Business Model of Visa: The Magic Card

image source: freepik

Even with pandemics linger the world, Visa could still record growth for its number of transactions processed. In Fiscal Year 2020, Visa recorded more than 140 B transactions – up 2% from the previous period. Here, We try to understand the Business Model of Visa, How the card company makes money.

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In This Issue

  1. Tech or Financial Company: The Data Processing Segment
  2. The Role of Middleman: Services Segment
  3. International Transaction: Forex
  4. Client in Crime: To make it Happens
  5. Investor Key Takeaway

Every time people swipe their credit or debit card – something happens, several giant corporations with their billion technology are involved to make that transaction done.

To have the perspective of how it works, imagine Sandro, a tech geek in his apartment in Mountain View order PS5 using his Visa credit card online. Well, as we know, it doesn’t just happen.

The first thing to do is, Sandro, summon his card – Visa the Giant Network – and present it to, let say, Rebecca, a single mom merchant in Seattle. Rebecca then processes the card and information within it to her bank. Suppose she uses Bank of Captain America, In this phase, she requests authorization from it.

Bank of Captain America is too busy to calculate its money, has no time and technology to deal with it. Thus, it forward this request to Visa.

Data Processing Segment in Business Model of Visa

Funny things, Visa – The Giant Network, has no information regarding Sandro. What is Sandro’s occupation, how much Sandro makes money, Does Sandro has the capability to pay his debt? What Visa does, simply, forward this request to the Issuer of Sandro’s credit card. Visa asks the Issuer, Does Sandro deserve to make this transaction? This step is called authorization. Another funny fact, Visa makes money by doing this. The Giant Network set $0.0195 for credit authorizations and $0.0155 if Sandro uses a debit card instead.

Let say Sandro us credit card issued by U.S. Bancorp. After it gets requested by Visa, U.S. Bancorp examines Sandro’s financial situation and decides whether this transaction approved or not. And because Sandro is the programmer in Google and has a nerd lifestyle, Bancorp approves this transaction, then says to Visa”Tell the Bank of captain America, Let this guy get his PS5.”

Visa do so – short story short – the merchant complete the transaction. The newest generation of console get packed and wrapped.

Clearing and Settlement

Now we are going to more difficult parts of the transaction. Yeah, it doesn’t end like that, my friend. Because Sandro bought it via credit, it has to be paid in the next month. Here we introduce you to clearing and settlement.

Back to our transaction. Who gets the money? None, because Sandro doesn’t pay it yet. Clearing, as the name implies, is an effort to make everything is clear. That is, in this case, transferring all the parties in right amount (PS5 included all fees) and right time (next month, for example).

After the PS5 are delivered to Mountain View, what is the situation?

The merchant bank, Bank of Captain America, gives money to the merchant bank account and forwards this activity as a record to Visa.

The Giant Card Network then pays money to merchant Bank. In these circumstances, the cardholder bank has “debt” to Visa. The transaction will be “settle” when the cardholder – Sandro, has paid this console. Once it is paid, the merchant bank will transfer money to Visa and done.

Similar with authorization, Visa monetize In this clearing and settlement process with flat fee.

Into Financial Report

In its SEC filing (aka financial report), this revenue (authorization, clearing, and settlement) is recorded under the “data processing segment”. In the fiscal year 2020, this segment generates almost 11 Billion or 34% of total Visa revenue. So, if there is a debate whether Visa is a technology company or is it a financial company, I would say that Visa can be classified as a technology company since it deals with the data – very big data. What kind of data? well, financial data.

Oh, yeah, if you are interested in whether the Blockchain and its cryptocurrency – Bitcoin and gang – could disrupt this vicious cycle, you can refer here. Spoiler alert: it can’t

The Service in Business Model of Visa

Visa not only monetizes the data processing – authorization, clearing, settlement – but also makes money from its involvement in that transaction. And Visa takes it in percentage, usually 0.11% of the total cost.

In its annual report and other SEC filing, this revenue classified as services revenue. This is the second-largest contributor of Visa revenue – around 34%. Last year, it contribute almost 10 B in revenue.

In 2020, this segment generated almost 11 Billion in revenue.

image source: freepik

Cross Border Transaction in Business Model of Visa

Imagine now after getting stuck in the Dark Souls 2 game, Sandro decides to have a vacation in Portugal. To see Champion League Final since he is a big fan of Ivan Pulisic. If Sandro needs to buy or rent something in Europe, the transaction of his credit card is getting more complicated since it deals with foreign currency.

Thus, every time Sandro uses his card – to have lunch, rent a room, rent a car, buy Ivan Pulisic jersey – it is all done in Euro but he has to pay it later (assuming credit) in US dollar.

Due to the volatile nature of the exchange rate – EURUSD could give traders a very wild swing – The Network companies like Visa charge more than “usual” domestic transactions (within 1% to 3%).

In 2020, Visa pulled 1.4 B revenue from this segment.

Segment contribution analysis helps us to identify the Business Model of Visa
source: Visa annual report for FY 2020
Breakdown the revenue helps us to identify the Business Model of Visa
source: Visa annual report for FY 2020

Client Incentives

Besides its technological leadership and inerrancy (yeah, almost) services, to strengthen the bond in this payment ecosystem, Visa gives “money back” to all its partners. This “expense” accounted for more than 20% of Visa’s total revenue. I think it is not bad at all, Visa still has the rest 80% – I still say that it is a high-profit margin business.

Cost of revenue in Business Model of Visa
source: Visa annual report for FY 2020

Key Takeaway

So, what can I say? This is an old business, the old magic card that really unbroken. Boring, but a safe investment. Visa moves along with the economy, so, where the economy heading, Visa will go in the same direction. My point is, as long as there is no serious challenge to payment trifecta – Master Card, Amex, Visa – Visa growth will here to stay.

We recommend you to read our balance sheet analysis of Visa to help to make a better investment decision.