Entry of Non-Financial Firms and Competition in the Retail Payments Market

Abstract

We investigate the effects of a non-financial firm’s entry on competition in the retail payments market, from the perspective of duopoly between an incumbent and an entrant in conditions of vertical restraints. Considering the cross-platform externalities in payment processing, differentiated preferences for payment platforms, and competitive bottleneck on the consumer side, we derive the following results. When only the entry of a vertically integrated (or end-to-end service) provider is allowed, either all merchants choose to multi-home or no entry occurs, regardless of the regulatory requirement. On the other hand, if the entry of a downstream-only (or front-end service) provider is possible, a partial multi-homing equilibrium result can emerge for some conditions under which the entry of an end-to-end service provider does not occur. In addition, due to the lowered entry cost, the overall welfare is greater when the entry of downstream-only service is possible although the entire increase in welfare goes to the entrant. Without regulation, however, the vertically integrated incumbent does not voluntarily provide the back-end service to the entrant when the merchant’s benefit from the payments service is not sufficiently high. It suggests the need for proper regulatory measures to reach a socially desirable outcome from the new entry in the retail payments market.