Wednesday, March 26, 2008

Risk Of Increasing Competition To Visa And MasterCard

Visa and MasterCard are credit card brands that were started by banks to facilitate transaction payment. Their business model is to simply facilitate and process the credit and debit transactions between the bank of the merchant and the bank of the customer and generate revenue from the service and transaction fees. In other words, they were created to add a layer of convenience to the consumers for the payment of goods and services. As more convenient forms of using credit cards and debit cards are added, the likelihood of consumers using credit card and debit cards increases. For Visa and MasterCard, this is a good thing because, as more Visa and MasterCard credit card and debit card transactions occur, more fee income they will make – a very simple business model.

So Where Is The Risk?
The very simplicity of the business model is also the weakness of Visa and MasterCard. Due to its simplicity and the rapidly changing landscape of commerce, there are risks of increasing competition from retailers and yet to be developed or in development payment facilitation systems. Additionally, credit cards are in danger of reaching full saturation where there will be no appreciable growth of new customers or new ways of using their credit cards for payment. Finally, there are the existing competitions: American Express and Discover Card.

Risk From eCommerce
Just as Visa and MasterCard changed the landscape of commerce, there are other companies currently working on and effecting change, this time, in the electronic landscape. Internet commerce, or eCommerce, is now a major marketplace. According to geocart, an eCommerce application and service company, the market size of eCommerce in the U.S. as of 2006 was estimated to be $130.3 billion from 210.8 million online users. CNNMoney reports that eCommerce will grow to approximately $259.1 billion in 2007. eCommerce Journal estimated that in 2007 “about 13% of total US retails sales excluding cars and groceries are processed online.” While it is not a lot, it is amazing given that online sales did not exist 10 years ago.

While credit cards still dominate in eCommerce, PayPal, a payment system owned by eBay is making rapid gains. In 2007, PayPal had $47.5 billion in total payment volume (TPV), out of a total of approximately $113 billion in TPV for eBay, a 33% increase over 2006. PayPal is accepted in other eCommerce sites, making it a major contender to Visa and MasterCard for payment services on the Internet. Another emerging payment facilitator in eCommerce is Amazon Payment, which went live in 2007. Amazon Payment Service will allow payment of goods directly from a bank account or Amazon Payment Account. This service is not limited to purchases on Amazon only but on other eCommerce sites. In addition, there is a growing list of eCommerce payment facilitators that will erode credit cards’ dominance in eCommerce.

Given that eBay and Amazon, two largest online retailers, have their own payment systems to compete with credit cards will be a growing risk to Visa and MasterCard.

Risk From Brick & Mortar Commerce
Credit cards are not only being attacked from eCommerce. The traditional ‘brick and mortar’ businesses have been increasingly offering gift cards as a form of payment. While the appeal of gift cards are limited, their growing use, especially as a replacement of the traditional holiday purchases, will also limit credit cards’ growth in the existing retail market. For traditional retailers, the gift card provided a way to capture loyalty and sale without having to pay processing fees to the credit cards. notes that the gift card use in 2007 would be approximately $35 billion, an increase of 25% from 2006.

Risk From Saturation article notes this risk.

“Simply put, everyone has a credit card who wants one…Credit card issuers now look to cash spending, not other credit cards, as their chief competition.”
As credit card uses reach near saturation point, the next step in the evolving use of credit cards is in the smaller purchases. However, the resistance so far comes from the razor thin profit margin that is associated with smaller purchases. Therefore, the growth from adding on additional functions to the credit cards to capture more of the smaller purchases will not be as sizeable as hoped, unless payment facilitating and processing fees come down drastically.

The risk to Visa and MasterCard right now is that they were too successful. Having captured most of the payment facilitation and processing market, their only hope of growing is to increase fees or to figure out a way to wring out more of the smaller purchases.

To accomplish this, Visa and MasterCard are moving to a mobile platform. However, they are not the only ones. PayPal has already moved to a mobile platform. Furthermore, as technology evolves and improves, there will be more competition coming into the market for payment facilitation and processing, especially in eCommerce and Mobile commerce (mCommerce).

It will be interesting to see how Visa and MasterCard adapt to these challenges. However, it seems that investors are already betting that Visa will figure out a way. This is evident by their current trading multiple of approximately 28.75x, based on today’s close of $63.25 and annualizing their 4Q 2007 net income per share of $0.55. Knowing their model, I don’t think that this is a wise bet.

May your trading be profitable!

Ed Kim
DISCLOSURE: The author holds no long or short positions in Visa, Amex, Discover, or MasterCard at this time.

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