Forbes on Visa and Payments

Forbes.com - Magazine Article

On The Cover/Top Stories
Hard Charger
Stephane Fitch 10.27.08

Visa is bulletproof to bad credit but not to new rivals and new ways to pay. That leaves boss Joe Saunders to revamp a business built on plastic or go the way of the rabbit ears antenna

The Dharavi slum in Mumbai is one of India’s most overcrowded and desperately poor places. On the northern edge of this sea of humanity and corrugated tin shacks stands a sign of hope: A row of leather shops is thriving by custommaking virtually any bag a customer desires. Inside Star Bags, Ehsan Ansari is doing such a brisk business that three months ago he began accepting Visa cards.

“Everywhere you want to be,” is how the world’s top purveyor of plastic has long touted itself. The notion rings true, even in India, where 71 million citizens can now swipe their Visa cards at a half-million outlets. Yet they tend to do so as a last resort rather than as a first choice. That’s because most shops accept plastic only grudgingly.

Star Bags’ Ansari does so only after tacking onto his price Visa’s 2% fee, plus 12.5% in sales tax he’d dodge on a cash sale. The story is much the same throughout the Third World. People who want to pay electronically are much less likely to whip out plastic than a mobile phone, which allows them to swap money or prepaid talk minutes, free of taxes and bank fees.

Finding a way to persuade 4 billion developing-world consumers to make their cards the centerpiece of their payment habits is only one of the items on the to-do list of Joseph Saunders, Visa’s new chief executive. Saunders, 62, is an industry warhorse who stumbled into his job ten months ahead of Visa’s March public offering. Rather than easing in, Saunders has been confronted with the need to answer a more pressing question than any his predecessors faced: What is the future of money, and does the world’s reigning king of consumer credit have a place in it?

Although most of the action is still going on behind the scenes, the rules are changing radically for how consumers will pay for things even a few years down the road—at home at least as fast as abroad. No player is as at risk as much as Visa. The U.S. accounted for 58% of its $4.6 billion in sales in the nine months through June and perhaps 75% of its $1.2 billion in profits. Yet the firm now faces a horde of rivals jumping the moats that once gave it a virtually unassailable position on its home turf.

Until Visa’s public offering, big banks were both its owners and closest allies. Now they’re in cahoots with Visa’s fiercest competitors, issuing cards for the likes of American Express and Discover, for big retailers launching a new generation of plastic and for insurgents like RevolutionMoney.

The attacks are supported by game-changing technologies, too. In the days of yore, competition was restrained partly by the limit on how many pieces of plastic Americans could stuff into their billfolds. Now microchips no bigger than a postage stamp are starting to serve the same function and can be stuck to wallets and cell phones by the dozen. E-payment innovators like PayPal and Bill Me Later, meanwhile, are expanding from Internet beachheads into traditional merchandising. And then there are the lawyers, attacking Visa for everything from allegedly usurious fees to anticompetitive practices.

Through it all Saunders talks a good game. “More and more people think they can fit in this business,” he concedes. “But in the U.S. we’ll be involved in mobile phone technology and make it more secure and simple to use a Visa account on the Internet. Elsewhere, if we close on 10% or 15% of the opportunity, we’ll double or triple in size.”

Visa is a formidable incumbent. The San Francisco-based firm started out as Bank of America’s in-house BankAmericard in 1958 and grew in California by offering consumers revolving credit. Bank of America expanded the brand nationally by franchising it to other banks. It was renamed Visa in 1976. Visa competed neck and neck with MasterCard until it pulled away after the marketing coup that came with being the exclusive plastic of the 1988 Seoul Olympics.

After Visa built a lead, the then chief executive Carl Pascarella boasted to FORBES in 2002 that his brand would double annual volume to 42 billion transactions by 2007. As he set to the task, the banks that collectively owned Visa put aside their parochial squabbles long enough to upgrade its capacity threefold in 2006 to handle 12,000 transactions a second. No sooner was that fire out than a decade-old legal battle with Wal-Mart and other big retailers climaxed. Visa and MasterCard agreed to slice fees they and their bank issuers charge on debit cards by 30% and shelled out billions in payments.

In the end, Visa exceeded Pascarella’s projections by 20%, handling 50 billion transactions worth $3.8 trillion last year. Yet it was something of a pyrrhic victory. Visa’s legal settlement virtually wiped its balance sheet of equity, and MasterCard positioned itself to recapitalize quicker by going public.

Visa’s regional boards decided to follow MasterCard’s lead by going public, too. Saunders, a lanky Chicago native who hangs Cubs memorabilia over his desk in San Francisco, has spent 30 years pushing plastic. He built Household International’s operation almost from scratch into a $30 billion (receivables outstanding) business. He moved in 2001 to moneylosing Providian Financial, a credit card issuer that he steered back to profitability and through a 2005 sale for $6.5 billion to Washington Mutual. While running the business for WaMu, Saunders took on a Visa committee search for a new chief executive and was eventually asked if he would be willing to skip his planned retirement and take the job himself.

“You couldn’t in a million years say ‘no’ if you have a competitive bone in your body,” he says.

Although it’s often compared with banks, Visa operates more like a switchboard, connecting millions of disparate players through its network. For each $100 a consumer spends with a Visa card, merchants cough up $2.10 in fees. The card-issuing bank pockets $1.75 and Visa about 17 cents for marketing and transaction processing. The rest goes to the merchant’s bank.

Wall Street loves the model and Visa’s dominance of it. With 1.6 billion cards in circulation, Visa towers over MasterCard, with 900 million cards out, and American Express, with 90 million. At a recent $57, Visa’s stock is up 30% from its March debut. That puts it at 42 times earnings in the year through June, which dwarfs Google’s multiple of 25. Its lofty valuation makes Visa, with a $48 billion market value, worth more than AmEx, which boasts multiple business lines and several times the revenue, income and head count.
Visa’s strategy is “growth, growth and more growth,” according to UBS analyst Adam Frisch, one in the army of analysts bullish on the firm. Frisch and others on Wall Street are counting on Saunders to keep Visa’s fee revenues growing 12% and earnings 20% annually well into the future.

Coming through would be no small feat. True, Visa is a rare island of calm amid the raging financial storm. No matter how many consumers default on Visa cards, the banks that issued them will eat the losses while Visa pockets processing fees. Safe from poor-quality credit, Visa is nevertheless highly dependent on the quantity of spending. That’s especially true in its biggest market, the U.S., where consumers are, by choice or necessity, ceasing to be the spendthrifts they once were.

Even as Saunders grapples with a receding economic tide, the competitive landscape around him is becoming more hostile. Until recently, rolling out a competing card was a daunting task. When Sears, Roebuck & Co. tried to do it with the Discover Card in 1986, banks’ agreements with Visa and MasterCard banned them from helping out. That forced Sears, Roebuck to itself send out Discover Cards to 22 million Sears cardholders, field thousands of salesmen to sign up retailers and install new data lines and payment gear at each point of sale. “You’d never have to do it the same way now,” says Tom E. Dailey, who ran Discover for Morgan Stanley.

Since 2001 the U.S. card payment processing business has come under the control of four companies, the largest of which is not a bank and has no interest in protecting Saunders’ franchise. First Data is run by Michael Capellas, the quirky former chief executive of computer maker Compaq and telecom outfit MCI in its post-WorldCom incarnation. Capellas’ Denver outfit handled 30 billion card transactions, with a value of $1.5 trillion last year, giving it a 50% share of the processing market. Three-quarters of the nation’s top 100 retailers rely on First Data to process payments.

What’s more, a quarter of the terminals in the 1.1 million stores First Data serves are remotely programmable—meaning they can be tweaked to accept new cards with a few keystrokes. When First Data snatches away the processing work on a $100 charge swiped on a Visa card, Visa still gets a 17-cent royalty for connecting First Data to the card-issuing bank; First Data gets 17 to 20 cents.

“Old-line payment networks like Visa still have a wealth of advantages, but they’ll have to innovate or die,” says James Van Dyke, founder of credit card analysis firm Javelin Strategy & Research.

First Data’s Capellas has been pushing merchants like Starbucks and Best Buy to expand prepaid and store-card operations. Capellas has been showing off a sticker embedded with a so-called near-field communication chip—a stamp-size gizmo that replaces a plastic card. More than 35,000 retail outlets can already accept the chips. Industry analysts expect Capellas eventually to go one step further and launch a new brand and payment network that competes head-to-head with Visa and MasterCard.

“We’ve traditionally been in the business of cooperating with [Visa], but you know, it’s a strategic question that comes up now and then,” says a coy Capellas.

“First Data tried to go around us before, and it didn’t work,” snarls Saunders. “They’re perfectly capable of issuing and processing private-label cards, doing it within their system and never coming near Visa.”

Among new rivals is RevolutionMoney. Since February it Chase Paymentech, Fifth Third Bank and WorldPay. What makes RevolutionMoney such a threat: It charges merchants only 0.5% of transaction value—75% less than they fork over to Visa and MasterCard.

RevolutionMoney expects that by year’s end its cards will be accepted in a million stores, including Wal-Mart and Macy’s, that account for more than 70% of chain store sales. Jason Hogg, its 37-year-old chief executive, hopes to strike a deal with First Data by December to further consolidate the card’s reach.

“I don’t need to bang on doors like Discover did for 20 years and lay fiber to stores to accept my cards,” says Hogg, whose father, Russell, ran MasterCard in the 1980s.

The real challenge for Hogg, and other upstarts, will be persuading banks—the primary beneficiaries of those lush Visa and MasterCard fees—to issue its cards. So far, First Bank & Trust of Brookings, S.D. is the only taker. Hogg says he’s nearing a pact with a big credit-card-issuing bank, however, that he boasts will render RevolutionCard the biggest thing since Discover (which currently has 50 million cards in circulation). One possible partner: Citigroup, which invested in RevolutionMoney. A Citi spokesman declined comment.

Meanwhile, Hogg has persuaded merchants to do some of the card-issuing work for him. Murphy Oil, which runs gas stations at 1,000 Wal-Marts, is offering a 3-cent-a-gallon discount to customers who pay with the RevolutionCard. Hogg hopes such incentives will get consumers to ask for his card.

One convert is Steve Case. The former AOL boss invested $10 million in RevolutionMoney last year, figuring high card fees represent a $60 billion annual “tax” on consumers.

“There’s an opportunity to use new technology and a fresh approach,” Case says. “The credit card industry is an oligopoly, and there hasn’t been much innovation in decades. RevolutionMoney is being driven by a groundswell of merchant dissatisfaction.”

Visa’s greatest threat may be changes in its bank ties. Institutions that once jealously protected it are now backing rivals. Citibank and Bank of America now offer American Express cards, the result of an antitrust lawsuit AmEx won against Visa and MasterCard in 2005. The bank-issued AmEx cards pay higher rewards than does the Visa Signature card, which is aimed at clients with household incomes above $125,000.

Some industry analysts believe Bank of America, Chase and Citigroup are considering buying Discover or starting rival payment networks. “I think it’s probably a matter of time before Bank of America revives the BankAmericard to compete directly with Visa,” says former Discover chief Dailey. Bank of America declined comment.

Even if Visa’s would-be rivals fail to gain traction, they’re adding to grousing by merchants and bankers that Visa overcharges for running ads and data centers—a claim that has been stoked by fee hikes of up to 30% in its fees since last year.

“If they [Visa] don’t keep delivering the products, I’ll go after them on pricing,” says Richard Davis, chief executive of U.S. Bancorp.

With Americans already packing an average of five charge cards, Saunders has been appealing to bankers like Davis by making his plastic smarter and thus more valuable in attracting customers. With security a growing concern, especially amid the rise of debit cards,which thieves can use to drain customer accounts, Visa has begun offering a cell phone message service to notify users when their (or their teenager’s) card is used. Cardholders can quickly call their bank and reject crooked transactions.

On the promotional front Visa has linked up 100 million Signature and Rewards accounts to receive merchant mailers. It will begin signing up the lower number of actual customers in the program (it won’t say how many there are) to receive coupons via mobile phones by year’s end.

Saunders is also going after the corporate market, long an AmEx stronghold. It throws in only 12% of Visa’s transaction volume but is growing 20% a year. U.S. Bancorp’s Davis is pushing Visa cards to corporate clients to keep tabs on spending. The cards can apprise, say, a car parts distributor when a salesman uses its card for smokes or girlie magazines rather than gas and meals. U.S. Bancorp can find out if a trucking client’s drivers are heavy users of, say, Texaco stations and work out discounts when the gasoline retailer’s diesel is charged to the bank’s Visa cards.

“The payments business is about moving money more transparently,” says Davis. “Nobody’s got the depth and technology that Visa has for that.”

When and how Visa unshackles customers from their wad of plastic is a tricky question—politically at least as much as technologically. Zapping money to a cabbie or babysitter via cell phone is technologically within reach, but Visa’s bank partners fear such transactions could cut them out of the fee flow. Other prickly issues include how to brand the service—Visa or Citibank—and what fee the cell networks will receive. Saunders just cut a deal that will enable users of Google’s much-anticipated Android cell phone to download Visa software this winter and begin replacing their credit cards early next year.

Visa’s e-commerce glass, meantime, is at best half-full. It directly captured nearly half the $164 billion in U.S. online spending last year. Another $31 billion went through PayPal, with card issuers earning fees on half that amount. Now PayPal is expanding beyond Internet strongholds. Airlines, including Southwest and Continental, already accept its payments.

With competition heating up in the U.S., Saunders is determined to expand abroad, where his main rival is still cash. In the U.S. one-third of the $9.7 trillion in consumer spending goes through credit and debit cards (Visa handles 48% of the card action and 18% of the total). In Asia, the Middle East, Central and South America and eastern Europe, less than 10% of the $9 trillion in annual consumer spending involves plastic.

During the decades Visa was bank-owned, its six regional associations squabbled over international expansion and failed to make much headway. Now that it’s public, Saunders faces a huge opportunity, as well as huge obstacles.

Merchants in many markets resent the fees American credit card giants exact. Australian retailers persuaded regulators in 2005 to force card issuers to cut fees nearly in half to around 1%. European Union regulators are considering similar cuts.

In China Visa faces protectionist party cadres. Despite its high-profile sponsorship of the Beijing Olympics, Visa has been virtually shut out in favor of government-backed China UnionPay. A Visa knockoff, it connects 14 Chinese banks. Visa gets second billing on most China UnionPay cards and gets fees when cardholders travel abroad. “There are severe limitations on what we can do,” Saunders says delicately.

In other developing markets Saunders’ challenge is to adapt his product to societies where both bank accounts and the concept of living on credit are foreign. In Brazil the number of cards in circulation has been growing 15% a year to 266 million, and Visa claims two-thirds of the market. Unfortunately the cards are used mostly to withdraw cash from ATMs; monthly retailer volume averages a piddling $40 per card.

Visa did persuade Brazil to replace $2.6 billion in food vouchers with prepaid cards in 2007. It has also embedded cards with chips for use at toll plazas. Its PassFirst lets Brazilians swipe cards, rather than use paper tickets, at stadiums and theaters.

The Dominican Republic is using Visa cards to distribute aid. The 800,000 Solidaridad prepaid cards entitle the poor to $10 to $20 in monthly assistance. The government expects to expand the operation to 1 million recipients and $300 million in aid next year.

Given its openness and size, India is perhaps Visa’s most fertile foreign test bed. Saunders believes the real opportunity lies with the 350 million middle-class Indians earning between $2 and $12 a day. Since few have computers or bank accounts, he hopes to capitalize on the Indian obsession with mobile phones; there are 305 million in use, and the figure is growing by 5 million a month.

Visa India has launched a version of electronic bill payment for mobile phones. It will roll out a service this fall, so any Indian with a mobile phone and a Visa card can transfer funds domestically to any other Visa cardholder for a 2% fee (to be split by the card-issuing bank, mobile phone vendor and Visa).

Saunders thinks it’s such a good idea, he plans to launch a similar service in the U.S. by the end of the year. Getting big banks to come on board and consumers to turn the service into a mainstay sums up the broader challenge faced by Saunders and Visa: find ways to make the best payment options work around the world and dominate the future of electronic payments, or leave the dominating to rivals.

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