Towards a More Competitive Mobile Payment Industry: Standardization And Beyond

Abstract

Mobile payments are becoming increasingly popular around the world. In countries like China, they appear in the form of barcode payments and are poised to replace cash and bank card payments for day-to-day consumer purchases. Against that backdrop, this paper analyzes the availability of barcode standardization as an approach to interoperability and ultimately to enhanced competition in the mobile payment industry. It uses the Chinese industry as a study case, which features a duopoly structure and shifting competitive dynamics among three definable groups of market players. This paper confirms that standardization can enhance competition and argues that, in this case, a government-mandated standardization is preferable to a voluntary one because the latter is prone to financial market failures. Along this line, this paper makes three suggestions for furthering the barcode standardization. It also advises prudence and competitive neutrality for the financial regulator and calls for more active involvements of the competition and data protection authorities.

I. INTRODUCTION

In just a few years since 2014, cash and bank card payments have gone from being dominant to being increasingly obsolete in China. Now it is the age of mobile payments—more specifically, payments by scanning barcodes with smartphones. These barcodes usually take the form of Quick Response (QR) codes, a type of barcode featuring square black-and-white dot matrixes. They contain payer or payee data that is readable through a smartphone camera enabled by the payment apps. Each transactional entity on a given platform has a unique barcode. Barcode payments have become the most popular payment method for both online and offline purchases, thanks to the wide availability of mobile Internet and the near-ubiquity of smartphone ownerships.

The mobile payment revolution is led by Alipay and Wechat Pay. With more than 1 billion registered users each (as of 2019), they dominate the mobile payment industry in China and have become world leaders in fintech (“financial technology”).¹ Alipay is the product of Ant Financial, China’s biggest fintech firm and an affiliate of the e-commerce giant Alibaba. Wechat Pay belongs to the social media and gaming giant Tencent and is built in the omnipresent smartphone app Wechat. There is also a notable up-and-comer: QuickPass. It is operated by UnionPay, the only bankcard association in China, on behalf of its bank members.²

Both Alipay and Wechat Pay emerged as two-sided, nonbanking payment platforms. The People’s Bank of China (PBoC), which is the national financial regulatory authority,³ defined nonbanking payment platforms as those fulfilling two requirements: (1) providing online payment services such as Internet payment, mobile phone payment, landline phone payment, and digital TV payment and (2) having obtained a Payment Business Permit for providing the said services.⁴ The two sides of these platforms host consumers and merchants, respectively.⁵ Consumers pay merchants for their purchases through the platforms; they can also transfer money to each other there.

China initially adopted a loose regulatory framework on mobile payments. The intention was to encourage innovation and economic growth in this rather nascent industry.⁶ The loose regulations have proven to be instrumental for the industry’s flourish, compared with the failed mobile payment schemes in some other countries.⁷ But as the pioneers grow into titans, the industry is becoming increasingly concentrated. This calls for regulatory and antitrust attention. In August 2019, the PBoC issued the Fintech Development Plan (2019–2021).⁸ This Plan outlines the “development background, general requirements, key tasks, and guarantee measures” for fintech developments in these 3 years. One of the key tasks is to interconnect the barcode-based payment platforms,⁹ including, among others, Alipay, Wechat Pay, and QuickPass.

To interconnect these platforms means to standardize the payment barcodes. In that sense, the aim of this task is clearly to unlock compatible competition among platforms.¹⁰ To be sure, platforms may also compete on an incompatible basis by adopting closed ecosystems that tend to lock in users who practice single-homing.¹¹ There, platforms compete for a given user’s needs over time, rather than their needs at a particular point of time. In industrial organization literature, this is referred to as “life-cycle competition” or “competition for the market.”¹² However, as studies have found, incompatible competition is likely to become soft over time if the switching costs are significant, and it is likely to induce monopolization when there are network effects.¹³ Such consequences would be difficult to remedy ex post, considering the high barriers to large-scale entry.¹⁴ Therefore, compatible competition may be preferable to incompatible competition, as long as it is not more socially costly.¹⁵ This justifies the regulatory measure of using standardization to negate switching costs and ultimately to enhance competition.

Competition lawyers often exalt interoperability as the way forward for the digital economy, but not enough studies have been done as to how interoperability can or should be achieved in particular contexts. Not much antitrust attention has been paid to the mobile payment industry either. This paper contributes to filling these gaps by conducting a case analysis of the standardization approach to interoperability of payment platforms by the Chinese regulator. The background to this case is that the PBoC has not yet laid down a detailed plan for achieving the said interoperability. The technical aspect of it should be easy, as it boils down to a barcode standardization. The difficulty is to set the rules that will be industry reforming.¹⁶ Too feeble rules would not effectuate compatible competition, whereas too forceful ones might discourage innovation from the incumbents.¹⁷ A further complication is that some of the market players are state-owned commercial banks and one player assumes the dual role of competitor and network provider.¹⁸ This gives rise to concerns for competitive neutrality.

Since the barcode interconnection has been put on the policy agenda, this paper adopts a forward-looking, regulatory viewpoint and discusses the perils that the regulatory authority needs to resolve in the interoperability-building process. To that end, the remaining parts of the paper are structured as follows. Section 2 describes the business model and the regulatory framework of the mobile payment industry, particularly the PBoC decision to bring the nonbanking payment platforms into a quadripartite system. On that basis, Section 3 sheds light on the ensued changes in competitive dynamics. Based on the relevant literature, Section 4 discusses the benefits of barcode standardization and interoperability. It also explains why a voluntary approach to barcode interoperability is unreliable and the potential pitfalls for a mandated standardization approach. Section 5 envisages how the barcode standardization may unfold. It proposes additional measures that could help mitigate the anticompetitive risks posed by market and government forces alike. Section 6 concludes.

II. PUTTING MOBILE PAYMENT PLATFORMS IN A QUADRIPARTITE SYSTEM

Chinese mobile payment platforms used to enjoy loose financial regulations. That is not the case anymore. The PBoC has been tightening control over them to ensure financial security and stability. It is now in the process of reforming the landscape of the barcode payment business, as it once did with the bankcard industry: bringing the payment platforms into a quadripartite system.¹⁹ Such a system consists of four groups of entities: the merchants, the (merchant-)acquiring service providers, the (consumer account-)issuing service providers, and the clearing organizations. To be clear, establishing a centralized four-party system is not a necessary condition for achieving interoperability among the mobile payment service providers; rather, the PBoC is doing this mainly to strengthen regulatory supervision and to minimize financial risks that are particular to the burgeoning mobile payment industry.²⁰

A. Online and Offline Barcode Payments

Barcode payments take place in two scenarios, depending on whether the merchant in a payment transaction is online or offline. In the online scenario, a consumer purchases at a virtual establishment and then chooses an available payment platform to pay. If the purchase is made from a smartphone, the consumer will be directed to the chosen payment app, and therein authorizes the money transfer from their platform digital wallet, which may or may not be linked to their bank cards.²¹ If the purchase is made from a personal computer, a barcode will appear on the screen and the consumer can authorize the money transfer by scanning the code with the payment app on their smartphone.

In the offline scenario, the merchant has a physical presence, and the consumer can pay either by scanning the barcode displayed by the merchant or by showing the barcodes on their payment apps to the merchant’s barcode-scanning device.²² Compared with point-of-sale terminals and near-field communication (NFC) devices,²³ barcodes payments are less costly to set up and more accommodating of the varying transactional situations.²⁴ On that account, and thanks to the enhanced connectivity of mobile Internet and the near-ubiquity of smartphone ownerships, barcode payments have become the most popular mobile payment solution both in online and offline scenarios.²⁵

B. The Bankcard Model: Cooperative and Proprietary Networks

The quadripartite system that the PBoC wants to establish in the barcode payment industry is drawn from the bankcard industry. To understand it, we should take a look at the bankcard industry, where two types of payment processing networks coexist. They can be characterized as cooperative and proprietary networks.

In a cooperative bankcard network, a payment transaction involves four parties (besides the cardholder): the issuing bank, the network provider, the acquiring bank, and the merchant.²⁶ The issuing bank issues credit or debit cards to the cardholder, whereas the acquiring bank offers the merchant an account and a line of credit. After the cardholder makes a purchase, the merchant entrusts the acquiring bank to claim the payment from the issuing bank, who in turn collects from the cardholder. When the issuing bank pays the acquiring bank the due amount, it deducts an interchange fee from the sum. This interchange fee is set by the network provider. In addition, the acquiring bank may also charge a service fee before paying the merchant the remaining fund.²⁷ Visa, Mastercard, and UnionPay are examples of a cooperative bankcard network.

The same four parties appear in a proprietary network, but with a role overlap: the network provider acts as both the issuer and the acquirer and deals directly with the other two parties. For each transaction, the provider pays the merchant the value of the cardholder’s purchase, minus a provider’s fee.²⁸ The difference between a cooperative and a proprietary network is that the latter does not entail an interchange fee. American Express is an example of a proprietary network. It earns revenue by charging a merchant fee while rebating cardholders to incentivize more card spending, which in turn attracts more merchants.²⁹

QuickPass is a cooperative mobile payment platform. It is analogous to the traditional UnionPay card network, except the former is mobile based whereas the latter is card based. UnionPay launched and operates QuickPass. So far, the interbank clearing fees are UnionPay’s only revenue stream for operating QuickPass.³⁰

Alipay and Wechat Pay started as proprietary platforms. However, this is going to change with the forthcoming barcode standardization. When interoperable barcodes enable cross-platform payments, a clearing and settlement organization will be entrusted to process such payments, and consequently, proprietary platforms like Alipay and Wechat Pay will be reduced to the role of either an issuer or an acquirer in a wider cooperative system. In that sense, strictly speaking, they will no longer be “platforms” when handling payment transactions that cross service providers, because there, they are stripped off the clearing responsibilities and so lose the defining “acquirer-issuer” two-sidedness. To be clear, however, they will remain as two-sided proprietary platforms when processing within-provider payments, which fall outside the quadripartite system; besides, their platform origin will remain a determinant of their competitive behavior in the quadripartite system, irrespective of the cross- and within-provider scenarios.³¹ This role shift and its implications are further discussed in Section 3.

C. The Merchant Acquiring Business

Merchant acquiring is a profitable business. On the one hand, merchants demand bank accounts for accepting payments in card-based transactions.³² On the other hand, banks are incentivized to supply, because merchant accounts bring revenue in both cooperative and proprietary networks.³³ Naturally, banks market their merchant account services. They contract third-party entities to do this when it is more cost-effective to do so.³⁴ These entities are referred to as “independent sales organizations” (ISOs).³⁵ Overall, four parties are involved in the operationalization of a merchant bank account: the acquired merchant, the acquiring bank, an ISO, and the network provider (namely the clearing organization).

For mobile payment platforms, merchant acquiring is a two-party or three-party business, involving merchants, the platform, and—in a growing number of cases—ISOs. The increasing reliance on ISOs is strategic: mobile payment platforms are motivated to expand as much as possible to payment scenarios that are traditionally dominated by cash and cards,³⁶ but they have limited capacity to do so on their own. This is why both Alipay and Wechat Pay have dedicated policies to support merchant acquiring by ISOs. For example, Alipay’s Blue Sea Initiative offers fee discounts to merchants in the food industry that are signed up by ISOs; it also rewards ISOs that provide continued assistance to the merchants they have signed.³⁷ Similarly, Wechat Pay had the Oasis Plan, which offered incentive programs to ISOs and their acquired merchants.³⁸

Notably, compared with Alipay, Wechat Pay is more dependent on ISOs to sign up merchants. This is attributable to their different competitive edges: Alipay is integrated into Alibaba’s sophisticated e-commerce ecosystem and so benefits from a strong online merchant base; meanwhile, Wechat Pay is endowed with an unparalleled number of consumer users, thanks to Wechat’s ubiquity as a social media app in China.³⁹ The vast consumer potential has prompted Wechat Pay to move aggressively in acquiring offline merchants ever since barcode payments first took off. Wechat Pay does so by contracting a mass of licensed ISOs consisting of banks and marginal rival platforms. These ISOs often outsource the sales to unlicensed regional agents. It was reported that outsourced sales accounted for 90 percent of Wechat Pay’s merchant sign-ups.⁴⁰

D. The Quadripartite System for Payment Processing

As described in Section 2.2., traditionally a payment transaction involves four parties: the issuer, the network provider, the acquirer, and the merchant. When a consumer makes a purchase, a debt arises between the issuer and the acquirer, and it is the network provider’s task to settle that debt under the supervision of regulatory authorities.

However, that was not the case when barcode payments first started. For quite some time, Alipay and Wechat Pay operated in a tripartite “direct link” model, with the role of a clearing and settlement organization missing. It works like this: on the one hand, the two platforms hold accounts in a bank, and on the other hand, they require their (consumer and merchant) users, upon registration, to link at least one of their bank accounts to their platform accounts. Therefore, when a consumer pays through a given platform, the payment sum will be transferred from a particular bank account of the consumer to the platform’s account at the same bank; meanwhile, the platform pays the merchant a value equal to the payment sum (minus service fees) from an account at the bank where the merchant holds its payment receiving account. The payment transaction is complete when both transfers are made. In this model, no cross-bank transactions are made, so there is no room for a clearing and settlement organization.

The situation changed in August 2017, when the PBoC issued a Notice requiring all nonbanking payment service providers to relocate their online payment business to NetsUnion before June 30, 2018.⁴¹ In December 2017, the PBoC issued another Notice, requiring nonbanking service providers to relocate their offline payment business to “the inter-bank clearing system of the PBoC or a clearing organization with legal qualifications.”⁴² It is implied in this Notice that the clearing organization for offline payments is UnionPay.⁴³ These two policy documents instituted a quadripartite system for mobile payments. Accordingly, there is no more direct link between nonbanking payment platforms and banks; a payment sum has to go through a clearing organization (NetsUnion or UnionPay) before arriving at the payee’s bank account. Thus, Alipay and Wechat Pay are, to a large extent, stripped off the clearing responsibilities they have been assuming de facto. The policy objective was to eliminate the systemic financial risk ensued from nonbanking payment service providers acting as clearinghouses.

Notably, this quadripartite system governs only payment transactions that involve a bank platform “crossover.” It does not apply to transactions in which the consumer pays out of their platform digital wallet and the merchant keeps the received funds in their platform account, nor does it apply to transactions between two merchant accounts on the same platform. Importantly, a consumer/merchant can be dissuaded from moving funds outside a platform, and Alipay and Wechat Pay, being the two-sided platforms that they fundamentally are, have been striving for that. Their main strategy is to advance their financial ecosystems that cater to users’ diverse needs for financial products related to payments and fund management. For example, they (especially Alipay) provide built-in financial services including interest-bearing accounts (for example, Yu’e Bao, which is Alipay’s money market fund program), stock investment brokerages, virtual credit cards, and online lending.⁴⁴ It was reported that transactions between these interest-bearing accounts have taken up 70 percent of Alipay’s payment processing business.⁴⁵

With the quadripartite system being established, the dynamics among the various market players become more definable. The following Section looks at these dynamics, with a focus on their competitive implications.

III. COMPETITIVE DYNAMICS AMONG PAYMENT SERVICE PROVIDERS

A. The Duopolistic Platforms

As mentioned in Section 2.3., Alipay and Wechat Pay have different strengths as the duopolistic incumbents: Alipay dominates online payment transactions, thanks to Alibaba’s advanced e-commerce ecosystem and large online merchant base. Meanwhile, Wechat Pay has a stronger presence in offline payment transactions, because of Wechat’s wild popularity as a social media app among consumers.⁴⁶ It was estimated that, in the roughly defined Chinese mobile payment market, Alipay and Wechat Pay had respectively a 53.76 and 38.95 percent share in the first quarter of 2018, with none of their rivals having a share above 2 percent.⁴⁷ In the first quarter of 2019, their market shares maintained steadily as 53.21 and 39.44 percent, respectively.⁴⁸ The duopoly structure remains strong.

However, the PBoC’s decision to standardize barcodes will make entrenching the duopoly more difficult. First and foremost, it intensifies competition between Alipay and Wechat Pay by destabilizing their user bases. After barcodes become interoperable, competition among mobile payment platforms will revolve around attracting merchant users.⁴⁹ This can be explained as follows. To start with, the interoperability entails that a merchant will need only one barcode account from whichever platform to receive payments. Thus, multihoming becomes rather costly for merchants, considering the fees they have to pay to each acquiring platform and ISO.⁵⁰ In comparison, it has always been cheaper for consumers to multihome, as the costs consist of mostly the downloading of different apps and the account registration on those apps. In that sense, generally, consumers have a more elastic demand than merchants. This means it is more cost-effective for payment platforms—who want to attract merchants and consumers alike to boost within-platform payment transactions and the sales of complementary financial products—to build a strong merchant base first and then attract consumer users through indirect network effects, but not the other way around.⁵¹ The practical implication is that the barcode standardization poses a bigger threat to Wechat Pay, who has been more dependent on consumer users than Alipay.

Besides gearing the duopolistic dynamic towards intensified rivalry, the upcoming barcode interoperability also brings external competitive threats. It is most likely to mitigate the two platforms’ incumbency advantages, as it will significantly reduce user switching costs and consequently barriers to entry and expansion.⁵² Among the existing rivals, QuickPass appears as a promising contender.⁵³ Potential entrants are also lining up. For example, in December 2019, PayPal completed its acquisition of Gopay, a licensed Chinese online payment service provider, making it the first foreign player in the Chinese mobile payment business.⁵⁴ It remains to be seen whether these contenders will make a difference.

B. Changing Roles of the ISOs

Besides having a weaker merchant base than Alipay, Wechat Pay will also have to face new competitive challenges brought by the barcode standardization. Namely, as interoperable barcodes become available and a clearing organization is set up, the must-have value of Alipay and Wechat Pay merchant accounts will dissolve. Consequently, for cross-provider payment transactions, Alipay and Wechat Pay will be reduced to issuers/acquirers and lose their original two-sidedness, whereas the ISOs—which consist of commercial banks and marginal nonbanking payment service providers—will be elevated to an acquirer position capable of signing up merchants for themselves. This is a potential threat to the duopolistic incumbents since ISOs already have direct access to a large merchant base that the incumbent platforms do not have.⁵⁵

Unsurprisingly, Wechat Pay has been taking countermeasures to preserve its incumbency advantages, and the transitioning regulatory framework gives it some room for maneuver. In March 2019, the PBoC issued a Notice requiring all payment platforms to tighten their verification procedures when acquiring merchants.⁵⁶ The main purpose of this Notice is to combat money laundering. As described in Section 2.3., for quick market expansion, Wechat Pay has been relying heavily on ISOs, who then outsource the sales to unlicensed agents. In this outsourcing model, verifications of merchant business authenticity were rather loose and illegitimate businesses could easily slip through. The PBoC Notice urged Wechat Pay to review its merchant acquiring business, but Wechat Pay took one step further: it used the PBoC Notice as a justification to re-register all the merchants acquired through ISOs, thus gaining direct control of these merchant accounts.⁵⁷ The underlying logic is simple: to disconnect the acquired merchants from the ISOs who signed them up, before the barcode standardization makes these ISOs competitors in the merchant acquiring business.

This Wechat Pay example indicates that, as the ISOs become competitive threats to the duopolistic platforms, they could alternatively be heading towards a dim future. Namely, there is a possibility that the duopolistic platforms could leverage their market power to monopolize the merchant acquiring business, marginalizing the ISOs into becoming upstream service providers that are functionally the same as those outsourced-to agents.⁵⁸ Consequently, the ISOs would no longer be “independent” and the duopolistic platforms would be able to entrench their incumbent positions. This necessitates the consideration of measures additional to the barcode standardization under the competition enhancement objective.

C. The Clearing Organizations

When instituting the quadripartite system for mobile payment processing, the PBoC designated UnionPay and NetsUnion to handle respectively offline and online payment clearing.

1. UnionPay and QuickPass

Although assuming the task of offline payment clearing, UnionPay also operates QuickPass, a mobile payment platform that competes directly with Alipay and Wechat Pay alike in both online and offline scenarios.

Before UnionPay rolled out QuickPass in 2017, each commercial bank was operating its own online banking app. This fragmentation greatly inhibited the banks’ competitiveness when Alipay and Wechat Pay ushered in the age of barcode payments. Now the banks are trying to catch up by joining forces at QuickPass. In that light, the competitive edge of QuickPass stems from UnionPay’s vast bank network.⁵⁹ Connecting almost all national and regional banks in China, QuickPass allows debit cardholders to check the balance and to transfer funds free of charge. It also serves as a window where users can apply for credit cards from the bank members and pay their credit card bills.

The intricacy is that, although banks are now putting aside their banking apps to promote QuickPass, they do not control it; UnionPay does. Therein lies the issue: the interests of UnionPay and its bank members are not fully aligned, nor are the interests of the bank members. It was reported that the reason why QuickPass was able to consolidate the fragmented bank platforms was that the PBoC endorsed it.⁶⁰ A day might come when some banks (especially the larger ones) want to opt out of QuickPass because it is no longer a cost-effective way to attract customers for their banking business. In other words, banks with sufficient resources and knowhow might want to launch their proprietary payment platforms—independent from and in competition with the cooperative QuickPass platform. When that happens, the foundation of QuickPass (which is UnionPay’s uniting of commercial banks to compete with Alipay and Wechat Pay) will be undermined, and it is questionable whether UnionPay will stay committed to QuickPass when the bank members no longer do, since it assumes the parallel and more essential responsibility of payment clearing.

2. NetsUnion

As mentioned in Sections 2.2. and 3.2., the barcode standardization denotes the stripping off of clearing responsibilities from the proprietary platforms like Alipay and Wechat Pay, entailing a drastic role shifting for them: for cross-provider payment transactions, they will lose their original two-sidedness and be reduced to the role of an issuer/acquirer in a wider cooperative network centered by whoever that assumes of the clearing and settlement responsibility. The PBoC designated NetsUnion to be the clearing organization for online payment transactions, whereas UnionPay for offline transactions.⁶¹ All payment service providers are connected simultaneously to UnionPay and NetsUnion since they acquire both virtually and physically present merchants.

In this setting, a latent competitive dynamic comes into being between UnionPay and NetsUnion. This is because the current “turf” division between the two clearing organizations is not absolute, as merchants can and often do operate in both online and offline scenarios. As of 2019, UnionPay was reportedly ahead in payment clearing, with its business size five times larger than that of NetsUnion.⁶²

Furthermore, new competitors are looming as the domestic payment industry is gradually opening up to foreign companies. In 2018, the PBoC licensed American Express to build a yuan-denominated card clearing network in China; in February 2020, it approved Mastercard’s joint venture with NetsUnion to begin domestic bankcard clearing services as well.⁶³ It remains to be seen to what extent (if at all) foreign companies will be allowed to participate in the mobile payment-clearing business.

Last but not least, NetsUnion is incorporated, with six PBoC-affiliated entities holding the largest share (35 percent), whereas Alipay and Tencent each holding 10 percent. The remaining 45 percent shares are distributed among 36 nonbanking payment service providers.⁶⁴ Admittedly, the 10 percent shareholder positions may afford Alipay and Wechat Pay certain influences on NetsUnion, but that is unlikely to suffice for them to undermine the independent role that the PBoC has envisaged for NetsUnion. This is because, first, this PBoC-dominated shareholder structure was specifically designed to ensure that NetsUnion can act independently from the duopolistic companies.⁶⁵ In that regard, the PBoC has reliably drawn from its experience of establishing a neutral UnionPay against certain powerful commercial banks two decades ago. Second, the smaller payment companies can help as monitors: when they perceive competitive favoritism by NetsUnion towards the duopolistic companies, they can pressure the PBoC to intervene by choosing to withdraw from linking with NetsUnion.⁶⁶ The PBoC has everything to lose and nothing to gain from the faltering of NetsUnion.

To sum up this Section, competitive dynamics are shifting as the PBoC institutes an industry-wide quadripartite system for payment processing and proposes to make payment barcodes interoperable through standardization. On that basis, a question can be asked as to what extent (if at all) competition can be enhanced by these regulatory interventions. To reply, the following Section discusses the role of barcode standardization in attaining interoperability and thereby enhancing competition. It also discusses the potential pitfalls for such a regulatory approach.

D. BARCODE STANDARDIZATION AS A REGULATORY APPROACH TO ENHANCED COMPETITION

To be sure, China is not the only jurisdiction that is using regulatory measures to reshape mobile payment competition; nor is standardization the only regulatory measure to achieve that. For example, the German legislature recently enacted a Section 58a of the German Payment Service Supervisory Act, which is aimed at granting mobile payment service providers a right to access “technical infrastructure” such as Apple iOS’s NFC interface.⁶⁷ However, as discussed in Sections 2 and 3, the particularity of the Chinese case is that a duopoly is already there and that the PBoC aims at not only enhancing competition but also strengthening financial supervision. These are the backdrop to this Section’s analysis.

1. Competitive Benefits of Standardization

a. Stimulating Dynamic Competition

Dynamic competition can be understood as “a style of competition that relies on innovation to produce new products and processes and concomitant price reductions of substantial magnitude.”⁶⁸ Standards are advanced as a catalyst that can help sustain innovation in various ways.⁶⁹ Put simply, they can build the infrastructure that fosters “credibility, focus and critical mass in markets for new technologies” by establishing rigorous quality control and product compatibility.⁷⁰ Regarding quality control, the PBoC has vowed to reinforce payment security and convenience with the upcoming barcode standardization.⁷¹ Regarding product compatibility, it has become increasingly clear that interoperability is central to innovation in data-intensive industries.⁷² This has, for example, prompted European Union (EU) policymakers to adopt a broad range of initiatives to promote data sharing and portability.⁷³ Needless to say, it also underlies the Chinese policymakers’ decision to standardize barcodes.

The compatibility-enabling value of standardization lies in the reduction of transaction costs and the unleashing of network effects.⁷⁴ Firms seek interoperability because normally the more interconnected different producers are in a market, the greater the extent of the consumption externalities will be, which translates to an increase of scale economies.⁷⁵ Standardization saves the negotiation costs to reach bilateral agreements for the parties that want to establish interoperability with each other, and the transaction cost reduction attracts an increasing number of parties that seek interoperability to join the standard, which then feeds back to enhancing the standard. The same applies to the online banking industry, which features intensive data usage.⁷⁶

Admittedly, there is a potential risk of innovation inhibition if firms could be stuck to an inferior standard.⁷⁷ This concern stems from the fact that firms with market power are less willing to adopt a new standard because doing so would jeopardize its current position, even if the adoption is socially beneficial.⁷⁸ Farrell and Saloner (1985) terms as “excessive inertia” the inefficient situation of firms staying committed to an inferior standard over an available superior one. They find that, when firms hold diverging attitudes towards switching to a new standard because of their different market positions, the excessive inertia can be persistent, and communication of attitudes will only entrench the firms’ original (un) willingness to switch.⁷⁹ In that sense, standardization itself does not impede innovation, the abuse of market power does. The key is to disentangle the standardization process from the market power that actually does the impediment.⁸⁰

b. Lowering Switching Costs

As studies have found, the banking industry is generally characterized by significant switching costs.⁸¹ This shapes competition in profound ways. The idea is that, although the presence of (substantial) switching costs does not necessarily soften or harden competition,⁸² it sets competition to an incompatible mode,⁸³ and facilitates the locking-in of customers who do not multihome due to high costs.⁸⁴ There, firms will compete intensely at the initial stages of market development but become relaxed over time.⁸⁵ Particularly, in a duopolistic setting where the firms cannot discriminate between locked-in and new customers, incompatible price competition will entail higher overall prices, and the higher the switching costs, the less intense the duopolistic competition will be. This is because it is in a firm’s nature to exploit an inelastic customer base.⁸⁶

To be sure, we need more nuanced perspectives on incompatibility when customers can multihome,⁸⁷ but this does not automatically exonerate incompatibility. First, the fact remains that multihoming generates costs internalized by customers, which may not be ideal for social welfare in certain circumstances.⁸⁸ Besides, as the circumstances change, the costs can become too high for multihoming to remain a better option than single-homing, as explained in Section 3.1. Last but not least, multihoming among incompatible firms can make customers less responsive to price changes,⁸⁹ and even worse if they cannot effectively switch, which would lead them into the same situation as their locked-in single-homing counterparts. These observations apply to two-sided platform markets, which often feature multihoming on at least one side.⁹⁰ Nonetheless, platform markets are slightly more complex, considering, among other factors, that one side’s homing habit affects the behavior of not only the platform firm but also the other side of customers.⁹¹ Thus, a more context-specific analysis is warranted.

In that light, compatible competition may be more desirable than incompatible competition, “when choosing compatibility would be no more costly.”⁹² By the same token, switching costs should be reduced whenever possible.⁹³ This would increase economies of scale and scope, the benefit of which is further amplified by the presence of network externalities.⁹⁴ An array of switching costs has been identified. They include, inter alia, learning costs, transactional costs, contractual costs, search costs, uncertainty costs, compatibility costs, and shopping costs.⁹⁵

The barcode standardization can lower to a certain extent the switching costs for payment platform users. It will bring two immediate changes: a consumer can choose to pay through whichever payment platform and realistically expect being accepted by a merchant; meanwhile, a merchant will need only one barcode account from whichever platform. Consequently, learning costs are reduced because platforms will be providing barcodes based on the same sets of technical standards, so are uncertainty costs, because a user can rely fairly on the common standards and other user reviews to evaluate the merits of an alternative platform with which they have had no prior experience.

Admittedly, however, some switching costs will persist, and they are mostly for merchants. This is because the barcode standardization only makes payment transactions interoperable and does not disrupt the merchant acquiring business. As mentioned in Section 3.1., the standardization will enable platforms competition to revolve around merchants, because merchants will become more likely to single-home and a strong merchant base attracts consumers through indirect network effects. This gives rise to an antitrust concern: platforms might strategically raise transactional costs and compatibility costs to lock in merchants.⁹⁶ Transactional costs are present because of merchants’ single-homing habit. A merchant that closes its account at platform A and switches to platform B would have to restart the account-opening process if they wish to switch back to platform A. Compatibility costs are becoming increasingly significant as platforms expand their fintech ecosystems. For example, Alipay provides online lending to both merchants and consumers, and it uses payment transaction data to generate their credit scores,⁹⁷ so switching platforms will entail high costs if the payment transaction data is not portable. Standardization is inadequate and perhaps ill-suited to address these switching costs. A better solution would be to rely on rigorous antitrust enforcement, which intervenes ex post when the dominant merchant–acquirers leverage their market power to raise switching costs.

2. Why Voluntary Interoperability of Payment Barcodes is Unattainable

a. Voluntary Versus Mandated Standardization

Industry-wide standardization can be achieved through a bottom-up approach—namely, standardization initiated by private collective action and through standard-setting organizations.⁹⁸ A recent example is the Data Transfer Project, jointly launched by Microsoft, Google, Twitter, and Facebook to facilitate user data transferring.⁹⁹ Factors prompting firms’ standardization efforts include, among others, market access, knowledge seeking, technical problem solving, and the desire to induce industry-friendly regulations, according to an empirical study of the Germany electrical engineering and machinery industry.¹⁰⁰

There is also the top-down approach, where governments take the initiative. Here, two types of measures can be further distinguished: soft measures, such as recommendations and sharing of best practices, and hard measures, which entails the adoption of general or industry-specific regulations that mandate standardization.¹⁰¹ It has been suggested that, when the industry at issue is still at the “emergence” phase, soft measures may be more desirable.¹⁰²

The PBoC’s barcode standardization initiative is more on the hard measure side, as the stakeholders are participating on a mandated rather than a voluntary basis. Here, hard measures may be more adequate than soft ones for fostering competition, considering the possible misalignment of undertakings’ private interests with the competition policy goals.¹⁰³ Nonetheless, even with hard measures, it is indispensable that the relevant private parties enter into negotiations (with each other and with the PBoC) and reach some kind of consensus;¹⁰⁴ otherwise, an efficacious and innovation-stimulating standard may not come into being.¹⁰⁵ This could be a protracted process.¹⁰⁶ In that sense, the pursuit of compatible competition has costs, which may or may not be greater than those of incompatible competition.¹⁰⁷

b. Hurdles for Voluntary Efforts to Interoperability

It was found that firms are more likely to agree on making their products compatible with each other (so as to reap the ensued consumption externalities) when their customer bases do not differ significantly in size.¹⁰⁸ They can achieve compatibility by entrusting a private standard-setting organization or through standards competition.¹⁰⁹ Nonetheless, these approaches may not be applicable here for two reasons. First, when a firm becomes as dominant as Alipay and Wechat Pay, it is more likely to be disincentivized to adopt a new compatibility standard, as this would jeopardize its position in a market characterized by strong network effects.¹¹⁰ Even if such disincentives were somehow neutralized, inefficient situations—such as fragmented standards and standard wars—might still rise, as a result of the firms’ diverging interests.¹¹¹ Moreover, as the study has found, companies can be wary of sharing data when their competition and ownership concerns regarding data usage are inadequately addressed by law; on top of that, the more data-intensive an industry (such as online banking) is, the more technically challenging it is to implement data sharing.¹¹²

Second and more specifically to the barcode payment industry, voluntary initiatives entail higher risks of consumer fraud. Here, voluntary interoperability is not so much unavailable as hazardous. There have been market demands for payment platform interoperability, and some firms have already responded to the market demands and started providing complementary interconnection services. They are the so-called “aggregation service providers.” They use the readily available standardization technologies and sell to merchants’ barcode-scanning devices and payment-receiving barcodes that simultaneously support and automatically distinguish the payment accounts from different platforms.

It is crucial to note that these aggregation agents are not licensed to play any part in the payment processing system. They are not even licensed ISOs.¹¹³ Functionally similar to a directory, they are supposed to direct the payer to the relevant platform where the payment actually takes place. Therefore, it became a financial hazard that many of these profit-seeking agents mutated: they began masquerading as merchants, opening accounts on each payment platform, and cumulating the received payments before distributing the due funds to the real merchant payees. This constituted a second-round, unauthorized payment clearing, and the risk of capital chain rupture was alarmingly high since these agents were unlicensed. Unsurprisingly, the PBoC stepped in. It decided to prohibit these agents from participating in payment processing,¹¹⁴ and proposed to achieve payment platform interoperability through an official barcode standardization process.

To a certain extent, this aggregation service resembles the “converters” path to compatibility identified by Farrell and Simcoe (2012).¹¹⁵ As they described, this path is the more flexible alternative to industry-wide standardization.¹¹⁶ The idea is that, in certain settings, a firm that desires compatibility with a “closed” system or platform may be able to link up to that platform without the latter’s active cooperation.¹¹⁷ It is comparable with people using travel adapters and converters to charge their electronics when traveling to countries that have adopted different electricity plug and voltage standards. The fact that the link-up happens on a unilateral basis means that such “converters” initiatives are market driven. In that sense, they may be susceptible to market failures caused by the presence of market power and principal-agent problems. Namely, the aggregators’ profit-seeking incentives are possibly in conflict with (1) the self-preserving, interoperability-inhibiting incentives of the dominant payment service providers and (2) the demand for timely and secure payment collection of merchants. These incentive misalignments are, coupled with information asymmetries between the parties, responsible for causing market failures such as the aforementioned high-risk second-round payment clearing. Here, the imperative need for financial security means a low tolerance for such market failures. For that reason, the market-driven aggregation service is unsustainable as an approach to interoperability.

3. Pitfalls for a PBoC-Led Standardization

Now that a government-mandated approach to payment platform interoperability seems appropriate, questions arise as to how it should proceed. Considering the duopoly structure and the finding that firms are less likely to pursue compatibility as their market power grows,¹¹⁸ one can expect a government-imposed standardization to be met with strong (but perhaps subtle) resistance from the dominant firms.¹¹⁹ This adds complexity to the PBoC-led barcode standardization, in the sense that the PBoC needs to tread a fine line between two pitfalls: on the one hand, a forceful and ill-contrived standardization scheme is likely to chill dynamic competition,¹²⁰ and on the other hand, a standardization scheme that is too deferential to the existing duopoly runs the risk of being superfluous or even preferential to the incumbents.¹²¹

First, standardization may inhibit innovation if product variety is vital to the latter.¹²² To be sure, however, the variety-reducing effect of standardization is “inextricably linked” to its innovation-stimulating effect, in the sense that there is an inherent trade-off between the constraints on certain aspects of choice and the innovation “infrastructure” function that standards perform.¹²³ Different standards are likely to fall at different points on a continuum with respect to their overall effects. For example, a food quality standard is more on the constraining side, whereas a 5G telecommunication standard is more of an infrastructure project as it codifies and diffuses knowledge.¹²⁴ Therefore, a more contextualized approach is needed to assess the innovation-inhibiting effect of standardization.¹²⁵ In addition, in specific circumstances, standardization is desirable, but mandating a singular standard may give rise to the problem of free riding on rivals’ innovation efforts. For this, dual standards could be a solution.¹²⁶

Second, the standardization may present an opportunity for the incumbent firms to entrench their positions. To be sure, the establishing of a standard (which contains proprietary patents) does not necessarily confer market power on the relevant proprietor,¹²⁷ but from a public choice perspective, a government-imposed standard can be misled to competition distortion.¹²⁸ In our case, such a concern stems from the fact that, with the industry innovation at stake, the PBoC cannot impose an efficacious standard without a high level of consensus from the active market players—most importantly from Alipay and Wechat.¹²⁹

In that light, attention should be paid to the standard-setting process, where negotiations take place regarding the technical aspects of the barcode standard. There, heightened antitrust scrutiny is warranted for two reasons. First, when side payments are available, firms may pay each other to agree to preferential standards, which ultimately undermines consumer welfare.¹³⁰ In this case, side payments may indeed be available because many marginal payment service providers have business relationships with the duopolistic firms on the merchant-acquiring front.¹³¹ Second, when there is information asymmetry between them and the PBoC, firms may exploit it and steer the standard setting towards where it has proprietary claims such as patent rights.¹³²

Also, the PBoC must adhere to the principle of competitive neutrality,¹³³ which is upheld by the Fair Competition Review Mechanism. In 2016, the Chinese State Council promulgated a policy document titled “Opinion on Establishing a Fair Competition Review System during the Development of Market-oriented Systems.”¹³⁴ This policy is intended to safeguard market competition by delineating the boundaries of governmental intervention in market supervision. It does so by introducing a requirement upon the governmental agencies at all levels to self-evaluate ex ante their abstract administrative measures for their potential to interfere with market competition. In 2017, five subordinate agencies of the State Council issued a joint Notice, laying down the procedures and criteria for the self-evaluation.¹³⁵ Admittedly, this policy currently lacks a coherent implementation framework and relies mostly on agency self-restraints,¹³⁶ but there is no reason why the PBoC should be excused from it. Besides, this policy corresponds to Article 37 of the Chinese Anti-Monopoly Law (AML), which states that “Administrative organs may not abuse their administrative power to formulate regulations with the contents of eliminating or restricting competition.”¹³⁷ Financial regulators are in no way immune from the AML application.

In any event, using standardization to enhance competition is an intricate project. Thus, the engagement of the PBoC alone may not be adequate, even if it were able to circumvent the aforementioned pitfalls. In that light, the following Section points to three measures that can assist and further the barcode standardization.

V. ADDITIONAL MEASURES TO ENHANCE COMPETITION

1. Unlocking Merchant Account Portability

The barcode standardization enables payment platform interoperability, but in that regard, there is a limit to how much it can enhance compatible competition. Namely, the fact that poststandardization competition will revolve around acquiring merchants means there is still a risk of dominant platforms leveraging their market power to lock in users.

It is important to note as a background that the acquirer service fee¹³⁸ is not the only source of revenue for most of the payment platforms, as they also offer financial products of interest-bearing savings and online lending in their respective financial ecosystems.¹³⁹ The same is true for ISOs: they earn commission fees for acquiring merchants, but more importantly, they earn revenue by providing value-added services to both merchants and acquirers. For example, they offer restaurant merchants software support regarding customer queue management and digital invoice formation; they also help payment platforms sell financial products.¹⁴⁰ These revenue models shape how the payment platforms behave in competition.

The tightening financial regulation also has an impact on the platforms’ competitive behavior. The PBoC prohibits direct links between nonbanking payment platforms and banks.¹⁴¹ It also requires all payment platforms to deposit the “clients’ reserves” in full amount to special reserve accounts opened at the PBoC.¹⁴² These regulatory measures effectively remove the interest-generating “clients’ reserves” as a source of revenue for the platforms. The implication is that the payment processing business or the merchant acquiring business alone delivers meager returns; instead, payment platforms must explore economies of scope. This is an extra incentive for them to lock in users.

In light of the above, it is worth discussing how soon, if at all, the PBoC should promote the next level of interoperability—the portability of merchant accounts. This would help neutralize the risk of users being locked in. The key to such portability is merchants being able to claim the control of their historical transactional data. To that end, the authority must address the issue of user-related data ownership, including the conditions under which the platforms can sell access to (presumably anonymized) user-generated data to third parties.¹⁴³ There are two alternative approaches to addressing this issue: (1) legislatively defining a general data portability right that is applicable to merchants and (2) regulatorily addressing merchant data portability on an industry-specific basis.¹⁴⁴

To be sure, differential treatment of merchant data and consumer data is warranted, because most merchants are companies whereas consumers are natural persons, and therein lies a distinction of personal and nonpersonal data.¹⁴⁵ Data protection laws are understandably less restrictive with respect to nonpersonal data since its free flow is vital to the digital economy.¹⁴⁶ On the minus side, however, a less restrictive legal stance means companies have a weaker claim of data portability compared with consumers.¹⁴⁷ Therefore, a general approach to establish merchant account portability could be challenging.¹⁴⁸ Besides, it was suggested that the social costs of such a general approach could be prohibitive.¹⁴⁹ China has been continuously adopting laws and regulations on data protection,¹⁵⁰ but nonpersonal data portability has not yet entered the legislative horizon. In that light, an industry-specific approach led by the PBoC appears to be more promising for addressing merchant account portability.

One option for the PBoC is to revise the Measures for the Non-Banking Online Payment Business.¹⁵¹ Article 28 of the Measures confers on payment platforms the obligation to provide, free of charge, merchant customers access to their transactional information for at least the past year, whereas Article 29 upholds customers’ freedom to choose payment service providers. On these bases, a revision could be made to allow merchant customers to store and reproduce information unchanged on a different platform free of charge. Alternatively, it could allow, upon request, direct transmission of account data from one platform to another for a reasonable fee.¹⁵² This approach to account portability has been carried out, for example, by the EU in the revised Payment Services Directive.¹⁵³ Under Article 58 of this Directive, a payee could transport transactional data, provided that the payee’s payment service provider opted in for such an information-sharing obligation or that a Member State imposed such an obligation.

2. Enabling Networks Competition

The barcode standardization plan stops at making payment platforms interoperable. It keeps intact the division of labor between UnionPay and NetsUnion. After the barcode standardization is complete, they will function de facto as two network providers in the mobile payment industry: UnionPay handles offline payment clearing whereas NetsUnion online payment clearing.¹⁵⁴

This paper suggests that a further step can be taken to remove this online–offline division. This would greatly enhance compatible competition in a poststandardization landscape, where a quasi-cooperative network emerges and payment service providers act as issuers and acquirers. This suggestion hinges on the prediction that competition among these service providers will gravitate towards the merchant acquiring business.¹⁵⁵ A division between online and offline payment transactions is analogous to a market-sharing agreement when it has no regulatory justifications. In contrast, if a merchant could choose the network through which they collect payments from consumers, networks would compete with one another by lowering their clearing service fees as well as the interchange fees.¹⁵⁶

Of course, to sustain the internetwork competition, regulatory and antitrust rules should be in place to ensure that all payment service providers actively participate in both networks. This is to guarantee merchants’ ability to choose between the networks, just as standardized barcodes guarantee consumers’ ability to choose among the service providers (by enabling the counterparty merchant to accept whichever payment method chosen by a consumer).

An alternative is to relocate the offline clearing responsibility from UnionPay to NetsUnion. What prompts this relocation is that, while performing the essential clearing and settlement function for all the competing service providers, UnionPay also owns one of them (QuickPass). The concern is that UnionPay may be motivated to distort competition, by, for instance, setting discriminatory rules on interchange fees to favor the vertically integrated QuickPass.¹⁵⁷

3. Vigilant Antitrust Oversight

The barcode standardization will be an intricate and time-consuming process, considering the structural changes it sets out to achieve and the diverging interests of the stakeholders.¹⁵⁸ In this case, a mandated regulatory approach is well-suited for attaining interoperability. However, this does not mean competition law authorities should be sidelined.¹⁵⁹ Rather, they can play a watchdog role against anticompetitive practices that may take place during and after the standardization process. There are two aspects to this role.

The first aspect is rigorous antitrust enforcement against private anticompetitive practices. As exemplified in Section 3.2., the incumbent payment platforms may attempt to neutralize competitive threats by monopolizing complementary markets. Also, as explained in Sections 4.1.1. and 4.1.2., the duopoly structure gives rise to monopolization risks of dominant payment platforms leveraging their market power to undermine barcode interoperability and to lock in users. In these regards, two (conceptual) categories of unilateral conduct deserve special attention: refusal to deal/license and exclusive dealing.

When the dominant platforms hold sway with respect to the standard setting, they may be able to add in the standard elements that are covered by patent protection or incumbency advantages.¹⁶⁰ This would create a bottleneck situation where the dominant firms can use their proprietary claims to raise rivals’ costs in seeking interoperability.¹⁶¹ Approaching this problem from an antitrust perspective, the principle of proportionality has gained traction. It is poised as a less intrusive approach to data sharing and compatibility, compared with the rather controversial essential facility doctrine.¹⁶²

Besides, after a standard has been established, the dominant platforms may be able to undermine interoperability by locking in merchant users.¹⁶³ This calls for rigorous market monitoring and antitrust enforcement. Particularly, heightened scrutiny should be in place for exclusive dealing conditions and exclusivity rebate schemes imposed on merchants by the duopolistic payment platforms. To be sure, however, the proscriptive and ex post nature of antitrust enforcement means it may not always be able to offer timely remedies for the lock-in problem.¹⁶⁴

The second aspect of the watchdog role is advocacy for competitive neutrality before the policymakers. It was the PBoC who put the barcode standardization on the policy agenda, but interagency consultation is much needed on this matter because the aim and the expected outcome of this initiative extend far beyond the scope of financial regulation. The barcode standardization entails major structural changes for the mobile payment industry, and what is at stake is the dynamic competition in this vibrant industry and fintech in general. In that light, the PBoC must adopt a prudent and competition-neutral approach, to which the State Administration for Market Regulation (the SAMR), the Chinese competition authority, could provide valuable contributions.

The SAMR is the public enforcer of the AML, which is undergoing a legislative revision after being in force for almost 12 years. At the start of 2020, the SAMR released a draft revision of the AML, soliciting revision advice from the public.¹⁶⁵ This draft proposes to assess business market power in a more robust way that takes into account network externalities, lock-in effects, data control of platform firms in the Internet sector; it also proposes to increase significantly the punishment thresholds for law infringements. Most relevantly here, it urges government agencies to adopt measures implementing the Fair Competition Review Mechanism.¹⁶⁶ These propositions address some issues that have long been troubling the AML enforcement,¹⁶⁷ and in that sense, are plausible for placing the AML and the SAMR to a more pivotal role in progressing the nation’s market-oriented economy.

VI. CONCLUSIONS

Although still thriving, the Chinese mobile payment industry is undergoing major structural changes, as the central financial regulator (the PBoC) tightens supervision. The most profound changes are the establishment of a quadripartite payment processing system and the (upcoming) standardization of payment barcodes. The former was aimed at strengthening regulatory supervision on this burgeoning industry, whereas the latter is set out to enhance competition among the payment service providers.

The barcode standardization will make mobile payment platforms interoperable. In that sense, it will be a game changer that reshapes the industry’s competitive dynamics. The key point is that competition will gravitate towards attracting merchant users because they tend to single-home. The different parties—including the payment service providers (the acquirers), the ISOs, and the clearing organizations—will be competing on the one hand and cooperating on the other. Competition is likely to intensify between the duopolistic platforms—Alipay and Wechat Pay, as interoperable barcodes will destabilize their user bases. Meanwhile, smaller competitors are expecting from the barcode standardization an opportunity to expand.

From a theoretical viewpoint, it is possible for standardization to contribute to (compatible) competition in given circumstances. First, standardization may promote dynamic competition by establishing quality control and enabling compatibility. Second, it may intensify static competition by reducing user switching costs; thus, increasing economies of scale and scope along with network externalities. Notably, however, in the case of payment barcodes, a voluntary approach to interoperability is unreliable because it is prone to financial risks. This provides grounds for a regulator-mandated standardization. In that regard, the regulator needs to pay attention to the standard-setting process and tread a fine line between preserving innovation and avoiding regulatory capture.

To the end of enhanced (compatible) competition in the mobile payment industry, measures additional to the barcode standardization should be taken. This paper has three suggestions in that regard: unlocking the portability of merchant platform accounts, removing the division of labor between the two clearing organizations, and robust competition law enforcement and participation in the policymaking. Overall, there should be a bigger role for competition and data protection authorities alongside the financial regulator in shaping a competitive and innovative mobile payment industry.

Footnotes