Visa | The evolution of the payments industry

Ever wondered what really happens when you swipe your card? In this episode, we uncover the fascinating world of payments, focusing on one of the biggest players in the game: Visa. 

From the history of money to the incredible network behind modern transactions, this episode will change how you think about every payment you make. We'll try to make it in-depth yet simple to understand.

Ready to talk payments? Dive in!

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Transcript

 Welcome back. Today, payments, more specifically Visa and the payments' industry. Have you ever wondered what happens when you swipe your card? The payment processing industry looks pretty simple on the surface however there are many parties involved in this seemingly basic process. You might think you know how your credit cards and transactions works, but there's a lot more going on behind the scenes.

So, if you're curious about Visa and how your money moves around the world. We’ll break it down into simple, digestible bits, making sure even the most complex concepts are easy to follow. Let’s talk payments!

Chapter 1: Payments before the internet

I apologize if my voice sounds a bit different today. I'm not feeling my best, but I'm still excited about today's episode. Let’s talk about the world of payments and also focus on a major player in the industry; Visa.

But before we do, we have to look in the rearview mirror to a time before the internet, when payments were all about the physical world. Back in the day, before money existed, people traded goods and services directly. You have a cow, and I have grain—let's make a deal. A fisherman traded his catch for tools, a potter exchanged clay pots for bread, and deals were struck face-to-face. It was a system built on trust and necessity, but it wasn’t perfect. This system worked, but had its limits. This worked at the time, but came with challenges. It's hard to agree on value. Is one cow worth 50 sacks of grain or 100? It’s also very inconvenient to carry 50 sacks of grain to trade for a cow.

To solve the inefficiencies of barter, people invented money as a standard way to exchange value. The first “currencies” were anything from shells to beads to precious metals. Then, someone came up with an idea, thousands of years ago. According to Herodotus, coins were first minted by the Lydians, while Aristotle claims the first coins were thought of by the wide of King Midas of Phrygia. An Ancient Greek King, remembered in Greek mythology for his ability to turn anything into gold.

Now let’s leap forward to ancient Rome. Coins are everywhere, but coins came with their own list of problems. They could get stolen, they were heavy and also not the most convenient. Enter, paper money. Lighter than coins, easier to carry and backed by the lords and ladies at the time, and backed by governments today. But even paper money had its limits. As economies grew and people began trading over greater distances, carrying cash, no matter how light, still posed risks and logistical issues.

Fast-forward to the mid-20th century, and the next big shake-up arrives. The first credit cards emerge, and with them, a whole new way to think about payments. Diners Club led the charge, quickly followed by Visa and Mastercard. But don’t picture the seamless swipe of a card reader just yet. Early credit card payments were far from smooth. Transactions required carbon paper slips and manual processing—a system as clunky as it was innovative. The Bank of America launched Visa as the nation's first licensed credit card for middle-class consumers and small to medium size merchants in 1958. They introduced the first debit card in 1975.

Then, in 1979, Visa launched the first electronic credit card terminal. This was a game-changer. By the 1980s, stores were using terminals to speed up payments and reduce mistakes. Companies like Verifone and Ingenico created the machines that connected stores to banks through phone lines—cutting-edge at the time!

Still, payments were very much tied to the physical world. But all that was about to change with the rise of the internet.

Enter the internet, and suddenly, the rules of the game changed. In the mid-90s, businesses started popping up online, and they needed a way to accept payments digitally. That’s when we got payment gateways—online versions of the card terminals used in stores. Companies like Authorize.net and CyberSource led the charge, helping businesses connect with banks in this new, virtual world.

These gateways were crucial in bridging the gap between old-school banking systems and the fast-paced demands of the internet. And then came ecommerce. Amazon and eBay hit the scene in the 90s, and online shopping took off. Payment systems had to evolve fast to keep up. Gateways adapted to handle huge volumes of transactions while also dealing with new challenges, like fraud and encryption.

Today, payments have gone even further. It’s not just about online or in-store anymore—it’s about everywhere. We’re in the age of omnichannel payments, where businesses must offer every possible way to pay. Contactless cards are a must, being able to pay with QR codes, or digital wallets like Google Pay or Apple pay. And in some places, cashless systems are becoming the norm.

The key here is simplicity. Behind the scenes, payments are super complicated, but for customers, it needs to feel easy—whether they’re swiping a card at a store, tapping their phone, or buying something with one click online.

Chapter 2: Visa’s power and role

Let’s start with Visa itself. 

Visa isn’t a bank.

Visa doesn’t profit from credit card interest fees—that’s the job of the banks that issue the cards. These banks, like Bank of America, Wells Fargo, or local institutions, are the ones that lend money, taking on the associated risks. Although the cards carry the Visa logo, they are the banks' cards, with Visa simply acting as the network that connects the system.

Visa operates on a "four-party model," involving:

1. You (the customer),
2. Your bank (which issued the card),
3. The merchant (where you make a purchase),
4. Visa (the network connecting them all).

Think of the Visa network as you would any other network: a phone network transmits voice via radio waves, the internet transmits information, and Visa transmits – you guessed it – money.

Whenever you swipe your card, Visa makes sure that the payment flows seamlessly from the buyer’s bank to the seller’s bank. For this service, Visa charges a small fee. Not to consumers directly, but to the merchants and banks involved. These fees, known as the Merchant Discount Rate or MDR are typically around 1-2% of the total transaction and consist of three key components: the interchange fee, the network fee and the processing fee.

1. The Interchange Fee is paid by merchants to the issuing bank and are around 1.6%.
2. The Network Fee is Paid to Visa for using the infrastructure, usually around 0.2%.
3. Finally, is the so-called Processing Fee. This is paid to the acquiring bank that processes the payment and is also around 0.2%. These are often used by the acquiring bank, and technology provider. Think JPMorgan, Adyen, Stripe or Worldpay.

So, the fee really depends on a bunch of factors. Think about the risk involved, the currency being used, and whether it's a debit or credit card. It's a bit of a mix-and-match. Really good way to think about Visa's revenue stream is for every $100 spent on a Visa card anywhere in the world, they make about a quarter of that meaning 25 cents, an actual quarter, every time you buy a pair of shoes, that's $100, they get 25 cents of that. As the network has scaled that's very high incremental margins and so the profitability of the business naturally goes up.

Chapter 3: The Payments Industry

The payments' industry is a big and complex ecosystem. It makes sense. We all buy goods and services and it has to be processed somehow. In 2018 Visa processed over $8 trillion in Volume, today, fiscal year 2024, a staggering 13.5 trillion dollars. A sum so large it's difficult to grasp. To give you a sense of how large that actually is, 

Were you to divide that by the world's population, each person would receive almost $1700 dollars. Or, if you were to buy a house for every person in the United States, for around $300,000, you'd still have over $10 trillion left over. Crazy right? And that’s annually.

At the heart of it, we've got a few key players: the issuing banks, the acquiring banks, and the payment networks. At the heart of it, we've got a few key players: the issuing banks, the acquiring banks, and the payment networks. Let’s go over them so you have a better understanding of how it all works together.

First up, we have the issuing banks, also known as card issuers. These are the banks or financial institutions that give you that shiny credit card you love to use. They are also responsible for underwriting the credit risk.

Then, we have the acquiring banks, also known as merchant banks or acquirers. These financial institutions that partner with businesses to processes the payments. They let you swipe your card at your favorite stores.

And finally, the payment networks, like Visa and Mastercard. They are the connectors, acting as a bridge, making sure your transaction goes smoothly from point A to point B.

Visa and Mastercard dominate this space, forming a near-duopoly. Together, they control 65% of the global market, 85% of the U.S. credit card market. Their network is unmatched, spanning over 200 countries with 14.500 connected banks and more than 44 million merchants. The scale they’ve reached is almost unbeatable at this point, unless governments intervene. 

We've got payment gateways like Adyen, Stripe, Square, and PayPal, acting as the digital middlemen between your online store and the payment networks. And let's not forget the ISOs and MSPs. These operate behind the scenes and help businesses set up and manage their payment systems. But that’s a story for another episode.

It's a complex world, but it all comes together to make sure your shopping experience, whether in-store or online is as smooth as possible. Let’s go back to Visa. More specifically, Visa’s size.

Not just economies of scale help Visa stand out. Two other factors or advantages stand out:

1. The first being global network effects. We’ve done a full deep dive into network effects for our premium members, explaining everything in detail if you’re interested. But in essence, a double-sided global network effects is the strongest of all network effects. The more people and merchants using Visa, the more valuable the network becomes. This creates a cycle that attracts even more participants. If the flywheel keeps going, it’s incredibly hard to beat. So as a business, the reason it's so profitable is because it's a primarily fixed cost business is once you've got that infrastructure all in place, each incremental transaction that's flowing through that ecosystem comes in at extremely high incremental margins, because it's just this massive capacity network. And so, as Visa has scaled their profitability has gone up dramatically for that reason.
2. The other advantage we see are high Barriers to Entry. Not just any barrier, but perhaps some of the highest barriers out there. I mean, Trying to compete with Visa is like trying to climb Mount Everest in flip-flops. The investment, the regulations, the partnerships – it's a very difficult task. That's why most companies choose to work with Visa, rather than against it.

And as we discussed in our premium fundamental analysis, there are risks, like emerging competition, that use counter positioning. Think of digital wallets, cryptocurrencies, or even government-led payment initiatives. However, most still rely on Visa’s network for critical infrastructure. 

But perhaps you’re wondering if there's a way to ditch Visa and Mastercard altogether? Well, there's a gray area. We've got options like account-to-account payments, where you move money directly between bank accounts. Governments are also getting in on the act, with initiatives like FedNow in the US and Wero in Europe. They're building their own payment networks to shake things up a bit.

FinTech companies like Venmo and Cash App initially sought to operate outside the established networks. However, many of these players have found it advantageous to collaborate with Visa and Mastercard, either partially or fully integrating them into their systems. Even Apple Pay, despite its popularity, utilizes the underlying infrastructure of these networks. You end up paying for convenience.

Visa was set up to be dominant. They started actually as an association of 1000s of banks across the country. So all these banks came together and established Visa to have this national credit card. But of course, they had a dominant position because it was virtually all the banks. There are still Class B shares of Visa's stock which are actually owned still by those original banks.

The truth is, none of these alternatives have quite reached critical mass yet. Visa and Mastercard still reign supreme.

Chapter 5: Quick promotion

He, before we continue, and I give you the conclusion and key takeaways, we’d like to quickly promote ourselves. We, The Dutch Investors team, give you a brand new deep dive into an interesting company every single week. If you decide to join TDI premium, you’ll gain instant access to over 35 fundamental reports, such as Kering, Duolingo, ASML, Wix, Evolution and many more. You’ll also gain instant access to our personal portfolio’s, updated in real-time and available 24/7. But that’s not all, you also get access to exclusive articles, industry reports and more.

We don’t like to promote ourselves because we believe our quality and quantity speaks for itself.

We’d be happy to welcome you.

Head on over to thedutchinvestors.com. Back to the episode.

Chapter 6: Takeaways

So, what did we learn today?

Well, folks, today we took a deep dive into the world of payments and discovered why Visa is the king of the castle. We learned that Visa isn't actually a bank, but rather a network that connects banks and merchants, making sure your money flows smoothly when you swipe that card. Like any business, Visa charges a fee for its services. Every time you swipe your card, a small fee is charged to the merchant. 

Visa’s global network effect and extremely high barriers to entry make it one-of-a-kind. It’s almost unimaginable to think Visa could be gone in 10 years. And to be fair, the stock market recognized this, which is why Visa is almost always pretty expensive on a valuation basis.

But Visa's value proposition is too good to ignore, work with us, and gain instant access to a network of 3 billion cardholders, 14.500 banks, and 44 million merchants across more than 200 countries. For businesses, a payment network like Visa or Mastercard is a must-have.

So, there you have it. Visa, the silent giant that powers the global economy. From your cup of coffee to your golden ring. Visa and Mastercard are here to stay. For now.

If you want the full fundamental analysis of Visa, head on over to thedutchinvestors.com. Don’t forget to follow, and leave us a 5-star review. Until next time, stay curious, keep learning and happy investing.