POST PLASTIC

Bitcoin has fizzled, but digital transactions are thriving on pre-internet networks

Visa and Mastercard will outlive plastic.
Visa and Mastercard will outlive plastic.
Image: AP Photo/Keith Srakocic
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More transactions than ever are being made digitally—we shop online, and use phones to hail taxis, order food, and swap money with our friends. But as pocketbooks increasingly become electronic, two of the biggest winners are, so far, payment pioneers that predate the internet: Visa and Mastercard.

The idea of a digital payments revolution sounds like something from a cryptocurrency conference—just last week, Malta’s prime minister told the United Nations that crypto is the “inevitable future of money.” But bitcoin has fizzled as a means of payment. Instead, the digital economy is humming along using old fashioned government-issued fiat money.

And as more things are bought and sold digitally, stock investors (if not crypto investors) have embraced the card companies. Visa stock has soared more than 800% since the company went public in 2008, compared with around 150% for JPMorgan during that span. Mastercard has rocketed more than 1,200% in the past decade.

Both companies posted double-digit revenue growth last year and are positioned for even greater gains. Online payment volume may exceed $50 trillion by 2026, according to Goldman Sachs, generating more than $200 billion fees (up from $85 billion in fees in 2016).

“Digital payments will no question continue to increase,” said Visa president Ryan McInerney. “We’ve taken a very purposeful and explicit strategy to partner with anyone and everyone who is providing digital commerce.”

Network effects create tech giants

Long before tech companies like Facebook started building digital empires, Visa—the payment card leader just about everywhere outside of China—was creating a business model that benefits from networks effects, according to James Faucette, an analyst at Morgan Stanley. That means each additional user makes its product more valuable. It took 60 years to build, but now some 3.2 billion cards have Visa’s name on them, which compares with Facebook’s 2.23 billion monthly active users.

Now, the card networks are the electronic railroads for many of the world’s digital transactions. It has happened so gradually that their scale has gone unnoticed to most people: Visa handled $10.2 trillion in payments through more than 110 billion individual transactions last year (both of which increased more than a quarter from 2016). The system can process 65,000 transactions per second, compared with fewer than a dozen per second for the bitcoin cryptocurrency network.

Yet nobody expected a cashless revolution when Bank of America launched its paper card in 1958 with a $300 limit. The BankAmericard later became Visa, and then became a consortium run by banks before its IPO in 2008 that raised $17.9 billion. Visa is now worth more than $330 billion, some 10 times bigger than Snap and Twitter combined.

“I don’t think people saw this coming at all,” Antony Jenkins, the former Barclays CEO and founder of 10X, a digital banking platform, said of the payment card industry. At that time, nobody could anticipate the rise of the internet and smart phones. “They were among the first organizations to benefit from network effects,” he said.

Data center businesses

“What a lot of people don’t understand is that Visa and Mastercard in particular, they essentially just operate data centers,” said Morgan Stanley’s Faucette. “Their cost base can just continue to get more efficient.”

Visa has four data centers around the world that are connected together with a massive private telecommunications system. The network of cables could circle the Earth some 400 times. Like Amazon Web Services, every new user makes the company’s cost base smaller while feeding into profits. And the sheer number of users, in the form of billions of cards and millions of merchants, means the card companies can underprice just about any challenger.

“To put it bluntly, there’s no way to underprice Visa and Mastercard,” Faucette said. “If you are going to go around them or not use them, there has to be some other motivation. Typically, those motivations are political or regulatory in nature rather than economic.”

Merchants grumble about the fees, but only a thin slice of the charges go to the payment networks. Visa and Mastercard charge a few basis points (one basis point is 0.01 percentage point) on each transaction, according to Julius Baer, a bank based in Switzerland. The majority of the charges go to other part of the chain, like the card-issuing banks.

The total charge for card payments runs about 1% to 3%, and depends on things like the size of the merchant, geography, online or in-shop. Unlike the card payment rails, these other parts of the chain are seen as being at higher risk of disruption.

As vast as it is, the US payment companies’ reach doesn’t extend to China, where they’ve been effectively locked out. That’s given China UnionPay a monopoly in the world’s most populous country. The trio of UnionPay, Visa, and Mastercard account for about 80% of cards around the world, with UnionPay at the top; The Chinese company, however, has almost no market share outside its home country, and faces a major competitive threat from payment giants Alipay and WeChat.

Post plastic

One of many questions is what happens to the payment card companies when cards go away. Right now you see their logos, and branding, in your wallet, but this isn’t expected to last. Square CFO Sarah Friar pointed out in an interview a few months ago that as software eats the world, the plastic rectangles will also fade away.

Mobile phones are the payment method of choice in China’s major cities, where Alipay and WeChat rule. There’s also Apple Pay, Google Pay and apps where you only have to fish around in your purse or wallet once for a payment card and then the rest of your Uber-like transactions are invisible. In Sweden they’re experimenting with sub-cutaneous microchips that could be used for identification and payments. Farther out, cards could be increasingly replaced by biometrics, according to analysts at Forrester Research.

Visa’s McInerney acknowledges that payments are becoming invisible. He notes that the card company has trademarked “sensory branding,” like sounds and haptics, a touch sensation or vibration that indicates when a Visa purchase has been made. He says consumers still want to know that their money is moving along a trusted network even if it happens invisibly.

As plastic cards melt away, Faucette said he sees little threat to Visa. Apple Pay, for example, runs on the card networks. “They basically run payment rails,” he said. “The manner in which a payment is made really doesn’t really matter to them.”

What could go wrong?

So what else could possibly go wrong for card companies? Plenty, it turns out. The fast-growing Chinese payment giants Alipay and WeChat—which don’t rely on card network rails—are widely feared by western financial companies. Blockchain, lawsuits, and computer server meltdowns are among the other hurdles facing the incumbent payment systems. PayPal is expanding rapidly, native to the internet, and has ways to process transactions internally without using the card networks. 10X’s Jenkins thinks crypto and distributed ledger technology can one day challenge the card networks.

All are risks, but they haven’t come close to derailing the payment card businesses so far. Visa and Mastercard’s share prices suggest investors don’t see them as an immediate threats.

Bitcoin, for example, has sputtered as a means of payment. (Visa CEO Alfred Kelly recently said blockchain, while potentially useful in some parts of finance, isn’t “really at its core, for us, a good technology.”) And given China’s restrictions on the likes Visa and Mastercard, some analysts expect Alipay and WeChat  to face resistance from Western regulators in markets like the US. (The Trump administration earlier blocked Alipay parent Ant Financial’s acquisition of US-based MoneyGram.)

PayPal is sitting on its own network effects, but many of its transactions also run on card companies’ rails. Even a recent Visa outage in Europe seemingly had little impact on the companies’ prospects. “It made headlines because the networks are very reliable,” Faucette said. “If there is an occasional outage, consumers will tolerate that.”

Amazonification

For now, Amazon is the potential disrupter that’s most often cited by analysts. After all, the e-commerce company’s network effects are already in place: It has more than 100 million Amazon prime customers and 2 million sellers. Visa and Mastercard have quietly become the fabric for much of the world’s consumer commerce, but many expect Amazon to eventually use its scale to invade the financial industry, which could include payments.

“They have a huge merchant and user network, and could just basically shift the money from one account to another,” Fabiano Vallesi, head of next generation research at Julius Baer, said of Amazon. “It’s a key competitive risk to Visa and Mastercard.”

In the meantime, life is good for the card companies. The digital commerce boom is barely getting started—only 10% of retail sales took place online last year, a figure that Julius Baer expects will climb to 18% by 2021. As a revolution in electronic money gets underway, Visa and Mastercard are at the center of it.