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Episode: Visa

Author: Ben Gilbert and David Rosenthal
Duration: 03:42:04

Episode Shownotes

To paraphrase Visa founder Dee Hock, how many of you know Visa? Great, all of you. Now, how many of you know how it started? Or, for that matter, who started it? Who runs and governs it? Where is it headquartered? What’s its business model?For the 11th largest market cap

company in the world, Visa’s history and strategy is almost shockingly unknown. A huge portion of the world’s population uses their products on a daily basis (you might say Visa is… everywhere people want to be), but very few know the amazing story behind how that came to be. Or why Visa continues to be one of the most incredible and incredibly durable business franchises of all-time. (50%+ net income margins!! On $30B of revenue!) Today we do our part to change that. Tune in for one heck of a journey.Sponsors:ServiceNow: https://bit.ly/acqsnaiagentsHuntress: https://bit.ly/acqhuntressVanta: https://bit.ly/acquiredvantaMore Acquired!:Get email updates with hints on next episode and follow-ups from recent episodesJoin the SlackSubscribe to ACQ2Merch Store!Links:Burger King rolling out credit cards in 1993Get your BankAmericard MasterCard today! (!?)Episode sourcesCarve Outs:I Think You Should LeaveMistborn‍Note: Acquired hosts and guests may hold assets discussed in this episode. This podcast is not investment advice, and is intended for informational and entertainment purposes only. You should do your own research and make your own independent decisions when considering any financial transactions.

Full Transcript

00:00:00 Speaker_00
It's funny, when we picked this episode, I was like, oh, this is going to be pretty down the middle and easy. And then, of course, as we get into the research, as always, it's like, oh, no, big story here.

00:00:08 Speaker_01
Yep. There's always a story.

00:00:11 Speaker_02
Who got the truth? Is it you? Is it you? Is it you? Who got the truth now? Is it you? Is it you? Is it you? Sit me down. Say it straight. Another story on the way.

00:00:28 Speaker_00
Welcome to Season 13, Episode 4 of Acquired, the podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert. I'm David Rosenthal. And we are your hosts.

00:00:39 Speaker_00
Today, we tell the story of an absolutely incredible system. You can show up anywhere in the entire world with a piece of plastic and transact for anything you want in any currency.

00:00:51 Speaker_00
The merchant doesn't need to know you or trust you, and you do not need to know or trust the merchant.

00:00:57 Speaker_00
And Visa, along with just one other competitor, MasterCard, has tirelessly spent decades stitching together all the banks, merchants, and the relationships with consumers to make this possible.

00:01:08 Speaker_00
Now, this is just the rosy side of the story, and merchants may harbor far less rosy feelings about Visa given how much of their profits go to interchange fees, but the duality of the story is what makes it so interesting to understand.

00:01:23 Speaker_00
Today, we will explore how the whole thing came to be and try to understand the value that the credit and debit card system creates compared with how much it captures and by whom in what situations. So here are some astonishing stats on Visa.

00:01:39 Speaker_00
It is the 11th most valuable company in the world. It is worth more than any bank in the world, including every bank involved in creating it. Visa's brand is among the very most trusted in the world, associated with reliability and security.

00:01:55 Speaker_00
But that said, if you asked most people what Visa does, they could not actually articulate it. Visa does not extend credit. They do not issue cards. They do not work directly with merchants. They do not work directly with consumers.

00:02:09 Speaker_00
They are not a bank or a financial institution. They don't ever bear any risk. They are merely a network connecting banks to other banks. David, it is insane.

00:02:20 Speaker_01
This is such an insane story. I can't believe we're all the way in season 13 and we haven't talked about this company yet. But as we will get into, it's always been overlooked and underrated.

00:02:30 Speaker_00
Well, perhaps not underrated the last decade or so. If you listeners want to know every time an episode drops, you can sign up for email updates at acquired.fm slash email. Two new fun things.

00:02:42 Speaker_00
One, emails now include little hints and some teasers about what next episode will be. So if you want to play the guessing game, sign up at acquired.fm slash email. And the emails have another new feature.

00:02:54 Speaker_00
We are including follow-ups from previous episodes when we learn new things from you after release. Come talk about this episode with us after listening at acquired.fm slash slack.

00:03:06 Speaker_00
And if you want more from David and I outside of these big, long main acquired episodes, check out ACQ2, our interviews on a second podcast feed. Now, without further ado, this show is not investment advice.

00:03:19 Speaker_00
David and I may have investments in the companies we discuss, and this show is for informational and entertainment purposes only. David Rosenthal, where are we starting today?

00:03:28 Speaker_01
Well, we are starting actually with a big thank you to Dave Stearns, author of what is undeniably the very best book on Visa and its history, Electronic Value Exchange.

00:03:39 Speaker_01
And we owe a thank you to Dave both for writing the book and for talking to us as we researched and helping us sift through everything as we're preparing here.

00:03:46 Speaker_00
Fellow Seattleite, and the book, which is so wonderfully esoterically named Electronic Value Exchange, was his, I think, PhD thesis that they sort of turned into a book.

00:03:55 Speaker_01
Correct.

00:03:56 Speaker_00
All right. Take us back in time.

00:03:59 Speaker_01
So, D. Hawk, the founder of Visa, who we will talk a lot about as we go along here,

00:04:04 Speaker_01
He told this great story of how after his time at Visa and his kind of older age, he would start his speaking engagements with a little thought exercise for the audience.

00:04:15 Speaker_01
He would get up on stage, he'd hold up his Visa card, and he would ask, how many of you recognize this? And of course, every single hand in the room would go up as I assume all of yours listening are going up now too.

00:04:28 Speaker_01
Then he would say, okay, now how many of you can tell me who owns this company? every single hand in the room would always go down. And then he would say, how did this company start? No hands. Who runs it and who governs it? No hands.

00:04:42 Speaker_01
Where is it headquartered? No hands. It's just wild, as we were saying in the intro, how important this company is.

00:04:49 Speaker_01
And yet still to this day, I think, you know, maybe a few more people than in Dee's time know the answer to these questions, but not many.

00:04:56 Speaker_00
Yeah, it's one of these things too. It's like one of the only essential pieces of financial infrastructure in the United States that has not run out of New York.

00:05:03 Speaker_01
So our task today is to tackle these questions. And we start where some of you I suspect know, but the vast majority of you I also suspect don't. We start in 1958 in Fresno, California with the drop.

00:05:21 Speaker_00
The Drop, this is the name of the title in this fantastic book, A Piece of the Action, How the Middle Class Joined the Money Class, and it is chapter one, The Drop, 1958.

00:05:32 Speaker_00
The Drop has become like, if you say The Drop to someone in the fintech industry, they're like, oh, September 1958, Fresno. Yep.

00:05:40 Speaker_01
And the rest of the world has no idea. Yep. All right, so what happened?

00:05:46 Speaker_01
the then largest bank in America, the San Francisco-based Bank of America, which formerly was called the Bank of Italy, both of which were total misnomers because it was actually more accurately the Bank of California.

00:06:02 Speaker_01
It was illegal to operate banks across multiple states back then, as we will discuss.

00:06:07 Speaker_00
And the reason it was named Bank of Italy was it was started by an Italian immigrant who wanted to create something for the underbanked Italians in his California community.

00:06:15 Speaker_01
Yeah, mostly farmers and merchants in San Francisco. It really started as like the Bank of the Little Guy.

00:06:22 Speaker_01
So Bank of America decides that they are going to mail out little rectangular pieces of plastic to every single one of their 65,000 customers in the city of Fresno, completely unsolicited. Now, a couple things about this. One, it's wild.

00:06:44 Speaker_01
I think the Fresno population at this point in time was like maybe 200, 250,000 people. So like a huge portion of the city of Fresno banked with Bank of America. And that was true for all of California at the time. Two, they just send these things out.

00:07:00 Speaker_01
Obviously, these are credit cards. People don't know what they are. They have no idea what to use them. Mass chaos ensues.

00:07:06 Speaker_00
Well, and certainly nobody asked for them. There's this great quote, again from a piece of the action, that describes it and says, All right.

00:07:25 Speaker_01
So, to explain how we got here, we need to spend a few more minutes on Bank of America's history and the history of banking and payment industries in the U.S. more broadly.

00:07:36 Speaker_01
So, like we said, B of A was the biggest bank in America in the 1950s, but it was not like all the other big banks at the time. It was a consumer bank. The other large and influential banks in America back then were like the JP Morgans.

00:07:52 Speaker_01
They were white shoe corporate banks based in New York. We talked about this a lot in the Nike episode. It was illegal for banks to operate across state lines until much, much later in history.

00:08:04 Speaker_01
So for banks back then, the only way that you could actually get big for just about everybody else in the industry was to go the corporate route and to go the investment banking route, because you could service very large corporations that obviously were large themselves, would generate lots of deposits, lots of lending activity.

00:08:20 Speaker_01
The investment banking activities around that were obviously very lucrative. That's how the JP Morgans, you know, the Morgan Stanleys, et cetera, the world came to be. For the most part, consumer banks were kind of backwater, small.

00:08:34 Speaker_01
There was no way to aggregate enough customers that you could get big enough.

00:08:38 Speaker_00
Well, and in most states, they would have restrictions on the number of branches that banks could actually have. In some states, I think Texas was one of them, you literally could only have one branch.

00:08:50 Speaker_00
Other states would limit them as something like three, other states would limit them and say none outside the city, so you were sort of a bank of a city.

00:08:57 Speaker_00
You could almost think about these more as credit unions than these sort of big banks that we think about today. California happened to be unique in that you could actually have branches all over the state.

00:09:07 Speaker_00
And California happened to have quite a large population. So it was kind of the only place you could pull off a large consumer bank.

00:09:16 Speaker_01
Yes, exactly. California was already the second biggest state in the nation at that time behind New York.

00:09:21 Speaker_01
But the New York banking industry was super fragmented because Bank of America, starting as Bank of Italy with all these immigrants, had built up a consumer base. They really were unique.

00:09:31 Speaker_01
So, you know, the business of banking is, well, banking, you take deposits, you make loans, you make your money on the loans. B of A was doing tons and tons and tons of small, little and disparate consumer loans and lending.

00:09:50 Speaker_01
So obviously mortgages and car loans like those still exist today, but they were doing like washing machine loans.

00:09:56 Speaker_00
They were doing like buy now pay later, but instead of on the website, you would go to your local bank branch, you would schedule time, you would sit down with the bank manager, and he would authorize you to go spend $150 at some merchant and make you a loan that you would come pay back over the next few months in installments.

00:10:14 Speaker_00
And every single time that you wanted to buy something now and pay for it later, you would repeat this very physical one-off manual process.

00:10:22 Speaker_01
and for specific items to like go buy a refrigerator. Wild. It was just wild to imagine today.

00:10:28 Speaker_01
So you can see why for a bank like Bank of America that is doing this at such large scale, the idea of a consumer credit card, well, it's pretty awesome because you can take all of these disparate lending programs, consolidate it into just one card, cut out a ton of overhead fees and make it way more efficient.

00:10:49 Speaker_01
So this is what they are launching first in Fresno as the pilot market, and they call it the Bank AmeriCard. Beautiful name. Beautiful name. And it would survive for quite a long time. Now, this wasn't exactly a new idea on the part of Bank of America.

00:11:06 Speaker_01
Charge cards and credit cards have been around for decades. What was new was this was the first time that a bank had entered this market at scale. So let's talk about the history. Historically in the US, transferring money was actually not that easy.

00:11:21 Speaker_01
You had two options. You could use cash or you could use checks. And checks worked, but they also had a bunch of problems. One, until the creation of the Federal Reserve in the 1910s,

00:11:35 Speaker_01
The parties cashing the check, receiving the check, didn't actually receive the full face value of the check because there was a bunch of work and like mailing stuff around, traveling around the country that had to be done.

00:11:45 Speaker_01
And that was taken as a discount out of the check.

00:11:48 Speaker_00
And this is super important. This thing that we have today, interchange rates on credit cards. That was happening with checks too. There was really a lot of expense and risk in processing checks when they first got started.

00:12:00 Speaker_00
And like, of course you would take a discount out of the fact that you're taking risk and you're spending money to go and make sure that this check that someone handed you eventually turned into dollars that you could have in your possession.

00:12:12 Speaker_01
So, problem number one, you didn't get all the money. Right. Problem number two, also a big problem, it took a really long time. Imagine, you know, we're talking like the 1800s, early 1900s.

00:12:24 Speaker_01
This stuff was on the Pony Express, you know, pieces of paper going around a really, really big country. Not ideal.

00:12:31 Speaker_00
Yeah, and until ACH, where the banks would sort of all meet once a day and decide, okay, how much do I owe you? How much do you owe me?

00:12:39 Speaker_00
In aggregate, okay, let's just settle one transaction and then we'll figure out all of our internal accounting ourselves. They were literally like check by check and saying, okay, I have this check, so you owe me $6.08. Okay, next check.

00:12:52 Speaker_00
Oh, I owe you $4.20. And it was this crazy system of individual couriers bringing checks from the person who gave it to the merchant for the merchant to go and track down the money and bring the money back.

00:13:05 Speaker_01
Totally. And, spoiler alert, ACH doesn't get developed in the U.S. until the 1970s. Wow. Humans, though, are quite ingenious creatures at solving their problems, particularly when motivated by money.

00:13:20 Speaker_01
So there is sort of an obvious solution to this for merchants and their sort of usual regular customers, and that is credit accounts, charge accounts.

00:13:30 Speaker_01
Rather than giving me money or a check, let me just keep tabs on a ledger of what you bought, what the value is. I'll tab it all up. And then at the end of the month, you'll come give me a check or cash for it.

00:13:41 Speaker_01
I remember even me growing up in the 1980s, we had this at our local gas station near our house. Really?

00:13:49 Speaker_01
We had a credit account, and it was just like, whenever any of our family would go to this gas station, we would get the gas, and then we'd go inside and be like, oh, we have an account here, and they'd just write down what it was.

00:14:01 Speaker_01
And then at the end of the month, I assumed my dad would go give them some money.

00:14:05 Speaker_00
Which saves on operations for everyone. It's, oh great, now we only need to move money once, we move it at the end of the month, and I trust you because I've seen you lots.

00:14:13 Speaker_01
So from charge accounts at individual gas stations or individual branches of a grocery store chain or something like that, it's not a leap to think the next stage of evolution would be, oh, a card or account that would work at all the branches of a given brand.

00:14:29 Speaker_01
So like the gas stations get into this in a big way. Standard oil gets into this in a big way. Lots of standard stations across the country. You can have an account that works at all standard stations.

00:14:40 Speaker_00
Yep, in 1939, Standard Oil of Indiana sent 250,000 unsolicited cards directly to all of their customers.

00:14:49 Speaker_01
Yeah, making the Fresno drop look like a drop in the bucket, shall we say?

00:14:52 Speaker_00
Well, and interestingly, this is 20 years before. But again, this is not a bank. This is a single merchant mailing it out to all of their customers exclusively for use at their facility.

00:15:04 Speaker_01
Yep. So there was that phase, then pretty quickly in a given local area, some of the retailers would get together and be like, you know, we compete with each other, but it sucks running these charge account programs on our own.

00:15:24 Speaker_01
We could collaborate and have a standardized charge account system that we could share.

00:15:31 Speaker_00
And just literally to simplify the back office as the first value proposition here.

00:15:36 Speaker_01
Yep. And for consumers, that's also pretty awesome, because do you really want to carry around 57 different charge cards in your wallet? Or would you rather have one that would be like, you know, your visa to everywhere you want to be? Yes.

00:15:52 Speaker_00
And, not to mention, on top of this, there is the huge benefit of a shared credit history.

00:15:58 Speaker_00
Now, all these merchants who were losing money on people coming and getting a loan from them in the form of, I'm going to buy some goods, I'll pay you back later, but it turns out they had run up a tab all over town and weren't paying their bills anywhere.

00:16:10 Speaker_00
Now, with this idea of a shared card, you actually can have a shared notion of who a consumer is across locations and across different retailers.

00:16:19 Speaker_01
Yep. So this comes to be kind of post-depression in the 1930s, 1940s in the U.S. And this really is starting to sound a lot like Visa. Except, as you point out, Ben, there is a problem here.

00:16:34 Speaker_01
As the size of any given network of retailers that are collaborating on this grows, so does the intensity of competition within that network. So once you get to a certain scale, nobody's really incentivized to keep making this work.

00:16:51 Speaker_01
A, because now you're enabling people to shop all your competitors. But also, B, once you get past, I don't know, a couple hundred, a thousand participants here, like are individual merchants equipped to manage a network like this?

00:17:04 Speaker_01
No, they don't have the resources to do this.

00:17:07 Speaker_00
Right. So you have to spin up some kind of like shared organization that all the merchants are pooling their capital into in order to run the network on behalf of all of the merchants. It gets messy.

00:17:17 Speaker_01
Or there could be an independent third party for profit network that does this. And this is when Diners Club and American Express arrive on the scene. So Diners Club was first and people might know and have heard of Diners Club. It still exists today.

00:17:34 Speaker_01
It's like a sub brand of Discover. Totally. There's a very famous legendary origin story behind Diners Club and it goes like this.

00:17:46 Speaker_01
In 1949, you know, post-World War II, economic prosperity, beginning of the Mad Men years in New York and Manhattan, a New York businessman named Frank McNamara is hosting a lavish business dinner in downtown.

00:18:00 Speaker_01
halfway through the dinner, he realizes that he forgot his wallet at home.

00:18:05 Speaker_01
He does not have cash to pay for the dinner, so he excuses himself, he goes to the payphone, he calls his wife at home on Long Island, she speeds into the city with enough cash in time to pay the bill for the dinner and, you know, face is saved, his reputation as an erudite businessman is preserved.

00:18:25 Speaker_01
And then afterwards, he's talking to his wife, he's like, oh, there's got to be a better way to do this.

00:18:30 Speaker_01
There really should be a business person focused charge card network that would work at all the restaurants in Manhattan where business people host dinners.

00:18:40 Speaker_00
So nobody ever needs to bring their cash, and you could just imagine that we're all in this club of diners where anywhere we dine, we can stand up, we can authorize the bill, we can leave, we can pay no dollars out of our pocket that moment, and we get one nice statement at the end of the month that, importantly, we do need to pay in full.

00:18:58 Speaker_00
We cannot roll it over into a loan. We must pay it. But that's nice because all of my business transactions are on one single statement. It's easy for my expense reports. It's easy for me to not have to carry a wallet around.

00:19:10 Speaker_00
And of course, I get to look super awesome in front of all of my colleagues.

00:19:15 Speaker_01
I think there are two really important points here. One, you said I pay it. I don't pay at my company. I don't care to the most important point.

00:19:24 Speaker_01
I get to look super awesome in front of all my colleagues and customers and people that I'm trying to impress. I don't need to bring cash. They know me here. I'm good for it.

00:19:35 Speaker_00
And just to start tracking a certain number here, when we were talking about checks earlier that were getting a discount, and even in this era of early Diner's Club, early American Express, we're talking about a 5% to 7% discount of what actually got remitted ultimately to the restaurant or the retailer versus what the bill was originally that the consumer authorized.

00:19:57 Speaker_01
So all that's a very nice story, except it's completely fabricated. None of that actually happened, although stories like that did play out, I'm sure, on a nightly basis in Manhattan.

00:20:09 Speaker_01
The reality is Frank just thought this would be a good business idea. And he was right. You know, you see this all the time with networks, network effect businesses. This was the right little node of the network to start with.

00:20:22 Speaker_01
This was like Harvard and Facebook, because restaurants in Manhattan They're competitive with one another, but it's not exclusive competition. This isn't JCPenney's versus Macy's.

00:20:34 Speaker_01
No restaurateur in Manhattan, no matter how good they are, really honestly believes that a majority of their customers are only going to dine at their restaurant.

00:20:43 Speaker_00
Great point. So there's some incentivized sharing. It's almost like the reason to enter into a bundle for your most extreme fans, which are only going to be like the top 5% of your customers.

00:20:56 Speaker_00
Sure, you want some kind of exclusive relationship and you want to maximize the dollar value you can get out of them.

00:21:01 Speaker_00
But for your casual fans who like your business but aren't necessarily exclusively going to use your business, you should figure out some kind of bundling system that makes you work with complements of yours so that people can shop you and everything like you with the easiest way possible.

00:21:18 Speaker_00
And you can still make some money on everybody.

00:21:20 Speaker_01
You're enabling people to spend money in your restaurant easier and more frequently. And you don't really care that they also go to other restaurants because they're going to do that anyway. It's crazy.

00:21:30 Speaker_01
Like you said, diners club is able to charge restaurants and other merchants. They expand to hotels, you know, airlines, anything that a business person traveler would need. 7% of the gross bill, you know, merchants complain about 3% today, 7%.

00:21:43 Speaker_01
And these are restaurants like that's crazy. Eventually they have so much power in what they're doing. This product is so good. They also add a fee for the card holders. And it's companies like it's not individual people paying this fee.

00:21:58 Speaker_01
It's the companies paying this fee. Of course, they're happy to pay it. It enables business. Amazing, brilliant idea back in the day.

00:22:05 Speaker_00
And we should say this is pricing power in action to have those very high fees. It's also a necessity. The cost of running these networks in a previous technology generation was super high, and it was not at full scale yet.

00:22:20 Speaker_00
So it's just operating with a bunch of restaurants and retailers in New York City. So you actually need a lot of people, both because there's not a lot of technology, but you need a lot of people even though there aren't actually a lot of merchants.

00:22:32 Speaker_00
And so it turns out there's just a lot of cost in the system to run it.

00:22:36 Speaker_01
And Diners Club would ultimately fade, although it grows to over a million members, it goes national, it gets acquired by Citibank, then sold to Discover in 2008, as we said, still a brand today.

00:22:47 Speaker_01
But it's basically impossible to create a independent from the ground up network of this at the time, because you were just talking about the operational costs of running this thing. Think about the merchant and customer acquisition costs.

00:23:02 Speaker_01
Nobody knew what Diners Club was.

00:23:04 Speaker_01
They have to now go canvas the entire island of Manhattan and ultimately, you know, the whole country and world and sign up all of these merchants and go sign up all of these companies to get their employees to use it.

00:23:15 Speaker_01
That is a very expensive sales proposition. Whereas from this point on, basically everybody else that comes into the industry already has established relationship sales channels into one or both sides of the market.

00:23:29 Speaker_01
Which, of course, brings us to the brand you're all probably thinking about here, American Express.

00:23:35 Speaker_00
which is the diner's club of today. It's the favored card by businesses. It is the card that is most used for travel and entertainment and meals. Yep.

00:23:46 Speaker_01
And so as you might remember from our Berkshire Hathaway series a couple of years ago, Amex at this point in time was primarily a traveler's checks business. That's how they started, right? Well, actually, no, they started in 1850. This is amazing.

00:24:00 Speaker_01
Do you know who started American Express? This is a version of D-Hawk holding up the visa card.

00:24:04 Speaker_00
Ooh, no I don't.

00:24:07 Speaker_01
I did not either until doing research for this episode. It was started by a group of people, two of the most prominent among whom were- Oh, Wells and Fargo. Henry Wells and William Fargo. Amazing. Totally amazing, man, 1850.

00:24:21 Speaker_01
The Wild West, different time.

00:24:23 Speaker_00
It was something like they started American Express, but then had a conflict. And so they left and they started Wells Fargo after that.

00:24:30 Speaker_01
Yeah, something like that. The infrastructure of America was getting built out. So American Express called American Express. It was an express mail company. It was like the Pony Express. That was how they moved stuff around.

00:24:41 Speaker_01
And I think Wells and Fargo were doing banking. And so obviously banks, as we're talking about, you need to move stuff around the country. It was like a related business.

00:24:49 Speaker_00
It's amazing. I think it's fascinating that Wells Fargo came after Amex. Like, you think Wells Fargo as this old-timey foundation of America. American Express is even older than that.

00:25:00 Speaker_01
So, Amex, by this point in time, had become a traveler's checks primarily. That was their primary business. As we talked about on the Berkshire episode, that was a freaking awesome business.

00:25:11 Speaker_01
Partially because traveler's checks, you know, they made good money.

00:25:14 Speaker_01
You would buy a hundred dollar traveler's check and pay MX a little fee or whatever, but the float and the breakage, like there's traveler's checks out there today that are 50, a hundred years old that have never been cashed. And Amex has just been.

00:25:26 Speaker_01
Sitting on that cash for decades, investing it. What an amazing business.

00:25:32 Speaker_00
Okay, so Amex observes Diners Club and says, hey, we need to get into this and we actually have an ability to get into this fast. And they actually try to buy Diners Club, but they can't get there on price.

00:25:43 Speaker_01
And so they're like, well, we don't need to pay you a lot of money because we can just do this too. And like I was just saying, not only can we do it too, we can do it better than you because we're American Express. We have relationships.

00:25:58 Speaker_01
with companies. We have relationships with restaurants. We have relationships with hotels. We don't need you, Diners Club.

00:26:05 Speaker_01
So just within like a year or maybe even two from when Amex launches their charge card, you know, business traveler program, they sign up 700,000 members, which is almost as much as Diners Club had signed up, you know, many years of working on it.

00:26:22 Speaker_00
And importantly here, the thing you're seeing is this is the first time a real financial company is coming into the industry.

00:26:31 Speaker_00
All of the we know you're good for it-ness was happening directly from retailers before or by organizations that represented retailers and restaurants.

00:26:41 Speaker_00
And so now you sort of have not a bank, but a bank-like entity that is starting to say, oh, this could be an interesting business.

00:26:49 Speaker_01
So this brings us right back to Fresno in 1958, because the timelines match up exactly. This is crazy. Amex launched their charge card program in 1958. B of A sees what's happening.

00:27:04 Speaker_01
They, of course, had seen everything else going on in the industry before. They understand the transformative power that this can have for their scaled consumer banking business in California. And they're like, okay, the time is right.

00:27:17 Speaker_01
Let's do credit cards. Let's go to Fresno. But hopefully as we painted the picture, their motivation and Diner's Club and Amex and even the merchants and retailers motivations are very different. B of A wants two things out of this.

00:27:33 Speaker_01
One, like we were saying earlier, they want to streamline and simplify all their wildly diverse lending programs. This is going to be huge operational savings for the bank if they can pull this off.

00:27:45 Speaker_01
Two, though, the bigger opportunity for B of A is what can this do for our banking business itself? Because remember, how do banks make money? They make money on loans.

00:27:59 Speaker_01
And this is going to enable so much more effective loan volume to flow through our system that we can make money on.

00:28:10 Speaker_00
So this is where B of A, informed by their previous business model of lending to consumers, really paves the path of what credit cards would become today.

00:28:21 Speaker_00
Often, in the past, before the Bank of America card, what would happen is you'd have this charge card, not a credit card, and the bill would arrive at the end of the month and then you would pay it.

00:28:31 Speaker_00
The innovation baked into the Bank of America card is they say, well, after the 30 days, you can get your statement, you can pay it in full, or you can roll it into a loan. And we love loans. We would be happy to extend loans to our customers.

00:28:45 Speaker_00
We can learn a lot about them. We can make a good amount of money on that interest. And so the modern credit card is born.

00:28:52 Speaker_01
And it was already happening at B of A. They were doing these loans. This wasn't actually like new behavior. It was just a way easier, way more streamlined on-ramp into this consumer lending that turbocharged it.

00:29:06 Speaker_00
This product is the combination of three things. The charge card that had been happening over in Diners Club, Amex, the gas stations, the retailer land. Then the second pillar is this consumer lending.

00:29:21 Speaker_00
And the third thing is it is now from a real and proper bank that you already have your primary financial relationship with, not from some industry association or hodgepodge of retailers, but now this is issued by your bank.

00:29:35 Speaker_00
The big takeaway for Bank AmeriCard is it really bundled two different things together. One was convenience and the other is credit.

00:29:43 Speaker_01
And there's one more really, really important sub point here to what this loan is. And it relates to the banks and why this is so powerful for B of A and for all banks. Think back to the old way that B of A was doing this.

00:29:58 Speaker_01
A California, you know, homeowner wants to go buy a new refrigerator. They walk into a B of A, talk about it with the lending officer, blah, blah, blah, a bunch of operational costs. Who cares about that?

00:30:09 Speaker_01
At the end of the process, B of A gives them the money. The money is now out of B of A's hands. It's out the door. The consumer then goes to the merchant and gives the merchant the money and buys the refrigerator.

00:30:22 Speaker_01
What's happening now with credit cards is actually a little different. The consumer goes to the store, the consumer buys the refrigerator with the credit card. No money has left B of A's hands yet. They get to keep the money.

00:30:38 Speaker_00
Right. A transaction has been authorized, but yes, they get to keep the money.

00:30:43 Speaker_01
And because we're talking about California here, there is a very high likelihood chance, and I think at the beginning, I suspect a 100% chance,

00:30:52 Speaker_01
that the merchant also banks with B of A. So that money is never leaving Bank of America's hands, which frees up more capital, which frees up float, which is just like. the B of A management must have been besides themselves with glee about this.

00:31:07 Speaker_00
Well, in theory, if they managed to put any sort of financial controls or proper risk underwriting on this whole thing, but it turns out, David, as I'm sure you are about to tell us. That's exactly where we're going.

00:31:17 Speaker_00
When you mail 65,000 cards indiscriminately with the same credit limit to every single customer and say, have at it, guys, and this is a brand new consumer behavior that

00:31:28 Speaker_00
they've heard about and they might have witnessed in one form or another, but now they have a bona fide charge plus credit card sitting in their hands, you're going to lose a lot of money at first.

00:31:38 Speaker_01
Yeah, because there's another more pernicious way that this type of lending is different than the previous type of lending that B of A was doing. It's unsecured.

00:31:48 Speaker_01
If you give a customer a loan to go buy the refrigerator, you don't want to go repossess the refrigerator, but push comes to shove, you can go repossess the refrigerator. this whole consumer credit card land is unsecured lending.

00:32:01 Speaker_00
So you probably shouldn't apply the assumptions about your loss ratios from secured lending to unsecured lending, but that is exactly what happened.

00:32:10 Speaker_01
And this all comes back to why it really had to be Bank of America to start this program. Because they do this, they do the drop in Fresno, 65,000 unsolicited cards go out to unsuspecting consumers. Fraud is out of control.

00:32:26 Speaker_01
$20 million of fraud within the first pilot program, 22% of the credit that they issued to that initial Fresno cohort ends up being default or delinquent, which I think is like five or six times what their delinquency rate was before on traditional lending.

00:32:47 Speaker_00
Yeah, it is pretty crazy. So it's worth pointing out, you know, we're talking a lot about credit and debt at this point in time. And now in 2023, some of these kind of sound like bad words.

00:32:58 Speaker_00
And frankly, it's because of the situation that the society has sort of like push Americans to.

00:33:04 Speaker_00
But it was a very different time back when credit cards were first getting started and when this sort of practice of installment loans was extremely common in the pre-card era.

00:33:16 Speaker_00
So I want to read, there's a great passage from A Piece of the Action that I mentioned earlier that I just want to read here. Despite the denunciations, despite the free-floating anxiety, Americans have always borrowed money to buy things.

00:33:29 Speaker_00
If not from a bank, then from somebody. From a finance company, or a credit union, or a department store, or a loan shark for that matter. There isn't another Western country that has relied so heavily on consumer credit.

00:33:40 Speaker_00
Between 1958 and 1990, there was never a year where the amount of outstanding consumer debt wasn't higher than the year before.

00:33:49 Speaker_00
Years later, a Bank of America executive could look back on his lifetime in the credit card industry and say proudly, consumer credit built this country. Whatever one's feelings about personal debt is difficult to disagree with this assertion.

00:34:02 Speaker_00
So interestingly, what's basically happening here is people are using debt not because of this bleak, horrible time that they're in. It's actually because of their optimism.

00:34:13 Speaker_00
They believe that the future is brighter than the present, and so they're fine taking on debt.

00:34:19 Speaker_00
And that is sort of what has sort of led us to today, where because the growth of the American economy and the global economy has been so strong, people have always generally been fine, or at least we exist in a system that teaches you you should kind of be fine, betting that the future is going to be better than today.

00:34:37 Speaker_01
Such a good point. As long as growth is happening in an economy, a society, industry, whatever, you should absolutely use capital to fuel into that growth.

00:34:49 Speaker_00
Yep. And that may not be true on an individual basis, but it is absolutely true on a societal basis.

00:34:54 Speaker_01
Yep. So back to what I was saying about why B of A is so important. B of A can absorb this loss. No other consumer bank at the time, if they had seen $20 million of losses in like a set of months, they would have pulled the ripcord immediately.

00:35:09 Speaker_01
B of A though, they can absorb this loss no problem. And they know if we can make this work, this is going to transform our business. So rather than pulling the ripcord, They expand, they roll it out quickly across the whole rest of California.

00:35:28 Speaker_01
Over the next year, all within the first year, they sign up 20,000 merchants in California and get this. Do you know how many cardholders they sign up in that first year?

00:35:39 Speaker_00
No.

00:35:39 Speaker_01
Two million California cardholders signed up using the card in the first year. It took Diners Club years to get to a million. Amex was so proud in the first year or two, they get to 700,000.

00:35:53 Speaker_01
B of A instantly at scale is the largest charge card credit card program, certainly in America, I suspect in the world. And that's one year and one state.

00:36:07 Speaker_00
This is like meta launching threads or Microsoft launching teams. You can sort of sit back for a while and watch the innovation and figure out what the very best product is that people want.

00:36:19 Speaker_00
And then you can go ram it through your distribution channels when you invent one of your own.

00:36:23 Speaker_01
Yep. And it's even more than that. As we said, this really was a big innovation. Like it wasn't just that they copied Amex and Diners Club or anything else like they were adding credit to this. This was a huge innovation. Yep.

00:36:35 Speaker_01
So by 1961, year three of the program, they're able to get fraud under control enough that the whole program is profitable.

00:36:43 Speaker_00
But they keep that under their hats.

00:36:45 Speaker_01
Yes. Yes. They don't want anybody else to know about this.

00:36:47 Speaker_00
So there's been all these newspaper articles about all this money that B of A is losing.

00:36:51 Speaker_00
So many banks that had been thinking about launching a similar program abandoned it because they were like, oh man, we thought this was going to work, but clearly it's not working for B of A. So people were shutting down their efforts.

00:37:02 Speaker_00
There was rumors that another bank was going to launch in LA, in San Francisco, and B of A had actually rushed theirs to market to go be sooner than these other banks that actually never ended up launching because the market perception was that it was such a gigantic failure.

00:37:18 Speaker_00
Here's a crazy stat. From 1960 to 1966, so this whole era is actually a profitable era for B of A, but no one else knows it.

00:37:28 Speaker_00
There were only 10 new credit cards introduced in the entire United States because they did such a good job keeping what became a cash gusher for them quiet.

00:37:39 Speaker_00
But secret comes out in 1966, and from 1966 to 1968, just two years, approximately 440 credit cards were introduced by banks, large and small, throughout the country.

00:37:51 Speaker_01
Yes, and it is specifically 1966 when the secret gets out because phase two of Bank of America's grandmaster plan here gets unveiled, which is maybe worth a quick setup. As we said, this was transformative for their business in California.

00:38:09 Speaker_01
but they're the biggest bank in America. And they have been itching for any kind of way to expand, to truly be the bank of America. Like why the hell did they change the name to bank of America?

00:38:20 Speaker_01
It's not because they wanted to be the bank of California. So they're like, maybe this is our path. And California is only like 10% of the U S population. In 1966, they create the bank AmeriCard service organization.

00:38:37 Speaker_01
with the express purpose of licensing out the Bank AmeriCard program and network to banks across the country, across all 50 states. And this is the seed of Visa.

00:38:53 Speaker_00
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00:38:58 Speaker_01
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00:39:14 Speaker_00
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00:39:38 Speaker_01
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00:39:51 Speaker_00
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00:40:01 Speaker_01
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00:40:13 Speaker_00
Yep. So learn how you can put AI agents to work for your people by clicking the link in the show notes or going to servicenow.com slash ai-agents. Okay, David, so how do we get to Visa?

00:40:28 Speaker_00
You have been telling me about the BankAmericard from Bank of America, and I opened this show saying Visa's not a bank, and Visa doesn't have direct relationships. It's this big indirect thing where they work with other banks. This is a big mismatch.

00:40:42 Speaker_01
This story is so wild because this first chapter that we just told, there's only one entity in the world that could have done this, Bank of America.

00:40:52 Speaker_01
In this second chapter, there is also only one person in the world that could have taken Bank AmeriCard and turned it into Visa, and that is D-Hawk. So here we are in 1966.

00:41:05 Speaker_01
B of A now starts going around to all the other consumer banks in other states and selling them on joining the network as BankAmericard licensees. And the deal is that you pay B of A a $25,000 franchise fee to get your franchise of the BankAmericard.

00:41:23 Speaker_01
This is like a Wendy's or something. Plus then you pay them a percentage of the gross transaction revenues. It literally is like a McDonald's. This is wild.

00:41:33 Speaker_01
I mean, I get the executives must have just been throwing party after party because A, this whole thing turbocharged their own business.

00:41:42 Speaker_01
B, now they're like, oh, we're going to make all the other consumer banks in the country essentially into like serfs on our kingdom here.

00:41:49 Speaker_00
Right, and one of the assumptions they made was correct, and the other one was too hubris.

00:41:53 Speaker_00
The first assumption is a good business model decision, which is, okay, we've now created this distributed asset, which is all these customers with our card that want to use our card at lots of merchants.

00:42:05 Speaker_00
People still weren't using credit cards the way we do today, just treating it like cash and using it for coffees and little things here and there.

00:42:11 Speaker_00
It was still sort of treated as, this is the card for big purchases, some of which I may want to finance and decide later.

00:42:19 Speaker_01
It was also an intensely private thing, kind of taboo thing, right? Because when you were using a credit card in these days, you were implicitly saying, I'm using debt to buy this transaction.

00:42:30 Speaker_01
And so you didn't want other people to necessarily know that.

00:42:32 Speaker_00
Right. It's a bit odd. But consumers clearly did want to use this thing for some subset of the purposes that they did today. And so Bank of America is kind of leaning into it and saying, we've got this asset. Surely, we can leverage that for great gain.

00:42:47 Speaker_00
But the specific implementation of it was a bad assumption where they said the way that we can take advantage of the fact that now all these consumers have the card and all these merchants out there and accept the card is this weird franchising thing.

00:42:59 Speaker_01
Well, the bad assumption was that other banks would consent to basically being serfs in their kingdom. Yes. But at the outset, these other banks see the power.

00:43:11 Speaker_01
And now that B of A is telling them of what this has done for B of A, and they're like, wow, this is already the biggest charge card credit network in America, if not the world. We can now bring this to our state.

00:43:24 Speaker_01
And I think B of A offers exclusivity to banks in geographic areas, too, to start. That eventually, of course, gets dropped. But it does tempt a lot of people. So within two years, by 1968, A couple hundred banks have signed up.

00:43:37 Speaker_01
There are six million cardholders across the country and beyond the country. Actually, Barclays Bank in the UK had signed up to be a franchisee of Bank AmeriCard back in the day.

00:43:48 Speaker_00
Whoa. What year is this? This is like in the mid-60s. Whoa, that's way earlier than I realized for international expansion.

00:43:56 Speaker_01
Yeah, it was already out of the US because the system is a great system.

00:44:02 Speaker_01
But as this expands beyond B of A, it becomes clear that a bunch of stuff that were either just assumptions or ways of business within B of A or things they didn't have to worry about ain't gonna scale to hundreds of banks

00:44:19 Speaker_01
all 50 states, multiple countries around the world. One of the examples, I alluded to this earlier, in California, in the Bank of America owned and operated Bank AmeriCard system, usually all parties in the transaction were Bank of America customers.

00:44:37 Speaker_01
So like there wasn't really any difference between the bank of the consumer, the cardholder, and the bank of the merchant. And B of A controlled both sides.

00:44:47 Speaker_01
Once they expand the network and let other banks in, all of a sudden that's almost never the case.

00:44:53 Speaker_00
Right. You know, B of A realized the sort of cardinal sin of many entrepreneurs, which is my particular situation is actually not a pattern of several other customers. It's actually an N of one. I'm idiosyncratic.

00:45:05 Speaker_00
So when I'm just making the same assumptions about all the future customers about serving my own needs, that's actually a false assumption.

00:45:11 Speaker_01
Yeah, so B of A has no distinction between what ultimately now in the Visa network and MasterCard and others is called issuing banks. These are the banks that give the cards to the customers and merchant banks that are the banks of the merchants.

00:45:25 Speaker_00
It's all just one for B of A. Yes, and these merchant banks, we'll come back to some of this terminology later, has gone on to become the acquiring bank because this is the bank that acquires the merchant relationship as a customer.

00:45:37 Speaker_01
So now in this new world where there's different banks on each side of the transaction, this creates the need for a network and operational services to settle those transactions.

00:45:49 Speaker_01
This comes to be known as interchange and interchange fees are obviously what Visa does today.

00:45:57 Speaker_00
Yeah. And this is the first moment that we start to see a departure from what American Express was doing. The original Bank AmeriCard was very similar to American Express and Diners Club, where they were closed loop systems.

00:46:09 Speaker_00
It was a bank that issued a card to be used at a payment terminal that all stayed within the bank's closed loop network.

00:46:16 Speaker_00
And now, with this new Bank AmeriCard licensee system that they're starting to sort of develop here that would become Visa, it's an open loop system.

00:46:25 Speaker_00
It's, hey, there's one bank on one side who owns the customer, who owns the cardholder, and one bank on another side, and we're going to enable those systems to talk to each other, but they're not the same party. This is open loop now.

00:46:37 Speaker_01
So this interchange thing, all of the other banks that are now signing up to become, you know, B of A franchisees for the Bank of America card system, They come to B of A and they're like, hey, this whole thing is a problem.

00:46:50 Speaker_01
Bank of America isn't providing any service to do this. There are also all these costs that these other banks are incurring because they need to figure out this interchange thing.

00:46:59 Speaker_00
Oh, so the problem they're experiencing is like, hey, Bank of America, how did you build all the technology to do this?

00:47:05 Speaker_01
And Bank of America's response is like, we didn't have that problem because in our corner of the world, we're the bank on both sides. Right. We're closed loop. So I don't know. You guys figure it out.

00:47:17 Speaker_00
This sounds like a you problem, not a me problem. I see. So when these banks are coming to Bank of America, they're not actually complaining about price in any way. They're literally just saying, how do you solve this problem?

00:47:28 Speaker_01
No, I don't think price was an issue. I think it was this and like a set of other things along these lines where the franchisees were like, hey, we signed up for a franchise. You operate the whole system, right? And Bank of America is like, no, no, no.

00:47:41 Speaker_01
We sold you a marketing system.

00:47:43 Speaker_00
I see. So it's like, you know, you buy a McDonald's franchise and they ship you some golden arches and they're like, good luck figuring out how to make cheeseburgers. That is exactly right.

00:47:52 Speaker_01
Now, to be somewhat fair to Bank of America here, the golden arches are worth a lot. The Bank of America card three-colored bands, the blue, white, and gold, are also worth an incredible amount here.

00:48:07 Speaker_00
And, of course, the ability to actually be on the network that sends those payments, right? Yes, of course.

00:48:13 Speaker_01
The network has incredible value. But back to the brand and the marketing. So as all these other banks are considering whether to become franchisees of BankAmericard, and some of them are like, no, I'm not going to do that.

00:48:27 Speaker_01
Some of the ones who do become franchisees, well, really all the ones who do become franchisees become very frustrated. of course, people are going to start competing systems.

00:48:37 Speaker_01
And right in this time, over this kind of year or two period, a bunch of local geographical competing credit card systems by various bank consortiums come together.

00:48:48 Speaker_01
Those pretty quickly all merge into a national association called Interbank, which, spoiler alert, Interbank is Mastercard, But at this point in time, Interbank is a Franken network.

00:49:02 Speaker_01
There's no common brand, mark, visual identity for all of these cards. So now you're trying to make this payments network operate.

00:49:14 Speaker_01
How do you as a consumer know that my card that I got from XYZ, you know, I don't know, Bank of Illinois, that's part of the Interbank network, supposedly. Now I go somewhere. I've got that card. It looks like one thing.

00:49:25 Speaker_01
I'm looking at this store, at this restaurant or whatever, they've got a thing on the door that says they take something that looks totally different.

00:49:32 Speaker_01
I don't know that this is going to work, even though it actually might work because it's part of the MasterCard Interbank Network.

00:49:38 Speaker_00
I see.

00:49:39 Speaker_00
It's like when I'm trying to figure out, like, I have to keep pulling up Alaska Airlines Partner Network to figure out what international airline I should fly since I pay no attention to anything other than, well, it's Alaska, you know, is it One World?

00:49:50 Speaker_00
I still don't even know what the... One World, yeah. Yeah.

00:49:52 Speaker_01
And you know, that's today with the internet, you can do that.

00:49:56 Speaker_01
Back in the 1960s, there's literally no way for a prospective customer of a merchant to know by looking at their card and looking at the sign on the door, if that card is going to be accepted, unless they all have the same brand and mark.

00:50:11 Speaker_00
It's so funny.

00:50:12 Speaker_00
This is the original problem of Diners Club, too, because Diners Club, they, I think it was Diners Club that originally shipped a little folded thing that fit in your wallet with the card that was a little booklet that was a list of all the merchants.

00:50:25 Speaker_00
So you could literally know if the card would be accepted at the restaurant you're at.

00:50:29 Speaker_01
That's right. But now, like, the scale that these networks are starting to be at, like, obviously that's not tenable. So back to the mark.

00:50:36 Speaker_01
what these franchisees are buying from Bank of America and what Bank of America is like, hey, this is what we're selling you. It has value. It's access to the network. But the network is homogenous.

00:50:46 Speaker_01
It all is the Bank of America card name, brand and importantly, mark. So what are the colors of Visa? I'm sure everybody listening probably around the world knows this. It's blue, white and gold.

00:50:56 Speaker_00
which is the hills of California, right?

00:50:57 Speaker_01
There's this amazing origin story to this. It's super reminiscent to the Windows XP Bliss wallpaper, you know, that is the most viewed photo in the world. You know, the hills. It's actually in Sonoma, California. Huh.

00:51:10 Speaker_01
So the story is, the B of A team, when they were first rolling out the program, the guy tasked with cart design, he lived in Pleasanton, California, in the East Bay, the San Francisco Bay area, where, you know, it's pleasant.

00:51:22 Speaker_01
And one fine spring morning, he looks out his back door at the local hillside. The sky is this beautiful blue with white puffy clouds, very much like the Windows XP Bliss background.

00:51:33 Speaker_01
And the hill is covered with beautiful golden colored California poppies in bloom. He rushes back inside, he paints an abstracted version of his beautiful hillside. Voila, the three bands, blue, white, gold. Bank AmeriCard, Visa.

00:51:51 Speaker_00
And this would go on to be incredibly valuable to plaster on your storefront and say, we accept Bank AmeriCard here, and that just means your sales are going to go up. Friction to purchase goods goes down.

00:52:03 Speaker_00
Customers are excited to spend with you because their shiny, cool thing that they like spending money on works there, and it's good for your business to be able to accept it.

00:52:11 Speaker_01
It's so wild that today, you know, we would think, oh, what's a moat? What's a competitive advantage? What's durable? You know, you need technology advantage.

00:52:20 Speaker_01
You know, even how we think of brand, all the companies we've covered on the show, it's so much more than this, but it was so simple back in the day. It was just, could you create a two-sided network where there was a common signal of acceptance? Yep.

00:52:34 Speaker_01
So from B of A's perspective, they're like, yeah, we did all the work. We created this. This is what you are franchising from us. Take it or leave it.

00:52:43 Speaker_01
From the franchisees' perspective, as we were talking about, they're like, you gave us a marketing program. How do we run this damn thing?

00:52:50 Speaker_00
Okay, so they got this marketing program. How did it literally work? Because this is pre-magnetic stripe. Yeah, there's no technology here. I mean, this is literally like, cool, I've become a Bank of America licensee.

00:53:01 Speaker_00
What transactions does that let me do and how does that happen?

00:53:04 Speaker_01
So the banks, they have to resort all the way back to how checks worked back in like the, you know, 1800s, early 1900s in the US, where it was all decentralized.

00:53:16 Speaker_00
The bank would go sign up a merchant in their local town.

00:53:18 Speaker_01
Yep. And the banks would take the sales drafts from their merchants that the merchants had brought to them. And then they would go kind of individually decentralized mail around the country to the issuing banks, the cardholder banks to get the money.

00:53:36 Speaker_01
And they just, the way they've financed all this was a discount fee, just like checks back in the day. Like, Oh, Hey, this sales draft is for a hundred dollars. This is all really hard to figure out.

00:53:45 Speaker_01
So like, okay, you give me $97 instead, or you give me $90 instead. And there was no standardization. It wasn't like a set discount fee. It was just whatever they negotiated with one another.

00:53:56 Speaker_00
So the sales drafts get handed to the licensee. So you've got, let's say you're running a department store and keep going with the Illinois example that you said. So you're running a Chicago department store.

00:54:07 Speaker_00
After a whole day of sales, you've got a bunch of sales drafts where you say, all these customers came in with Bank AmeriCard. They said they're good for the money. So I gave them the goods. And now I'm holding the sales drafts.

00:54:18 Speaker_00
I actually have no idea if they were good for the money, but the fact that I have a sales draft and the fact that I, the merchant, have a contract with a bank, and that bank has a contract with Bank of America, means that I feel very good that I'm going to get my, you know, 93 cents on the dollar or whatever.

00:54:34 Speaker_00
So, then the bank is responsible, probably?

00:54:39 Speaker_01
Yeah, so the merchant bank, that acquiring bank.

00:54:41 Speaker_00
Mails all those, effectively, invoices to all the other banks.

00:54:46 Speaker_01
That the people who bought the goods there to their banks with their cards, and there was no standardized discount. This is ludicrously expensive. Totally. I mean, it's chaos. People are so pissed. And again, BFA's like, yeah, whatever.

00:55:01 Speaker_00
Yeah, whatever. For us, we just moved a few numbers internally. We actually didn't have to do any of this.

00:55:05 Speaker_01
And you all are paying us now money. So like our empire dreams are coming true. Wow. This is maybe painting Bank of America into poor light. You know, like I said, nobody knew this is the first time that a banking

00:55:20 Speaker_01
charge card, credit card system is operating at scale in the country. And even though Bank of America had been operating for a couple of years internally to B of A in California, now it's going across state lines.

00:55:31 Speaker_01
This had never been a problem before, you know, the merchant banks versus the consumer banks, the issuing banks, et cetera. Right.

00:55:38 Speaker_01
So all of these tensions come to a head in October, 1968, when the licensees, all the franchisees of Bank of America, all these other banks across the country, they demand a summit.

00:55:51 Speaker_01
They need to air their grievances with, you know, the parent with Bank of America. This is untenable. We can't operate like this. We got to fix this. B of A says, OK, fine. We'll all get together. in Columbus, Ohio.

00:56:05 Speaker_00
Really? No way.

00:56:06 Speaker_01
In the middle of the country. You didn't know this? No. Oh, amazing. I thought you knew this. Yeah. Columbus, Ohio. Ohio State. Oh, wow. Amazing. This is where the birth of Visa happens. So the summit gets organized.

00:56:18 Speaker_01
And for the franchisee banks, this is sort of becoming existential for their businesses. They're racking up such huge losses. This is such chaos. They're sending senior representatives from the banks, everybody running their card programs.

00:56:31 Speaker_01
Everybody's converging in Columbus. B of A sends two mid-level marketing managers to go face the angry mob. None of the senior executives from B of A could be bothered enough to go deal with this. Wow. Which just says everything.

00:56:47 Speaker_01
And these poor guys who show up. I mean, they are literally facing pitchforks. the franchisees are incensed. And they're incensed both because the situation sucks and they're like, God damn it, B of A, take us seriously.

00:57:02 Speaker_01
You have meddled in our entire businesses. This is in chaos. Like, we got to fix this. So what do these two poor B of A guys do? Right before lunch on the second day, they're like, yo, we got to save our skins. We got to get out of here.

00:57:19 Speaker_01
Let's do the smart thing to make sure that everybody gets placated, but nothing actually happens. Because they don't have any authorization from Bank of America to do anything. They're just the people sent to face the mob.

00:57:30 Speaker_01
Let's appoint a committee of licensees to, quote unquote, investigate all of the operating problems and report back to us. You know, they can come out to San Francisco. They can meet us at B of A headquarters and we'll listen to their problems. Wow.

00:57:48 Speaker_01
But. Unfortunately for their goals, their very narrow goals that particular morning, but very, very fortunately for all involved, the franchisees, the world, consumers. In the long term, at least.

00:58:03 Speaker_01
In the long term, and also Bank of America in the long term. One of the people that gets put on that committee.

00:58:12 Speaker_01
is the BankAmericard Franchisee Program Manager from a small bank in Seattle, the Seattle National Bank of Commerce, which would go on to become Rainier Bank. And then, ironically, do you know what happened to Rainier Bank?

00:58:27 Speaker_01
You can't make this stuff up. No, I don't, but I can guess where this is going. Yep. Once interstate banking regulations get loosened up, they get acquired by Bank of America, of course, in the 1990s.

00:58:40 Speaker_01
But for the moment, the person running their Bank of America card franchisee program is one D. Hawk. And I think you could really say on this day, the founder of Visa.

00:58:54 Speaker_00
And one of the most interesting characters in anything we've ever studied, because he's not a tycoon the way that most of these people are.

00:59:03 Speaker_01
No, and we're gonna talk much more about D in a minute, but just to keep the story going so we don't leave you all in suspense on this day. During the lunch break, D has gotten put on this committee.

00:59:13 Speaker_01
He goes up to the two B of A guys and he's like, hey, rather than us just putting together a list of grievances and reporting back to you at B of A,

00:59:24 Speaker_01
What if, instead, we do examine all the problems in this system, but what if we ourselves, this committee, we design and propose a new way of operating the whole thing? And after some convincing, the B of A guys are like, eh, sure.

00:59:45 Speaker_01
I mean, they're not agreeing to anything. Their goal is just to escape the mob anyway. They're like, Whatever, if this makes you happy, if this lets us escape back to California, sure.

00:59:57 Speaker_01
And probably, almost assuredly, I mean this is a committee we're talking about, nothing is going to come of this. Yep.

01:00:05 Speaker_01
So the whole summit reconvenes after lunch, and D gets up on stage, not the Bank of America guys, and he proposes this idea to the group. Say, hey, we've got this committee.

01:00:19 Speaker_01
Rather than us taking a list of grievances back to B of A, what if we try and design a new way that the system could operate and operate better for everyone? They take a vote on it. Everybody agrees.

01:00:33 Speaker_01
Mostly, I think, just because they wanted to get out of there, go back home and away from this disaster of a meeting. They all get on planes. They all leave. Most of them probably thinking that nothing is ever going to come of this.

01:00:45 Speaker_01
Certainly the B of A guys thinking nothing is ever going to come of this. But D kind of thinks he just got authorization to go create Visa.

01:00:57 Speaker_00
Whole new system. And he has no power at this point, but he kind of thinks he does.

01:01:03 Speaker_01
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01:03:14 Speaker_00
Our huge thanks to Huntress. Okay, so David, D-Hawk thinks he's got a mandate to go change things up in a big way and create some big, crazy new proposal.

01:03:24 Speaker_01
Yeah, and he's not wrong. Fortune favors the bold, you know, might you say? Yes.

01:03:30 Speaker_01
So, to say a few more words about why this is so hard to organize this group of now-competing banks to collaborate with one another, you've got multiple banks in the same state that are part of this system.

01:03:42 Speaker_01
Let's take Illinois again to stick with this. You've got a bunch of banks in Illinois that are now all part of the BankAmericard payment network, which is intimately linked with their banking operations.

01:03:53 Speaker_01
If I'm any one of those banks, I would want to say like, hey, no, I want to be the only bank in Illinois doing this.

01:03:59 Speaker_01
And okay, maybe there are a few others here with me, but I sure as hell want to shut the door to anybody else coming in and being part of this network.

01:04:06 Speaker_01
Whereas when you think about growing the value and power of the network, you want as many merchants and cardholders in the system as possible. And the merchants obviously want as many cardholders as possible.

01:04:18 Speaker_01
And the cardholders obviously want as many merchants as possible. That means that you need all the banks because you need all the merchants, you need all the customers, you need all the banks.

01:04:30 Speaker_00
And you basically want it to happen as fast as possible. So maybe if you only allow 20% of the banks in America or 20% of the banks in a state to be members of this thing, eventually they could sort of bootstrap the whole network.

01:04:43 Speaker_00
But it takes a lot of time to go door to door to door to door. And maybe that particular merchant doesn't want to take on a second banking relationship. They already have one. They're good.

01:04:52 Speaker_01
Totally. This is a classic two-sided network. You want to race to get ubiquity as fast as possible on both sides of the network. Yep.

01:05:00 Speaker_01
So as D goes off and reflects on all this, he realizes that the fundamental problem is you've got this huge and diverse set of banks that both directly compete with one another.

01:05:15 Speaker_01
But also, if they're gonna make this thing actually work, they need to collaborate and work together. And that sounds like a really, really, really difficult problem to solve.

01:05:27 Speaker_01
Even if you could do that, how are you going to get the DOJ to let you do that? Antitrust is going to be an issue here for sure. But, you know, and this is D, he's like, OK, if, though, if we could do this, what is the opportunity?

01:05:45 Speaker_01
Well, we've seen what the opportunity is for Bank of America. That is the shining case study. So at a minimum, this could do for all the other banks in the world what it has done for Bank of America.

01:06:01 Speaker_01
Even more than that, though, Bank of America was trying to stretch here. They got greedy, to a certain extent, in franchising this out to other banks.

01:06:13 Speaker_01
But other banks signed up for this, and they were willing to pay both a franchise fee and a percentage of transaction volume to Bank of America because the siren song, the reward of doing this, was so great to them.

01:06:28 Speaker_00
And frankly, all powered by the fact that this is what consumers want. Yes, absolutely.

01:06:33 Speaker_01
So in a certain way, this is sort of, I don't want to say inevitable, because this is definitely not inevitable. But again, in the thought exercise of could you do this, the actual organization itself, like the network, would have so much value.

01:06:49 Speaker_01
You know, if you could get every bank in America, and then every bank in the world, and D is thinking big from the beginning, to be part of this, and you could power this global payments and credit network, and you were allowed to take a fee on the transaction volume for doing that, the value that you would unlock and generate, it beggars the imagination to think about what this could be.

01:07:14 Speaker_00
And if we could grow the pie enough, would B of A be comfortable not owning the whole thing? That's the bottom line here.

01:07:21 Speaker_01
So there's this great passage from him in his book, One for Many. He says, any organization that could guarantee, transport, and settle transactions in the form of arranged electronic particles, that's what he calls digital information.

01:07:35 Speaker_00
Amazing.

01:07:36 Speaker_01
24 hours a day, seven days a week around the globe would have a market. every exchange of value in the world that beggared the imagination.

01:07:45 Speaker_01
The necessary technology had been discovered and would be available in geometrically increasing abundance at geometrically diminishing costs. But there was a problem. No bank could do it. No hierarchical stock corporation could do it.

01:08:00 Speaker_01
No nation state could do it. In fact, no existing form of organization we could think of could do it. On a hunch, I made an estimate of the financial resources of all the banks in the world. It dwarfed the resources of most nations.

01:08:16 Speaker_01
Jointly, they could do it. But how? It would require a transcendental organization linking together in wholly new ways an unimaginable complex of diverse institutions and individuals.

01:08:30 Speaker_01
This is the opportunity and this is what he essentially takes to Bank of America. And now we got to say a few words about D because this situation is nuts. D is a banker.

01:08:43 Speaker_01
He is running the Bank of AmeriCard franchise program at what would become Rainier Bank in Seattle. But He's an outsider. He's kind of a nobody. He's not senior in a small bank in Seattle.

01:08:56 Speaker_01
He was raised in rural Utah, basically in poverty during the Depression. He didn't go to a four-year college. He only has an associate's degree.

01:09:06 Speaker_01
He bounced around in a bunch of random consumer finance jobs on the West Coast, all of which he got fired from because he's too insubordinate.

01:09:15 Speaker_01
He now walking into the boardroom in Bank of America, which is what he's going to do, and standing toe to toe with the vice chairman of Bank of America and saying, I think you should give me the Bank of America card program because it is in your self-interest to do so, which almost literally are the words that come out of his mouth in that boardroom, is just absolutely wild.

01:09:42 Speaker_01
Fortune favors the bold. Fortune favors the bold.

01:09:44 Speaker_00
Importantly, though, fortune favors the bold who have done the work to figure out how to align incentives such that a logical person will think through and come to the same conclusion he has.

01:09:54 Speaker_01
And this is the thing. D is an odd duck for sure, but he is amazingly smart. He's like basically all self-taught. He's incredibly well read.

01:10:03 Speaker_01
He started reading every book on, you know, his little farm in Utah that he could get his hands on when he was seven years old. super importantly, you know, this is a Steve Jobs, you can only connect the dots looking backward moment.

01:10:14 Speaker_01
He was not very good at sports in high school. So he got into debate instead. And then he also did debate in college when he did his associate's degree. And so he uses all of the techniques that he learned from competitive debate and persuasion.

01:10:29 Speaker_01
He has this amazing quote. He says, during my years of college debate, I held fast to the notion that until someone has repeatedly said no and adamantly refuses another word on the subject, they are in the process of saying yes and don't know it."

01:10:45 Speaker_01
I mean, Dee basically is the prototypical Silicon Valley founder. He's just a generation too early and in the wrong industry.

01:10:57 Speaker_00
I once had a Silicon Valley founder give a talk at a startup weekend I ran 10, 12 years ago, who said, until your company shuts down, you are just in the act of succeeding.

01:11:06 Speaker_01
Totally. I mean, cut from the same cloth, right down to every single stitch. There's one other important aspect to Dee that I think we should highlight here that enables him and all of Visa to succeed.

01:11:23 Speaker_01
And that's that he's about as far from the man and image of J.P. Morgan as you could imagine. is what enables this.

01:11:31 Speaker_01
Because if he were the CEO of another bank, or a senior executive, or some well-respected person, marching into the Bank of America boardroom and standing toe-to-toe with their board and saying, I want you to give me your very precious crown jewel,

01:11:51 Speaker_01
there's no way it would work. Of course, Bank of America would say, what's in it for you? I don't trust you. I don't believe you.

01:11:59 Speaker_01
Even if they did trust and believe this person, they would lose all of their face and reputation if they were subordinating themselves to somebody who could conceivably be their equal.

01:12:10 Speaker_01
So Dee's just gone into B of A with this grand vision of like, you should give me this incredible asset because the value that it will create outside of your hands and your fractional ownership thereof will be so much greater than what it could be on its own.

01:12:27 Speaker_00
And miraculously, that works. Like, would you rather own a few percent of something that is the default global way that commerce is produced, or would you rather own 100% of, you know, Bank of America cards?

01:12:41 Speaker_01
Yep. Totally incredible that Dee actually convinces Bank of America to do this. Nobody in the world would have thought that this could happen. But now the work is sort of just beginning because there's two things now that he needs to do.

01:12:56 Speaker_01
One, he hasn't actually figured out how to architect this thing such that it works. So he's got to go do that. Two, though, then now he has to go back to all of the soon to be former franchisee banks and convince them why they should do this.

01:13:10 Speaker_01
And this is a different argument from what he made to B of A. B of A, he's trying to get them to give him the asset. With the other banks, he actually needs to get them to change their behavior.

01:13:22 Speaker_01
He needs to be able to go to, say, the couple banks in Illinois that are existing franchisees of the Bank of America card system and say,

01:13:32 Speaker_01
Hey, the new regulations, the new operating laws for this organization are going to be all the banks in Illinois can join. And we actively want to go convince all of your competitors to come join this system.

01:13:44 Speaker_00
I see.

01:13:44 Speaker_00
So he's basically coming to them with a waiver and saying, I want you to waive your exclusivity to some territory because in our new construct here where we're all working together, you and everyone else is agreeing that it's good for the value of us all if we waive our exclusivity.

01:14:01 Speaker_01
You know what this is like? This is like back in our NFL episode. Yes, that's exactly right. When the NFL started negotiating national television rights collectively as an organization. Yep.

01:14:12 Speaker_01
A bunch of the individual teams hated that because they were like, if I'm the Jets, I'm making more money in my New York metro area doing my own TV deals than I'm going to get as a share from you, the NFL, of a national deal.

01:14:24 Speaker_01
But in the long run, it was absolutely the right decision and value accretive to everybody, including the Jets, that the NFL centralized this.

01:14:32 Speaker_00
You'd rather be the Jets with their proportional share of the $14 billion a year TV deal that the NFL has today than whatever their very fat contract was alone in, what, the 60s, 70s? Totally.

01:14:46 Speaker_01
It is exactly the same thing here. Okay, so how's this whole thing gonna work?

01:14:51 Speaker_01
Dee and a few of his other fellow committee members, they go to Sausalito, California, just north of San Francisco, just across the Golden Gate Bridge, and they do an offsite for a couple days at a hotel in Sausalito.

01:15:04 Speaker_01
And there they come up with a number of operating regulations guidelines for this hypothetical new entity, four of which we're gonna talk about here that are super critical.

01:15:16 Speaker_01
One, ownership of this new organization that's gonna be called National Bank of AmeriCard Inc, the new owner of the Bank of AmeriCard program, is going to be in the form of irrevocable, non-transferable rights of participation.

01:15:33 Speaker_01
So you're not gonna own stock in this thing. There's no equity. The way that you have ownership and the percentage ownership that you have in the network is by participating in it and the amount of volume that you are contributing to the network.

01:15:50 Speaker_01
Oh, interesting. So this means a couple things. One, it's sort of like a representation and ownership according to value contributed. Two, It's non-transferable, so you can't sell it.

01:16:04 Speaker_01
Any individual bank, if they were to say like, oh, this is valuable now, I'm going to go sell it. And then I no longer have any incentive to participate in the network.

01:16:11 Speaker_01
If that starts happening, then it'll lead to a cascade for the exits and the network will lose value. So there's no way to do that.

01:16:18 Speaker_00
So it's basically designed for you to kind of break even on it.

01:16:21 Speaker_00
If you're putting in 17% of the transactions on the whole network and you're paying in fees on 17% of the transaction, well, good news, for all of the leftover profits from running the network, 17% of them go back to you.

01:16:33 Speaker_01
You're making the assumption that this is a cost-only organization, forgetting the fact that it is one of the greatest business models and revenue generators of all time. You are contributing 17% of the volume to this.

01:16:46 Speaker_01
You are entitled to 17% of the profits. I see. That we are extracting from the merchants and the cardholders.

01:16:53 Speaker_00
Yep.

01:16:54 Speaker_00
Because this is the natural business model of interchange to do the exact same things that was being done with the sales drafts Where you sort of give a discount to the retailer and when I say discount, I don't mean a beneficial one I mean I'm discounting the amount of money that I am giving you off of the hundred percent that you would have received by the customer basically taking that old check courier business model and carrying it into sort of a network form and

01:17:18 Speaker_01
Yep, exactly. So the actual legal structure that Dee and his fellow committee members land on for this is a for-profit, non-stock membership corporation.

01:17:30 Speaker_00
That is a mouthful.

01:17:31 Speaker_01
It is. There's a myth out there that Visa was originally a non-profit and then was converted to a for-profit before the IPO in 2008. That's not true. It was always for-profit. It was just a non-stock membership corporation.

01:17:47 Speaker_01
And that was to get around banks selling their interest. So you don't participate in it. You don't own it. So say it one more time. It is a for-profit. A for-profit non-stock membership corporation. Your ownership is your membership. Fascinating.

01:18:06 Speaker_01
It's like a co-op. It's like REI or something like that.

01:18:08 Speaker_00
Yeah. Yeah.

01:18:09 Speaker_01
The way that Deed describes it to all the other banks is it is a reverse holding company. The parent entity is owned by the subordinate members as opposed to the top level holding company owning all the subordinates.

01:18:20 Speaker_00
There's actually another NFL analogy here. The NFL doesn't own the teams, the team owners own the NFL.

01:18:26 Speaker_01
Yes, but the NFL sets all the regulations for how the game is played and all the teams submit to it.

01:18:31 Speaker_00
That's actually probably the best analogy for Visa as the NFL league organization. I think it totally is.

01:18:39 Speaker_01
Okay, so that's point number one. Maybe the most important one. Point number two. It is a self-organizing body with irrevocable governance rights for each member. And this is, well, I guess also how it's like the NFL.

01:18:55 Speaker_01
Basically, this means this is a democracy. Every member has a vote. in determining how this organization runs.

01:19:04 Speaker_01
Anything that you could conceivably have a vote on, changing our regulations, setting them in the first place, budgets, fees, all this stuff, every single member bank will have a vote.

01:19:16 Speaker_01
And importantly, every single member bank can call a vote at any time. I mean, it's literally like a pure democracy. Wow.

01:19:24 Speaker_00
You could imagine nothing happening if everybody has the right to do that.

01:19:28 Speaker_01
Well, they set the threshold at 80% for anything to happen. I see. So there's a strong incentive not to call a vote and waste everybody's time unless you really think you can round up 80% of the votes.

01:19:38 Speaker_00
Fascinating.

01:19:39 Speaker_01
Which, in practice, just gives D all of the control and power of the company. Because everybody's going to listen to him as the CEO.

01:19:48 Speaker_01
Point three, we've basically already discussed, and that is that the mission of this organization is to facilitate cooperation and trust among competing institutions to grow the Bank of America hard payment network larger than any one institution could on its own.

01:20:03 Speaker_01
which is the pitch he gave to Bank of America leadership. Also though, this is a implicit kind of forbidding of banks in the network from going off and also forming or participating in competing networks.

01:20:19 Speaker_01
So to borrow like a crypto phrase here, like no side chains allowed. Everything happens on the main network.

01:20:26 Speaker_00
I see. So none of these banks are members of Interbank at this point. These banks are exclusively members of whatever the heck Visa's predecessor name is?

01:20:38 Speaker_01
National Bank of America, I think. National Bank of America, I think. Yes. At this point in time, a antitrust lawsuit would change that very shortly. I see. But at this point in time, it's like, nope, you are part of MBI exclusively.

01:20:52 Speaker_01
You don't go join Interbank MasterCard, and you also don't go start your own networks or peel off parts of the network. Everything that you are doing in payment card operations needs to route into this network. That's a big contract to sign. Totally.

01:21:09 Speaker_01
Again, this is why D needed to paint the picture, both to Bank of America and all the other banks. The prize is worth it. Yep. And then finally, point four.

01:21:18 Speaker_01
there will be a singular, universal set of operating and governing procedures that, much like the U.S. Constitution, is infinitely modifiable by a threshold vote of all members, this is the 80% I talked about, and two, also like the U.S.

01:21:36 Speaker_01
Constitution to its citizens, all members agree to be bound by its law both now and as it is so then modified in the future.

01:21:46 Speaker_01
So like if you're signing up for this you are signing up for the regulations and operating procedures as they exist today and for any future changes that come of which you will have a vote in. This is a democracy but you can't go leave the democracy.

01:22:03 Speaker_00
Right. You're signing up for something that might change in the future and you don't get to know today if it's going to change in the future, but at least you have some say in it. That is exactly the pitch.

01:22:12 Speaker_01
And amazingly, even describing this now, having done all the research, read all the books, written the script that we're talking about here, I still can't believe this actually happens. D goes on like a tour across the country.

01:22:25 Speaker_01
He goes and meets with all the banks. Bank of America helps him out. They bring senior executives too to help convene, you know, meetings with all the banks to persuade them.

01:22:34 Speaker_01
Every single member bank of the previous Bank of America franchisee organization, every single one of them signs up for the new organization led by D. Not a single person jumps ship. How many banks were it at this point? Over 200.

01:22:52 Speaker_00
Wow. Isn't that wild? I mean, once you get to like 70 or something, then it kind of seems likely that everyone's going to tip. But in those first 20, the fact that nobody was out is crazy.

01:23:03 Speaker_01
Totally. And Dee writes about this too. Bank of America helped him out. They identified the 13 most influential banks and they convened the first summits with them of like, hey, what do we got to do to horse trade to get you guys involved?

01:23:17 Speaker_01
And then you kind of spiral out from there. But yeah, every single one. Nobody jumped ship. And when is this, like 1970-ish? The process starts in 1968. It all wraps up in either 1970 or 1971. Hmm.

01:23:30 Speaker_01
Importantly, we've talked about antitrust and DOJ a bunch here. You would think that this would be setting off massive alarm bells in Washington and with the Department of Justice. they get ahead of this.

01:23:41 Speaker_01
So D goes to see them and he gives the same pitch to the government. He says like, look, obviously this is the whole industry, all the competitors in the industry colluding to work together. That's the whole premise of the organization.

01:23:58 Speaker_01
But what we can create by doing this would not be possible otherwise, and it will be so profoundly useful and important to the American consumer and American businesses that it is worth you letting us do this."

01:24:10 Speaker_01
So they actually get a letter from the DOJ saying like, Hall pass, you're good on this one.

01:24:16 Speaker_00
Wow. Yeah.

01:24:17 Speaker_00
It's just like the presidential exceptions for the NFL, like an antitrust exemption where, yeah, we're amenable to the fact that you're collaborating, potentially colluding, but it is actually one of the things that we believe will make the country better, so go for it.

01:24:31 Speaker_01
America wants both its football and its credit cards. Amazing. And that was a key point in then going and convincing all the other banks to sign up for this, because that was one of the first questions they asked.

01:24:43 Speaker_01
Hey, if we do this, aren't we inviting the DOJ on our backs? And Dee is able to say like, nope, got the letter right here. We're good. Wow. Amazing. So very shortly after this, after the creation of NBI, National Bank of AmeriCard, Inc.

01:24:58 Speaker_01
Dee in 1972, he's thinking globally from the get-go. He goes and creates a parallel, similar organization of international banks using the Bank of AmeriCard system. Visa was global from basically day one. And it wasn't just Barclays in the UK.

01:25:16 Speaker_01
It was Sumitomo Bank in Japan. It was other banks throughout Europe. It was Canada. It was Latin America. We won't go into all the detail here except one amazing story we're going to tell.

01:25:25 Speaker_01
This was actually harder to pull off, if you can imagine that, than forming NBI because it really is not clear for some of these international banks that it is better for them to be part of the global network than if they could run the table on their entire country.

01:25:43 Speaker_01
Say you're, I don't know, I'll pick Sumitomo Bank in Japan.

01:25:46 Speaker_01
You have to decide, do I want to buy these pitch of it's worth it to me to be a proportional owner of Visa, or I could be the singular dominant credit card network in my own country, which is more valuable?

01:26:02 Speaker_00
And for many of them, they'd be right in saying it actually would be better to be singular and dominant. Like you look at China Union Pay, I mean, that is the dominant way of payments flowing in China. That was, for them, the right move.

01:26:14 Speaker_01
Totally. So, once again, in Sausalito, this all comes to a head. D knows that probably not all of the international banks are going to agree to this, and some of them are going to go their own way. So he calls a final summit in Sausalito.

01:26:31 Speaker_01
They're going to vote the next morning, final vote on who's going to join the soon-to-be Visa network and who's going to go it on their own.

01:26:39 Speaker_01
And Dee gives this nostalgic speech at the end of dinner saying, here in Sausalito, looking out at the bay, this is where me and my colleagues, we dreamed up the original vision for what this could be.

01:26:52 Speaker_01
And it's sad that this won't be extended to the whole world and a true global payment monetary system. But we're all gathered here. We should celebrate having accomplished so much and had a chance at this dream. Just having the chance is worth it.

01:27:10 Speaker_01
He's really good with his debate skills. And then he's like, so before we meet one more time tomorrow to obviously disband this whole venture and have the dream just be a memory, we have one more thing for you. One more thing. He's like Steve Jobs.

01:27:27 Speaker_01
a small gift of appreciation for you giving your valuable time and effort as part of this global undertaking. Please take this little box out from under your seats.

01:27:37 Speaker_01
Everybody takes a little box out from under their seat, they unwrap it, and inside are a pair of pure gold cufflinks. that on each of the two cufflinks, there is one half of the globe.

01:27:49 Speaker_01
And under one side, it says in Latin, Studium ad Prosperitum, which translates as the will to succeed. And the other side says, Voluntas in Convienendum. Apologies to Latin speakers out there that I'm butchering that.

01:28:06 Speaker_01
Translates as the grace to compromise. And D explains this all, and somebody from the crowd yells out, D, you miserable bastard! Because he just pulled on everybody's heartstrings. And like, he gets the votes!

01:28:23 Speaker_01
And the next morning, all the holdouts reverse course. They all join, and- What? You can't make this stuff up. It literally happens.

01:28:31 Speaker_00
The cufflinks are out there, you can google them, he did this.

01:28:33 Speaker_00
So he's basically saying, hey, whether you voted for this or not, you're getting to leave with something saying, I'm so great, I had the will to compromise, even if you didn't, and you are the reason that you killed it. D is just such a character.

01:28:46 Speaker_01
So the other thing along these lines that he does, which is just hilarious. Once this is all set up, this, the international part of Visa becomes first IBANCO, I-B-A-N-C-O.

01:28:59 Speaker_01
Shortly after this, they rebrand the whole thing into Visa, which we'll talk about in a minute. For the board, the board is huge because it's like all the representatives from every region, from every country. There's like 25 people on the board.

01:29:11 Speaker_01
D holds board meetings all around the world, you know, different city all the time. It's a global organization, whatnot. He invites the spouses of all the board members to come to each location. He's all, it's a family trip, you know, et cetera.

01:29:26 Speaker_01
And then he gets the idea. He invites the spouses into the board meeting itself. Oh, what a nightmare. So 25 board members plus their spouses in his board meeting. This means two things. One, nothing is going to get done. There are 50 people in the room.

01:29:41 Speaker_01
Two, though, he needs all these people to behave well together and, you know, be generous and gallant. What better way to make sure they're on their best behavior than to have their spouse sitting behind them?

01:29:52 Speaker_02
Wow.

01:29:53 Speaker_01
So like, are you really going to act like an asshole in front of not only your spouse, but the spouses of all these other global bank heads?

01:30:00 Speaker_00
That's so funny.

01:30:02 Speaker_01
I'm gonna start doing that. We should have our wives in the room while we record.

01:30:05 Speaker_00
Definitely not.

01:30:07 Speaker_01
Oh, amazing. Amazing.

01:30:09 Speaker_00
I think neither would join for that.

01:30:10 Speaker_01
Totally. No, they'd be like, no.

01:30:13 Speaker_00
OK, so how does the name Visa come about? How does the sort of joining of the international and the domestic?

01:30:18 Speaker_01
OK, Visa is so important. It's not just a rebrand. It has to happen once this international organization is set up. Yeah, America can't be in the name. Bank of AmeriCard ain't going to work.

01:30:31 Speaker_01
And importantly, as we'll get into in a little bit, this is a huge problem for American Express, too. The soon-to-be Visa knows if we're really gonna realize this global vision, we need a truly global brand and mark.

01:30:43 Speaker_01
Remember back to the blue, white, and gold three stripes. That's iconic. It works internationally. Obviously, the name does not. Dee holds a contest internally within NBI slash iBanco to generate a new name.

01:30:59 Speaker_01
And he offers a $50 prize for the winning entry that is chosen. And as legend goes, there are so many submissions of the name Visa that when they finally unveil it, Dee makes a big deal and writes out a $50 check. Check? Why are they using a check?

01:31:14 Speaker_01
Made out to everyone in the company. Which is funny. But then they change the name to Visa. Visa, it's the most incredible name ever created. I mean, Nike was so great. This is like even better. You cannot have a better name for what this is.

01:31:32 Speaker_01
It's interesting it's in English. I mean, I guess it makes sense. It's the most spoken language, but... No, it's not just in English. The name Visa in every, if not almost every language on earth,

01:31:42 Speaker_01
And when you're traveling and you need a visa for a country, they call it a visa in other languages, too. That's what it is. But when you are traveling internationally, when you're going through customs in any country, it is identified as a visa.

01:31:53 Speaker_01
That is the name.

01:31:54 Speaker_00
Yeah. The universality, it's sort of a presumptive close because at this point, you know, they've got, what, three, four or five hundred banks. You know, and they have 16,000 today.

01:32:03 Speaker_00
It's quite the presumptive close that it will be universally accepted everywhere, the way that a visa would imply.

01:32:09 Speaker_01
Just every dimension, the presumptive close, the implication that this is a global network, that you can bring your visa with you when you're traveling to other countries and it'll work.

01:32:20 Speaker_01
The actual definition of the word visa, that it is your entry pass. This card is now your entry pass to commerce, to experiences, that it works everywhere, as you said, that it's universal. It's amazing.

01:32:33 Speaker_01
So the Visa name, brand, everything, there's two more levels at which it becomes really important. They do something really, really, really smart.

01:32:44 Speaker_01
So we talked about the need for the universality of a mark and why early interbank, that was a problem until they standardized on MasterCard. They've got the three bands, the blue, white, and gold. and now they have a global name.

01:33:00 Speaker_01
But all the individual banks, the hundreds, soon to be thousands of banks, they all want their own branding on the card too. So Visa says, okay, here's the operating regulations. Every card has to have the blue, white, and gold.

01:33:14 Speaker_01
In the middle white band, Visa logo goes there. Nothing but the Visa logo. on the top blue band, you can put whatever you want. You can put your own bank logo. You banks get creative. You can do literally whatever you want. Banks start going around.

01:33:31 Speaker_01
They do affinity card programs with NFL teams, with merchants. This is how you get the Southwest card. This is how you get the San Francisco 49ers card. This is how you get the XYZ everything that they're a bazillion of now.

01:33:45 Speaker_00
So in the blue stripe on the top of the top third of the card, the banks start co-branding with the name of their bank and some affinity.

01:33:53 Speaker_01
Yep. And this is kind of the brilliance of the Visa model. They were like, it's open. You can do whatever you want up there.

01:34:01 Speaker_00
Right. That seems good for us. We're happy with that.

01:34:03 Speaker_01
Of course, it's great. The whole goal is just get more consumers and more merchants on the network. So anything that's going to do that great while maintaining the universality of Visa. Great. We got the middle. You got the top. Go wild.

01:34:16 Speaker_01
Do whatever you want. Wow.

01:34:18 Speaker_00
And that's how I end up with BB8 on my card today. Amazing.

01:34:23 Speaker_01
Maybe the most important thing, though, for Visa really pulling away and becoming, at least for many decades, the dominant global payment card network, the name change ends up becoming this incredible growth hack. Because what happens is

01:34:42 Speaker_01
They're the new operating regulations now that mandate that all cards out there, all the previous Bank of America cards, need to be migrated to Visa cards. I think within like two years of this being declared or something like that.

01:34:55 Speaker_01
Some banks start to see this as an opportunity to go poach cardholders from other banks.

01:35:03 Speaker_01
So the competition within the network, obviously this still exists, because consumers now, they know when Visa runs a national advertising campaign, hey, your Bank of America card is going to switch to Visa.

01:35:15 Speaker_01
So some banks, in a version of the Fresno drop, they start sending unsolicited letters to consumers who are already Visa, Bank of America card customers with another bank. They're like, oh, hey, it's time to switch over to your Visa card.

01:35:29 Speaker_01
Here's the application. Sign up with this.

01:35:31 Speaker_00
Nice of them to, at this point in history, offer applications.

01:35:34 Speaker_00
I think a hundred million cards got dropped in the United States before the government made it illegal to just start randomly issuing credit to people without their awareness or asking for it.

01:35:45 Speaker_01
Totally wild. But because of this, a whole bunch of consumers start sort of unconsciously switching the bank that issues their visa card.

01:35:56 Speaker_01
And then once this starts happening, this kicks off a total arms race where all the banks in the network are now like, shoot, we got to blanket the whole country and like preserve our domain and see what we can capture from others.

01:36:07 Speaker_01
In the one year between when the visa name change first comes online and takes effect, which is in 1977, and the next year in 1978, the number of banks participating in the visa system grows by 20% because everybody who's not in the system now is like, I got to get in the visa system.

01:36:24 Speaker_00
By the way, this is the thing that pushes Visa ahead of what was, I believe, then called Master Charge. The inner bank had changed to Master Charge. They hadn't yet turned it to MasterCard. But in 1976, Master Charge was actually bigger.

01:36:39 Speaker_00
They had 7,400 banks, and at this point in history, Visa had about 7,000 banks. MasterCharge also had more cardholders, 37 million versus BankAmericard's 31 million before they changed to Visa.

01:36:53 Speaker_00
So this, despite all the deck chair rearranging between the member banks, it was great for Visa to leap ahead of MasterCard.

01:36:59 Speaker_01
Totally. So that was number of member banks grows by 20%. The number of active cardholders in the Visa network in this one year grows by 45%. Wow. Isn't that wild? So as you say, they blow way past MasterCard thanks to this.

01:37:14 Speaker_01
They're already way bigger than Amex because Amex is a different customer segment, which we'll talk about in a sec. And this really puts them on the path to becoming the dominant global network that they are today.

01:37:27 Speaker_00
Yeah, and it's worth a moment on Amex here because I would have thought just like Facebook or WhatsApp or Google, when you have this sort of winner-take-all massive network effect business, that the single centralized player network effect would win.

01:37:46 Speaker_00
Why wouldn't Amex win with their closed-loop system where they own the whole thing end-to-end and can provide the most incredibly custom experience for everyone on their platform, on the merchant side and on the consumer side?

01:37:59 Speaker_00
And one of the answers of why this open-loop system beat the closed-loop system is Visa adopts this strategy of the network of networks.

01:38:09 Speaker_00
They go sign up one bank that bank can go sign up, you know, a hundred billion customers or Two million merchants they get so much scale leverage on Signing up just one bank that this strategy makes it so that they have far more scalability Than something like Amex Amex also is a bank themselves So is highly regulated and they're a bank by this point in history, I believe on both sides of the transaction So they're both a card issuing bank

01:38:39 Speaker_00
And they are a merchant acquiring bank. And so in terms of scaling internationally, you mentioned their name holds them back.

01:38:46 Speaker_00
Also, they have to become a bank in another country in order to expand to that country, whereas Visa just needs to go tap a few banks and say, why don't you go figure out how to grow for us there?

01:38:57 Speaker_00
So this network of networks thing, the open loop system, well, it creates a little bit more of a kludgy user experience because they're sort of the lowest common denominator of data getting passed through the network.

01:39:08 Speaker_00
It's sort of open source versus something that's wholly owned and operated by a company or a protocol versus fully owned application.

01:39:16 Speaker_00
Anytime that you have something that's more distributed, you're going to be compromising a little bit on the user experience because you can't sort of rule by fiat when you want to make a change.

01:39:26 Speaker_00
But it does potentially come with much better scalability, which is the reason why Visa and MasterCard have become the dominant way versus the closed loop systems.

01:39:35 Speaker_01
Yep. It's also worth closing the loop on MasterCard here, too. I mentioned that the DOJ eventually came after both Visa and MasterCard and prevented them from being exclusive systems. That does happen in 1975.

01:39:49 Speaker_01
And so this concept of duality takes hold for the banks, duality meaning they can multi-home on both Visa and MasterCard. In all the testimony and case with the DOJ, Dee is obviously 100% against this happening.

01:40:03 Speaker_01
He doesn't want his banks to be able to join MasterCard too. But he also makes the surprisingly correct argument. He's like, look, this would be a huge mistake. Because U.S.

01:40:13 Speaker_01
government, if you do this, you are going to freeze the payment networks in the U.S. Nobody is ever going to develop a new competing open loop payment network because now there's no more competitive vector between Visa and MasterCard.

01:40:30 Speaker_01
We'll all have the same features. Banks will be members of both. They're kind of going to operate in lockstep. The prices should be identical for both. All this stuff. And the DOJ is like, no, no, no, no, we're going to do it anyway. Irony of ironies.

01:40:43 Speaker_01
Later in 1988, the DOJ again sues Visa and MasterCard for being a duopoly and not competitive enough.

01:40:52 Speaker_00
So Dee was right. Dee was right. And to this day, Dee has been right. There have been many attempts that we'll talk about toward the end of this episode of displacing Visa and MasterCard or inventing new payment systems.

01:41:02 Speaker_00
And like, they never work or they haven't worked yet.

01:41:06 Speaker_01
Great point. They're in the process of working.

01:41:11 Speaker_00
It's probably actually worth sharing the Amex thing.

01:41:13 Speaker_00
So Amex tried this crazy strategy in the 80s, and I'm flashing forward 10 years here, but they would basically cut their interchange, the discount rate that they were charging merchants massively if those merchants would go exclusive to Amex.

01:41:28 Speaker_00
And this actually continued until 1991 for many of their merchants. And for Costco, it went all the way to 2016, where they had the exclusive agreement with Amex. And if you were going to use a credit card at Costco, it had to be Amex.

01:41:44 Speaker_00
But, interestingly, Visa and MasterCard cried foul when, you know, all of their banks were multi-homing and Amex, with their virtue of a slightly different business model, was allowed to go and try to lock up merchants to be exclusive to them.

01:41:57 Speaker_00
So, eventually, the whole thing kind of stopped and, you know, flash forward to today, all cards are accepted at basically all locations.

01:42:04 Speaker_01
Yep. So this basically concludes the full Visa story. Like, how did this incredible thing happen? You know, we've answered these questions. Who owns this? Who runs it? How did it start?

01:42:20 Speaker_01
We could end the episode here, but we've actually really only told you half the story. What we've told you is all the incredible business, organizational, social, human behavior innovations that Visa and D created.

01:42:37 Speaker_00
Yeah, as Dave puts it in Electronic Value Exchange, there's a socio-technical aspect to this company. And we've talked about the socio, but not the technical.

01:42:47 Speaker_01
Something that is also true, and also I think really underappreciated about Visa, is it's also a technology company. And there is a whole technology story in parallel with this too, that enabled the Visa we know today.

01:43:03 Speaker_01
To Dee's question of where is Visa headquartered and nobody knowing that, it's headquartered in the Bay Area. It's a Silicon Valley company. It was started in the same place and time as Intel, Atari, Apple.

01:43:17 Speaker_01
The only thing that is different about it versus those other companies is it wasn't funded by venture capital. and it thus didn't make anybody rich except the banks who owned it and thus were already rich.

01:43:28 Speaker_00
but there's an incredible technology story. Yeah, great point. We want to thank our longtime friend of the show, Vanta, the leading trust management platform. Vanta, of course, automates your security reviews and compliance efforts.

01:43:42 Speaker_00
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01:43:55 Speaker_01
Yep, Fanta is the perfect example of the quote that we talk about all the time here on Acquired, Jeff Bezos, his idea that a company should only focus on what actually makes your beer taste better, i.e.

01:44:06 Speaker_01
spend your time and resources only on what's actually gonna move the needle for your product and your customers and outsource everything else that doesn't. Every company needs compliance and trust with their vendors and customers.

01:44:17 Speaker_01
It plays a major role in enabling revenue because customers and partners demand it, but yet it adds zero flavor to your actual product.

01:44:24 Speaker_00
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01:44:31 Speaker_00
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01:44:40 Speaker_00
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01:44:50 Speaker_01
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01:44:59 Speaker_00
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01:45:14 Speaker_00
And thanks to friend of the show, Christina, Vanta's CEO, all acquired listeners get $1,000 of free credit. Vanta.com slash acquired. Okay, so David, what is Visa's technical infrastructure look like and how did this come to be?

01:45:30 Speaker_01
So everything we just described up until now, amazing, incredible, unlikely, one in a million. But all it really bought, D and Visa, was the opportunity. Yes.

01:45:46 Speaker_01
To actually realize what he sold to Bank of America and the other banks of a instant global payment network that a large percentage of global commerce runs on, you had to build a lot of technology to make that happen.

01:46:06 Speaker_01
And if you asked the question of D back in 1968, okay, let's assume we do this and we put one of these soon-to-be Visa cards in the hand of every consumer on the planet, do they actually want to use them instead of cash and checks?

01:46:26 Speaker_01
And the answer to that was probably not. Fascinating.

01:46:31 Speaker_01
Now, they wanted to use them in specific use cases, like Ben, you pointed out, when you want to make a credit purchase, when you want to essentially do what installment financing was before, when you have any number of XYZ other set of factors.

01:46:45 Speaker_01
In the case of Diners Club and Amex, when you want to impress your colleagues and your business partners, there were use cases.

01:46:52 Speaker_01
But it wasn't like it is today, where obviously you're going to use your credit card, which is probably a visa and maybe a MasterCard to pay for everything that you do everywhere instantly.

01:47:04 Speaker_00
Yes, and to illustrate, we will link this in the show notes, but there is an old TV segment from 1993, not that old, pretty recent.

01:47:13 Speaker_01
Ben, I have really sad news. 1993 was 30 years ago. We remember it, but it's old now. 1993 to today is like the 1950s were to us when we were kids.

01:47:26 Speaker_00
Not good. Not good, David. Not good. This 1993 TV segment, the news is that Burger King has just rolled out credit cards. That should tell you a lot.

01:47:38 Speaker_00
Burger King, prior to 1993, did not accept credit cards, or at least this commercial makes it seem that way. And they interview this woman, and she says, I think it's pretty sad when you have to use a credit card when you go to a fast food restaurant.

01:47:52 Speaker_00
That was a view of someone just sitting in a Burger King in 1993.

01:47:57 Speaker_00
And a second guy is interviewed and says something to the effect of, I just hope it doesn't slow things down because, you know, they'll have to call New York and then they'll have to do the thing. And I just hope it doesn't slow things down.

01:48:10 Speaker_00
And it's like the prevailing idea is that cash is fast. Cash is easy. Cash is respectable. Credit cards are debt.

01:48:17 Speaker_01
What this woman is saying is really sad if you need to use debt to buy a burger.

01:48:21 Speaker_00
Yes, but even at this point in history, it was viewed as this cumbersome thing rather than a convenient thing to bust out the card rather than, you know, like I actually think Burger King corporate crunched the numbers and they were like, geez, for the amount of time we spend handling change, we just want to encourage everyone to be swiping the card all the time.

01:48:38 Speaker_00
even if they're losing some money on the interchange.

01:48:40 Speaker_01
It's crazy. That was 1993. Compare that to today. I don't know about you, but I get pissed when somebody ahead of me in line starts breaking out cash and coins. I'm like, oh my god.

01:48:53 Speaker_00
What are you doing? So start us back, I think the last time we checked in on how the settlement worked was around literally collecting paper sales drafts and then starting to mail it around. Yes.

01:49:05 Speaker_01
So to get from there to today, three major pieces of technology needed to be built by Visa. One was transaction authorizations.

01:49:16 Speaker_01
So when we were talking about transactions happening earlier, and the person in Burger King was referencing like, oh, they got a call to New York and they got to authorize the transaction and all that, we glossed over one sort of stopgap slash bandaid that Visa and other credit card networks implemented around authorization.

01:49:38 Speaker_01
they didn't actually authorize every transaction. So when you paid for something with a credit card in a store, all merchants had what was called a floor limit.

01:49:48 Speaker_01
And the floor limit was any transaction over that limit could not be authorized directly on the floor. And say it was, I don't know, 50 bucks or something like that.

01:49:58 Speaker_01
Anything paid with a credit card under $50, it was basically within the judgment of the cashier to say yes or no. And so, everybody just said yes.

01:50:08 Speaker_01
I mean, the reality was, this was the threshold below which the banks and Visa were willing to say, okay, we'll accept a certain amount of fraud. Interesting.

01:50:18 Speaker_01
And then above that limit, the cashier had to go call up the merchant bank, say, Hey, we got a card here. It's this number. Somebody's buying a refrigerator.

01:50:29 Speaker_01
Then that merchant bank would have to look up that card number, figure out based on the card number, what bank issued the card to the card holder, call up the card holder bank. Oh my God.

01:50:41 Speaker_01
Get somebody on the horn there, say, hey, I've got your card holder, Benjamin Gilbert. His card number is XYZ123. Can you look up his credit? He wants to buy a $500 refrigerator. Can you tell me if he's good for it?

01:50:57 Speaker_00
Right. And this effectively would be like, have they hit their limit yet?

01:51:00 Speaker_01
Yes. Have they hit their limit? The issuing bank would go look that up. The person there, literally the person, talk on the phone to the person at the merchant bank, give them the answer.

01:51:08 Speaker_01
The merchant bank then switches the line back to the cashier at the store and says like, yeah, Ben is good for it or no, Ben is not good for it.

01:51:16 Speaker_00
So you had banks talking to banks.

01:51:18 Speaker_01
People at merchants talking to people at their bank talking to people at the cardholders bank and then reversing the whole chain.

01:51:26 Speaker_00
But importantly, you had a person at the merchant's bank calling a person at the cardholder's bank.

01:51:34 Speaker_01
Yes.

01:51:35 Speaker_00
Today, that is known as VisaNet. There's this piece of technology that sits in the middle that eliminates that bank-to-bank phone call.

01:51:42 Speaker_01
And so this is a big part of one of the first things that Visa builds. And that process that we just described, that could take like 20 minutes and it just didn't work outside of business hours for those banks.

01:51:54 Speaker_01
So say, you know, now that Bank of America is nationwide, soon to be international. Imagine you're trying to buy something in Japan and the Japanese merchant bank calls your cardholder bank back in America, closed for business.

01:52:09 Speaker_01
Just no way for that transaction to happen. Wow, that's crazy. Not good. Definitely not good. So D and Visa know that this is like the first thing that they have to address.

01:52:22 Speaker_01
In 1971, right after NBI is formed, D starts a project called the Bank AmeriCard Authorization System Experimental, or BASE, to build technology to address this problem.

01:52:36 Speaker_01
The whole thing actually started rather inauspiciously because right after all the approvals came through for D to form NBI, I think it was literally the evening before the first board meeting, Bank of America comes up to D and they're like, can we take you aside?

01:52:53 Speaker_01
There's something you need to know.

01:52:55 Speaker_00
Oh, God, that's always fun before our first board meeting.

01:52:58 Speaker_01
And they're like, well, it's kind of hard to tell you. We've been in secret negotiations with American Express for months.

01:53:05 Speaker_01
to create a joint venture together, Bank of America and American Express, that will create an automated system for transaction authorization for multiple credit card systems across the whole country. And we're going to do this.

01:53:21 Speaker_01
So, you know, D, if you want us to remain part of MBI, remember, this is Bank of America, the most important part of MBI. Oh, my God. I know, you know, that part of the operating agreement is like,

01:53:32 Speaker_01
You know, we can't really operate outside of the bounds of MBI, but this isn't really outside the bounds of the MBI. This is a separate thing. This is authorization systems. We're going to do this, and if you say we can't do this, we're out. Whoa.

01:53:44 Speaker_01
So, not good.

01:53:46 Speaker_00
And it's true. It's not really like they're issuing new cards or acquiring new merchants. They're being a technology provider.

01:53:54 Speaker_01
because they and American Express both see that, hey, this is a really, really, really valuable piece of technology. D is, of course, pissed, but what's he gonna do? B of A says, take it or leave it. D takes it.

01:54:07 Speaker_01
As D then tells the story, Bank of America and Amex go out and they try and pitch the other banks in NBI and Interbank and MasterCard on joining the system, but there's all these problems with it, and they don't know how to build technology, and the whole thing dies on the vine.

01:54:23 Speaker_01
Maybe. Maybe that might be part of the story. The other thing that happens is Interbank and MasterCard actually get involved in the project.

01:54:32 Speaker_01
The whole thing then morphs into a tripartite consortium of Interbank, American Express, and Bank of America, and thus by association, NBI.

01:54:43 Speaker_01
Our old friends at the Department of Justice start sniffing around and they're like, all right, now this is actually collusion and anti-competitive behavior. So if you go forward with this, we're going to sue you. And they all abandon the project.

01:54:57 Speaker_01
And this is huge for Visa because this means they can build it on their own. Fascinating. So they do the natural thing at the time. I mean, these are bankers, even though they're based in San Francisco and Silicon Valley, these aren't tech folks.

01:55:09 Speaker_01
They put out an RFP to folks like IBM, systems integrators, you know, the Accentures of the day to go build this technology for them. Go build a computerized authorization system for the Bank of America Visa network.

01:55:26 Speaker_01
All the bids come back, and of course they are all way over budget and way over time. So D says, well, screw it. We're going to do it ourselves. How hard can it be? Wow.

01:55:36 Speaker_01
So in his very D way, he goes and he recruits the guy from the firm that impressed them the most throughout the bidding process was a firm named TRW and a guy named Aram Tatoulian. D goes back to him and he's like, I like you. You come work for me.

01:55:55 Speaker_01
Leave TRW, I'm going to hire you. You build this here in-house. Wow. And I'll give you the resources. You come join us and you'll build out your own tech team here within NBI slash Visa. Aram comes and joins and starts the core of the Visa tech team.

01:56:10 Speaker_01
Dee gives him nine months to build this entire thing from scratch. And to do this involves building a first nationwide and then ultimately worldwide telecom network so that the electronic communication can happen.

01:56:25 Speaker_01
Two, installing computer systems in each of the member banks around the country, so that instead of the banks calling the other banks, you know, this can happen over computers.

01:56:35 Speaker_01
Three, training the people at the banks on how to use these new computer systems. And then four, maybe most importantly for the long run, building a new centralized data center for Visa in the Bay Area. And this becomes the San Mateo campus.

01:56:51 Speaker_01
You can see it right off of 101 as you're driving between San Francisco and Silicon Valley. It is, I believe, still the headquarters of Visa today now. Huge campus in San Mateo where they build the data center.

01:57:02 Speaker_00
Until, I think, next year, it's going to go back up to San Francisco when they finish a new building. That's right. I think it's going to Mission Bay.

01:57:11 Speaker_01
So, miraculously, Aram and his new Tiger Visa tech team They do it, they do it in nine months and it works.

01:57:20 Speaker_01
So Dave Stearns writes in his book about this whole situation and about D, D maintained that if you give computer people more time, they will just consume it. So he always insisted. So it's so true.

01:57:34 Speaker_01
So he always insisted on shorter projects with uncompromising deadlines. They will just consume it. They'll just consume it.

01:57:43 Speaker_00
Fascinating. Okay, so they build what becomes VisaNet in-house. At this point, you know, there's no internet, so it's all just working over telephone communication.

01:57:53 Speaker_01
Yep. Direct networking. Amazing.

01:57:56 Speaker_00
And so they're just operating the whole network out of this data center in California.

01:58:01 Speaker_01
Yep. Now, importantly, this is only for transaction authorizations. So the cards and the point of sale have not been digitized yet. That's going to be the final third piece of the stool of technology that Visa builds.

01:58:14 Speaker_01
This is just when a merchant makes a call to their bank saying, hey, is this card good for this amount? This is then the interbank communication. I see. So how does the settlement happen at this point in history? So that's what's next.

01:58:30 Speaker_01
That's the next big operational technical problem that Visa needs to solve.

01:58:35 Speaker_00
It's like literally moving the money when it needs to be moved.

01:58:38 Speaker_01
Reconciling the transactions, moving the money, getting everything wrapped up at the end of the day, week, month, sending out statements, all this stuff.

01:58:47 Speaker_01
You can sort of think of the first piece that we just described as the authorization as sort of the front end of a payment card system. The settlement is the back end. You know, the front end piece consumed a lot of phone time and people.

01:59:01 Speaker_01
The back end piece consumed a lot of paper and time too. Maybe more time, but like a lot of paper. Because you're effectively mailing checks.

01:59:10 Speaker_01
And even more perniciously, as the network grew, and at this point in time, soon-to-be Visa is growing explosively, the complexity of this settlement piece also grows, sort of exponentially.

01:59:28 Speaker_01
every new bank node that you add into the system now has to interact with all the other bank nodes. And so, like, this is a hard computer science problem. It's an n-squared problem. Well, it's a problem that is easily solved by computers.

01:59:41 Speaker_01
But when you're doing all this manually with paper, this is a big, big problem.

01:59:45 Speaker_00
N-squared is much worse when you're doing it with paper than with computers.

01:59:48 Speaker_01
Yes. So what you really need to do this efficiently, to bring it all the way back to the beginning of the episode, is a clearinghouse. You need an automated clearinghouse. And this is unbelievable.

02:00:03 Speaker_01
A few people had referenced this to us as we were doing the research, but I kind of forgot about it till the end when I got to this point. And I was like, holy crap.

02:00:12 Speaker_01
Visa builds an automated clearinghouse for themselves to do settlement electronically over the network. They end up calling this project Base 2 after Base 1, which was the first thing doing authorizations.

02:00:26 Speaker_01
This happens at the exact same time and place as when the Federal Reserve is building their own ACH system for checks, you know, automated clearinghouse, ACH, everything in the banking system.

02:00:39 Speaker_01
That was built by the San Francisco branch of the Federal Reserve in the exact same years, in the 70s, when Visa was building their own essentially automated clearinghouse system. That is wild. Now, I've never read anything. I couldn't find anything.

02:00:55 Speaker_01
I've never heard anybody say that they, like, talked to each other, that they knew anything about what was going on, that they were sharing practices. I assume they probably didn't, but it's wild. The same place, the same time. Solving the same problem.

02:01:08 Speaker_01
Solving the same problem.

02:01:09 Speaker_00
Which, again, the problem is this gigantic list of a whole bunch of transactions just happened. People just agreed to make them happen, and now we need to settle up at the end of the day.

02:01:20 Speaker_00
And if you paid me 100 bucks 500 times, and I paid you 100 bucks 400 times, what is the net that actually needs to get transferred? And that is a far more efficient way.

02:01:32 Speaker_00
Batching them up is a far more efficient way than transferring the money back and forth every single time. but still can be a complicated problem, especially when you have thousands of banks on each side of that equation.

02:01:43 Speaker_01
It really is like the exact same problem that both of these teams are solving, and with the same users, the same banks. It's totally wild.

02:01:52 Speaker_01
Once base two is done, and again it also happens in less than a year that it's live and up and running, average settlement time for transactions on the Visa network go from taking a week on average to happening in batch overnight every single night.

02:02:08 Speaker_01
Every transaction on the network settled every single night. So the speed is super important. This has lots of implications for float amongst the banks, you know, like some good, some bad between the banks, between the merchants, the issuing banks.

02:02:21 Speaker_00
Right. If you're the one that owes the money, you kind of want the payment to take more time. Yes, exactly.

02:02:25 Speaker_01
Exactly. Also importantly, this is from Dave's book. It ends up saving about $15 million in labor and postage costs. to the banks by automating this just in year one. Wow. And imagine if this were done manually today.

02:02:42 Speaker_01
It wouldn't be possible to do this manually today. No.

02:02:45 Speaker_00
You needed the technology solutions that they've put in place to enable the commerce scale that flows on this network today.

02:02:50 Speaker_01
Yep. It is also during this project that one of the most famous Visa tech team stories in history happens. This is a good one. This is in Dave's book. So one of the guys, I think he was working on base one and then maybe got transferred into base two.

02:03:11 Speaker_01
He is thinking about the system and reliability is so important. You know, this network can't go down. And he's like, huh, we actually have a pretty serious vulnerability in this system. So he goes to CD.

02:03:27 Speaker_01
I mean, the whole visa organization, I think is like less than 50 people at this point in time. Wow. Just wild.

02:03:34 Speaker_01
And he's like, D, you know, all this technology we're building, you know, we've got authorizations running, we're in the middle of getting settlement running, like the whole visa network now depends on this technology.

02:03:44 Speaker_01
We're providing the service off of one computer in one data center, which is made out of wood and sits on a hillside that has dry grass right by a freeway below a parking lot that is perched on a cliff.

02:03:58 Speaker_01
And we're also about a mile from the San Andreas fault. So, you know, we really might want to think about having some sort of redundant parallel site, a data center out there. And D, in his very D way, he thinks about it.

02:04:13 Speaker_01
He's like, all right, let me think about this over the weekend. He comes back on Monday and he's like, all right, you're right. Thought about it? You now have a new job. Your job is to solve this problem. You're marching orders.

02:04:25 Speaker_01
You are to go move somewhere on the East Coast. I don't care where. Find a site where you can build a redundant data center, get it all built, and have it done within six months.

02:04:36 Speaker_00
and invent the technology to keep these things synchronized so they are actually redundant.

02:04:41 Speaker_01
Yes. So now, D is not technical enough to talk about that, but this is super important. Up until this point in time, state of the art in the sort of fledgling data center world was, yes, to have redundant other location backups.

02:04:58 Speaker_01
But the way that it was typically done was you had your primary data center that operated at full capacity all the time. The backups were just like cold storage.

02:05:09 Speaker_01
They were like dormant backups that only were there to come online if you had to fail over from the primary system.

02:05:17 Speaker_01
Visa, though, and the Visa tech team, they're like, you know, if we're going to go through all this trouble and expense of building another data center, let's use it. Let's use it.

02:05:25 Speaker_01
So they re-architected base one and completed architecting base two to run concurrently across multiple data centers as like shared operations running across multiple data centers, which I think

02:05:43 Speaker_01
may have been either the first or one of the first examples of that ever happening. Wow. Totally wild, right? I don't know that it was the first, but it was definitely not state-of-the-art before.

02:05:54 Speaker_01
This whole data center world was still pretty new, and Visa definitely, through ingenuity, invented a way to do this. Fascinating. And of course, this is now how every data center in the world runs today. Pretty amazing.

02:06:09 Speaker_01
So that was data center innovation, which sort of happens in concert with settlement digitization. The third big leg of the technology stool that Visa builds. is finally digitizing the point of the transaction itself.

02:06:26 Speaker_01
And that requires both figuring out some way to make the cards digital, or capable of being read in a digital manner, and digitizing the point of sale terminal in the merchants.

02:06:41 Speaker_00
Those Verifone, you know, traditionally, they had a huge market share.

02:06:44 Speaker_01
Well, this is when Verifone gets built. There was no Verifone before this. Yep. This is huge. This is the holy grail. The base one authorization system, that was still only for transactions above the floor limits at the merchants.

02:07:00 Speaker_01
So, you know, above 50 bucks or 100 bucks or whatever. It replaced the need for phone calls, but it didn't digitize the transactions themselves.

02:07:09 Speaker_00
So this is actually every transaction now is running digitally for authorization over the network. Exactly.

02:07:16 Speaker_01
not only authorization, but just think about all the things that happen digitally around transactions, the data, you know, everything. This is the beginning of it all. So the first step to doing this, as we mentioned, is digitizing the cards.

02:07:32 Speaker_01
And that really meant making them machine readable. So before this, the cards were just pieces of plastic with embossed numbers on them, like you had to say or type the numbers into something.

02:07:42 Speaker_00
And the nice thing about the embossing is that if you run a shunk shunk on it, a zip zap with the the zip zap or the card imprint reader, you actually can get the numbers off of it without writing it down yourself.

02:07:55 Speaker_00
That was a huge productivity gain when they launched the sort of imprint reader machines.

02:08:00 Speaker_01
Yep. So Visa makes the decision. They end up going with the mag stripe technology. This is the magnetic strip on the back of still to this day, almost everybody's cards out there. There's a whole bunch of drama around this.

02:08:12 Speaker_01
Citibank had financed a proprietary magnetic solution that they were trying to push on the industry. I think they're a bunch of lawsuits.

02:08:21 Speaker_00
And didn't they try to, like, hack the magnetic stripe, and then they did just to prove that, like, the proprietary thing would have been more secure? Yes, but it was proprietary.

02:08:30 Speaker_01
So Visa's like, hey, we're not going to pay you, Citibank, a skiff on everything that we do here. We take the skiff. You pay us a skiff on everything.

02:08:37 Speaker_03
You pay us a skiff. Exactly.

02:08:40 Speaker_01
So they standardize on the mag stripe for the cards. The next step then is they have to create a digital point of sale terminal.

02:08:48 Speaker_01
Now this is pretty far outside the scope of what Visa itself could do, like mass produce a small, inexpensive piece of hardware that needs to get distributed to millions of merchants around the globe. That is outside their circle of competence. Yes.

02:09:04 Speaker_01
We mentioned earlier, and you alluded to this is when Verifone takes off. So what Visa does is they create a spec. They're like, this is the spec of what we kind of need to be created. And they invite different technology vendors to bid on it.

02:09:19 Speaker_01
Verifone ends up becoming. the large dominant, I actually don't know what their market share was or is.

02:09:25 Speaker_00
I think they had like two thirds of the market at peak.

02:09:27 Speaker_01
Yeah. And it's pretty crazy. They come up with this sub $500 device that can sit pretty easily on a merchant countertop that already has a bunch of other stuff on it and not a lot of space and get it distributed and installed at all these merchants.

02:09:45 Speaker_01
Now, the merchants didn't exactly want this thing necessarily, but the way Visa incentivized them to get it is they gave merchants who used it a discount on transaction fees, I think for a period of time, for transactions that happened digitally over the digital network.

02:10:02 Speaker_00
I see. If you use this instead of the Zip Zap, you'll get cheaper fees. Yep, exactly. which that business model carries through to today.

02:10:10 Speaker_00
I mean, the way that you charge a card massively affects the interchange that gets charged, whether it's keyed in with numbers or whether it's swiped or whether it's an e-commerce transaction. Totally.

02:10:21 Speaker_01
One really fun piece of implementation detail around this, just like with base one and authorization where Visa had to build out a telecommunications network amongst all the banks.

02:10:33 Speaker_01
Now Visa needs a telecommunications network amongst all the merchants around the whole world, the country and the world. That's another whole step change. That's like single digit millions of nodes. Yes. So what are they gonna do?

02:10:47 Speaker_01
For the pilot program, they work with one of the big telecom vendors and essentially like build it out themselves.

02:10:53 Speaker_01
We're now in the 1980s here, but they realized during this that there's this new fledgling kind of consumer networking service out there called CompuServe.

02:11:06 Speaker_01
And for folks who either weren't alive in the US at this time or not Americans, CompuServe was like an AOL competitor in the early days of the internet. I think they invented the GIF. Oh, I think that might be right. Yeah.

02:11:19 Speaker_01
So as a consumer, you would pay a monthly fee to CompuServe or AOL or whatever, and it would be your internet service provider, but also like your email and, you know, your portal to the web. It was a proprietary internet.

02:11:32 Speaker_01
So they somehow get in touch with CompuServe. And they realize that CompuServe has this dynamic where they've architected out their network for peak capacity demand. which is probably when consumers are home at night.

02:11:48 Speaker_01
The rest of the day, they've got all this capacity that's unused sitting on their network. Visa ends up renting CompuServe network capacity to send their digital transactions from merchant point of sale terminals.

02:12:02 Speaker_01
And I think this goes on for like years.

02:12:05 Speaker_00
That's crazy. I had no idea. That's fascinating. Totally wild. Normally, you run into the problem where with spare capacity, where like the time where people want your extra capacity is when you have none.

02:12:18 Speaker_00
So it's kind of amazing to find two complementary use cases for the same infrastructure that when one is waxing, the other is waning.

02:12:25 Speaker_01
Yeah, pretty cool. So now, finally, with this third step, all the pieces of the transaction are digitized, computerized, fully implemented as part of the network. This has a huge impact on cutting down fraud.

02:12:43 Speaker_01
So like tons of fraud was happening below the floor limits. You know, if you're charging a $5 transaction to a card, it's just not worth it to the banks and Visa to like figure out whether that's fraudulent or not.

02:12:54 Speaker_01
Now, because it's all digital and instant, they can figure out whether that's fraudulent or not.

02:12:58 Speaker_03
Hmm.

02:12:59 Speaker_01
So during the pilot, banks and merchants that were participating in this program reduced chargebacks to the system by 82% relative to what was happening before. So it's just like a massive amount of fraud gets eliminated.

02:13:16 Speaker_00
which actually should totally justify a lower interchange. If you're not paying for all the fraud in the system, then the system should cost less to run. Absolutely.

02:13:27 Speaker_00
In many ways that, hey, we're going to, you know, reward you with lower interchange to install these terminals.

02:13:32 Speaker_00
Like at the end of the day, Visa probably could have maintained a margin and all the banks could have maintained a profit margin and not lost any margin percentage because just implementing this technology lowered the cost of running the whole thing.

02:13:42 Speaker_01
Yep, two other results from now having all parts of the system aggregated digitally. One, this is what enables the modern payments world we know today.

02:13:54 Speaker_01
You walk up to a terminal, you double-click your Apple Watch, or you insert a card, or you tap your reader, whatever, and it just works, and it gets authorized, and you get your thing immediately. This is the backbone to all of that being possible.

02:14:07 Speaker_01
Two, though, for Visa as a company and Visa as a business, they are now fully digital. They can scale infinitely with essentially zero marginal cost.

02:14:21 Speaker_00
Yes. We will later talk about what a astonishing financial profile this business has. But for now, just know that at this point, they got to stop spending money. And they got to only make every dollar after this basically fell to the bottom line. Yes.

02:14:38 Speaker_01
This unlocks just like an unfathomably good business model. Before this, some element of adding scale into the system required manual labor. Now, it's all just ones and zeros.

02:14:51 Speaker_00
Now the toll booth is fully built. It is a high functioning toll booth. It's a immovable toll booth.

02:14:59 Speaker_01
It's digitized. It no longer has a human sitting there. They've got the fast pass system or whatever.

02:15:06 Speaker_00
Yep. Well, David, catch us up to today. I will give us a bunch of information about the business today, some changes to the business model, and then we can go into analysis.

02:15:15 Speaker_00
But before that, I know there's obviously the IPO event that we want to talk about in 2008 and sort of how the structure of the whole thing changed. But I think you've got a marketing thing that you want to talk about too.

02:15:28 Speaker_01
Yeah. There's one more really fun marketing piece that I want to come back to before we move on to today. And that's the Olympics. A lot of people, probably everybody listening now knows Visa is associated with the Olympics.

02:15:43 Speaker_00
They're probably the most associated brand other than NBC.

02:15:48 Speaker_01
But that's only in America. NBC doesn't mean anything around the globe. Visa is the Olympics everywhere. So this happens right around the same time as the digitization of point of sale on the cards. It's 1986.

02:16:02 Speaker_01
The Olympics for the first time, they are going around to companies and offering a global Olympic sponsorship. This is just like the NFL episode. Before this, you could sponsor the Olympics in specific countries.

02:16:18 Speaker_01
You could sponsor whatever broadcast, whatever television radio was covering the Olympics in certain countries. You could have billboards and whatnot, but you couldn't do a global sponsorship.

02:16:29 Speaker_01
And there's no event like the Olympics that could really do this. I mean, certainly not the super bowl, not even the world cup. You're missing a large part of America. Like this is the only thing where you're going to reach everybody in the world.

02:16:42 Speaker_01
And up until this point, one of the main stay largest Olympic sponsors in America was American express. Cause this fits perfectly with American express. It's for American business people who are traveling abroad. Olympics. Great. Amazing.

02:17:01 Speaker_01
The Olympics, the IOC goes to Amex to try and sign them up to take this marquee global sponsorship slot. They think it's a no brainer. They give Amex a sweetheart introductory offer deal. You're the first people we're going to $14 million. Amex declines.

02:17:19 Speaker_01
Whoa, so they had their bite at the apple and they missed it. A couple of years before this, right as the Visa empire was being completed with the full digitization of the network, Dee ends up getting ousted from the company.

02:17:35 Speaker_01
I think, you know, if he were still alive today, he would probably agree with the characterization that Dee was one of the most amazing zero to one entrepreneurs in history.

02:17:46 Speaker_01
Not so much a one-to-N kind of guy, especially when the industry in which you're going from one to N and your shareholders and board is all some of the most conservative financial institutions in the world. A lot of conflict starts to erupt.

02:18:03 Speaker_01
Ends up with D leaving the company in 1984. After this happens, Visa brings on a new global chief marketing officer, a guy named John Bennett, who came from 20 years at American Express.

02:18:18 Speaker_01
So he and his team see that Amex has passed on this new amazing global opportunity with the Olympics. They're also formulating the new Visa marketing strategy.

02:18:30 Speaker_01
Up until that point, the marketing strategy had been mostly generate category awareness for consumers around the world. To the extent we competed with anybody, we competed with MasterCard, so we positioned against them.

02:18:45 Speaker_01
John comes in and he's like, no, no, no, no. The path to victory here is not positioning against MasterCard. The path to victory is positioning against American Express. Not because we want to kill American Express. We don't actually care.

02:19:00 Speaker_01
We're way, way, way bigger than American Express. But we need global ubiquity and adoption and people to get comfortable with using Visa and using credit cards. Remember, there's still this social stigma.

02:19:13 Speaker_01
That woman in 1993 in Burger King who's like, oh, it's sad if you're using debt to buy a hamburger.

02:19:19 Speaker_00
Which is so interesting because a signature piece of the Bank of America card since it launched was that it is actually a charge card where at the end of the first month you have the option to turn it into a loan.

02:19:32 Speaker_00
But I have never elected that option. I hold these things called credit cards, but that's a misnomer. I've never once used any credit.

02:19:39 Speaker_01
Right. And if this were certainly 1986 and still 1993, you would not feel that way. You might feel that way about your American Express card, but you wouldn't feel that way about your Visa card.

02:19:49 Speaker_00
Right. Although I should say, it's probably false to say I've never used any credit. The bank does float you the money for a month, but they have a one month grace period where you have no interest.

02:19:57 Speaker_01
Yes. You are using debt, you're just not paying interest.

02:20:00 Speaker_00
Yes.

02:20:01 Speaker_01
Which, you know, hey, that's a great thing to do.

02:20:03 Speaker_00
That's an amazing gift that these banks give the world.

02:20:06 Speaker_01
It's the American way. So John had just started. The strategy is use American Express to eliminate the stigma around visa and by association paint MasterCard as having that stigma because we're not even bothering to talk about them.

02:20:23 Speaker_01
So how do we go after American Express? Well, the network is much smaller. The American Express Merchant Network at the time was about 25% the size of Visas.

02:20:34 Speaker_01
So they design a whole marketing campaign around going after American Express and the tagline of the campaign, you know, they show these exotic locales, the type of customers who would be using American Express, that they would be dining at these restaurants or going to these events or going on these vacations.

02:20:53 Speaker_01
In the end, folks who are of our similar age probably remember exactly the words here. If you go there, remember to take your Visa card because they don't take American Express. So great. And then the second tagline to it was Visa.

02:21:08 Speaker_01
It's everywhere you want to be. So the Olympics come up. After Amex declines, John and the team get in touch with the IOC. The price tag has gone up to $17 million just for the rights. That's before any media buys.

02:21:24 Speaker_01
No advertising, that's just for the right to be a global sponsor of the Olympics. They pull the trigger, they become the founding global Olympic sponsor, they spend another $23 million in media for the 1988 Olympics.

02:21:40 Speaker_01
So $40 million in total on one global event. Well, two, there's the summer and the winter Olympics, but one year of global events.

02:21:50 Speaker_00
That's about $110 million in today's dollars. Yeah, wild.

02:21:55 Speaker_01
way more than they spent on any of the technology projects that we were just talking about.

02:21:59 Speaker_00
I mean, yeah, R&D costs money, but go-to-market costs more.

02:22:03 Speaker_01
Yeah. What's the line, first-time founders focus on technology, second-time founders focus on distribution? Yep. And then the real kicker, they, of course, become the exclusive payment provider at the Olympics.

02:22:18 Speaker_01
So everybody now coming to the Olympics, which is like a lot of people, from around the world that are going to the Olympics, the only payment card provider accepted there is Visa.

02:22:31 Speaker_01
So they're training all these people that are going to the Olympics year after year after year. It has now been 37 years that Visa is the exclusive payments global sponsor of the Olympics.

02:22:43 Speaker_01
They're contracted through 2032, so it will be at least 46 years where Visa is the only card accepted at the Olympics.

02:22:54 Speaker_01
Which that's not that big a deal because there's not that many people that go relative to the people that see the media and understand the brand association, of course, of course, but the reason we're talking about this a it's an awesome story, but To the last outstanding piece of enabling the global visa Empire.

02:23:09 Speaker_01
This last thing is the stigma How do they get rid of the stigma of I can use my credit card and not feel like it's a taboo. I This was it. Position against Amex, go to the Olympics. It's the perfect event. You're around the world.

02:23:24 Speaker_01
The type of people who go to the Olympics, the type of people who use Amex, they use their Visa cards and they're proud of it.

02:23:31 Speaker_00
Love it. So David, take us to the IPO. This thing was an organization that was owned, but not with stock.

02:23:40 Speaker_01
A for-profit non-stock membership organization.

02:23:43 Speaker_00
Right. And now they're an enormously profitable public company. So how did we get from there to here?

02:23:47 Speaker_01
Yep. Just about a half a trillion dollar market cap. So the precipitating event wasn't actually the banks trying to get greedy and monetize their asset, although they did monetize the asset.

02:24:00 Speaker_00
They were monetizing it just fine the way that they currently owned it.

02:24:03 Speaker_01
Yes. The profits being spit out of the system were just fine. In 2005, there finally was another huge antitrust lawsuit, I think against both Visa and MasterCard.

02:24:15 Speaker_00
It actually is a class action lawsuit that the merchants brought, and they basically got fully fed up with interchange. And every 10 years or so, there's some meaningful merchant push to try to change interchange.

02:24:32 Speaker_00
And they either do it in Congress or they do it in a class action case. There's a variety of different ways. And this particular class action suit in 2005 is still running today.

02:24:42 Speaker_00
And the numbers have mostly been figured out of how much Visa will owe from a 2012 ruling that then got appealed. So it's sort of still going on. But basically,

02:24:53 Speaker_00
there was a lot of uncertainty in the 2005 and 2006 time frame of, geez, what's the liability here going to be? And MasterCard had gone public and did not sort through this issue at all.

02:25:05 Speaker_00
They just said, oh, we're going public, and shareholders, yep, there's lots of uncertainty in our future, and we'll see, but buy our stock. And that, as you can imagine, did not go well at all.

02:25:15 Speaker_00
And so, as they're getting ready to go public, for lots of reasons, basically it was time. They wanted to have some liquid currency that floated for acquisitions. They had to be competitive with MasterCard, who was going public.

02:25:27 Speaker_00
Amex was already public. You know, you can reward and retain talent easier. There's just like lots of reasons why you would want this thing to be sort of a standalone entity, especially at this point in history.

02:25:38 Speaker_00
And what they had to do was they created these B shares and they isolated all the liability from this class action suit to the B shares.

02:25:46 Speaker_00
So while MasterCard had a pretty flubbed IPO, Visa had a great IPO because they said, whatever the court's rule, the banks who own the B shares, the preexisting shareholders will own all that liability and all the A shares, the new people who are coming in as owners of the company will be protected.

02:26:04 Speaker_01
Oh, that's awesome. I didn't realize that in the research. It finally happens in 2008. Visa goes public right as the financial crisis is starting, which obviously wasn't planned, but ends up being great for the banks and probably for Visa too.

02:26:21 Speaker_01
It becomes the largest US IPO in history. Up to that point, they raised $18 billion at a $90 billion initial market cap.

02:26:31 Speaker_01
But that $18 billion wasn't primary capital to the company's balance sheet because obviously Visa was incredibly profitable, did not need capital. It prints money. Why would you want to raise capital and dilute?

02:26:43 Speaker_01
That $18 billion was secondary selling to the banks that owned the company, which I think for many of them proved to be a total lifeline through the financial crisis that helped them survive.

02:26:57 Speaker_00
Yep. I mean, now Visa is owned mostly by big institutional shareholders, the vanguards and fidelities of the world. And the banks are much smaller shareholders.

02:27:06 Speaker_01
Well, at this point, Visa's market cap is significantly larger than any of its former member banks.

02:27:13 Speaker_00
It's wild. I mean, D-Hawk basically was right.

02:27:16 Speaker_00
That's the TLDR on this, is this thing, this information network that doesn't have to take on any of the risk of any of these transactions, it's purely about connecting buyers to sellers and moving information back and forth, has proven to be maybe the best business model ever.

02:27:34 Speaker_00
And let's go through the shape of the business today, and listeners, you can decide.

02:27:38 Speaker_00
So, David and I have made passing references to the idea that this is this ludicrously cash-generative business, and I think it's time to actually examine interchange fees today, how they've changed over time, how they flow, who benefits, what visas cut, all of that, so you can kind of understand it.

02:27:59 Speaker_00
Visa's business model. The first thing to know is almost nothing has changed since the 80s to today on how the transactions work.

02:28:08 Speaker_00
So the authorization flow is exactly the same as it was, where all the auth flows upstream, the merchant runs the card, checks with their bank, who checks with VisaNet, who checks with the issuer's bank,

02:28:21 Speaker_00
Is this account in good standing to make this transaction or not? And once they get the yes, then the response flows all the way back down the chain in the order that ultimately the flow of funds will happen later on.

02:28:33 Speaker_00
And you know, within milliseconds, unbelievably short period of time, no matter where you are in the world, and no matter what currency you are transacting in, your transaction can happen.

02:28:44 Speaker_00
Pretty unbelievable, amazing that within seconds you can know for certain that someone is vouching for the customer's money and paying in full. Well, nearly in full. Minus a merchant discount rate. So, what is this merchant discount rate?

02:28:57 Speaker_00
There are a few things at play here. There are interchange fees, and those interchange fees go to the issuing bank. There are assessment fees, or network fees, and that network fee goes to Visa, MasterCard, etc.

02:29:12 Speaker_00
And then there are payment processing fees, and those go to the acquiring bank, the bank that acquired the merchant, this is the merchant's bank, and the technology provider of whatever they're using to process their payments.

02:29:24 Speaker_00
So three fees, interchange, network fees, payment processing fees. Here's what those could look like. And again, I say could because they are different in every scenario.

02:29:35 Speaker_00
There's a very long PDF on Visa's website that is available with every different concoction you could imagine. So here's an example of a large merchant in the United States, so no foreign transaction, accepting a credit card.

02:29:49 Speaker_00
It is obviously different whether we're talking debit, smaller merchants, but large merchant, US credit card. The merchant is charged a 2% discount off the sale price. So it was $100 a pair of shoes. You're now making $98. And what happens to that 2%?

02:30:06 Speaker_00
So that 2%, the lion's share of it is the interchange, the 1.6%. That goes to the bank that issued the card.

02:30:14 Speaker_01
To the cardholder, to the consumer.

02:30:16 Speaker_00
Right. So when everybody on the planet is marketing credit card offers to you, they get the lion's share of the interchange.

02:30:23 Speaker_00
So they actually have a lot to play with in customer acquisition for their cards because they make the lion's share of the transaction, the interchange. There's a lot of costs in there too, because they bear all the fraud risk.

02:30:36 Speaker_00
There's a lot of things they got to do, but you know, they get most of the money. A small amount, on the order of like 0.2% or 20 bips for you finance people out there, goes to the bank that acquired the merchant.

02:30:49 Speaker_00
This could be Chase, Pfizer, Wells Fargo. This is, you know, the merchant's bank. It is important to know this may also get split with a technology provider.

02:31:00 Speaker_00
So sometimes the financial institution directly has technology that you can use, but other times the checkout terminal or software that you're using is not actually the financial institution behind it.

02:31:11 Speaker_00
So that 0.2% can kind of get split between the financial institution and the technology provider.

02:31:16 Speaker_01
And those are folks like First Data and stuff like that, right?

02:31:20 Speaker_00
Yes. 0.15 to 0.2% goes to the network. This number is actually quite hard to find. You read Visa's entire annual report and you're like, wait, but what part of the split do you actually get? And it's because they get it in a variety of different ways.

02:31:38 Speaker_00
I would say I don't know if the Visa people would tell you this is intentionally obfuscated or if it just ends up being kind of obfuscated, but it's not super easy to figure this out.

02:31:50 Speaker_00
So Visa, let's round it to 0.2%, gets 20 cents of that $100 shoe sale. But the cool thing about their 20 cents is there's basically no variable costs. Yes. It's not dealing with fraud. It's not moving heavy data around.

02:32:06 Speaker_00
I mean, merchants are allowed to have a 20-character name in Visa's network. Like, this is tiny amounts of data. Stack as much metadata as you want on top of that. We are not shipping around huge payloads here.

02:32:18 Speaker_00
There is not, like, NVIDIA chips that need to run in these data centers to do any crazy LLM processing. Like, this is just shipping

02:32:27 Speaker_00
very small pieces of information around the payload size of the data has remained infinitesimally small relative to the amount that technology has progressed.

02:32:37 Speaker_00
This 0.2%, the 20 cents on the $100 transaction, very low variable costs associated with that. So, a few caveats on this. Debit is significantly less in most cases, and often thanks to regulatory reasons.

02:32:53 Speaker_00
And the logic here is nobody's actually taking any risk to extend credit. So banks should not get to make a bunch of money on debit. It's literally just moving money out of your account and into the merchant's account.

02:33:05 Speaker_00
So debit cards are going to be less. Smaller merchants often pay closer to 3% than 2% because they're just doing lower volume. And for these small businesses, the acquiring bank actually has to do a lot more work.

02:33:19 Speaker_00
Think about how difficult it is to market a credit card to an individual. Well, small businesses kind of behave like individuals. So because the acquiring bank actually has to do a lot more work and incur costs, they get to make more money.

02:33:33 Speaker_00
So there's sort of this very interesting thing that has happened where interchange is intentionally quite flexible. This is a playbook theme that I want to pull forward.

02:33:46 Speaker_00
This business is probably the greatest masterclass in the entire world on incentive alignment. And I was talking with Lisa Ellis at Moffett Nathanson, who sort of woke me up to this idea. The interchange pool has an elegance to it.

02:34:00 Speaker_00
Since the money never actually gets sent to the merchant, the network and its partner banks or constituent banks can kind of figure out exactly how it should flow in each of these particular types of transactions.

02:34:13 Speaker_00
It's an envelope of value that the whole ecosystem can sort of play with. And I think that's an important thing to realize about interchange is that it's intentionally flexible.

02:34:23 Speaker_01
Yep, which brings up an obvious point that we perhaps didn't highlight as specifically as we should have earlier. This network is actually a five-sided system. There's the consumer that is buying something.

02:34:37 Speaker_01
There's the merchant that is selling that something to them.

02:34:41 Speaker_01
There's the Visa network in the middle, that's the third party, but then there also are the fourth and the fifth parties, which are the banks for each of the consumer, the issuing bank, and the merchant, the merchant bank.

02:34:53 Speaker_01
So this sort of envelope of value concept makes sense because those three parties in the middle, Visa and the two banks, they need to split up the value and depending on who is doing what work, it should be split different ways.

02:35:09 Speaker_00
And Visa has created these products where, you know, it's not just a Visa card, you might get a Visa signature, a Visa signature business, or a Visa... I don't even know what they are. But they basically have said, why don't we come up with...

02:35:22 Speaker_00
other types of Visa cards that just have higher interchange. And merchants are like, what do you mean just have higher interchange? Your new product is you charge me more?

02:35:31 Speaker_00
And Visa says, well, the cool thing about higher interchange is that there's more money in the envelope to play with to reward other constituents in the transaction.

02:35:43 Speaker_00
And so let's say we want to tell the issuing bank, hey, for this tier, this Visa signature, you actually get more money.

02:35:50 Speaker_00
Well, then they turn around and say, cool, I'm going to go and I'm going to give better rewards to higher spending, you know, more credit worthy customers. And then Visa's argument back to the merchant is, well, hey,

02:36:05 Speaker_00
because we're actually taking more money on this fancier card, you're getting access to customers that we've now brought onto our network who are much better customers that you really want to have at your establishment.

02:36:17 Speaker_00
And so it's this very interesting, again, envelope of value, I think is the way to describe it, where I'm sure the merchants wish they could be more a part of the decision process, but it does

02:36:31 Speaker_00
theoretically enable incentives to be spread around that benefit everyone in the ecosystem.

02:36:36 Speaker_01
Yep. And for merchants of scale today, they're cut in on this too, right? There's the Alaska Airlines mileage card, there's the Costco card, like merchants are able to, by working with banks, be part of this discussion too, if you're of a certain size.

02:36:57 Speaker_00
Right.

02:36:57 Speaker_00
In the olden days, you know, if you were the Affinity logo that got printed in the top stripe, the way that works today is you have a special deal with the issuing bank where you're going to say, hey, we're going to help you get more card members by putting our logo on the card.

02:37:12 Speaker_00
And so even though oftentimes we're the merchant, well actually what we're doing is we're helping you distribute cards on the issuing side.

02:37:21 Speaker_00
And maybe there's cool things we can do when those cards are spent at our establishment where we give extra awards, but it's effectively marketing channel for the issuing bank. So they get to split some of those economics.

02:37:34 Speaker_01
And I guess at the absolute very highest levels of scale, you have something like the Amazon and JPMorgan Chase relationship where JPMorgan Chase is the merchant bank and JPMorgan Chase is one of the largest issuing banks for cards in the world.

02:37:51 Speaker_01
And so the Amazon Chase credit card that I have and I do all my shopping on Amazon with and all my shopping at Whole Foods with is able to give me 5% cash back rewards.

02:38:03 Speaker_01
So Amazon or JP Morgan, and in this case, the two of them working together, represent three of the five parties in this transaction. The only people not party to this are the consumer and Visa, the network itself.

02:38:17 Speaker_01
And so thus, that's how they're able to do so much special stuff. They can control so much of that envelope of value. Yes.

02:38:24 Speaker_00
It is worth pointing out the system today is pretty tough to change absent government intervention. Consumers who spend the most love the system the way that it is.

02:38:35 Speaker_00
A huge amount of the fees that merchants pay come back to these consumers in the form of rewards. So the issuers and the networks end up with the consumer as their advocate for the system as it exists today.

02:38:48 Speaker_00
And meanwhile, no retailer owns enough of the total transactions to actually go invent their own better system.

02:38:54 Speaker_00
So when merchants have tried to go and get consumers to go direct and give them their bank account information, typically consumers won't do it unless they get some very high number of percent back.

02:39:04 Speaker_00
And that's actually more expensive than the interchange. The way that you end up having to pay your consumers in order to change their behavior away from credit cards that they love the reward so much on is to do something non-economic.

02:39:19 Speaker_00
Like, you have to believe that there's some long-term benefit to doing it.

02:39:22 Speaker_01
Yeah. And famously, Walmart and Target, too, I think, have been trying to do this for years and years and years, and they never can make it work.

02:39:30 Speaker_00
Nope. And the reason is basically like no one can ever figure out how to incentivize all the parties that need to change behavior enough to change the behavior.

02:39:40 Speaker_01
And the merchant in most cases is really the only party that is not thrilled with this arrangement.

02:39:48 Speaker_00
I mean, the most negative way someone could paint the ecosystem as it exists today is that the whole credit card system is a wide-scale bribe of the American consumer to, like, extort the world's retailers using the retailer's own money.

02:40:01 Speaker_00
But that is, like, a very cynical way to view it.

02:40:06 Speaker_01
I mean, I guess you could take that one step further and say consumers actually do bear the brunt of it because merchants will just raise their prices to compensate for it.

02:40:14 Speaker_00
So that's a strong argument. There's been independent research firms that have looked into this and basically determined that this is a reverse Robin Hood scenario, that the wealthiest consumers are the ones who have rewards cards.

02:40:27 Speaker_00
And because all the goods are marked up to accommodate interchange. Right.

02:40:33 Speaker_01
No matter who's buying, the goods are marked up.

02:40:35 Speaker_00
Right, if you aren't someone that has a rewards-based credit card, then your stuff just got more expensive.

02:40:42 Speaker_00
And so the research firm that looked into this, actually, I think it was the Fed, the Federal Reserve Bank of Boston, determined that on average each year, a household that uses cash to pay for things pays $149 inflated prices, because all prices, no matter how you pay, have to go up in order to make it so that paying in cash and cards

02:41:04 Speaker_00
is equivalent, because in most states, it's actually illegal to charge a meaningful premium to people who are using credit cards. So on average, a cash-using household pays $149. Effectively in subsidy. Yes.

02:41:17 Speaker_00
But a card-using household receives $1,100 in value. I mean, I guess that makes sense.

02:41:24 Speaker_01
I think about the value of the rewards I get every year.

02:41:27 Speaker_00
It's on average, what is it? 2% of everything you put on your card.

02:41:29 Speaker_01
Yeah. Which, I mean, especially us running a business, like, yeah, we put a lot of stuff on cards.

02:41:35 Speaker_00
Right. That is the other argument that this is like kind of net bad for the world is that it's regressive in who it rewards and who it penalizes.

02:41:44 Speaker_00
The other reason why it's really hard to change the system is this whole thing is a chicken or the egg problem. I mean, every two sided marketplace is a chicken or the egg problem.

02:41:53 Speaker_00
Bank of AmeriCard solved this when there were no regulations by dropping 65,000 credit lines on unwitting Americans, and you can't do that now. So how do you bootstrap one side of the marketplace when you can't do something like a drop?

02:42:08 Speaker_01
And they were in a unique position at that moment in time in California where they had such large market share of both consumers and merchants that they could kind of effectively create this network themselves.

02:42:20 Speaker_00
Right. So what you're basically relying on now is... some sort of extrinsic paradigm shift, probably a technology paradigm shift, that enables a new entrant to bootstrap one side of the marketplace in one way or the other to create a new system.

02:42:37 Speaker_00
And without a new paradigm emerging, this is the system. I'd say a new paradigm or the government intervention, this kind of is the system that we've made our bed and we're stuck with. For good and for bad. Yep. I mean, I love my rewards cards. Right.

02:42:52 Speaker_00
And look at all of the economic value that it created by enabling e-commerce. It is truly astonishing that without UPS to ship packages and without credit cards to let us pay for things on the internet, like it just wouldn't have happened.

02:43:06 Speaker_00
It's trillions of dollars of transactions in the economy that would not exist. So the arguments to merchants are, look, people spend more when they use a card. There's a broader range of buyers that use a card.

02:43:19 Speaker_00
A very cool feature of these credit card and debit cards is there's guaranteed payment with no risk. There's instant authorization for this consumer wants this thing.

02:43:30 Speaker_00
Now, they could return it, but you know for sure that they're good for the money and you're going to get the money very soon when they walk out the door, which that wouldn't happen in checks. there's a cost to checks.

02:43:42 Speaker_01
Right. If you're going to accept a check from somebody, there's a strong element of trust that you have to have with that individual or entity.

02:43:50 Speaker_00
Yep. And if you're saying you better come in here bearing cash or a cashier's check, you're gonna have way fewer customers. Not to mention, like, there's totally a cost of facilitating cash.

02:43:59 Speaker_00
You know, it's one thing for a coffee shop, but let's say you run a running shoe store and everything you sell is $150 to $250. There's a pretty meaningful amount of cash that piles up in your establishment.

02:44:10 Speaker_00
And so you need to make sure that you have security or like, you know, let's pick an even higher ticket item thing, like a jewelry store. You need security, you need, To move that cash somewhere, you need to make time to go to the bank to deposit it.

02:44:23 Speaker_00
Totally. The operational overhead associated with that. There is a value to providing payment and there is a cost to whatever the payment method is. Am I saying that the cost is 3% or in the old days 5% or 7%? No, absolutely not.

02:44:38 Speaker_00
But there certainly is some cost no matter what form of payment is used. Absolutely. So, the business today. What does Visa look like?

02:44:50 Speaker_00
Well, last year Visa processed $14 trillion of volume through their network, which is an almost meaninglessly large number. How do you even think about that?

02:45:00 Speaker_01
One fun way to think about that that I calculated is if you start from 1971, the first full year that the Bank of America card network was liberated from Bank of America, the growth in payment volume on the network since then has been 17.3% compounded annually for 51 years.

02:45:18 Speaker_01
Oh my God, wild.

02:45:26 Speaker_00
It turns out the world eventually did want to pay with frictionless, fast, and often credit-extending methods.

02:45:34 Speaker_01
Yep.

02:45:35 Speaker_00
Wow, 17% compounded for 51 years. Yeah, I mean this is like Berkshire levels of compounding that is happening here.

02:45:43 Speaker_01
Yep. And it's not like, you know, people may think, oh, 17%, like, oh, I have seen IRRs greater than that. Have you seen them greater than that over 51 years?

02:45:53 Speaker_00
Right. Not many of those. It's amazing. The number of transactions they processed last year was over 190 billion. So that is 27 transactions per person on earth, including young children every single year.

02:46:07 Speaker_00
Hey man, young children require a lot of commerce.

02:46:11 Speaker_01
Let me tell you.

02:46:12 Speaker_00
So I hear. There are 4.1 billion Visa cards in circulation. Their net revenue is 29 billion dollars. That's up from 22 billion two years ago. So there's an interesting thing that I didn't really realize with Visa, which is it's had a hell of a decade.

02:46:36 Speaker_00
In my head, Visa has been this steady state thing in the world, as has MasterCard, but the last decade has been the story of Visa's incredible dominance in revenue and transactions and volume.

02:46:48 Speaker_00
It's just actually true that a lot of their growth has been recent in the last decade. Their value-added services, this is an interesting thing that I want to come back to, was $6 billion.

02:46:59 Speaker_00
So look at their overall revenue number of $29 billion, their value-added services is $6 billion. We'll talk about what that means. The most shocking thing about the business is they have 50% net income margins.

02:47:14 Speaker_00
So of the 30-ish billion that they made in revenue, their net income was 15. Yeah.

02:47:21 Speaker_01
This is absurd. All the picture we painted in the whole story, it was all building toward that climax of they have created something with essentially zero marginal costs in

02:47:35 Speaker_01
Perhaps the largest market out there, certainly one of them, global commerce, both e and non e commerce.

02:47:43 Speaker_00
And as Visa would argue, both consumer, but also B2B commerce.

02:47:48 Speaker_01
Yeah. 50% net income margins on 30 billion in revenue. There it is.

02:47:53 Speaker_00
And you might say, so wait, if they have 50% net income margins, what is their gross margin? Because is it SAS level good at 75, 85%? Nope. Their gross margins are 98%. Unreal. There are no variable costs in this business.

02:48:10 Speaker_00
There are no costs of goods sold. Unreal. It's crazy. So I think with 50% net income margins, this is literally the most profitable large-scale company in the world.

02:48:22 Speaker_00
I don't know of any other businesses of this size or even like 5 or 10 times smaller that have over a 50% net income margin, including MasterCard, which is 43%.

02:48:35 Speaker_00
And just to throw some numbers out for people that are not looking at financial statements all the time, Microsoft, 34% net income margins. Microsoft sells software. They ship bits. Apple, 25%.

02:48:48 Speaker_00
They have an incredibly marked up product that is differentiated wildly by brand. 25% net income margins. Google, Google has a monopoly in a market of information. What are the costs involved in that business? 21% net income margins. Wow.

02:49:03 Speaker_01
I would have thought Google would be higher. As we were talking in my mind, I was like, well, Google is probably the only one that can come close. But wow, Microsoft is higher. I didn't realize that.

02:49:14 Speaker_00
Yeah, it's nuts. It's nuts. They do have 27,000 employees. In some ways, it feels like an oddly large number, and in other ways, it feels small. But I think we should talk about that in the context of the value-added services.

02:49:27 Speaker_00
Interestingly, there is another company that we have talked about recently on Acquired that does $30 billion in revenue and has 27,000 employees. Do you know what it is, David?

02:49:36 Speaker_01
That would be NVIDIA.

02:49:38 Speaker_00
Yeah.

02:49:39 Speaker_01
It's a weirdly mirror image. Even NVIDIA doesn't have gross margins like Visa. It is the ultimate solution. I think that is the takeaway. Yes.

02:49:49 Speaker_00
Visa does 707 million transactions per day. That is 8600 transactions per second, every second throughout the year. So a big takeaway should be like, my God, they have built. high throughput infrastructure globally.

02:50:06 Speaker_00
That's an unbelievably impressive thing with almost no downtime. It is 99.999% uptime, which I am not a site reliability engineer, but I think that is five nines. Which is wild.

02:50:19 Speaker_01
I mean, you hear about AWS going down more frequently than you hear about Visa going down. Totally.

02:50:24 Speaker_00
That's 16,000 banks in 200 countries. They have six data centers distributed across the world. It's kind of amazing it's only six, to be honest, with that kind of reliability and uptime.

02:50:35 Speaker_01
You know, related to that, though, you raised a good point earlier. The data envelope, as opposed to the value envelope, although I guess it is sort of the same, is also not that large relative to the importance and the value. Right.

02:50:51 Speaker_01
This is not YouTube. Yeah. The transactions themselves, in part because this was all architected in the 70s.

02:50:57 Speaker_00
Right. That is definitely why. Yeah. Lots of people in this ecosystem would love it if you could send entire receipts in machine-readable form across this network. You can't.

02:51:07 Speaker_00
We're stuck with a lowest common denominator protocol that we're shipping very crude pieces of information across.

02:51:15 Speaker_00
I will say, there are other people that are participants in this ecosystem that are perfectly fine with it having almost no information or minimal information going across it. An example of which is the banks.

02:51:28 Speaker_00
The banks don't want to be sharing any of this information that could put them at a strategic disadvantage. Your bank knows your name, knows your social security number, knows your address.

02:51:39 Speaker_00
Visa, I'm running transactions across their network all the time. All it knows is my card number. It has no notion of identity. Isn't that crazy? I didn't realize that. Yeah, that is crazy.

02:51:50 Speaker_00
And the banks like that, because then the banks get to say, no, no, no, this is my customer. Visa, we will use your network, because it is the way that I need to accomplish something for my customer.

02:51:59 Speaker_00
But I'm not just going to turn my customer into your customer. Why would I do that?

02:52:03 Speaker_01
And one of the things we didn't talk about in the story, because it was long enough as is, is the whole debit card struggle. Obviously debit cards are a big part and debit transactions a big part of the Visa network today.

02:52:13 Speaker_01
But when Visa first tried to introduce them, this was one of the things that led to D-Hawk's ouster. The banks were like, no, no, no, no, no debit cards. That sounds like banking relationships. Banking relationships are my domain.

02:52:26 Speaker_01
That's where I make my money. Those are my deposits. You look like you're trying to reach your hand across from being in service of us into competing with us. Uh-uh.

02:52:37 Speaker_01
And obviously debit cards did eventually become part of the system, but not in the way that it was looking like Dee initially wanted them to.

02:52:44 Speaker_00
It's pretty fascinating that debit came later. Functionally to me as a consumer, even though I get floated for a month, my credit card is essentially a debit card where if I want to, I can turn it into a loan at the end of 30 days.

02:52:59 Speaker_00
It's a debit card with a lot of benefits. Right. And obviously, like, I get to keep the money for 30 more days, so it's not quite the same thing. But debit is a simpler product.

02:53:09 Speaker_00
So it's so interesting that debit came decades after credit cards on the Visa network. You would think they would have started with debit, but of course they couldn't have started with debit. The banks would never have gone for that.

02:53:21 Speaker_01
Right. That was the domain of the banks. And actually, there was a big fight between Visa and all the ATM networks, and Dee wanted your Visa card to also be your ATM card. I mean, it makes sense, right? Like, why would you have different cards?

02:53:33 Speaker_01
Mine is today.

02:53:34 Speaker_00
They basically are now.

02:53:35 Speaker_01
But for many, many years, they weren't.

02:53:37 Speaker_00
And they certainly weren't back in Dee's day. Right.

02:53:41 Speaker_00
And I think part of the reason why debit cards were sort of like forced into existence was that consumers basically demanded it, where they were like, look, if I can pay with a card for this high value purchase, and I don't want to use credit, you're telling me that if I don't want credit, then I have to walk down the street, withdraw cash from my bank and bring the cash?

02:54:01 Speaker_00
Is there not something like a credit card but doesn't extend me alone? So, in closing on the numbers today, this is the important number to know, and one that may make you uncomfortable, but I'm curious how this lands for you, David. U.S.

02:54:14 Speaker_00
merchants paid an estimated $93 billion in Visa and MasterCard credit card fees last year, according to the Nielsen Report, an industry publication. That $93 billion was up from $33 billion in 2012. Wow. That's a lot more billions.

02:54:32 Speaker_00
That's a lot more billions. So we've talked a lot here about the interchange and how Visa makes money in the transaction.

02:54:41 Speaker_00
I will say half of Americans carry a credit card balance, which is absolutely brutal since those interest rates right now are around 22%. Oof.

02:54:50 Speaker_00
David, you and I learned in doing some research that the reason why we all get these credit cards from North Dakota is because every state used to have anti-usury laws, like no one was allowed to make you serious loans, and North Dakota was the first to drop them.

02:55:05 Speaker_00
And that's why all the banks issued all their card programs out of North Dakota, because you could do things like have 22% loans made to consumers. and have that be entirely fine.

02:55:16 Speaker_00
So that's the sad history of why your credit cards always get mailed from there.

02:55:20 Speaker_01
And there's no denying that is really sad and unfortunate on the consumer debt side of all this.

02:55:28 Speaker_01
You know, on the fee side, on the one hand, I'm tempted to say like, oh, obviously tripling the amount of fees that merchants are paying for credit card processing over 10 years, like that's ridiculous.

02:55:39 Speaker_00
But transaction value has meaningfully gone up too, like gross volume is way up.

02:55:42 Speaker_01
Yes, transaction value. But also, I have to imagine a big part of that is share of commerce that's happening as e-commerce versus traditional commerce. The credit card networks,

02:55:54 Speaker_01
really are providing a huge amount of value to e-commerce as you were saying earlier. They are to physical commerce too. Nobody wants to pay with cash or check anymore these days, but like e-commerce, there's no other way that that can happen.

02:56:08 Speaker_01
So does it make sense that the credit card networks and their associated parties take more value in that world? I think so.

02:56:17 Speaker_00
Yeah, there's been downward pressure on interchange for a long time. I think industry average right now is down around 2.24, which is, you know, compelling considering we started at 7%. Right.

02:56:28 Speaker_00
That downward pressure has been easy to give on by Visa for things like in-person transactions with card present.

02:56:37 Speaker_00
But for a lot of their super high margin online transactions where the growth is, that's where they decide, oh, actually, we have a really high interchange for that area.

02:56:47 Speaker_00
So Visa is sort of a master of packaging, figuring out how can we take some things and sort of make them more affordable to our merchants or give them away for free, while also figuring out how can we sort of move things around or invent new products that are super high margin that give us a lot of room to run in the future.

02:57:05 Speaker_01
Yep. And it makes sense. Just do the thought exercise, right? Let's say you're a physical merchant and you decide to walk away from Visa and all the credit card networks and say you're only cash or check.

02:57:16 Speaker_01
I mean, you probably are committing suicide as a business, but like you could operate. If you're providing enough value, like ATMs exist, you know, you can operate.

02:57:27 Speaker_00
There's plenty of cash only bars.

02:57:29 Speaker_01
Yeah, exactly. Bars. Great example. If you're on the internet and you say, I'm walking away from the credit card companies, you are literally committing suicide.

02:57:38 Speaker_00
Right.

02:57:39 Speaker_01
I mean, you could use PayPal, I guess.

02:57:41 Speaker_00
But you're paying just as much for that. Yeah, totally. Unless you are literally getting people to type in their account and routing numbers, you are paying credit card-like fees to accept payments on the internet. Yep.

02:57:52 Speaker_00
It's worth sharing, so while we're in the revenue streams here, the money that card issuers make, only a minority of it is actually from the interchange.

02:58:04 Speaker_00
And keep in mind, the card issuers are the ones that make that 1.6%, the bulk of the transaction. Most of the money that card issuers make is from interest payments.

02:58:15 Speaker_01
I mean, they're banks. That's the thing. All the way back to the beginning of the episode, what was the motivation for Bank of America in the early days? It was turbocharge my banking operations. What is your banking operation?

02:58:27 Speaker_01
It's taking deposits, make loans with them, make money on the interest rates on those loans. Nothing has changed in the banking industry.

02:58:35 Speaker_00
Totally. Visa's incentives are more transactions because we want more 0.2%. And the issuer's incentives are carry a balance because that's where we make most of our money.

02:58:45 Speaker_01
Yes. Because even though they're getting the lion's share of the transaction fee, that's going all right back to the consumer in the form of rewards.

02:58:53 Speaker_00
and anti-fraud measures and other value-added services that they have to buy from Visa. Probably a good time to introduce that $6 billion that Visa's doing in value-added services.

02:59:02 Speaker_00
That is all brand new, high-margin products that they've sort of invented in the last 10 years or so that they're trying to sell to merchants. High-margin product. There's no higher-margin product than the core product. Right.

02:59:13 Speaker_00
Brand new, also high-margin products. Right. Merchants, banks, they're basically trying to sell products to people in the ecosystem, anti-fraud, analytics, and it's working very well.

02:59:25 Speaker_00
They're making a lot of money on that and they view that as a high growth area in the future too. But again, it's a little bit of like shifting things around in the same picture.

02:59:34 Speaker_00
Like, look, there's downward pressure on interchange and we can demonstrate to you that interchange is going down. Oh, but we have this great product that is helpful and basically necessary that you also should buy. And there's a lot of that going on.

02:59:47 Speaker_00
All right, so that basically covers the high-level stats on the business today so that we can go into analysis. And you can have a general shape of the business we're talking about.

02:59:57 Speaker_00
But, you know, 11th largest company in the world, valued at half a trillion dollars, around $30 billion in revenue, and they get to keep half of that at the end of the day, and they take no financial risk, and they are just moving information around.

03:00:08 Speaker_00
Mind-blowing. They get to keep half of that after taxes at the end of the day. That's wild. There's actual cash in the bank. Right. This is not EBITDA. This is net income. Crazy. All right, David, power. Does that sound good to you?

03:00:22 Speaker_01
Oh, let's talk power.

03:00:23 Speaker_00
All right, so listeners, this is where we talk through Hamilton Helmer's seven powers framework, which is trying to figure out what is it about this particular business that enables it to achieve persistent differential returns and be more profitable than their closest competitor and do so sustainably.

03:00:41 Speaker_00
It's an interesting one here. This is a lot like the Lockheed Martin episode, where I'm actually not sure we can apply the formal definition where we say, like, what enables them to be more profitable than MasterCard?

03:00:54 Speaker_00
Because together, they're like this government-enabled duopoly.

03:00:58 Speaker_00
And the way that we did this in the Lockheed Martin episode was we said, let's look at the five defense contractors as one entity and say, what enables the five of them collectively to out-compete new entrants?

03:01:11 Speaker_00
And I think that's the right thing to do here with Visa and MasterCard too. At the end of the day, Visa and MasterCard have basically no sustainable competitive advantage over each other.

03:01:19 Speaker_00
It's just operational excellence who's slightly more clever on the bets they're willing to make for these value-added services or next product lines. So, yeah.

03:01:30 Speaker_01
I think the one area where there is difference between them and is probably less so today, but was quite strong through the 90s and 2000s was brand.

03:01:40 Speaker_01
I do think Visa made a genius move, positioning against American Express, going upmarket in perception and partnering with the Olympics.

03:01:50 Speaker_00
It's funny, even though it's a commodity, like them and MasterCard are a commodity, they somehow position themselves as more premium. Well, sugar water is a commodity too. That's why brand matters in these markets.

03:02:00 Speaker_00
But you're literally never making, I guess it's for the banks, because consumers are never making a buying decision on whether it's Visa or MasterCard. That is not how you decide what card to get.

03:02:09 Speaker_01
Well, the brand is like the Intel inside. It's an ingredient brand. So yes, the banks make the decision, but really the consumers make the decision. Because if consumers have a preference for Visa over MasterCard, they'll demand it from the banks.

03:02:21 Speaker_00
No, they're just not differentiated enough to demand it. I just so don't see that any consumer ever has sway there.

03:02:29 Speaker_00
I got the Chase Sapphire Reserve card five years ago because it was by far the best rewards card for the type of thing that I spend money on, as probably with half of our audience.

03:02:38 Speaker_00
And I think it's a Visa Infinite, which I'm sure is one of their high fee things, which is why they can pass on so many rewards.

03:02:44 Speaker_01
I think today that's true, but I do think based on the research, and I was maybe too biased towards Visa, but I think Visa did accelerate past MasterCard. And I think there was a strong brand element of that. I think it's more equal today.

03:02:59 Speaker_00
Yeah, it's interesting.

03:03:00 Speaker_00
It's funny how it used to feel more like you were getting a Visa card that was somehow like powered by a bank, and now it feels more like you are getting a custom proprietary product that a bank invented for you that happens to either say Visa or MasterCard on it.

03:03:14 Speaker_01
Yes. Totally agree.

03:03:17 Speaker_00
Or a merchant. I mean, when you have the Alaska card, you feel like you have the Alaska card. You're like, sorry, there's a bank behind this? And like, oh, is it Visa or MasterCard? I don't know. I don't care. It's the Alaska card.

03:03:26 Speaker_01
Yep. I think there's totally also a story that's beyond the scope of this episode, but how banks, and in particular, Chase, aid American Express's customer base over the last set of years.

03:03:39 Speaker_00
Yeah. I mean, in part, that's just bad strategy on Amex's part that, you know, eventually it was going to happen that they would not be the scale player. Being a closed loop network, you're just going to be a more niche player.

03:03:51 Speaker_00
And so how do you win as a niche player? You need to retain your highest value customers and your highest margin customers.

03:03:59 Speaker_01
Well, they missed the generational transfer. I think they did retain their highest value, highest margin customers. I think those customers are just 80 years old now.

03:04:06 Speaker_00
Yeah, it's true. I think there are less affluent people in our generation who have Amexes versus the premium products from banks or merchants. Okay, so Visa and MasterCard together, which of the seven powers do they have today?

03:04:21 Speaker_00
And if you want to also do the analysis, which did they have early days? And I will start, I think there's an easy no-brainer that you have scale economies.

03:04:31 Speaker_00
Any investment that Visa or MasterCard make get amortized across 16,000 member banks, across 4 billion cards, across half the humans on the planet or whatever it is.

03:04:44 Speaker_00
I mean, just good luck competing with any fixed cost investment that Visa is going to make. It'll pay back instantly if it works to the extent that they can roll it out to any tiny fraction of their customer base.

03:04:56 Speaker_00
It's just so huge that it fits the scale economies thing where You know, if Netflix goes and buys a piece of content, they can pay more for it because they can show it to more people. Visa is the exact same thing with all of their fixed R&D costs.

03:05:08 Speaker_00
Tell me if you think otherwise on this.

03:05:11 Speaker_01
I think there's basically like a law of economic nature that if your gross margins exceed, call it 75, 80 percent,

03:05:23 Speaker_01
and you are of a certain revenue scale threshold, like Argo's margins exceed 75, 80%, but we're a two-person company with a de minimis amount of revenue in the global economy.

03:05:35 Speaker_01
But say you're in the billions of dollars of revenue scale, you must have scale economy power.

03:05:40 Speaker_00
Right. It's almost stupid to say this one because it's like, okay, yeah, but that's actually not what gives the business, that's not what's so special about it. The network economies are what's so special about it. Yes, of course, of course.

03:05:51 Speaker_01
Yeah. But yeah, you must, you simply must, if you have those margins at that revenue scale, have scale economies.

03:05:57 Speaker_00
Right. That's a great point. Okay. Explain to us the network economies.

03:06:02 Speaker_01
Well, I mean, this is even better than the classic two-sided network. This is the classic five-sided network effect.

03:06:08 Speaker_00
Where you have an amplifier on each side because you have the banks going and using all of their scale to amplify your own go-to-market motion.

03:06:16 Speaker_01
Yep. I think this is also true. With network economies and network power, The more participants in a network, the greater complexity grows and the harder it is to actually pull off the network.

03:06:30 Speaker_01
There's plenty of single-sided networks, like Facebook is a single-sided network, at least on the user-based side. There's advertisers, you could argue that's the second side, but everybody's the same node in the network.

03:06:41 Speaker_01
Then there's two-sided networks, like Airbnb is the classic one, you know, something like that. There are three-sided networks out there, probably some four, and clearly this is an example of a five-sided network.

03:06:51 Speaker_01
But as you add sides to the network, the number of successful examples goes like way, way, way, way, way down because it's just so hard.

03:06:58 Speaker_00
Right. Because they're way harder to pull off, but they're so locked in once they're in. Yes.

03:07:03 Speaker_01
And I think this whole story that we told of how incredibly freaking hard and unlikely it was that this happened. means that you have a five sided network effect business, and it's basically unbreakable.

03:07:16 Speaker_00
Yeah, totally agree on network economies. I don't think there's much process power. I don't think there's really any switching costs.

03:07:23 Speaker_00
I mean, in fact, that's probably a bare case to any card company today is that especially with digital payments, you don't even have to carry cards with you anymore.

03:07:32 Speaker_00
I should go get approved for 50 cards and write a script to make it so that whatever the most interesting card for that given transaction is pops at the top of my wallet.

03:07:40 Speaker_00
I think there's almost no switching costs anywhere, really, because when any of these banks have their contract up, they just go and talk to Visa and MasterCard and say, who gives me a better deal? Because you guys are both the same.

03:07:51 Speaker_01
This is true after the first antitrust lawsuit when duality was introduced and banks could multi-home. Before then, yes. After then, zero.

03:08:00 Speaker_00
Well, yeah, I mean, before then, there's interesting analysis to do between Visa and MasterCard. Now there is none.

03:08:06 Speaker_01
Yeah, which is exactly what DHOC predicted.

03:08:09 Speaker_00
Yep. But yeah, is there switching costs between the Visa, MasterCard, Oligopoly and someone else? I suppose, yes. There isn't another option. Yep. Like if you were a bank that wanted to issue a bunch of cards that weren't Visa or MasterCard.

03:08:23 Speaker_00
I mean, I guess there's Discover. No, that's a closed loop network too.

03:08:26 Speaker_01
Oh, yeah, right.

03:08:27 Speaker_00
They are their own bank.

03:08:28 Speaker_01
Yep. Pretty interesting. Nobody else. Counter positioning, the last one, none now, I think. Right.

03:08:35 Speaker_00
Well, you almost can't have it as an incumbent.

03:08:37 Speaker_01
Right. But there was incredible counter positioning back in the day with Bank of America. They were the only institution in America that could pull this off, that could absorb the losses, that had minimum viable

03:08:49 Speaker_01
customer base on the consumer side and on the merchant side that had the dynamics that they did within California, that even though New York was still bigger as a state, the market was so fragmented there that none of the banks had enough power to pull this off.

03:09:04 Speaker_01
They were literally the only one who could do this.

03:09:06 Speaker_00
Yep. That's absolutely right. All right. I think that's it for power. Yep. Playbook.

03:09:12 Speaker_01
Let's do it.

03:09:13 Speaker_00
The first one is, this business is a toll booth, and toll booths make for great businesses, especially when everyone has to drive on your road or the road next to yours, and both of them charge the same toll. Well put.

03:09:26 Speaker_00
I'm going to do my best Charlie Munger.

03:09:28 Speaker_01
I have nothing to add on that one.

03:09:30 Speaker_00
There you go. The next one that I think is pretty interesting is Visa, as I read their whole annual report, they have a narrative around these new things that they're launching, especially the value-added services, being good for consumers.

03:09:45 Speaker_00
And everything that is good for consumers, often for security and privacy, is also good for Visa.

03:09:53 Speaker_00
That is sort of the playbook that Visa runs, is they figure out what is something that we can sort of advertise as a benefit to you that also helps us either increase number of transactions, margin, or lock-in.

03:10:05 Speaker_00
And that is the way to analyze their entire product suite. You hear something is launched, you're like, okay, why, which of those three needles isn't moving for them? That's my main one. I've got more analysis to do in Bear Bull, but what do you have?

03:10:19 Speaker_01
The two that jump out to me are, one, just like our NFL episode, just like our benchmark episodes, communist capitalism. Yes.

03:10:29 Speaker_00
The best example?

03:10:30 Speaker_01
Yes. A, it is the best example of communist capitalism. certainly that we've ever studied, probably in the world, hard to imagine one better. And two, it's like a special breed of communist capitalism.

03:10:41 Speaker_01
You're going to laugh at this, that I foreshadow is democratic communist capitalism. The ultimate irony, right? It's this idea of like, yes, it's capitalism. It's competitors banding together to create more value than they could alone.

03:10:56 Speaker_01
But this is at a massive scale. Like with Benchmark, it's five partners. With the NFL, it's 30, 32 teams, something like that.

03:11:05 Speaker_00
Yeah. This is our whole global financial infrastructure that has decided to do this together. Right.

03:11:11 Speaker_01
This is thousands of banks that have decided to do this together. It is its own separate class of this, I think. Way, way, way harder to pull off than like Yeah, Ben, you and me together, acquired is communist capitalism for sure.

03:11:28 Speaker_01
If we were starting a venture capital firm with three of our friends, can we pull it off with five people? Sure. Could we pull this off with 200 banks? No.

03:11:37 Speaker_00
Right. Especially when you're not starting from scratch. I mean, the 200 banks that they pulled it off with They all had an agreement in place where they owned a franchise.

03:11:48 Speaker_00
And you had to go to them and say, you have to forfeit your franchise and instead sign this other agreement. It's like, you're not starting from zero, you're starting from negative.

03:11:56 Speaker_01
And Bank of America, the franchisor, D had to go to them and say, hey, you're going to forfeit the whole asset. That's a great point. Totally. So that's one.

03:12:05 Speaker_01
And then the other two, you know, I think it's the twin stories of innovation here, which, you know, really hat tip to Dave Stearns for tipping us off on here.

03:12:14 Speaker_01
The socio-technical innovation, the organizational stuff, the communist capitalism, the democratic capitalism, everything we're talking about. Incredible. Also the technology story here. Incredible.

03:12:27 Speaker_01
Neither of which, because of this weird nature of who owned it and how it was set up, people really understood. But both of which are just world-class, incredible stories.

03:12:39 Speaker_00
Yeah, super true. And right here in Silicon Valley. Who would have thought a success story out of Silicon Valley? They've gotten so beat up over the last few years. They really deserve this nice.

03:12:50 Speaker_01
But that's what I find so funny. Nobody knows that this is a Silicon Valley company.

03:12:55 Speaker_00
Do you ever run into Visa people hanging out around San Francisco?

03:12:58 Speaker_01
Exceedingly rarely. Well, I take that back. In the tech and venture capital world, exceedingly rarely. In the corner of San Francisco that very much exists, which is the old money, finance, the legacy of Bank of America, Absolutely in that world.

03:13:18 Speaker_01
And Jenny's in that world because those are the folks who are on the board of the ballet, who are the patrons, who are the donors. The longtime chairman of the board of the ballet was the CEO of Visa USA for many years.

03:13:32 Speaker_01
Like there are a lot of Visa people in that world here. It's funny, though, that you would think it would have bled more into the Silicon Valley world, but it really hasn't.

03:13:41 Speaker_00
You would think. Every tech company would love to be Visa. The financial profile of Visa's business is more tech than any of the tech companies. It is what they all wish they could have. Yes. Fascinating. All right.

03:13:56 Speaker_00
You want to do value creation, value capture? Yes. So originally, Interchange was supposed to cover the costs of operating the network, creating a trusted system, preventing fraud, offering innovation every few years to improve the system.

03:14:13 Speaker_00
And with the incredible profit margin that Visa makes today, not to mention whatever the card issuing banks make, it is very clear that the market has evolved such that these players can charge more in a transaction than is necessary to cover their costs.

03:14:28 Speaker_00
And like, I'm not sitting here demonizing anyone who doesn't use cost plus pricing. I am a capitalist. I fully embrace the idea that a business can and should achieve pricing power if it can position itself to do so in a market.

03:14:42 Speaker_01
We're looking for high gross margins to invest in.

03:14:45 Speaker_00
Right, exactly.

03:14:47 Speaker_00
But it's interesting that because of the multi-layered network effect, David, that you brought up in the power section, it is not easy and potentially impossible for the free market to do its thing and have some new player that actually applies margin pressure here.

03:15:03 Speaker_00
The free market is clearly not playing out, and other than a big technology innovation that shifts the paradigm in a huge way,

03:15:11 Speaker_00
These entities have massively optimized their costs and continued to scale in a huge way such that they just get to capture way more value than it costs them to create. Seemingly indefinitely.

03:15:29 Speaker_01
There's a lot more to talk about in bare bull there.

03:15:32 Speaker_00
Yes. I mean, the worst place that this kind of shows up is the couple percent plus 30 cents that kind of feels small. Yeah. The 30 cents is really pernicious. It's pernicious, especially for small transaction items, so like coffee shops.

03:15:48 Speaker_00
There's an example of a piece that we'll link to in the episode sources of a coffee roaster and shop where their line item of what they had to pay in payment processing fees is actually larger than what they paid for beans.

03:16:03 Speaker_01
Wow, that's crazy.

03:16:05 Speaker_00
Even large retailers that run at pretty thin margins, it is often the case that their EBITDA is the same size as their card processing fees.

03:16:14 Speaker_01
I mean, any time where your average transaction value is less than $10, that $0.30 is a killer.

03:16:22 Speaker_00
That's where the $0.30 kills you. But any time that you are a low margin business, which many retailers are, if you're a discounter, if you're a Walmart, you're paying 2-3% of the whole transaction.

03:16:34 Speaker_00
But when you look at the margin profile, the way that that gets amplified is that you're paying 15% or more of your available gross margin on that item.

03:16:44 Speaker_00
So the only place where this doesn't kill you is if you're a high gross margin, high ticket item business. That's when you can be like, eh, card fees, whatever.

03:16:55 Speaker_00
But if you're selling too high priced of goods, then you often get into a scenario where you are

03:17:01 Speaker_00
Doing less frequent transactions more considered purchases and you can go around the system This is a bear case on visa is are they ever gonna participate in real estate or cars or no?

03:17:12 Speaker_00
Not at these interchange rates Why would anyone ever buckle to pay these sorts of things for things that cost a thousand dollars or more?

03:17:20 Speaker_01
Well, before we go into bear and bull where I know you and we have a lot to talk about what could potentially disrupt Visa and MasterCard. I think it is worth just one minute on the value creation side of this. And I really think.

03:17:33 Speaker_01
you hit the nail on the head a while back when you said e-commerce. Yes, all that other stuff we were just talking about, the 30 cents, you know, everything, that is a lot of value capture.

03:17:44 Speaker_01
There's a lot of value capture that Visa is doing and MasterCard too. On the other hand, I don't think e-commerce really would have happened, you know, alone. There's plenty of other value creation out there too.

03:17:56 Speaker_01
Lots and lots and lots, but let's just take e-commerce. I feel like this is Passover. Like, you know, that would have been enough. E-commerce would have been enough.

03:18:05 Speaker_00
Because I don't think it would have happened without credit cards. Or at least it would have been many years behind because you needed to sort of invent some new mechanism to enable payments over the internet.

03:18:15 Speaker_01
Yeah. And yeah, you know, PayPal and all that. But that would have been a long slog if PayPal had to get an adoption for all payments on the internet to happen.

03:18:24 Speaker_00
Yeah, that's a good point. Which, by the way, PayPal is on a shockingly large number of websites today. PayPal has a lot of market power because they have penetrated America.

03:18:34 Speaker_00
They are deep in terms of people's preferred payment method, which is something I've been kind of blind to. Really? Oh, I missed that in the research. That's quite surprising to me.

03:18:44 Speaker_01
Yeah. Well, that leads us right into Baron Bull.

03:18:46 Speaker_00
Yeah. PayPal is an especially interesting company right now because they're strategically pretty well positioned, but they're going through a leadership transition. And so you don't actually know what the new strategy is going to be yet.

03:18:57 Speaker_01
Yeah.

03:18:58 Speaker_00
Okay.

03:18:59 Speaker_01
Bare in ball. Let's do it.

03:19:00 Speaker_00
Well, OK, bear. And before I actually go into it, a tongue-in-cheek joke is, if they ever get to stop making the insane margins that they do on FX transactions, that's the ultimate bear case.

03:19:11 Speaker_00
It's something like 100 times the margin that they make on domestic ones. Wow.

03:19:17 Speaker_00
If you look at how Visa breaks out segments, you're like, oh my god, the international transactions are ludicrously profitable whenever they have to do a currency conversion.

03:19:25 Speaker_00
So that's worth knowing when you're trying to understand the shape of the businesses. The more international, the better for them.

03:19:31 Speaker_00
But my real bear case is that their business model has basically always been tied to the digitization of consumer payments, ever since they rolled out the three key technologies you were talking about, David.

03:19:45 Speaker_00
I mean, at this point in global history, which is kind of amazing, we're finally here, over 50% of consumer payments to merchants go on cards now. It took forever to get here, 40 years or something like that, 50 years.

03:19:59 Speaker_00
We will start decelerating because we've already shifted more than half the payments to happen on cards.

03:20:07 Speaker_01
Right. We're on the back half of the adoption curve.

03:20:10 Speaker_00
Right. So that is this tailwind that has been with Visa forever. Anytime you could come up with any bear case, it was always just trumped by the idea that

03:20:18 Speaker_00
Well, more people are going to do digital transactions, so they're just going to outrun any headwinds in their way. That will start to slow.

03:20:25 Speaker_00
It's not like Visa's core business revenue is going to like flatline or decline or anything like that, but they will have less of the growth tailwind from this amazing secular thing that's been happening, which is people shifting payments to cards and digital methods, you know, as the years progress.

03:20:41 Speaker_00
My next one is closed loop systems like Alipay and Tencent's ecosystem. To the extent that super apps actually happened in the US the way that they did in China, we would be telling a very different story.

03:20:54 Speaker_00
I mean, the amount of volume that flows in the mobile ecosystem there that is not a part of the credit card ecosystem, I actually don't know if it could have happened here, but The rise of that is super dangerous.

03:21:06 Speaker_00
And people often will cite like, well, the Starbucks app is a very good example of people using a digital wallet that's native to a retailer here.

03:21:14 Speaker_00
How many people do you know that reload their Starbucks app with their direct checking account, routing an account number? Everyone actually loads it using a credit card. That is not bad for them at all.

03:21:26 Speaker_00
It only becomes bad for them if they actually get disintermediated, where a bank and a merchant go direct to the merchant's consumer and manage to initiate a payment flow digitally that doesn't involve a card network.

03:21:38 Speaker_01
Yep. The two things I would want to investigate on the could what happened in China happen here. One, just the build out of infrastructure happened more concurrently in China, like payments infrastructure is already built out here.

03:21:51 Speaker_01
Technology infrastructure got built out afterwards, whereas it all happened all together in China. Two, though, maybe more important is just the government influence, right?

03:22:00 Speaker_01
I doubt the Chinese government wanted Visa, ostensibly American corporation, powering their payments.

03:22:08 Speaker_00
There's actually this really interesting, weird deal that got cut between China UnionPay and Visa, where if you use a cup card in China, CUP, it uses the CUP rails. But if you go internationally, where there is no China UnionPay terminal at

03:22:23 Speaker_00
you know, my local coffee shop here in Seattle, if you were to travel here and swipe it, it runs on Visa.

03:22:27 Speaker_00
But they sort of have the national security benefit and the economic benefit of for people in China, transacting in China, that runs on China owned payment rails.

03:22:37 Speaker_01
Yeah. Which, you know, I mean, I guess that is an associated bear case, right? China in and of itself. And could other governments around the world start adopting similar postures?

03:22:47 Speaker_00
Yep. The next one is similar, but a little bit different. Real-time payment networks are starting to become a thing. The instant bank transfers that these provide are not exactly a payment system.

03:23:00 Speaker_00
It lacks a lot of the features that you would need for payments, like the ability to refund is a prominent one. Like when you just initiate a bank transfer, there's no sort of insurance around the chargeback or

03:23:13 Speaker_00
a refund or anything like that, but you could build payment type features on top of it. And real-time payments are starting to become a thing in a lot of countries.

03:23:21 Speaker_00
So in the US, of course, we have FedNow, but the adoption of that is slow because there's not a Fed mandate. for it to happen the way that it has happened in other countries. In Brazil, PIX has had very fast uptake. UPI in India is another one.

03:23:39 Speaker_00
The UK has something called faster payments. And this can get especially scary for Visa when these start working across geographies. Like Singapore and India have already linked theirs up.

03:23:51 Speaker_00
And so that is a method of transferring money between countries that has nothing to do with Visa.

03:23:58 Speaker_00
And that's, I'm sure, something they're keeping a very close eye on and trying to figure out, is there a way that we can become the real-time payment system that governments decide that their country should adopt?

03:24:08 Speaker_01
And, you know, I mean, technology and infrastructure and ecosystem is getting built on this obviously around the world and here too. And great friends of the show, Modern Treasury, like they are enabling a lot of this. Totally.

03:24:19 Speaker_00
Yeah. Apple, I just think it's like a general bear case here, but here's my sort of specific implementation. Specifically Apple Pay, right? Yeah. So on a Apple Pay transaction, I'm pretty sure Apple makes about as much as Visa does.

03:24:35 Speaker_00
because they stack an extra 15 basis points on top of the other three fees that we talked about. The one to go to the issuer, the one to go to the merchant's bank, and the one to go to Visa itself.

03:24:49 Speaker_00
And so if Apple has convinced merchants that it's fine to lose another 15 basis points on every transaction because it's so freaking convenient that users get to tap their phone or their watch, That is just step one in an equation.

03:25:03 Speaker_00
Here's the like really extreme Apple payment bull case. If Apple were to have payment terminals, then they could totally run all of those Apple Pay payments on their own network.

03:25:15 Speaker_00
As it happens right now, you need to have a card issued by a bank that likely is issued on Visa or MasterCard or AmEx or Discover. And then it goes over those payment rails.

03:25:26 Speaker_00
Apple just puts a little charge on top of it, and then it's the same way any other transaction happens. But if I were to Apple Pay with my Apple card at an Apple point of sale, why would that ever need to run on Visa's network?

03:25:41 Speaker_00
And so, Apple doesn't make point-of-sale hardware today, but if they were to acquire Square, or if they were to do something way out of their DNA and go acquire like Verifone or a legacy provider, they could create their own closed-loop network where they're actually the payment method and the merchant's technology provider.

03:26:03 Speaker_01
Yep. I actually don't even think they'd need to do that. I mean, they're Apple, right? They just use iPads and they would have as part of Apple pay, they would have Apple pay for merchant software that would be on the iPads.

03:26:16 Speaker_00
No, that's too hard. That adoption curve sucks. I think they would pay the what's squares market cap or blocks like 30 billion or something right now. Apple could totally just go buy block and do this overnight and light up all the existing merchants.

03:26:29 Speaker_01
Yeah, true, true.

03:26:30 Speaker_00
Like what else are you going to do with 250 billion of cash? Yeah. I mean, maybe they would try, but Apple is not going to be in the business of directly having a sales force to sign up all these merchants. I don't think.

03:26:43 Speaker_01
Agreed. I have a counterpoint to that, but I'll save it for the bull side of the ledger here.

03:26:49 Speaker_00
I mean, the other thing, the lighter weight thing on Apple is even if they don't try to build their own closed loop thing, who really cares what's in your wallet when your wallet is your phone?

03:27:00 Speaker_00
For consumers now, if you're using your phone, in your head, your payment method is your phone. And it's like the card underneath it is not terribly important other than the fact that you need to remember to auto pay it.

03:27:11 Speaker_00
And like ideally it has the one with the best rewards. And that's not what most people are thinking because I think actually the majority of people don't have rewards based credit cards.

03:27:20 Speaker_00
But they loaded some card in there, they kind of forgot about it, and they pay. And Apple is actually the means of payment, not the card. Even though it's flowing over their rails, consumers don't think of it that way.

03:27:35 Speaker_00
So I don't know exactly how that will manifest in chiseling away at Visa's value, but it certainly is fair to say that the card network and the card issuer have less of a role in the consumer's mind than they used to based on the fact that we now have mobile payments.

03:27:52 Speaker_01
Yep. And Apple Pay and Google Pay along with it are, I think, by like many, many, many orders of magnitude, the most successful quasi-alternative payment systems that have actually gotten install bases.

03:28:10 Speaker_00
Right. Google Pay is very popular, too.

03:28:12 Speaker_01
Yeah, yeah, yeah. But like, what else? I mean, there have been other alternative payment systems over the years, and none of them match, at least domestically in the U.S., Apple and Google Pay.

03:28:21 Speaker_00
Yep. So my TLDR on the bear case is the core business matures, so that tailwind lessens.

03:28:29 Speaker_00
The debit networks get sort of chipped away at, more rails emerge for each use case that sort of, again, has further chipping away at their available use cases, even if not the actual ones that they're using today, but the ones that they could go tackle in the future might get eaten by other people.

03:28:45 Speaker_00
and they spend a bunch of wasted money trying to figure it out. But I don't know. Those are the best bear cases I can come up with.

03:28:52 Speaker_00
And the funniest thing is when I asked, we'll thank a bunch of people at the end of the show that we had conversations with, when we would ask people, hey, what's your bear and bull on Visa?

03:29:01 Speaker_00
Basically, everyone just gave us a bear case because they're like, the bull case is obvious.

03:29:04 Speaker_01
Yeah, totally. And I think the obvious case is this is just an incredibly powerful network effect that's 50 years in the making and is five-sided and Lord knows I can't think of any other five-sided network effects.

03:29:19 Speaker_00
Riding a secular increasing market.

03:29:22 Speaker_01
Yeah, riding a secular wave and nobody has ever broken it and past performance is a strong indicator of future performance in this domain.

03:29:32 Speaker_00
Yep. The corollary to that too is lots of people have had lots of similar bear cases that they've said five years ago, 10 years ago, and none of those things have come true.

03:29:40 Speaker_00
Visa has just continued to grow at low double digit percent growth every single year, or I guess to your calculation of 17% over 51 years. People in the past have said many of these bear cases, but have never come true.

03:29:57 Speaker_00
So, that's kind of the most obvious. Here are the few that are most evident to me that are sort of potentials on top of their core business. Because it is true that interchange is facing downward pressure.

03:30:09 Speaker_00
I mean, we talked about all the way from 7% down to 2% change. And so, they do these interesting other things.

03:30:18 Speaker_00
benefit to them of digital payments, we talked about the potential drawback with Apple being able to maybe disintermediate in some way that's not exactly clear yet, is tokenization.

03:30:28 Speaker_00
So the way that Apple Pay works is that your card doesn't actually get sent to the merchant, your card number. None of the identifying information on there goes.

03:30:38 Speaker_00
Instead, your card gets tokenized, and a token representing your card does, which is, as Visa will tell you, amazing for security and privacy. What it also does is allows them to create more proprietary services.

03:30:51 Speaker_00
In the old card number system, there was a lot more flexibility in what a merchant and their payment processor could actually do with the literal information on the card. They could choose what network to run it on.

03:31:03 Speaker_00
There was sort of more optionality with it when you had the raw information. And now Visa's like, hey, we got your token. Do you want us to do any of the cool token-based services that we have with it? And like, those are high margin for us.

03:31:14 Speaker_00
And so that's sort of the tokenization is good for them. They now have more digital tokens than card credentials. That's been growing really fast. It doubled last year, their sort of tokens on their network.

03:31:27 Speaker_00
So, you know, Visa's quote on this is, this marks a huge milestone, both for the transition to digital and in our work to secure the wider payments ecosystem.

03:31:35 Speaker_00
And you better bet that that's good for, you know, long-term margins and layering products later on. other bull cases. So this is like my favorite one from there. Remember the NVIDIA slide of the trillion-dollar TAM? So here's Visa's version.

03:31:50 Speaker_00
All of payments is about $200 trillion of volume, and cards are only $20 trillion. So here we've been playing in this tiny little fraction of the available market. And there's a few things that they call out that they want to move into.

03:32:08 Speaker_00
That B2B payments is about $120 trillion if they can access it. B2B commerce is actually just much larger than B2C commerce if you think about the amount of money that flows over invoices that are paid via ACH or wire.

03:32:22 Speaker_00
Visa, I think, is intensely aware that they're not going to take two and a half percent interchange on a company invoicing another company for a million dollar services provided thing.

03:32:33 Speaker_00
But, you know, there are elements of B2B that do have interchange. I mean, if you're issued a Ramp or Brex card and you go swipe, that's a B2B transaction.

03:32:42 Speaker_00
So they're very excited about addressing B2B both in their further push in cards, but also developing B2B specific products that have more appropriate monetization models.

03:32:53 Speaker_00
And then they also, we've been talking a lot about consumer to business, like when I decide to pay for something at a business, if you flip that business to consumer, that is a $30 trillion TAM, or a $30 trillion volume addressable opportunity.

03:33:10 Speaker_00
And you can think of that as like insurance company needs to like pay out after a car insurance and they need to make that happen fast. Or refunds, let's say you never bought anything but a company still needs to send you some money.

03:33:23 Speaker_00
Or like Uber needs to pay their drivers. This sort of thing is, there's a whole business they've created called Visa Direct, which is the business to consumer push-based payments, which is a kind of a new foray for them.

03:33:35 Speaker_00
And then the last one is just expansion of cross-border payments, if they can do more international transactions. That is hugely, hugely profitable. So that is me trying to faithfully represent the bull case that Visa paints for their shareholders.

03:33:48 Speaker_00
Because David, these bull cases are so easy. You should read the annual report. The whole thing's a bull case. Yeah, right.

03:33:54 Speaker_01
One other additional I said I was going to add on Boldcase sort of as a response to the Apple and by association Google bear case, you know, pretty much everybody we talked to pointed out as the number one most obvious bear case for Visa right now is Apple and Google and the incredible progress and inroads that they have made into rails and transactions.

03:34:16 Speaker_01
But as you say, all those transactions are still just tokenized Visa MasterCard cards, right?

03:34:23 Speaker_00
It's a bull case today.

03:34:24 Speaker_01
Yeah, it's a bull case today. You know, there may be nuance that I'm missing here, but if you play out how, let's say Apple decides, OK, we want to go after Visa. I'm not sure how Apple could actually do that really without becoming a bank themselves.

03:34:42 Speaker_01
You know, yeah, Amex is a closed loop system. It's a bank. Discover is closed loop system. It's a bank. Does Apple want to be a bank?

03:34:51 Speaker_00
Well, they could become like a stripe. Yeah, I guess so. Or like a square. They're the technology providers and they have merchant acquirer banks behind them.

03:35:00 Speaker_01
Yeah. Sure, they could do that. Apple's finance and fintech operations do not exist in a vacuum. Is Apple going to take on the risk to the Apple franchise of all the regulation and scrutiny that comes from that?

03:35:15 Speaker_00
It depends. Apple will eventually saturate their market and they are looking for what the next frontier is and $200 trillion of volume moving around the global economy. I think, yes, absolutely.

03:35:30 Speaker_01
And so I'm not saying this won't happen, but Tim Cook board level discussion on this, right? Let's play out the D-Hawk thought exercise. Apple succeeds. They do it. They eat Visa. Visa's market cap is now added to Apple's market cap.

03:35:45 Speaker_01
Great, Apple's market cap just grew by 25%.

03:35:47 Speaker_00
Well, I think they have to think that they can improve something. They won't go into this unless they think they can improve both the user experience and create a better business out of it. Great point, great point.

03:35:59 Speaker_00
And they will, I mean, the Vision Pro will come out and we'll have to see if that is the future or not. But post that, like, they're gonna do a car or they're gonna go into payments.

03:36:08 Speaker_01
Right, they gotta keep going after bigger and bigger markets.

03:36:11 Speaker_00
You're right. You're right. The cute apple that we know of years past is gone. And we just have to think about, like, what would a good capital allocator do with their strategic position?

03:36:19 Speaker_01
True. I'm not making the argument that there's still the cute apple.

03:36:22 Speaker_01
I'm just saying, like, I think actually entering this arena introduces a significant amount of risk to the whole franchise that they have to weigh in a way that some of these other markets don't.

03:36:32 Speaker_00
Yep, that's super true. Okay, I have one trivia thing for you before carve outs. You may already know this, but did you know that you can get a Bank of America card today?

03:36:44 Speaker_01
I did not. Is it like a branded visa product from Bank of America?

03:36:49 Speaker_00
It is a branded product from Bank of America, available on bankofamerica.com. There's no annual fee. Click on their website to apply now.

03:36:57 Speaker_00
And the beautiful irony that will tie a bow on this whole episode is the BankAmericard credit card by Bank of America runs on MasterCard's network.

03:37:09 Speaker_01
As you sort of started to set that up, I was like, I know where you're going with this. I know where you're going with this.

03:37:14 Speaker_00
Interbank for the win. We'll link to it in the show notes. Get yourself a BankAmericard and run your transactions over Mastercard's beautiful stellar network.

03:37:23 Speaker_01
Wow. Unbelievable. That is hilarious. What a great place to leave the story.

03:37:28 Speaker_00
There can't be that many people that are applying for this thing, and you would think that Visa would try to go get this deal done just for nostalgia purposes.

03:37:35 Speaker_01
That's a crime against internet and business history.

03:37:38 Speaker_00
What a story, man. Ah, truly. Okay, carve-outs? Carve-outs. Mine is... Available on Netflix, it is a show called I Think You Should Leave. I have not laughed this hard in a long time. Each episode's like 15 minutes.

03:37:53 Speaker_00
It's like three comedy sketches with a guy named Tim Robinson as sort of the brains behind it and is in many of the episodes. Oh, we were talking about this at our drinks in New York. Yes.

03:38:03 Speaker_00
If I were you, listeners, and you haven't watched this yet, I would go to season three, episode one. My favorite skit of them all starts approximately six minutes in.

03:38:13 Speaker_00
Actually, the whole episode's good, but the skits two and three are the truly unbelievable ones. But it's just, he's so outlandish and so I don't know.

03:38:24 Speaker_00
It's like everything that sketch comedy should be in the absolute highest production value you could possibly imagine, shot very convincingly, I think using the same cinematographer, but using a completely different set of lenses, lighting sets, post-production, such that everything that they're trying to emulate, whether it's a game show or a dating show or a commercial, feels like the appropriate thing that they're trying to emulate.

03:38:47 Speaker_00
It's just really good.

03:38:49 Speaker_01
That's amazing. I'll have to check it out. My Carveout is a book, I think this is my first fun fiction book in a while, Mistborn by Brandon Sanderson. It is a awesome fantasy novel, the first in the series, but you can read it as a standalone too.

03:39:06 Speaker_01
It's been out for a long time and has many, many passionate fans out there. It was recommended to me by great friend of the show, Guy Pagani, the founder of Snyk, last time we got together, which was super fun.

03:39:17 Speaker_01
Snyk is an amazing, very large cybersecurity company that I'm sure many of you know about. focused on developers, right? Yeah, developer security. You see their billboards all up and down 101 here in San Francisco.

03:39:27 Speaker_01
But yeah, he recommended it to me a while back, and it took me a while to get to it. You know, toddler parenting. But I read it. I thought it was awesome. Jenny read it. She loved.

03:39:36 Speaker_01
She's, of course, now done the whole series because she's a voracious reader. The world building the magical system. All the core fantasy elements are really great. The political intrigue. Highly recommend. Awesome.

03:39:50 Speaker_00
Well, we definitely have a few thank yous on this one. A huge thank you to Dave Stearns for spending the time with us and recanting his academic thesis, and it was just awesome reading the book.

03:40:00 Speaker_00
I have a personal thank you to a good friend of mine, Jason Pate of Plaid. Very helpful to get just general high-level thoughts on payments industry. Thank you to Lisa Ellis from Moffett Nathanson.

03:40:11 Speaker_00
Lisa did an amazing interview with Ben Thompson a few weeks back. If you are a Strategry subscriber, that is totally worth reading, and I prefer listening, so go listen to that.

03:40:20 Speaker_00
After I read that, I shot her an email, and I was like, we're about to do Visa. I would love to talk to you about some of this. So a huge thanks to her.

03:40:26 Speaker_00
Good friend of the show, Dimitri from Modern Treasury, for helping us quickly get up to speed on payments. And good friend of mine and David's both, Ben Eidelson, who is a former product person from Stripe.

03:40:38 Speaker_00
Sign up for emails to find out about the latest Acquired episodes, to get in on our teasers of what the next episode is going to be, and hear the follow-ups and corrections after we learn them from you.

03:40:49 Speaker_00
You should join the Slack, acquired.fm slash slack. You should check out ACQ2. In particular, our next episode, it is not out yet, is going to be a follow-up to this episode on Visa.

03:41:01 Speaker_00
Our buddy Gaurav from Thrive Capital is joining us for a follow-up to analyze the payments landscape today.

03:41:08 Speaker_00
And Gaurav has spent his entire career as a founder and investor in fintech companies, and he actually gave a talk on the history of credit cards that we used for research in this episode. Check out ACQ2, search and subscribe to any podcast player.

03:41:22 Speaker_00
And then the next week, maybe two weeks, our interview with Gaurav will come out, and be sure to check it out. With that, check out the merch store, acquired.fm slash store.

03:41:32 Speaker_00
Can sport some of this sweet, I'm wearing the shirt right now, sweet swag around. Pay some interchange fees. That's right. That's right. And with that, listeners, we'll see you next time.

03:41:42 Speaker_01
We'll see you next time.

03:41:47 Speaker_02
Is it you, is it you, is it you who got the truth now?