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Three may sustain a network, if two of them are happy.
Visa, Plaid, and the trick to building and maintaining a multi-party network.
In his excellent analysis of Visa’s acquisition of Plaid, Ben Thompson (@benthompson) points out that while consumers had an obvious reason to participate in Bank of America’s fledgeling payments network (which would eventually be spun off as Visa), the incentive for merchants was less clear.
when Bank of America dropped 60,000 Bank Americards on its customers in Fresno, California, in 1958, they had an immediate reason to give this new-fangled financial product a try.
What may be less obvious is why Fresno’s merchants might have been interested, particularly since Bank of America planned to charge them 6% of sales.
And indeed, large merchants like Sears weren’t thrilled (quote from Joe Nocera’s book A Piece of the Action):
Not the big merchants, like Sears, which had its own proprietary credit card and saw the bank’s entry into the credit card business as a form of poaching.
Smaller merchants, however, were a different story:
Larkin remembers visiting a drug store in Bakersfield, hoping to persuade its owner to accept BankAmericard. “When I explained the concept of our credit card,” he says, “the man almost knelt down and kissed my feet. ‘You’ll be the savior of my business,’ he said. We went into his back office,” Larkin continues. “He had three girls working on Burroughs bookkeeping machines, each handling 1,000 to 1,500 accounts. I looked at the size of the accounts: $4.58. $12.82. And he was sending out monthly bills on these accounts. Then the customers paid him maybe three or four months later. Think of what this man was spending on postage, labor, envelopes, stationery! His accounts receivables were dragging him under.”
And this was the beginning of our modern card payment infrastructure — a multi-party network that is so reliable and ubiquitous that, today, it’s irrational for any individual party (issuer/merchant/consumer) to not participate.
Retailers hate it.
But just because the network has grown into a position of near-universal participation doesn’t mean that all the participants are happy about it.
You may remember CurrentC — the disastrous attempt by a consortium of large retailers (MCX) to create an alternative payment network using mobile payments technology. The app, which itself never got beyond a short-lived trial in Columbus, Ohio, was expressly designed to help companies like Walmart avoid paying interchange fees to issuers and the networks. An issue that, for Walmart at least, became something of a personal vendetta, according to former CEO Lee Scott:
I don’t know that MCX will succeed, and I don’t care if it does as long as Visa suffers.
Despite all their efforts, Walmart and other large retailers have consistently failed to create a successful, large-scale alternative to credit cards. In order to run their businesses, they essentially have no choice but to accept cards.
But it begs the question — would Visa have a shot in hell of convincing merchants today to start participating in a fledgeling payments network that would cost them 2-6% of their sales in exchange for streamlining their back office operations?
Walmart, like Sears back in the 1950s, would almost assuredly say no. My guess is that, in the age of cloud-based back-office software products like Xero, even small businesses would be disinclined to participate.
What’s in it for banks exactly?
And this begs a similar question for the new, multi-party network Visa clearly has interest in building. Fintech developers have a clear incentive to participate in a multi-party data sharing network. Consumers who love those fintech apps do too.
Banks? Not so much.
Here’s Ben Thompson again:
The big problem is that the banks aren’t too sure if they want to participate … as long as it is hard to move money around, the more likely it is that that money will stay in the bank, collecting minuscule interest; or, if customers need value-added services, the path of lowest resistance will be simply getting them from their bank.
An API-based world could change this dramatically: suddenly consumers could commission robo-advisors to move their cash to whoever is offering the best rates, or to automatically refinance debt. Value-added services from multiple vendors would be equally easy to access, meaning they would have to compete on price or terms. In other words, much like the open Internet, banks fear that profits will be rapidly transformed into consumer benefit.
This is the fundamental issue at the root of open banking — banks don’t want banking to be open.
So how will Visa build and maintain its new network?
Obviously Visa understands this. They know that banks aren’t wild about sharing their customers’ data with fintechs (even with customers’ permission). So how will Visa build up and maintain this “new financial data network” in the words of Visa CEO Al Kelly?
Will they, perhaps, find a carrot? Something to entice banks to be active and enthusiastic participants in the network?
Improved security, perhaps?
The practice of using login credentials for screen-scraping poses significant security risks, which have been recognized for nearly two decades. Screen-scraping increases cybersecurity and fraud risks as consumers provide their login credentials to access fintech applications.
I’m skeptical that this will move the needle much for banks. Many are already well on their way to eliminating screen scraping as a method of sharing customer data through the adoption of common integration standards and the signing of individual agreements with aggregators and fintechs. The big banks don’t need Visa to do this (and the smaller banks may struggle to get Visa’s attention to help them do this).
Visa is clearly trying to mollify banks, upset with Plaid’s past willingness to get to consumers’ data through any means necessary (including screen scraping), with this statement from Al Kelly on the call discussing the acquisition:
We know there are financial institutions who would prefer Plaid operate differently in some cases, and we intend to address those concerns while not diminishing the value for developers, leveraging our global experience balancing a two-sided network
And I think that’s true. I think Visa will aggressively push Plaid to make changes to address banks’ concerns, especially around security and compliance.
But there’s something critical that Visa isn’t saying in that statement. Something they understand, perhaps better than anyone.
The trick to “balancing a two-sided network” is to always prioritize benefits to the end consumer, even if it means routinely neglecting the interests of one of the participants in that network.
You have only to look at how the card networks navigate the fraught no-man’s land between issuers and merchants in order to see this axiom in effect.
Take, for example, the “honor all cards” rule, which prohibits merchants from accepting some cards from a particular network, but not others. Retailers have been working for years to get the courts to nullify this rule, over the carefully-worded opposition of the card networks:
Visa believes consumers should always have a choice in how they pay, including being allowed to use their Visa credit card regardless of the card type or issuer. When consumer choice is limited, nobody wins
That statement, as meticulously crafted as it is, conveys a crystal clear message — credit cards are working great (for consumers and issuers), no changes are needed.
And even when changes are needed, such as the long-overdue transition from magstripes to chip and PIN in the U.S., the impact of those changes on network participants is rarely equitable. The networks mandated that issuers and merchants adopt chip cards in 2015, but there was some disagreement over PINs:
The disagreement over chip-and-PIN vs. chip-and-signature, then, primarily comes down to the competing interests of banks and retailers as each one tries to drive down the types of fraud that are most expensive for them. The issuing banks want to drive down counterfeit fraud—because they pay for the bulk of it—and they want to do it as cheaply as possible. And they don’t want to lose customers by making credit cards any more difficult to use. The merchants would also like to do things cheaply and without losing customers, but the cost of issuing PINs to millions of customers wouldn’t fall to them, and they have a greater interest in trying to drive down card-not-present and lost-or-stolen fraud, neither of which is impacted by the use of microchips alone.
You’ll never guess which side the networks came down on.
What happens next?
In their analysis of the Plaid acquisition, Commerce Ventures wrote:
In many ways, this positions Visa to further move beyond being an intermediary for card payments to becoming a foundational layer for financial data, transactions, and identity.
I think that’s absolutely right. I think Visa sees a future in which the day-to-day value consumers’ get from financial services flows, first and foremost, through fintech apps (and embedded fintech capabilities in non-fintech apps) and it wants to be a bigger part of it.
I think Visa will leverage its brand, merchant relationships (such as they are), and large R&D budget to significantly amplify the value that consumers get from fintech.
And I think Visa will try, quietly and with the convincing appearance of neutrality, to drag its recalcitrant bank partners into this brave new world.
When you think about the consumer value that the networks are so fiercely protecting in the credit card market, think of this stat (courtesy of @MercatorAdvisor): 92% of all U.S. credit-card purchase volume is currently charged on rewards credit cards, up from 67% in 2008.
And if you want a window into the challenge that Visa has in building a similarly strong consumer value proposition in the world of open banking, start with this stat (courtesy of The Clearing House, by way of @MaryMWisniewski): “Of the 54 percent of bank customers who used outside apps at least once in the past year, the survey found that the vast majority (80 percent) of consumers do not realize that the fintech app or third-party data aggregator may store their bank account username and passwords.”
ICYMI, a few of my favorite takes on the Visa/Plaid acquisition (which were published in a much more timely manner than mine): Penny Crosman (@pennycrosman) on what the acquisition means for banks and fintechs, with excellent insight from Brad Leimer (@Leimer) and Sam Maule (@sammaule). Ron Shevlin (rshevlin) on what Visa is going to do with Plaid. And Tom Noyes’s (@noyesclt) quick take on the acquisition.