cards are not necessarily excessive, which mainly depends on the degree of competition in card issuing markets, the control structure of the platform as well as the average net surplus for buying a house. But the total user surplus is the minimum. In the nonprofit monopoly platform case, the interchange fees are exactly equal to the socially optimal interchange fees, with the social welfare maximum. The platform competition does not guarantee that users must be able to get the surplus and only when the platform without conspiracy and with consumer multihoming, can the platform competition create surplus for users.(3) In the analysis of internalities of consumer multihoming in China’s bank card markets in Chapter5, it considers that whether consumers choose multi-homing wholly depends on their credit card costs and benefits during the consumption process, and the higher the cost, the lower the income is lower, the less likely the multihoming. Further, the cost and benefit of consumers are associated with the degree of competition (horizontal differentiation) of the bank card associations and the degree of consumer differences (vertical differentiation). Specifically, the increased competition between card associations would lead to a decline in the platform price and more consumers choosing multihoming; the greater the degree of heterogeneity of the consumers, more consumers can not choose multihoming. In addition, the consumer multihoming also strengthens the acquiring market competition made by card associations. According to the analysis of the acquiring market competition in China and VISA card associations, it shows that although the degree of differentiation not directly affect the acquiring market pricing, it affect the pricing of the card issuing markets. When the differences in the degree of the organization are small enough, the living space of China UnionPay as the enter is extremely narrow. In order to compete for market share, China UnionPay must accurately locate a narrow risk-free region to ensure some edge on its market performance.(4) With relaxing the same price assumption, it examines the impact of the card associations platform competition on the price level, price structure, as well as social welfare. It is believed that the higher price level made by a card organization platform for consumers and business, the greater the profits gained by the competing platform. On the contrary, reducing the prices of users on both sides implemented by the card associations will lead to declined demand and profits for a competitive platform. Therefore, competitions among the card associations are prone to fall into the "prisoner’s dilemma", which led to declined prices of the bank card markets and falling overall profits of card associations, thus increasing the welfare of consumers and business, even the entire social welfare. This conclusion is very different from the findings of some scholars. Regarding the large connections between prices and the interchange fee of consumers and business, this chapter uses an empirical model to analyze the impact of a decline in interchange fees in2004and other factors on the decisions of consumers and business, the bank card transaction volumes as well as banks revenue. The empirical results show that the average merchant fees decrease by1%, their number increase by approximately1.3%, and the increase in the number of merchants led to the increase in the number of cardholders. A decrease in the transaction fees in2004not only caused a substantial increase in the bank card transaction volumes and the substantial increase in the volume of such transactions offset the decline in revenue caused by downward transaction fees, making the revenue of the card issuers and the acquirers rising.The conclusions of this dissertation have some policy implications for bank card organization, namely, China UnionPay pricing and the future development of China’s bank card markets.