This is one of the most important services of modern society, but it’s also one of the least understood.
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This podcast was recorded on Feb. 29, 2016.
Gaby Lapera: The whole way that payment processing works is, you have four distinct parties involved. You have the issuer, the acquirer, the consumer, and the merchant. Do you want to talk a little bit more about that, Maxfield?
John Maxfield: Yeah. You know when you talk about, what are payments, or what is payments — I don’t even know, to be honest with you, if that’s a plural or singular noun (laughs), but let’s say it’s plural because it sounds better.
So, what are payments? Payments are basically just what it sounds like. You have me, like, I go to a store and buy something with my credit card, so I’m a consumer. Then you have the store, which is the merchant, that takes the transaction. Then, I have my bank, and the merchant has their bank. And what the payment system does, companies like Visa, MasterCard, American Express, is they tie all of these things together. They provide the technological infrastructure underlying that.
So, when I go and pay, they take the money from my bank, the merchant lets everybody know and they take the money from my bank, and then they put it into the merchant’s bank. And that’s basically what the payment system is.
Lapera: Right. So, in this case, in the scenario that I constructed before, Visa, MasterCard, and AmEx are issuers, they issue the credit cards. Then, the acquirer, the end acquirer, is going to be the merchant’s bank, right?
Lapera: Yeah. So, let’s talk a little bit about AmEx, Visa, and MasterCard. These are the big players in the credit card field right now. There’s also Discover, but Discover doesn’t really make that much money.
Maxfield: Yeah, and to put it in perspective, this is really an oligopoly, is what this market is, with these three really big players on top. To put some numbers to it, Visa in 2014 — which, if you look at their 2015 10-K, its most recent competitive landscape data that they give — in 2014 they processed 98 billion transactions, equal to $4.7 trillion in transactions. Second was MasterCard at 60 billion transactions and $3.3 trillion. Then, AmEx was at 6.7 billion transactions, worth roughly $1 trillion. Then, Discover comes quite a ways down at 2.4 billion transactions, roughly a third of AmEx. So, when you’re thinking about the payments landscape, you’re really talking about, right now, at least, Visa, MasterCard, and American Express.
Lapera: Right, and this is actually really interesting, right, because Visa and MasterCard are what’s called an open loop system, whereas AmEx is on a closed loop system, so the way they make money is actually slightly different.
Maxfield: Right, that’s exactly right. Visa and MasterCard, all they do is provide these services that connect everybody together, and then they just take a little cut from that. But the closed loop system, which is what AmEx does, is, they also provide the banking services. Where you can really see the difference between these business models is if you look at their income statement.
So, Visa, MasterCard, all of their income comes in basically services fees. Whereas, at American Express, I think it’s roughly one-fifth of their income also comes from net interest income. That is, you have a credit card, you have the credit card loan underlying the credit cards, but as opposed to that loan sitting on a bank at, say, Bank of America, Citigroup, or JP Morgan, or Wells Fargo, American Express actually houses that loan itself, so it gets the interest payments on that.