The Expanding Roles of Network
As Visa and MasterCard have been making announcements recently, there has been a lot of speculation about their strategy and intent. In particular, Tom Noyes recently wrote about the networks tilting away from issuers and Cherian Abraham wrote about the networks routing more than transactions and the widening “moat” around Visa and MasterCard.
Both of these insights hint at a potentially bigger change: allowing new, non-traditional players on the network. Understanding this possible shift requires some background on how networks operate today. Historically, Visa’s VisaNet and MasterCard’s BankNet have been walled gardens with (intentionally) high barriers to entry. Only certain types of endpoints were allowed on the network: issuers, acquirers and processors acting on issuers or acquirers behalf. The certification process to gain access to these networks is onerous in large part to maintain the security and integrity of the service. Even the documentation that details the operation of the network, the message formats used to communicate on the network, and the certification process is limited to licensees. Again, these licensees are typically limited to issuers, acquirers, processors, or companies working on their behalf.
HOW THIS COULD CHANGE
If Tom is right that the networks are tilting away from issuer-centricity, and if Cherian is right that the networks want to handle more than just payments, the way the networks think about endpoints has to change. First, the networks will have to differentiate between the acquirer/issuer/processor players (first-class citizens with full access to the network) and limited-service players. These limited-service players can play important roles in the payments ecosystem: they may interact with token services, generate certain (limited) types of transactions, or provide other value-added services to the first-class citizens.
Second, these limited-service players must have lower-barriers to entry. If the network can restrict the capabilities of an endpoint, it makes sense to make the certification process less demanding. This could be done by:
- lifting the requirement for “sponsorship” by an institution already connected to the network
- easing the certification requirements to be limited to only the transaction types a limited-service endpoint is authorized to perform
- making documentation for the transactions eligible for use by these limited-service players freely available
- providing sandboxes for development and testing with low-to-no cost of entry
- enabling alternate ways to access to the network (APIs) beyond the standard ISO messaging
These changes would create immense opportunity for the fintech community which has historically been boxed out of network access without a bank partner. On the last three points, the networks have already begun this shift as they have rolled out more developer-friendly offerings like MasterCard’s MoneySend API and Visa’s Checkout SDK.
WHY THIS COULD BE BIG
The networks have a unique market position. They:
- connect millions of merchants, tens of thousands of issuers and hundreds of millions of cardholders
- provide significant services beyond just routing authorization, clearing and settlement
- only within the last decade have been independent of issuers; prior to MasterCard’s IPO in 2006 and Visa’s IPO in 2008, they were a cooperative of banks
Let’s take these points one by one.
CONNECTING MILLIONS OF MERCHANTS WITH TENS OF THOUSANDS OF ISSUERS
Metcalfe’s Law states that the value of a network is proportional to the square of the number of connected users of the system. Adding endpoints to the network generates value and creates customer inertia that new entrants must overcome to compete with incumbent networks. Creating a network of similar scale is prohibitively expensive and would require overcoming virtually insurmountable merchant, issuer and consumer inertia.
Access to this network is incredibly valuable for reasons best explained in the next two points.
MORE THAN JUST ROUTING AUTHORIZATION, CLEARING AND SETTLEMENT
Networks sit at the center of tokenization processing, ID&V services for digital wallets, and provide a number of value-added services that most consumers never see. The networks provide sophisticated stand-in services when issuer authorization systems are down, fraud detection and prevention services, account renumbering services for merchants, dispute resolution services for issuers, and more. All this adds up to more than “dumb pipes”: there are complex business and operational problems that the networks have solved using decades of payment processing experience. The view that the networks just route transactions, manage an acceptance brand and adjudicate disputes is a dramatic over-simplification.
As new businesses – and business models – are created using newer network capabilities, these services will suddenly become very useful to new players. Tokenization and near real-time money sending are the two services that have tremendous value for creating new business. Fintech companies in particular could benefit from leveraging these kinds of foundational payment services and focus on product specialization. Networks could charge for these services, basically becoming the Amazon Web Services of payment infrastructure. Similar to Amazon, it would create a new revenue stream out of fixed-cost assets that the network has already deployed and, in many cases, are already fully depreciated. It’s gravy for the networks. While this approach is often highlighted as one that banks should be exploring, there has not been much focus on the untapped potential available to the networks as well.
Apple Pay and Android Pay are prime examples of new business models adding value to customers by sitting on top of network services. Both companies realized that the quickest path to support from the merchant, issuers, and every party in-between was to utilize the existing networks already in place.
It stands to reason that mobile wallets and tokenization are just the beginning. The networks have effectively solved the near real-time money movement problem with Visa OCT and MasterCard MoneySend and there are hundreds of use-cases for new businesses that are enabled by reliable, ubiquitous, fast money movement.
NETWORK INDEPENDENCE FROM ISSUERS AND PROFIT-MOTIVE IS FAIRLY RECENT
The last point is significant because it explains the historic “tilt” towards issuers that Tom highlights in his article. Visa and MasterCard are still evolving… It takes time to turn the ship, but their obligation to shareholders mandates that they maximize profits, even if it means upsetting the status quo put in place by their issuer origins. The organizational muscle memory that comes from their issuer-focused beginnings cannot be understated. The Visa and MasterCard that we see today is one that is still adapting to their relatively recent independence while also recognizing that the issuers are actively working on alternative routes for their transactions as well.
This evolution will continue to lead Visa and MasterCard to finding innovative ways to leverage their market position and assets. Merchants and payments observers in particular are quick to ascribe this behavior to some evil motivation, but we believe the reality is much simpler – the networks are acting the way that a rational, publicly traded company should behave to maximize their value. In the search for maximizing growth and profits, it’s impossible to ignore the value their network could create for new players.
The networks are just getting started. Our advice for each of the ecosystem players:
- Networks: Continue looking for ways to monetize your assets from new players.
- Issuers: Network-based revenue is being threatened. Anyone not planning for ways to replace interchange revenue is behind the curve. The networks serve more than one master.
- Merchants: Tom is right, the networks will become more merchant-friendly. That said, there is always a danger posed by being handcuffed to two companies for the majority of debit and credit transactions. While efforts like MCX have stumbled, they are necessary to continue exploring alternatives to the networks.
- Fintech Companies: Look for ways to leverage network and issuer assets that solve the thorny problems for you and you’d be willing to pay the networks to use. We suspect the networks will be increasingly open to entertaining these sorts of deals.