RDP 2015-03: The Value of Payment Instruments: Estimating Willingness to Pay and Consumer Surplus 1. Introduction

Consumers have significant decision-making power in the choice of which payment method to use to pay for purchases. Standard economic models would suggest that an individual will chose the option that gives them the greatest net benefit (i.e. the greatest benefit once costs are taken into account). Consumers are likely to value different payment methods based on their features; for example, cash may offer greater privacy, while the use of debit or credit card payments may allow consumers to carry less cash. Measuring the value that consumers place on different payment instruments is a key step in understanding consumers' choice of payment instrument and how this choice may change if an explicit price (a surcharge) is charged on some payment instruments at the point of sale. Having a measure of the relative value also enables the calculation and comparison of changes in consumer surplus at different price levels.

Although previous research has looked extensively at how consumers' characteristics affect the choice of payment method, few studies have looked to measure the relative value that consumers place on using different payment methods. One reason is that data are scarce; explicit pricing of payment products at the point of sale is not common practice and so it is difficult to observe directly how consumers will behave when they do face a price.

To overcome the lack of data, we adopt an approach used widely in other areas of economics and apply it to measuring the value of payment methods. Using a modified form of a discrete choice experiment (DCE) as implemented in the Reserve Bank of Australia's 2013 Survey of Consumers' Use of Payment Methods, we obtained consumers' stated willingness to pay for debit card and credit card payments. Specifically, two DCE questions measured the maximum surcharges that 1,167 consumers were willing to pay to make a $50 purchase using a debit card and a credit card, respectively, instead of using cash. The results can be interpreted as the relative value that each consumer places on using debit cards and credit cards instead of cash.

Using this novel dataset, we first aim to quantify in monetary terms the value that consumers place on debit card and credit card payments relative to cash payments. We show that there is considerable heterogeneity in respondents' willingness to pay for debit card and credit card payments and that the proportion of consumers willing to pay to use a payment method decreases in a plausible way in response to an increase in the surcharge. Positing that the heterogeneity is likely to be related to the characteristics of the consumer and the features of the card that they hold, we attempt to measure the value that consumers place on two specific features of credit cards: interest rates and rewards programs.

Our second aim is to show how information on consumers' willingness to pay for different payment methods can be used to understand payment method choice, particularly in response to surcharging of payment methods. We examine how consumers' use of payment methods may change when the costs of each method are transparently passed on to consumers at the point of sale through a surcharge instead of being built into, and increasing, the baseline price across all consumers. We outline a model in which consumers choose the payment method that offers them the greatest benefit at the point of sale. We then explore how consumers switch between cash, debit card and credit card payments when a cost to consumers is introduced in the form of a surcharge, considering a range of hypothetical cost scenarios. The aggregate consumer surplus is calculated for each scenario, providing an objective criterion to rank the efficiency of each scenario. Measuring consumer surplus is a key advantage of obtaining willingness-to-pay data using DCE.