Is the Debit Card Revolution Finally Here?

Federal Reserve Bank of Kansas City - Economic Review, Fourth Quarter 1994 by Caskey, John P, Sellon, Gordon H Jr

A large number of products have been cited as subject to network externalities. Important examples are communication equipment, such as telephones or fax machines, personal computers, compact disc players, and video cassette recorders. Payments system products may also exhibit network externalities. For example, individuals carrying a popular credit card can benefit because the card is likely to be widely accepted by merchants. Similarly, the benefit an individual derives from carrying an ATM card will depend on the geographic dispersion of ATM machines that accept the card. This dispersion in turn is likely to be a function of the number of people belonging to the ATM network (McAndrews; Saloner and Shepard).

When such externalities are significant, they can act as a barrier to the adoption of new technologies (Carlton and Klamer). For example, if there are several producers of a product subject to positive network externalities, people may resist using the product unless some or all producers agree to use compatible technological standards. Without such compatibility, the network of users for each producer's product might be too small to make the product sufficiently useful. Another consequence of network externalities is that many potential users of the product might decide to wait for it to attain some initial success before entering the market. This delay occurs because early adopters will see few benefits from the product until its use is widespread. If a sufficient number of consumers adopt a wait-and-see attitude, there may be insufficient demand to launch the product successfully. [2]

A constraint on debit card acceptance

Such network externalities provide one explanation for the slow growth in the use of debit cards in the 1980s. Because ATM cards can also function as on-line debit cards, the widespread use of ATM cards to obtain cash in the 1980s meant that debit card availability was probably not a limiting factor. Instead, the absence of retail locations that would accept ATM cards for consumer purchases was the key impediment. [3]

The lack of retail acceptance can be explained by the way ATM networks evolved. As discussed earlier, an on-line debit card system essentially piggybacks on an existing ATM system. An ATM card becomes a debit card when a merchant installs a debit terminal that is linked to an ATM network and permits a customer to make a retail purchase using the card. Initially, most ATM systems were proprietary; that is, cards could only be used in machines owned by the bank issuing the card. Moreover, the different proprietary systems used different equipment and software, and so were generally not technically compatible. In this situation, a retailer interested in installing a debit card system would have to choose from different, competing ATM systems, knowing that a choice would exclude a potentially large group of customers with competing cards. The alternative, installing different equipment for each ATM system, would be prohibitively expensive. Thus, retailers would have a strong incentive to install debit card readers only in areas where one bank's ATM cards enjoyed a significant market share.