Network Effects in Credit Card Standards
When it comes to credit card technology, America seems behind much of the world. America still uses old magnetic “swipe card” technology , which makes identity theft easier than the newer E.M.V. or “chip and pin” type cards prominent in Europe and Asia. These cards have a chip and require a PIN number to be entered to be used, rather than a mere swipe. However, these cards have not yet been widely adopted in America.
Image from http://creditcardstipsblog.com/wp-content/uploads/2010/10/chipandpinreader.jpg
Why is this so? A New York Times article says that this is “mainly because of the expense merchants and banks would have to take on to convert to E.M.V.-enabled cards and cash registers.” The lack of adoption of this technology can be modeled as a network effect. In instances of standardization, the value of one standard depends on the number of other people adhering to the same standard. Likewise, the value of installing E.M.V. enabled cards and cash registers depends partly on the number of other merchants and banks also using the new technology.
A rough sketch of r(z)f(z)
This could give us a graph similar to ones we have seen in lectures (and above), where the reservation price of a good is r(z)f(z), where z is the fraction of people using the good, in this case, the number of merchants and banks in the US using the new technology. Currently, the price of adopting the new technology is high, and a low fraction of US merchants are currently equipped to handle chip and pin cards. This creates a low value for adopting the chip and pin card technology because the value is based on the number of other merchants and banks who are also using the technology. There is likely a downward pressure on the adoption of the chip and pin cards, since the value of switching to the technology is less than the price.
However, if the price of installing the new technology were to come down, than the tipping point is lowered. The tipping point is the fraction of merchants and banks z that are needed to reach the point where the value of switching to the new technology is equal to the price it costs to switch. Once this tipping point is reached, it creates and effect where more and more merchants and banks will adopt the technology until it reaches the equilibrium point on the right side of the graph. This is more likely to happen with a lower price of adoption of the new standard, since the tipping point will be lower.
Another way to make the adoption of the chip and pin in standard reach a tipping point sooner would be to change who we consider including in our number of merchants and banks. This could change the fraction z, which can affect how much switching to the new technology is valued. Recently, Bank of America Merrill Lynch announced “that in early 2012, it will begin offering EMV-enabled corporate credit cards to U.S. business customers who travel abroad.” Other banks are doing the same thing. Why would this be so? If we only look at merchants and banks in the US, the value of z is low. However, if we look at a larger population, including that of Europe, z becomes higher, and the value gained by switching to the new technology may be more than the price it costs to switch. Since these business customers travel abroad, it makes sense to widen z to include chip and pin using merchants and banks from Europe and Asia, since these are two areas which are large business centers. In this case, it seems that this widened value of z has caused the value of switching to the new technology so that it’s in the banks’ best interests to introduce chip and pin cards.
It is important to note that this is a simplified model. There are more reasons as to why the US has not switched types of credit cards than just the number of merchants. There are also reasons related to consumer demand, and lack of knowledge about E.M.V. cards and the likelihood of identity theft from magnetic strip cards. It was assumed that the number of merchants and banks were the only factor in determining value, while other things such as comfort in having more security may also play a role in determining the value. The role of the number of merchants and banks using chip and pin credit cards was focused on because the primary reason for justifying not switching card types have been the prices that merchants and banks would have to pay. It also makes sense to look at the number of merchants and banks using chip and pin technology, as they are important actors in determining standards within the credit card industry.
Sources:
- http://travel.nytimes.com/2011/06/12/travel/how-to-avoid-credit-card-problems-abroad-practical-traveler.html
- http://www.banktech.com/payments-cards/231902575