Explaining the Interplay Between Merchant Acceptance and Consumer Adoption in Two-Sided Markets for Payment Methods

Recent consumer and merchant surveys show a decrease in the use of cash at point-of-sale (POS). Increasingly, consumers and merchants have access to a growing array of payment innovations as substitutes for cash. The market for payments is two-sided, meaning that a method of payment can be used only if both consumers and merchants adopt/accept it. This paper develops a model to assess how innovations affect consumers’ adoption and merchants’ acceptance of various payment instruments, and their usage patterns at the POS.

We model this interdependence in two stages. First, consumers and merchants decide on which methods of payment to adopt and accept, respectively. Second, consumers and merchants meet at the POS, and the consumer chooses their preferred method of payment given what the merchant accepts. Estimates from our model suggest that both sides of the market can benefit from accepting all means of payment. Further, our model predicts that merchants are much more sensitive to an increase in their payment costs than consumers.

We use our model to predict what would happen under three scenarios. First, increasing merchants’ cost of using credit cards would significantly reduce merchant acceptance of this payment instrument in favour of debit. Second, the cost of using cash would have to increase substantially on both sides of the market for cash usage to fall below 1 percent of transaction volume. Finally, even if all consumers/merchants adopted/accepted all methods of payment, cash would fall but would remain at 20 percent of transaction volume. These findings suggest a completely cashless society is unlikely in the foreseeable future.