Review: Paying with Plastic – The Digital Revolution in Buying and Borrowing

Paying with Plastic: The Digital Revolution in Buying and Borrowing by David S. Evans and Richard Schmalensee (2nd edition, MIT Press 2005) was, from a personal perspective, a very unusual read in more than one way: first, it took me a shamefully long time to read it, more than a year. Second, it was mostly about stuff I should already know. Third, it took me another year after finishing the book to write a review about it. Finally, despite these somewhat ominous signs, I can honestly say that it was a really good read and an excellent book.

So what’s it about?

Well, in short, it’s about credit cards, how they work, how the business is run and how they’ve changed the way we do our daily business. And unless you were born more than 50 years ago, you may not even realize how much it has changed things before reading this book.

Paying with Plastic starts off with a comprehensive tour of the history of payments, obviously focusing on the birth and development of the credit card industry and its competitive dynamics. Significant amount of space is also devoted to the economics of multisided business platforms which I have discussed also earlier; if you’re still unfamiliar with them, this book provides more than a short introduction to the multisided business models of the payment industry. What I found particularly interesting was the deep insight into the competitive and regulatory dynamics of the business and how they have changed over time.

“Right, whatever, not a book for me”, you may say – so is there anything everyone can take away from this book without having a professional interest in the field? Well, this excerpt, when discussing about merchant competition, brings up an interesting point that seems to indicate there is inevitably too much advertising in the world:

This sort of nonprice competition, which includes competing by accepting checks and payment cards, has a curious feature: it can be socially excessive. Consider advertising. If merchant A’s advertising simply shifts business from merchant B to A, the gain to A is like to substantially outweigh the gain, if any, to society as a whole – that is, to all merchants, including B, and all consumers in aggregate. With a few more assumptions, one can argue that merchants as a group tend to advertise more than would be optimal from the standpoint of society as a whole. This “market failure” has been almost completely ignored in policy circles for one simple reason: even if there is too much advertising in theory, it is not clear how in practice one could ever calculate the optimal amount of advertising, let alone attain it.

Another interesting point that arises from the nature of multisided business models is that price discrimination is not always bad – indeed, sometimes it’s necessary. This may sound counter-intuitive at first (I mean it’s unfair for some to pay more than others, right?), but the necessity becomes clear when you think about it:

Most businesses in single-sided and multisided markets engage in price discrimination because it is possible to increase revenue by doing so, and because in the case of businesses with extensive scale of economies, it may be the only way to cover fixed costs. A dating club may charge men a higher price just because they have more inelastic demand and because it is easy to identify consumers on the basis of gender. But businesses in multisided markets have an additional reason to price discriminate: by charging one group a lower price, the business can charge another group a higher price; and unless prices are low enough to attract enough of the former group, the business cannot obtain any sales at all.

As we’ve again seen recently out there in the real world, markets hardly ever cooperate by following simple textbook rules. But things get much more difficult in multisided models:

In traditional markets, however, the classic truism can at least serve as a starting point for more nuanced analysis.
[...]
By contrast, multisided platforms – especially those in new markets – all too often require clean-sheet planning. With multiple yet interdependent business constituents to serve, costs offer little guidance for pricing strategies. By the same token, early entry may yield first-mover advantages or provide an instructive failure that simplifies the search for successful strategies that follow.

In addition to the multi-sided business models utilized throughout the payment industry, another interesting feature is the co-opetitive nature of the credit card business; they co-operate and compete at the same time. This leads to interesting issues with how to prevent the tragedy of the commons from taking place, how to deal with negative externalities, free-riding and loyalty issues. These are governed by several rules and it’s fascinating to see learn the system has been built.

Overall, Paying with Plastic is a book I can highly recommend if you’re dealing with or are interested in anything dealing with the credit card business. From the retail to the banks and the consumers, it is a fascinating read offering interesting anecdotes to the surprisingly eventful history of the credit card business. The book wraps up with an appropriate chapter on discussing the future and the rising technologies as well as business ecosystem issues.

I would be willing to bet there’s new information and insight in Paying with Plastic even for most industry professionals. And you know the saying how those who are unfamiliar with the history are doomed to repeat it? The history of the credit card business has a plethora of lessons to learn. Admittedly Paying with Plastic takes on a somewhat US-centric view and given that it’s somewhat different from other parts of the world, I would’ve welcomed more views, commentary and statistics from other parts of the world. But despite this shortcoming it’s a great book.

As sidenote, it’s outrageous how much we in Finland still have to pay for our credit cards considering their benefits – or the lack thereof – compared to the ubiquitous and free debit cards. In other countries that have some real competition and customer service, it goes the other way around. It seems that over here, the issuers and banks seem to want to implement the multi-sided business model in a very strange way; so that each and every party from merchants to consumers ends up paying as much as humanly possible. News flash, guys, that’s _not_ how the model is supposed to work.