Debit or Credit?(Why “Model”

Consumer Payment Choice)

FRBBOS Retail Payments ConferenceJonathan Zinman

Dartmouth CollegeOctober 28, 2005

Primer:“Modeling” Consumer Choice

• Why social scientists “model” human behavior:– Get to essence/drivers of choices– Explain, and ultimately predict behavior– That’s why we’re here today!

Primer:“Modeling” Consumer Choice

• How we model:– Behavior very complex

• Hard to identify what causes what

– Our tools (math and statistics) have “bandwidth” limits

– So: we simplify by making assumptions• Makes problem tractable• Permits focus on what really matters

Primer:Empirical Social Science

1. Ask an interesting question– I.e., formulate a hypothesis

2. Build or modify a model that makes realistic simplifying assumptions

3. Find/collect/generate the right data for testing your model

4. Test it

My paper does not satisfy all 4 criteria!

Two Views of Consumer Choice and Payment Choice

#1. Homo economicus (“rational” man)– Recognizes when a choice needs to be made

(i.e.., no confusion)– Makes a choice (i.e., no procrastination)– Chooses based on:

• Stable preferences (i.e., I know what I want)• Full/adequate info (i.e.., know what I’m choosing)

– Sticks to choice (i.e.., no self-control problem)

View #1: Economic Model ofConsumer Payment Choice

• “Cost is king”:– Including implicit costs, not just fees, but:– Finance charges, foregone interest– Time/hassle costs

View #2: Psychological Modelof Consumer Payment Choice

• Homo consumaloticus (“psychological man”)– Lots of things drive payment choice– How I pay impacts how much I spend– In particular, credit leads me to spend more

• Perhaps more than I want to in more reflective moments

– Other payment media, including debit, help me control spending by helping me:

• “Feel the pain” (salience)• Track spending (mental accounting)

Psychological Model

• Thought experiment to show how this works:– Randomly assign debit cards to a pool of credit users– If “salience” dominates

• debit users’ overall spending will fall• debit used at times/places where temptation is greatest

– If “mental accounting”• debit users’ spending falls• payment choice varies systematically with what is being purchased

(conditional on transaction size, acceptance)

• This seems to be the conventional framework for explaining debit use (at least relative to credit)– Trade press– Popular press

What My Paper Does

• Test whether choice between debit and credit is consistent with economicus model– In coarse but nationally representative data

• Fairly convincingly rules out widespread indifference among payment choices

• Casts doubt on primacy of spend-control motives for choosing debit over credit

What Paper Does Not Do

• Nothing to say about choice mechanics– Not solving calculus….– Intuition– Rules-of-thumb?– Trial-and-error?

• Little to say about why debit has grown• Paper can not directly rule out spending-control motives

– Merely questions their importance

• Paper’s findings should not shift your prior beliefs– Only question them– Motivate you (bank/issuers) to give me data needed for direct

testing of psychologicus explanations

How Paper TestsEconomic Model: Data

• Survey of Consumer Finances (SCF)– Only nationally representative data, with decent

sample size, that knows anything about both debit and credit use

– But doesn’t know much• Do use debit regularly• Good measure of credit card holding• Decent measures of credit revolving and utilization• Nothing on rewards, cash back, acceptance, etc.• Nothing on transactions

– And only a snapshot• Most recent survey in 2001 (2004 out soon)

How Paper Tests Economic Model: Focus on Debit v Credit

• No data on cash or check use SCF• Debit and credit very similar re: most

attributes:– acceptance (at least by 2001)– portability– security– time at POS

• So can focus in on costs as driver of choice

Testing the Economic Model

3 key predictions on who’s most likely to use debit:

1. Those lacking a credit card• otherwise float and get miles, except…

2. Revolvers more likely to use debit• to minimize costs from “borrowing-to-charge”

3. High intensity revolvers even more likely

Results of Tests

• All economic predictions borne out

• Correlations are big

• Robust to controls for:– Demographic characteristics– Spending patterns (rough proxies)

• All this despite data limitations that work against finding support for the model’s predictions

Other Data/FindingsCast Doubt on Spending Control

• Most important/provocative:– May 2004 Survey of Consumers (“Michigan Survey”

used to measure consumer confidence, etc.)– Asked open-ended questions: “Why do/don’t you use

debit to make purchases?”• 5.8% of debit users said something related to spend control• 5.5% of nonusers said something related to spend control

• See Borzekowski, Kiser, and Ahmed 2005 for this & more interesting results

Some Food for Thought: From Modeling to Business Apps

• What’s (irr)rational consumer behavior? Be careful.

• Example. Free checking:– Not necessarily irrational (Stavins)– Intense transactors should choose min balance option– (Not necessarily irrational for banks either.)

• Example. Slow e-payments adoption.– Small benefits to adoption– (Perceived) big downside risk– High cost of getting info to accurately assess

downside risk– Inertia may be rational/optimal

From Modeling to Business Apps:Learning About Customers

• How do we ask them?– Survey responses depend greatly on how you

ask/frame questions (psych wins here!)• May explain difference between market research

and Survey of Consumers on spending control

– Will customer’s responses to hypothetical questions have useable content?

• General concern in social science• Particularly so here: stakes of payments decision

are small for most consumers (maybe $10 a month on average)

From Modeling to Business Apps:How Much Should the Consumer

Know/Deliberate?• Not much, necessarily

– Rational to devote little energy/attention to payments choice in face of small stakes

• So… how to communicate with or “educate” consumers– Less is more

• “Information overload” with debt, saving, jam(!), doctor’s Rx choices (psych wins again)

• Be especially careful in payments– small stakes

Going Forward

• With richer data:– From bank/issuer– With deposit/debit and credit customers (account-level info)– Transaction level data

• Direct tests of spending-control models• Finer tests of economicus model:

– Impact of rewards– Impact of credit pricing– Time costs vs. (implicit) pecuniary costs

• Insight into choice mechanisms:– Adoption– Learning

Take-Aways

• Understanding of “rational” behavior must be nuanced. Impacts how we:– Develop, market, and price products– Collect and interpret info on customers– Communicate info to customers

• Paper’s findings not rich enough to change your mind on what drives debit use– But re-examine your beliefs and model(s)

• We can reach a deeper understanding of what drives consumer (payment) choice– Analytic framework in place– Just give me the data!