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Strategic Incompatibility in ATM Markets

Strategic Incompatibility in ATM Markets. Christopher R. Knittel (UC Davis and NBER) Victor Stango (Tuck School at Dartmouth). ATMs and Deposit Accounts. Banks offer both deposit account services and ATM services Banks bundle deposit accounts with own ATMs

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Strategic Incompatibility in ATM Markets

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  1. Strategic Incompatibility inATM Markets Christopher R. Knittel (UC Davis and NBER) Victor Stango (Tuck School at Dartmouth)

  2. ATMs and Deposit Accounts • Banks offer both deposit account services and ATM services • Banks bundle deposit accounts with own ATMs • Bank also allow others’ customers to use their ATMs • After 1996, banks began imposing surcharges paid by customerson these transactions • Banks also can impose foreign fees on their own customers’ use of competitors ATMs • We observe these, but they don’t change much over our sample

  3. Pricing a Foreign ATM Transaction: Pre-1996 ATM Network Switch fee Interchange fee ATM Owner Cardholder’s Bank Foreign fee ATM Cardholder

  4. Pricing a Foreign ATM Transaction: Post-1996 ATM Network Switch fee Interchange fee ATM Owner Cardholder’s Bank Foreign fee Surcharge ATM Cardholder

  5. The Economics of Incompatibility • `ATM surcharges may put small banks--or, more accurately, banks that do not own many ATMs--at a disadvantage...If large banks that own many ATMs impose surcharges on transactions by other banks' customers, small-bank customers will…move their deposit accounts to the larger banks, resulting in increased concentration in local banking markets.' `Competition in ATM Markets,' CBO (1998) • Essentially describes large banks’ attempt to restrict compatibility of their ATMs with competitors’ ATM cards • An attempt to siphon deposit accounts away from competitors or create differentiation • Analogous to the strategic use of interconnection or “off-network” access fees • Economides, others • Though, there are also non-strategic motives for surcharging considering ATMs as a stand-alone business

  6. What We Do, and the Context • We use this market to test an empirical model of incompatibility • Advent of surcharging provides natural experiment • Are surcharges consistent with strategic behavior? • Test of incompatibility most closely related to Genakos et al. (2004) • Relates to many other papers on ATMs: • Ishii (2005), Hannan (2005), Hannan et al (2003), Massoud, Saunders and Scholnick (2006), Prager (2001), etc.

  7. Summary of results • We find that large banks charge higher fees consistent with strategic incompatibility • Small banks’ pricing appears non-strategic • The motive behind strategic incompatibility is higher deposit account prices • We find little evidence of a business stealing effect • Observed equilibrium changes also support this • Banks choosing “strategic” incompatibility have higher deposit account prices, but we don’t find evidence of an increase in market share

  8. Modeling ATM Profits • Profits for a bank operating in ATM and deposit (card) markets: • si,-i = surcharge of ATM owner or competitors • f-i= foreign fee of ATM owner’s competitors • k = interchange received by ATM owner • cA = MC of ATM transaction (to owner) • cC= MC of a deposit account • pC= price for deposit account • A = number of ATMs • QA(.) = number of foreign transactions (per month) • QD(.) = demand for deposit accounts

  9. Profit Maximization • The firm’s FOC implies: • Note: premium is increasing in deposit account margin, decreasing in elasticity of foreign transaction demand, increasing in “deposit siphoning effect” “Incompatibility Premium”=“Z”

  10. Empirical Strategy 1. Estimate the premium term as a residual Have estimates Data Data Residual Slope of residual demand for foreign transactions

  11. Summary Statistics

  12. Residual Demand Estimates

  13. Incompatibility premia

  14. Estimating the FOC • Increasing incompatibility can lead to deposit account prices or business-stealing from from other firms • The higher price incentive is increasing in the number of current members • The business stealing incentive is increasing in the margin on cards • We can specify the FOC as:

  15. FOC Results

  16. Equilibrium effects • We next ask whether our estimated strategic incompatibility premia are correlated with: • Changes in equilibrium deposit account prices • Changes in equilibrium deposits • We regress bank changes in these variables on: • Own surcharges and incompatibility premia • We don’t push a causal interpretation since we would expect those banks that know increasing their premium will have an effect to have larger premia • But, if what we call a premium is spurious, we wouldn’t expect to see any correlations

  17. Results

  18. Conclusions • The data are consistent with strategic incompatibility • This is limited to large firms • Across all large banks, the incompatibility premium represents (on average) 28% of observed surcharges • Conditioning on whether the firm surcharges, increases this to 66% • The motives behind strategic incompatibility are to increase prices, not business stealing • This is also consistent with observed equilibrium effects • Our previous work suggests that we can’t draw too many welfare implications from this • But, it represents a market where incompatibility motives exist

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