Economic Analysis for Business Decisions Market Definition

Overview: Credit Card Case • Market Definition – Review – Market Participants – Pricing Discussion • Other Issues in Case – Timing and Strategic Interaction – Market Power – ... Market Definition : Review • Definition : collection of buyers and sellers that, through actual or potential interactions, determine the price of a product • Point of departure: `If I try to raise (lower) prices, where will current customers go (new customers come from)?' • Remarks : – Always relative to a specific question – Important for business strategy, pricing, anti-trust 1 Market Definition Current Suppliers Current Customers Substitutes Market Potential Customers Potential Entrants U.K. Credit Card Industry • Who are the players? • What are the issues? 2 The Product 'Credit Card' 3 Direct Substitutes Longer-range Substitutes • Note : Lecture 7 discusses network effects 4 Increasing the Interest Rate • Note : Lecture 19 discusses adverse selection Important Consumer Characteristics 5 Charging a Fixed Fee • Note : Lecture 9 and 10 discuss pricing schemes 6 Profitability : Assumptions • • • • APR : 26.8% Cost of Money : 10% MSC : 2% of sales Cost : 3.1% of sales (Exhibit 5) • Note : Lecture 4 discusses economic costs Measuring Substitutes • Cross-price elasticity • Correlation of Prices • Correlation of Market Shares 7 Payment Mechanism Substitution 60 50 40 check cash payment card 30 20 10 0 1984 1996 Evolution of $ volume shares of different payment mechanisms in US (in %) Timing • Should Barclays go first? • Barclays payoffs : Other Bank Wait until Move now other moves Move now +2 -4 Wait until other moves +10 -2 Barclays • Note : Lectures 12 and 13 discuss game theory and prisoner's dilemma 8 Further Issues • System level and market power • Market of retailers: Incentives in negotiating • What happened in the U.K.? System Level & Market Power • What if Visa imposes the annual fee on all the issuers? • Definition of market power (US DoJ): "ability of one or more firms profitably to maintain prices above competitive levels for a significant period of time" • Does Barclays have market power? Visa? Visa and MasterCard? • Note : Lectures 14 and 15 discuss collusion and anti-trust 9 Market of Retailers MSC are negotiated by acquiring banks but get passed on to issuing banks – Do these banks have the right incentives in negotiation? More or less, because they are also issuers. – With specialized acquirers as in U.S, you need different system: MSC goes to acquirer (who now pays interchange fee) – BUT, the acquirer still does not take into account the effect on the whole system. The choice of interchange fee is key to this. • Note : Lectures 18 and 20 discuss incentives and externalities What Happened in the U.K.? – Feb '89 : Barclays considers an annual fee – Aug '89 : Lloyds announces annual fee, Barclays waits – Feb '90 : Annual fee takes effect; Lloyds estimates loss of 10% of its credit card customers – Mar '90 : Lloyds loss of 20% of its customers; Lloyds credit card profits declined substantially relative to other banks – Apr '90 : Barclays announces annual fee, to take effect in June – During '91 : Midland and Natwest also introduce annual fees 10 Take Away Points • Market Definition can be complex – be clear about the question – be clear about the product (function) – consider both supply and demand • Economics is directly relevant to business decisions – – – – – economic cost pricing sorting game theory incentives For Next Time – Sugar Industry Case: • Study the case • No need to prepare answers to the questions in the case 11