Thank you for having me.
I'm a professor at the University of Alberta. I should emphasize that I have no relationship with any of the various parties that have come before you in the last couple of weeks.
My role this morning is to give you some sense of what economists talk about when they think about this market. This is a very complicated market; it's very different from our standard textbook market. So maybe economists can give you some help in deciding how to approach the problem you have.
I think the key point, as my colleague has mentioned, is the notion of a two-sided market. This dominates economic thinking, and this is the key concept the committee should understand before deciding how to proceed. The idea of a two-sided market is the notion that you have a single platform—and this is the key word, “platform”—that brings together many buyers and many sellers.
What does this mean? What I've done on this slide is try to give you some examples—and there are countless examples—of platforms and how the economics work. The first example of a platform is precisely what you're discussing in these hearings. Visa and MasterCard provide a platform where they bring together lots of people on one side of the market, the retailers, and lots of people on the other side of the market, the consumers. By bringing these two sides together, they create some value. That's the value of their platform.
But there are many other examples, which I've shown you on this slide. For example, for real estate listings, real estate boards have websites all over the country. These websites bring together house buyers and house sellers. But the platform in the middle is the real estate board, and that's the key economic actor we care about.
Another example is shopping malls. A shopping mall can be thought of economically as a platform. What does it do? The owner of the shopping mall brings together two sides—side one, the store owners, and side two, the shoppers. So the shopping mall in itself doesn't do anything or sell anything, but it brings these parties together.
Other examples are the Yellow Pages and PDF files. A PDF file is a platform with readers and writers. And Google can be thought of as a platform; you have Google advertisers and Google searchers. One point to emphasize with these platforms is how their services are priced. How do Google or the Yellow Pages price their services? What you find very commonly with all of these platforms is that one side is highly subsidized—in many cases it's free—and the other side pays. So in the examples I've shown you, when you search on Google, for instance, it costs you nothing. But when you advertise on Google, when you're a seller, it costs you a significant amount of money. And for PDF readers, when you read a PDF document from Adobe, it's free. But if you want to write one of these things, it costs you a lot of money. Similarly with the Yellow Pages; on the one side the readers get it for free, etc.
So what you have as a standard outcome in the economics literature with the pricing of these platforms is that one side bears the costs and one side gets it for free. In fact, I would argue that in the credit card case, not only do the consumers get it for free, but they also actually get rewarded or more money when they use their credit cards. That, of course, is the notion of rewards—air miles and cash back, etc. This fits in very much with standard economic thinking about how these two-sided markets should work.
So what are the implications of these two-sided markets? The key point to emphasize, I believe, is the notion of winner takes all, or what we call “network effects” in economic jargon. What this means is that if you have a platform that everybody loves, if you have a platform that both the buyer side and the seller side use extensively, then you have a very valuable asset.
The second part of the winner-takes-all story is that once you get big, you get even bigger. So the big get bigger. There are built-in economies of scale, the way economists describe this. That, of course, is the situation that Visa and MasterCard find themselves in—and that is the situation every platform owner wants to be in. Another example is Microsoft as a platform. It's so big, everybody uses it. Nobody has a choice not to use it.
The key objective of the people who own the platform, whether it's Microsoft, Google, Visa, MasterCard, Yellow Pages, or whatever, is to get as much money as possible, like every business owner. But at the same time they have to balance and make sure they have enough on the buy side and enough on the sales side to keep the thing going. As soon as you have a situation where either one of these parties leaves the platform and goes somewhere else, the value of the platform gets less and eventually becomes zero. So they have to get as much money as they can, while at the same time keeping everybody using them.
So you have a situation--and this is standard economics and how we understand these two-sided markets--where you find yourself like the retailers you've heard in your committee. If you find yourself in a situation like in the Visa or MasterCard case, where you have a very successful and dominant platform, you're essentially stuck. You can't get out because all your customers demand that you use the platform, and there's nothing you can really do to reduce your fees.
So what do they do? Standard economics literature on two-sided markets says they do precisely what's happening at this meeting this morning. They lobby Parliament and go to the courts, the central banks, and the competition authorities. The economics literature tells us it is not possible for these guys to use standard economic mechanisms to escape the trap in which they find themselves.
So how do we get out of this? What is the threat to Visa or MasterCard, or any of these two-sided markets? I could be talking about Microsoft or Google; it's the same argument. The threat they face is a new and better platform that does things to make more people happy--new technology. I've given you the example of PayPal and the slow emergence of a platform on the web that might one day overcome Visa and MasterCard as a payment provider. That's the thing: once this new platform comes into being, Visa and MasterCard face the problem.
What are the implications of these two-sided markets? What does economics literature tell us to expect? First, the fight you've had before you for the last couple of weeks between Visa and MasterCard on the one side and the retailers on the other side is very predictable. This always happens. This identical fight has been happening around the world. My argument is that this will continue. These meetings will certainly not be the last ones this House hears on this matter.
Even if a new dominant platform overtakes Visa or MasterCard, this kind of conflict between the retailers on the one hand and the platform on the other hand will carry on. Even if, for example, the Reserve Bank of Australia imposes some sort of regulation, this will not solve the problem. There is no nice, easy answer based on economics literature as to how to fix this problem, because of the nature of these two-sided markets.
Thank you.