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Card networks economics: Increased profitability post-IPO

The card networks, Visa and MasterCard have grown significantly and altered their market approaches since their initial public offerings (Visa in 2008, MasterCard in 2006).

While market headwinds, including the great recession and the Durbin Amendment, have created hurdles, gross dollar volume has increased at a 9.9% and 10.0% CAGR between 2008 and 2014, for Visa and MasterCard, respectively. Both networks have increased net revenue on a constant dollar basis since 2008, driven primarily by increased cross border activity, launching new services, and increasing fees to network participants – writes Myron Schwarcz, Principal and Andrew Gordon, Senior Consultant, Strategic Sourcing, First Annapolis.

Visa and MasterCard employ similar pricing structures for network participants, charging fees for use of the network and offering incentives to help issuers grow payment card volume and to reward merchants/acquirers for steering a larger portion of volume to their respective networks. In essence, the incentive arrangements are a mechanism for providing discounts relative to “list pricing” to lower the net cost of payment card network participation. In return, the networks seek long-term commitments to help ensure payments volume and revenue is protected moving forward.

An analysis of public filings released by both networks shows that the effective pricing in basis points (i.e., net revenue / gross dollar volume) paid by issuers and acquirers in aggregate increased at a CAGR of 3.8% between 2008 and 2014 (4.2% for Visa and 3.5% for MasterCard) (see Figure 1). This growth is the result of a greater increase in gross fees relative to client incentives.

Figure 1: U.S. Net Revenues, 2008-2014

Figure-1_-US-Net-Revenues-2008-to-2014Source: Visa and MasterCard Annual Reports, First Annapolis Consulting analysis.

It is difficult to pinpoint the specific areas that have contributed to higher net revenues; both industry-level impacts and network-specific strategies are key factors. For example, increases in cross-border activity and small-dollar transactions, and lower incentives for lower year-over-year growth all drive higher net revenue per transaction based on Visa and MasterCard pricing structures. At the same time, both networks have increased list pricing on existing fees and introduced optional services. Visa noted in its 2013 annual report that “operating revenue growth also benefited from pricing modifications made on various services.”

It is not surprising that Visa and MasterCard are focused on profitability as public companies. They operate highly resilient business models that have rewarded shareholders handsomely.

Still, net margin expansion from 28% to 43% and 25% to 38%, respectively, for Visa and MasterCard on a global basis places them in a delicate situation as they seek to negotiate long-term agreements. Issuers and merchants/acquirers likely have not experienced the same level of profitability growth and may look at their network participation agreements as a way to reduce expenses, to the extent they are able, given the lack of alternatives and high switching costs.

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