Debit or Credit? (Why “Model” Consumer Payment Choice)

1. Debit or Credit?(Why “Model”Consumer Payment Choice) FRBBOS Retail Payments Conference Jonathan Zinman Dartmouth College October 28, 2005

2. Primer:“Modeling” Consumer Choice • Why social scientists “model” human behavior: • Get to essence/drivers of choices • Explain, and ultimately predict behavior • That’s why we’re here today!

3. Primer:“Modeling” Consumer Choice • How we model: • Behavior very complex • Hard to identify what causes what • Our tools (math and statistics) have “bandwidth” limits • So: we simplify by making assumptions • Makes problem tractable • Permits focus on what really matters

4. Primer:Empirical Social Science • Ask an interesting question • I.e., formulate a hypothesis • Build or modify a model that makes realistic simplifying assumptions • Find/collect/generate the right data for testing your model • Test it My paper does not satisfy all 4 criteria!

5. Two Views of Consumer Choice and Payment Choice #1. Homo economicus (“rational”man) • Recognizes when a choice needs to be made (i.e.., no confusion) • Makes a choice (i.e., no procrastination) • Chooses based on: • Stable preferences (i.e., I know what I want) • Full/adequate info (i.e.., know what I’m choosing) • Sticks to choice (i.e.., no self-control problem)

6. View #1: Economic Model ofConsumer Payment Choice • “Cost is king”: • Including implicit costs, not just fees, but: • Finance charges, foregone interest • Time/hassle costs

7. View #2: Psychological Modelof Consumer Payment Choice • Homo consumaloticus (“psychological man”) • Lots of things drive payment choice • How I pay impacts how much I spend • In particular, credit leads me to spend more • Perhaps more than I want to in more reflective moments • Other payment media, including debit, help me control spending by helping me: • “Feel the pain” (salience) • Track spending (mental accounting)

8. Psychological Model • Thought experiment to show how this works: • Randomly assign debit cards to a pool of credit users • If “salience” dominates • debit users’ overall spending will fall • debit used at times/places where temptation is greatest • If “mental accounting” • debit users’ spending falls • payment choice varies systematically with what is being purchased (conditional on transaction size, acceptance) • This seems to be the conventional framework for explaining debit use (at least relative to credit) • Trade press • Popular press

9. What My Paper Does • Test whether choice between debit and credit is consistent with economicus model • In coarse but nationally representative data • Fairly convincingly rules out widespread indifference among payment choices • Casts doubt on primacy of spend-control motives for choosing debit over credit

10. What Paper Does Not Do • Nothing to say about choice mechanics • Not solving calculus…. • Intuition • Rules-of-thumb? • Trial-and-error? • Little to say about why debit has grown • Paper can not directly rule out spending-control motives • Merely questions their importance • Paper’s findings should not shift your prior beliefs • Only question them • Motivate you (bank/issuers) to give me data needed for direct testing of psychologicus explanations

11. How Paper TestsEconomic Model: Data • Survey of Consumer Finances (SCF) • Only nationally representative data, with decent sample size, that knows anything about both debit and credit use • But doesn’t know much • Do use debit regularly • Good measure of credit card holding • Decent measures of credit revolving and utilization • Nothing on rewards, cash back, acceptance, etc. • Nothing on transactions • And only a snapshot • Most recent survey in 2001 (2004 out soon)

12. How Paper Tests Economic Model: Focus on Debit v Credit • No data on cash or check use SCF • Debit and credit very similar re: most attributes: • acceptance (at least by 2001) • portability • security • time at POS • So can focus in on costs as driver of choice

13. Testing the Economic Model 3 key predictions on who’s most likely to use debit: • Those lacking a credit card • otherwise float and get miles, except… • Revolvers more likely to use debit • to minimize costs from “borrowing-to-charge” • High intensity revolvers even more likely

14. Results of Tests • All economic predictions borne out • Correlations are big • Robust to controls for: • Demographic characteristics • Spending patterns (rough proxies) • All this despite data limitations that work against finding support for the model’s predictions

15. Other Data/FindingsCast Doubt on Spending Control • Most important/provocative: • May 2004 Survey of Consumers (“Michigan Survey” used to measure consumer confidence, etc.) • Asked open-ended questions: “Why do/don’t you use debit to make purchases?” • 5.8% of debit users said something related to spend control • 5.5% of nonusers said something related to spend control • See Borzekowski, Kiser, and Ahmed 2005 for this & more interesting results

16. Some Food for Thought: From Modeling to Business Apps • What’s (irr)rational consumer behavior? Be careful. • Example. Free checking: • Not necessarily irrational (Stavins) • Intense transactors should choose min balance option • (Not necessarily irrational for banks either.) • Example. Slow e-payments adoption. • Small benefits to adoption • (Perceived) big downside risk • High cost of getting info to accurately assess downside risk • Inertia may be rational/optimal

17. From Modeling to Business Apps:Learning About Customers • How do we ask them? • Survey responses depend greatly on how you ask/frame questions (psych wins here!) • May explain difference between market research and Survey of Consumers on spending control • Will customer’s responses to hypothetical questions have useable content? • General concern in social science • Particularly so here: stakes of payments decision are small for most consumers (maybe $10 a month on average)

18. From Modeling to Business Apps:How Much Should the Consumer Know/Deliberate? • Not much, necessarily • Rational to devote little energy/attention to payments choice in face of small stakes • So… how to communicate with or “educate” consumers • Less is more • “Information overload” with debt, saving, jam(!), doctor’s Rx choices (psych wins again) • Be especially careful in payments– small stakes

19. Going Forward • With richer data: • From bank/issuer • With deposit/debit and credit customers (account-level info) • Transaction level data • Direct tests of spending-control models • Finer tests of economicus model: • Impact of rewards • Impact of credit pricing • Time costs vs. (implicit) pecuniary costs • Insight into choice mechanisms: • Adoption • Learning

20. Take-Aways • Understanding of “rational” behavior must be nuanced. Impacts how we: • Develop, market, and price products • Collect and interpret info on customers • Communicate info to customers • Paper’s findings not rich enough to change your mind on what drives debit use • But re-examine your beliefs and model(s) • We can reach a deeper understanding of what drives consumer (payment) choice • Analytic framework in place • Just give me the data!