The Power of Networks

A couple of recent news items started me thinking about the power of various payment networks.

First, the Wall Street Journal reported back on April 6th that major U.S. banks are considering if and how to use their Zelle peer-to-peer payments system as an alternative network to Visa and Mastercard.

Second, MacRumors, published a report that Apple is swapping its Apple Cash Card to Visa from Discover for new users. (Note, the Apple Cash Card is a peer-to-peer debit account for payments that also receives reward dollars from the Apple Credit Card, but it is a different product.)

I’m excited to share some thoughts here but trepidatious that I will ruffle some feathers at the networks.

Network History Lesson

There are four major payment card networks in the United States for what are known as dual-message or signature-based transactions: Visa, Mastercard, American Express, and Discover. If you swipe, dip, tap, or otherwise use your card (physical or virtual) and do not type in a PIN to complete the transaction, you are running on these network rails.

The networks did not spring out of thin air. The two largest, Visa and Mastercard, are descendants of bank-owned consortia. Visa started as a project of Bank of America and Mastercard as a group of banks. Over many years these alliances grew, rebranded, and eventually were required to admit cross-membership. While in the early days, a bank had to choose one over the other, today, many (most) card issuers work with both networks.

Seeing the massive growth of these companies and with each company seeking control of its destiny, both Mastercard and Visa pursued a path to independence from the banks in public stock offerings. That move made the banks customers instead of owners (and made a lot of people wealthy).

Visa and Mastercard have similar merchant acceptance in the United States today, and both operate as four-party networks (cardholders, merchants, networks, and banks). Visa is significantly larger than Mastercard from a total payments volume processed standpoint. Both networks are fast, reliable, and very efficient.

If you’re inclined to learn more, I recommend Lewis Mandell’s The Credit Card Industry (out of print).

American Express’s (AMEX) history is a thrilling tale of business feuds over the past 150+ years, from a mail company (hence, Express) to a global financial services giant. Unlike Visa and Mastercard, AMEX is a three-party system most of the time, with AMEX operating as both the network and the bank. AMEX also can operate as a four-party network with certain banks issuing cards on the AMEX network. (AMEX’s interest in this appears to wax and wane from the outside. Interest seems on the upswing; the network recently announced a collaboration with processor i2c to expand issuing with fintech companies.

If you want to enjoy a more thrilling than average business history, I recommend Peter Grossman’s American Express: The Unofficial History of the People Who Built the Great Financial Empire (also out of print, yes, I have copies of both on my desk).

For our fourth network, let’s touch on Discover. The Discover Network (and Discover Bank and Discover Cards) grew out of the Sears & Roebuck financial empire at a time when the retail behemoth also owned Dean Witter brokerage. Discover also started as a three-party network and now supports four-party issuing. Discover was a tough sell for many merchants while owned by Sears due to competitive concerns. Discover remains the smallest network.

Does the Network Matter (anymore)?

As card payments were maturing in the past 60+ years, the card network mattered a lot. The networks were very unequal in acceptance. The ubiquity of acceptance is the single most important factor in a network. Reliability, accuracy, and speed are critical, but you can’t use the network if it’s not present. Growing up, I recall my father always preferring to try to use his Discover card (I don’t know why) and often being turned down as the merchant didn’t accept it.

Acceptance continued to be a challenge even into the past decade. My favorite cafe locally didn’t accept Discover when they first opened. Many merchants would not accept American Express due to the higher costs AMEX imposed on merchants. Today, payment facilitators that provide simple pricing and all-in-one solutions like Square and Toast make it simple for every merchant to accept every network.

Visa and Mastercard continue to win on acceptance. Visa owns the coveted limited acceptance at Costco Warehouse stores (When AMEX owned this, approximately 13% of their cards were Costco co-brands). On a day-to-day basis, however, it is less and less likely any individual cardholder will get turned down for having the wrong network on the card.

Major banks also used to promote the network ahead of their brand proudly.

Today, major issuers don’t include the network on their advertising or even card fronts. Consumers don’t worry about this anymore.

Smaller issuers and fintech companies still behave like banks of old: they use the network logo to confer legitimacy to their products and typically prominently place it on their card and marketing materials.

The Network Still Matters

While the differences between the networks appear to be diminishing, and the nation’s largest card issuers downplay them, they are still important. The issuers can diminish the logos because consumers trust that they are there and the cards will simply work. There are differences in product types, benefits, ease of working with, marketing dollars, and more from an industry perspective. I don’t think choosing Mastercard instead of Visa will make your product succeed or fail on its own; having your product on Mastercard or Visa is essential to its success.

I can think of many reasons Apple may be switching to Visa from Discover: marketing dollars, volume incentives, redundancy/flexibility, and acceptance. The move doesn’t surprise me (launching on Discover did), but they are moving to a known large network. I can’t imagine them moving to something unproven.

Zelle

Where does all this leave the major banks on Zelle? The Zelle network enables peer-to-peer and consumer-to-business push payments. It’s developed and operated by Early Warning Systems, a bank-owned company/consortium much like Visa and Mastercard were (before the banks sold them).

Zelle has been under fire lately for the proliferation of scams on it. Consumers are incorrectly assuming it carries the same protections that their Visa or Mastercard cards do–it doesn’t. With Zelle, a consumer must push (send) the payment to a recipient. If you get duped into sending it…you still sent it. As a result, banks are not forgiving on returns, which typically come out of their pocket. Zelle is not designed as a reversible system. It’s a single message, and that message is “take this cash.”

When a consumer uses a credit or debit card, numerous regulatory protections cover them and zero dollar liability guarantees from the networks. If you buy a good or service from a merchant and they don’t provide it, you can dispute the charge. Consumers win many of these disputes. The bank may still take a loss, but the network arbitrates the case. If you were scammed, even if you provided your card number to the merchant, the merchant is the entity that initiated and pulled (took) the payment. The merchant has to prove they lived up to their end of the bargain.

Anecdotally, I see a lot of Zelle adoption from small merchants (like my pool cleaner or car detailer). These merchants didn’t previously accept cards. They don’t want to pay the fees nor deal with the disputes. Zelle is an excellent way for them to stop accepting paper checks and start receiving low-risk instant payments. What I don’t see is Zelle taking volume away from cards.

Aside from the form factor issues of receiving and managing Zelle payments in retail (what will you do send your supermarket payment to 555-555-1212 at the checkout stand?), banks love their interchange fees, consumers love their protections, and everything already works.

If you want to build something new that wins, you have to solve a problem. Zelle solves a cash acceptance problem for small merchants and individuals that don’t accept cards. It doesn’t help merchants that already do, except from a fee perspective. I’m willing to bet major banks enjoy that revenue and won’t make the trade simply for network ownership (they already had this choice).

In the end, Visa and Mastercard (and AMEX and Discover) have hugely successful businesses and near-complete ubiquity of acceptance in retail. While Early Warning Systems could evolve Zelle into something new, I don’t think that’s a path worth exploring. As always, cards for the win.

CardsFTW

Thanks for reading CardsFTW, a weekly-ish newsletter about all things debit and credit. CardsFTW is written and curated by Matthew Goldman, Chief Product Officer at Apto Payments. If you’re looking for insights into everyday payments beyond deal blogs, please subscribe for free at cardsftw.substack.com. If you enjoyed this, please share it with a friend! Follow me on Twitter @magoldman.