Electronic commerce revisited.

• Author: Scott, Kenneth E.
• Position: Baxter Symposium

In 1977 William F. Baxter, Paul H. Cootner, and Kenneth E. Scott co-authored a book predicting the development of competitive networks of point of sale terminals and the significant growth of credit and debit cards which would displace the use of cash and checks. In this article, Professor Kenneth E. Scott reviews these forecasts and finds legal developments have hampered the formation of competitive networks. In terms of payment systems, debit card use has not yet grown as much as predicted while the use of cash has remained relatively stable and the use of checks has declined. By contrast, credit card use has doubled over the past twenty years.

While Bill has had a very extensive practice in the area of electronic commerce, he has published only a few academic works--albeit substantial ones.

Electronic commerce in the sense I am using it is rather distinct from its contemporary meaning of all business transactions done over the Internet. Bill's publications have, more strictly, dealt with payments systems. But the U.S. payments system is not a minor or inconsequential business. In 1997 it comprised an estimated 650 billion payments, worth approximately $22 trillion.(1) Commerce over the Internet represented only 1/2 of 1% of all retail purchases, although it is expected to grow rapidly.(2) The revenues derived from the payments system were about $115 billion, shared among banks, third-party service providers, and technology vendors.(3) And revenues aside, the sheer volume of transactions makes the efficiency of the system important to the smooth functioning of the economy.

Bill's first contribution in this area was the outgrowth of a study project that he, the late Paul Cootner, and I undertook in 1975 for Citicorp which resulted in a book on electronic funds transfer.(4) Following that book in 1983, Bill authored a related law review article on the economics and history of the exchange and clearance of checks, credit card charges, and debit card charges.(5)

My focus will be on the book, which was an attempt to look forward from 1975 to the potential future of electronic payments systems in light of the economic forces and legal constraints affecting them as well as to offer some policy recommendations. In collaborating on the book, while of course we criticized each other's drafts, I wrote the portions on bank and consumer regulation, Paul did the models of bank and consumer costs and retail selling, and Bill was concerned with the economic and antitrust issues for ATM and point of sale (POS) networks. For this occasion, the latter will be my primary concern.

I.

The perspective of the book was that electronic funds transfer (EFT) issues had to be analyzed in terms of the existing competition among cash, checks, credit cards, and newly emerging debit cards, for consumer use in purchase payments, and how that competition would be affected by advancing technology that enabled immediate access over telephone lines to vast amounts of data on consumer accounts. In particular, technology was making feasible the creation of networks of POS terminals. Sitting on retail counters next to the cash register, these terminals were directly connected to banks that had previously issued the customer a credit card or held his deposit account. These networks were potentially going to reduce greatly the cost of transacting, for both the merchant and the customer as well as the bank. Networks would play an increasing role in the future payments system. Debit cards would experience significant growth, displacing cash and also checks.

A central issue of the book was whether these nets would develop as natural monopolies, to be regulated by the government like public utilities, or as rivalrous firms, regulated by market forces. An attempt to answer that question required, first, an estimation of the economies of scale in network operation and the demand for terminals. That involved a series of factual inquiries. At what size did the long run average cost curve for a network become nearly flat? At that scale, what would be the annual cost of a terminal? What would be the savings per transaction it would produce? What annual sales volume would be required to generate enough transaction savings to cover the terminal cost? How many retailers have annual sales sufficient to employ one or more terminals? How many terminals, under such conditions, might be installed in each state? How many efficient nets could that number of terminals sustain?

Obviously, all of those inquiries were answered on the basis of then available data and cost figures, and with the aid of assumptions intended to be conservative. To simplify, Bill's conclusion was that, for the nation as a whole, there could be from 2.5 to 5.5 million...