Standard sizes allow us to efficiently pick out clothing to try on at any store we go to, and even to shop online. Standard file formats enable the exchange of documents between computers with different operating systems and software programs. Similarly, standard payment formats ensure that our payment cards work at a wide range of merchants regardless of where we bank. Although we often take standards for granted, they are absolutely critical to the efficient functioning of the payment system.
Standard formats are a classic public good: they can be used by multiple people at no marginal cost per user and it is difficult to exclude people from using them. Typically, public goods have to be provided by the government, because no individual firm has sufficient incentive to provide them privately. However, in the payments industry, standard payment formats have frequently been adopted without government intervention. Instead, private firms generally cooperate to develop payment standards through membership organizations like NACHA, the Accredited Standards Committee X9, and EMVCo. These organizations are direct competitors who choose to cooperate in developing shared industry utilities. Atlanta Fed payments risk expert Doug King has written extensively on industry efforts to implement the EMV payment card standard in the United States.
The payments industry might be able to supply its own public goods due to the relatively low transaction costs of doing so. While a small number of companies manage the majority of card payments across the globe, the U.S. industry includes several well-established companies and numerous smaller competitors as well as start-ups. Most of the companies are already members of established industry organizations that facilitate collaboration. This is much simpler than the market providing a public good like low pollution in a river, for example. Somehow the many consumers and firms who access that river must assemble and agree on the pollution level, develop an enforcement mechanism, and implement the agreement—and many of these stakeholders will likely never have worked together before.
The effect of payment standards on competition is unclear. It’s possible that standards increase competition in the payments industry by leveling the playing field between established firms and start-ups. However, some payments standards are proprietary and may inherently favor the companies that most influenced their development. For example, to the extent that the largest card networks dictate the specifications for the EMV standard, this may disadvantage smaller networks. Those smaller networks are left in the unenviable position of having to comply with standards in which they had little voice in developing. Thus, although the payments industry seems to have been effective in developing standards cooperatively, it’s possible that this market activity has favored the dominant players. How will the move to the EMV payment card standard affect competition in the U.S. market?
By Jennifer C. Windh, a senior payments risk analyst in the Retail Payments Risk Forum at the Atlanta Fed