Credit Cards and Internet Service: Joint Products Continue to Raise Controversy

    When I practiced law, I spent much of my time defending a computerized reservation system (CRS) against claims of monopoly pricing.  After four years of litigation, we won a four-month jury trial, in which the jury found that we weren't a monopoly, and weren't engaged in unjust pricing.  Now, the same economic issues involved in the CRS litigation are again front and center in two current regulatory disputes.

    The basic economic issue with CRSs arose from their nature as what economists call "joint products." This is defined by Wikipedia as "two or more products, produced from the same process or operation, considered to be of relative equal importance"   The CRS produced a reservation transaction that equally benefited the airline that provided service and the travel agent who made the booking (and ultimately the consumer).   Since it is recognized that cost allocation of common cost is entirely arbitrary, the pricing of CRS services was controversial for many years.  In the early days of CRS, travel agents paid a little, many airlines got a free ride, and the vendors lost substantial amount of money.  The vendors were able to get significant booking fees from some smaller airlines, who complained of discrimination.  After the CAB adopted regulations requiring nondiscriminatory fees, all airlines were required to pay booking fees, and the CRS's became highly profitable.  The vendors then engaged in intense competition for placement in travel agencies, which resulted in competing away some of the profits generated from airlines in increasing discounts to travel agents.

    The battle over pricing of joint products is now again being fought in Washington -- this time over Internet services and credit cards.  Both are joint products.  The Internet is similar to the classic example of a joint product -- a newspaper.  Indeed, it is so similar, that it is quickly displacing newspapers.  The Internet connects suppliers and users, both of whom contribute to the cost of the systems.  Users pay fees to the telephone or cable company that provides Internet service.  Websites also pay fees for their connection to the Internet, and offset these fees by collecting revenue from advertisers, or sometimes subscription fees from viewers.
  
    Some vendors use substantially more bandwidth than others.  Sites such as YouTube that provide video or movies are obviously intensive users who absorb tremendous amounts of Internet capacity.  The whole "net neutrality" issue arose when network providers suggested that they might charge more for high consumers of bandwidth.  This was quickly labeled discrimination by vendors that might have to pay more, and the battle has been fought under the appealing banner of "net neutrality."  But it is really a battle over pricing -- heavy consumers are trying to avoid a pricing structure that reflects their impact on the network.  They want all users priced equally, thus forcing light users to subsidize bandwidth hogs.  It is not very reasonable to require users who use the Internet for e-mail and browsing news articles to pay as much for their Internet service as young people who use the Internet for watching movies and playing games.

    The credit card issue is similar.  Credit cards are a joint product, providing equal benefits to both merchants and users.  Again, the traditional pricing structure charges both beneficiaries.  Subscribers usually pay annual fees, plus interest of bills were paid in a timely manner.  Merchants also paid in the form of discount fees, equal to a small portion of the amount charged by the consumer.  MasterCard and Visa  discount fees were usually somewhat less than 2%, while American Express charged more -- sometimes 3% for merchants, and even higher for smaller companies such as restaurants. 

    Merchants have fought for years to restrict these fees, and have recently found some success.  In early May,  the Senate adopted an amendment to the Financial Reform bill that would require merchant fees for debit cards to be "reasonable and proportionate" to the actual cost of processing these transactions.  (The amendment does not apply to credit card fees.)  Of course, this runs right into the question of how to allocate the common costs of a joint product.  The House bill does not contain a similar provision, so the amendment may not survive the conference committee.

    It does seem that merchants may be paying too much, not because their prices exceed some cost standard, but because credit card companies are competing away much of their revenue from merchants to attract new consumers.  Rewards cards are the prime example of credit card vendors using revenue from merchants to give points that consumers may use to redeem merchandise, or even simply to pay consumers one or two percent of the total amount charged.  Of course, in the current economic environment, the card companies are suffering tremendous losses, and can reasonably argue that they need to maximize revenue from both merchants and consumers in order to survive.

    I will do some more research on both credit card and net neutrality issues, and continue to blog on these questions.

Airlines Cancel First Flights Bacause of New DOT Delay Rules

When DOT adopted new rules that airlines counld not delay flights before take-off for more than three hours before facing draconian DOT penalties. carriers and others warned that they would have every incentive to cancel the flights before the deadline, rather than become liable to millions of dollars in penalties.  Consumer groups rejected this possibility.  Now that the rule has become effective we are receiving reports of the first cancellations.  Surprise -- corporations react to economic incentives.

Obamacare Projected Costs Increase by $115 Billion; Wipe Out Alleged Savings

The hard light of reality has finally wiped out all the alleged cost savings from the healthcare bill.  The Congressional Budget Office has identified $115 billion in additional costs in administration and other areas.  As reported by ABC:


"The director of the Congressional Budget Office said Tuesday that the health care reform legislation would cost, over the next ten years, $115 billion more than previously thought, bringing the total cost to more than $1 trillion.
The revised figure is due to estimated costs to federal agencies to implement the new health care reform bill – such as administrative expenses for the Internal Revenue Services and the Department of Health and Human Services -- and the costs for a "variety of grant and other program spending for which specified funding levels for one or more years are provided in the act."
CBO had originally estimated that the health care reform bill would result in a net reduction in federal deficits of $143 billion from 2010-2019; this revised number would eliminate most of that savings"