Visa

it's funny when we picked this episode I was like oh this is going to be pretty down thee middle and easy and then of course as we get into the research as always it's like oh nope big story here yep there's always a story 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 got the truth welcome to season 13 episode four of acquired the podcast about great technology companies and the stories and playbooks behind them I'm Ben Gilbert I'm David renthal and we are your hosts 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 the merchant doesn't need to know you or trust you and you do not need to know or trust the merchant and Visa along with just one other competitor master card

has tirelessly spent decades stitching together all the banks merchants and the relationships with consumers to make this possible 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 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 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 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 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 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 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 acquire.

fmil to new fun things 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. fmil and the emails have another new feature 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/ slack and if you want more from David and I outside of these big long main acquired episodes check out aq2 our interviews on the second podcast feed now without further Ado this show is not investment advice 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 well we are starting actually with a big thank you to Dave Sterns author of what is undeniably the very best book on Visa and its history

electronic value exchange 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 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 correct all right take us back in time so de Hawk the founder of Visa who we will talk a lot about as we go along here 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 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 then he would say okay now how many of you can tell me who

owns this company and every single hand in the room would always go down and they would say how did this company start no hands who runs it and who governs it no hands where is it headquartered no hands it's just wild as we were saying in the intro how important this company is and yet still to this day I think you know maybe a few more people than in D's time know the answer to these questions but not many 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 is not run out of New York 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 198 in Fresno California with the drop 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 is chapter 1 the drop

1958 the drop has become like if you say the drop to someone in the fintech industry they're like oh September 1958 Fresno yep and the rest of the world has no idea yep all right so what happened well 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 it was illegal to operate Banks across multiple States back then as we will discuss 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 yeah mostly Farmers and Merchants in San Francisco it really started as like the bank of the little guy 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 unselected now couple things about this one it's wild 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 obviously these are credit cards people don't know what they are they have no idea what to use them mass chaos ensues well and certainly nobody asked for them there's this great quote again from a piece of the action that describes it and says there had been no outward yearning among the residents of Fresno for such a device nor even the dimmest awareness that such a thing was in the works it simply arrived one day with no Advance warning as if it had dropped out of the sky all right 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 US more broadly so like we said BFA 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 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 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 the investment banking activities around that were obviously very lucrative

that's how the JP Morgans you know the Morgan Stanley Etc of the world came to be for the most part consumer Banks were kind of Backwater small there was no way to aggregate enough customers that you could get big enough 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 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 you could almost think about these more as credit unions than the 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 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 yes exactly California was

already the second biggest state in the nation at that time behind New York 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 so you know the business of banking is well banking you take deposits you make loans you make your money on the loans B OFA was doing tons and tons and tons of small little and disperate Consumer loans and lending so obviously mortgages and car loans like those still exist today but they were doing like washing machine loans 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 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 yeah and for specific items to like go buy a refrigerator wild it was just wild to imagine today 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 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 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 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 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 and that was taken as a discount out of the check 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 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 totally so problem number one you didn't get all the money right problem number two also big problem it took a really long time imagine you know we're talking like the 1800s early 1900s this stuff was on the Pony Express you know pieces of paper going around a really really big country not ideal yeah and until a 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 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 $68 okay next check oh I owe you $44.20 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 totally and spoiler alert a doesn't get developed in the US until the 1970s wow humans though are quite ingenious creatures at solving their problems particularly when motivated by money 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 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 I remember even Me growing up in the 1980s we had this at our local gas station near our house really 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 go inside and be like oh we have an account here and they just write down what it was and then at the end of

the month I assume my dad would go give them some money which saves on operations for everyone it's uh 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 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 it all the branches of a brand 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 yep in 1939 Standard Oil of Indiana sent 250,000 unsolicited cards directly to all of their customers yeah making the Fresno drop look like a uh drop in the bucket shall we say 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 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 we could collaborate and have a standardized chart account system that we could share and just literally to simplify the back office as the first value proposition here 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 and not to mention on top of this there is a huge benefit of a shared credit history 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 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 yep so this comes to be kind of post depression in the 1930s 1940s in the US and this really is starting to sound a lot like Visa except as you point out Ben there is a problem here 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 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 of thousand participants here like are individual Merchants equipped to manage a network like this

no they don't have the resources to do this right so you have to spin up some kind of like shared organization that all the merchants are pulling their Capital into in order to run the network on behalf of all of the merchants it gets messy or there could be an independent third-party for-profit Network that does this and this is when Diner club and American Express arrive on the scene so Diner's Club was first and people might know and have heard of Diner Club it still exists today it's like a sub brand of discover totally there's a very famous legendary origin story behind Diner club and it goes like this 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 mcamera is hosting a lavish business business dinner in downtown halfway through the dinner he realizes that he forgot his wallet at home he does not have cash to

pay for the dinner so he excuses himself he goes to the pay phone 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 a arod dite businessman is preserved and then afterwards you know he's like talking to his wife he's like oh there's got to be a better way to do this there really should be a businessperson focused charge card Network that would work at all the restaurants in Manhattan where business people host dinners so nobody ever needs to bring their cash and you know you could just imagine that like 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 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 and of course I get to look super awesome in front of all of my colleagues I think there are two really important points here one you said I pay it I don't pay it my company pays it you know I don't care to the most important point I get to look super awwesome 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 and just to start tracking a certain number here when we were talking about checks earlier that we getting a discount and even in this era of early Diners 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 so 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 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 this was Lake Harvard and Facebook because restaurants in Manhattan they're competitive with one another but it's not exclusive competition this isn't JC Penney's versus Macy's no restaurer 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 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 sure you want some kind of exclusive relation ship and you want to maximize the dollar value you can get out of them 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 compliments of yours so that people can shop you and everything like you with the easiest way possible and you can still make some money on everybody 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 cuz they're going to do that anyway it's crazy like you said Diner 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% 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 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 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 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 lot of Technology but you need a lot of people even though there aren't actually a lot of merchants and so it turns out there's just a lot of cost in the system to run it and Diner's Club would ultimately

fade although it grows to over a million members it goes National it gets acquired by City bank then sold to discover in 2008 as we said it's still a brand today but it's basically impossible to create a independent from the groundup network of this at the time because you were just talking about the operational cost of of running this thing think about the merchant and customer acquisition costs nobody knew what Diner Club was 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 that is a very expensive sales proposition whereas from this point on basically everybody else that comes into the industry already has established relationships sales channels into one or both sides to the market which of course brings us to the brand you're all

probably thinking about here American Express which is the Diners 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 and so as you might remember from our birkshire Hathaway series a couple years ago AMX 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 do you know who started American Express this is a version of dhawk holding up the Visa card o no I don't 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 Wells and Fargo Henry Wells and William Fargo amazing totally amazing man 1850 the wild west different time it was something like they started American Express but then had a conflict and so they left and they started Wells Fargo after that yeah something like that the

infrastructure of America was getting built out so American Express it's called American Express it was an Express Mail company it was like the Pony Express that was how they moved stuff around 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 it's amazing and I think it's fascinating that Wells Fargo came after MX like you think Wells Fargo as this old timey Foundation of America American Express is even older than that so AMX by this point in time had become a traveler's check primarily that was their primary business as we talked about on the birkshire episode that was a freaking awesome business partially because Travelers checks you know they made good money you would buy a $100 Travelers check and pay MX a little fee or whatever but the float and the breakage like there's Travelers

checks out there today that are 50 100 years old that have never been cast and MX has just been sitting on that c cash for decades investing it what an amazing business okay so AMX observes Diner 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 Diner Club but they can't get their own price 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 with companies we have relationships with restaurants we have relationships with hotels We Don't Need You Diner Club so just within like a year or maybe even two from when MX launches their charge card you know business traveler program they sign up 700,000 members which is almost as much as Diner Club had signed

up you know many years of working on it and importantly here the thing you're seeing is this is the first time a real financial company is coming into the industry all of the we know you're good for itness was happening directly from retailers before or by organizations that represented retailers in restaurants and so now you sort of have not a bank but a bank likee entity that is starting to say oh this could be an interesting business so this brings us right back to Fresno in 1958 because the timelines match up exactly this is crazy MX launched their charge card program in 1958 BFA sees what's happening 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 let's do credit cards let's go to Fresno but hopefully as we painted the picture their

motivation and Diner club and AMX and even the merchants and retailers motivations are very different BFA wants two things out of this 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 two though the bigger opportunity for B OFA is what can this do for our banking business itself because remember how do banks make money they make money on loans and this is going to enable so much more effective loan volume to flow through our system that we can make money on so this is where BFA informed by their previous business model of lending to Consumers really paves the path of what credit cards would become today often in the past before the bank amera 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 the Innovation baked into the bank Amer card is they say well after the 30 days you 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 we can learn a lot about them we can make good amount of money on that interest and so the modern credit card is born and it was already happening at BFA 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 this product is the combination of three things the charge card that had been happening over in Diners Club AMX the gas stations the retailer land then the second pillar is this consumer lending 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 hodg podge

of retailers but now this is issued by your bank the big takeaway for bank americard is it really bundled two different things together one was convenience and the other is credit and there's one more really really important subo here to what this loan is and it relates to the banks and why this is so powerful for BFA and for all banks think back to the old way that BFA was is doing this a California you know homeowner wants to go buy a new refrigerator they walk into a b OFA talk about it with the lending officer blah blah blah a bunch of operational costs who cares about that at the end of the process B OFA gives them the money the money is now out of bfa's hands it's out the door the consumer then goes to the merchant and gives the merchant the money and buys the refrigerator 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 ofa's hands yet they get to keep the money right a transaction has been authorized but yes they get to keep the money 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 that the merchant also banks with boa 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 BFA management must have been besides themselves with Glee about this well in theory if they manag 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 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 beh behavior that

they've heard about or they might have witnessed in one form or another but now they have a Bonafide charge Plus Credit Card sitting in their hands uh you're going to lose a lot of money at first yeah because there's another more pernicious way that this type of lending is different than the previous type of lending that BFA was doing it's unsecured 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 so you probably shouldn't apply the assumptions about your loss ratios from secured lending to unsecured lending but that is exactly what happened 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 control2 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 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 and frankly it's because of the situation that the society has sort of like pushed Americans to 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 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 if not from a bank then from somebody from a finance company or a credit union or a department store or a loone shark for that matter there isn't another Western country that has relied so heavily on consumer credit between 1958 and 1990 there was never a year where the amount of outstanding Consumer Debt wasn't higher than the year before 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 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 they believe that the future is brighter than the present and so they're fine taking on debt 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 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 yep and that may not be true on an individual basis but it's absolutely true on a societal basis yep so back to what I was saying about why BFA is so important BFA 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 rip cord immediately B OFA 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 rip

cord they expand they roll it out quickly across the whole rest California 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 card holders they signed up in that first year no two million California card holders signed up using the card in the first year it took Diner Club years to get to a million MX was so proud in the first year or two they get to 700,000 BFA 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 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 and then you can go Ram it through your distribution channels when you invent one of your own 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 AMX and Diner club or else like they wereing credit to this this was a huge Innovation yep so by 1961 year three of the program they're able to get fraud under control enough that the whole program is profitable but they keep that under their hats yes yes they don't want anybody else to know about this so there's been all these newspaper articles about all this money that BFA is losing so many banks that had been thinking about launching a similar program abandoned it cuz they were like oh man we thought this was going to work but clearly it's not working for BFA so people were shutting down their efforts there was rumors that another bank was going to launch in LA in San Francisco and BFA 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

here's a crazy stat from 1960 to 1966 so this whole era is actually a profitable era for a but no one else knows it 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 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 yes and it is specifically 1966 when The Secret Gets Out because phase two of Bank of America's grandmas plan here gets unveiled which is maybe worth a quick setup as we said this was transformative for their business in California 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 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 US population in 1966 they create the bank americard service organization 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 but listeners before we talk about how the bank americard licensing Association morphs into Visa now is the perfect time to tell you about one of our favorite companies blinkist and their new parent company go one where David and I are proud Angel Investors yes blinkist as you know takes books and condenses them into the most important points so you can read or listen to the summaries it's great if your job unlike ours isn't just to sit around and read books all day but you still want the amazing insights so as blinkist has been doing throughout the season they are creating blinks of our

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show notes okay David so how do we get to Visa you have been telling me about the bank amera card from Bank of America and I opened this show saying Visa is not a bank and Visa doesn't have direct relationships is this big indirect thing where they work with other Banks this is a big mismatch 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 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 dhawk so here we are in 1966 B OFA now starts going around to all the other consumer Banks in other states and selling them on joining the network as Bank americard licenses and the deal is that you pay BFA a $25,000 franchise fee to get your franchise of the bank America 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 I mean again the executives must have just been throwing party after party because a this whole thing turbocharge their own business B now they're like oh we are going to make all the other consumer banks in the country essentially into like surfs on our kingdom here right and one of the assumptions they made was correct and the other one was too hubris 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 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 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 it

was also an intensely like private thing kind of taboo thing right cuz when you were using a credit card in these days you were implicitly saying I'm using debt to buy this transaction and so you didn't want other people to necessarily know that right it was 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 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 well the bad assumption was that other Banks would consent to basically being surfs in their kingdom yes but at the outset these other Banks see the power and now

that BFA is telling them of what this has done for BFA 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 and I think BFA 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 2 years by 1968 a couple hundred banks have signed up there are 6 million card holders across the country and Beyond the country actually Barclay's Bank in the UK had signed up to be a franchisee of Bank americard back in the day whoa what year is this this is like in the you know mid-60s whoa that's way earlier than I realized for international expansion yeah it was already out of the US cu the system is a great system but as this expands Beyond BFA it becomes clear that a bunch of stuff that were I either just assumptions or ways of business within

BFA or things they didn't have to worry about ain't going to scale to hundreds of banks 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 so like there wasn't really any difference between the bank of the consumer the card holder and the bank of the merchant and B OFA controlled both sides once they expand the network and let other banks in all of a sudden that's almost never the case right you know BFA 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 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 yep

so BFA 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 it's all just one for BFA 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 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 this comes to be known as interchange and interchange fees are obviously what visa does today 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 Diner Club where

they were closed loop systems 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 and now with this new bank americard license e system that they're starting to sort of develop here that would become Visa it's an open loop system it's hey there's One Bank on one side who owns the customer who owns the card holder 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 so this interchange thing all of the other banks that are now signing up to become you know BFA franchisees for the bank America card system they come to BF and they're like hey this whole thing is a problem 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 oh so the problem they're experiencing is like hey Bank of America how did you build all the technology to do this 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 Clos Loop so I don't know you guys figure it out 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 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 franchises were like hey we signed up for a franchise you operate the whole system right and Bank of America was like no no no we sold you a marketing system I see so it's like you know you buy a McDonald's franchise and they ship you some Golden Archers and they're like

good luck figuring out how to make cheeseburgers that is exactly right okay now to be somewhat fair to Bank of America here the golden arches are worth a lot the bank americard three colored bands the blue white and gold are also worth an incredible amount here and of course the ability to actually beyond the network that sends those payments right yes of course 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 bank americard and some of them are like no I'm not going to do that some of the ones who do become franchisees well really all the ones who do become franchises become very frustrated of course people are going to start competing systems 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 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 there's no common brand Mark visual identity for all of these cards so now you're trying to make this payments Network operate 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 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 I don't know that this is going to work even though it actually might work cuz it's part of the MasterCard inbank Network I see 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 I don't I still don't even know what the one world yeah yeah and you know that's today with the internet you can do that 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 it's so funny this is the original problem of Diners Club too cuz 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 so you could literally know if the card would be accepted at the restaurant you're at 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 what these franchises 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 homogeneous it all is the bank americard 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 which is the hills of California right 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 and it's actually in Sona California H so the story is the BFA team when they were first rolling out the program the guy tasked with card design he lived in Pleasanton California in the East Bay of the San Francisco Bay area where you know it's Pleasant 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 and the hill is covered with beautiful golden colored California poppies in blue he rushes back inside he paints an abstracted version of his beautiful Hillside voila the three bands blue white gold Bank America card Visa and this would go on to be incredibly valuable to plaster on your storefront and say we accept Bank America card here and that just means your sales are going to go up friction to purchase Goods goes down 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 it's so wild that today you know we would think oh what's a mo what's a competitive Advantage what's durable you know you need technology Advantage 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 so from B'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 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 okay so they got this marketing program how did it literally work because this is premm magnetic stripe yeah there's no technology here I mean this is literally like cool I've become a Bank of America lensee what transactions does that let me do and how does that happen 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 the bank

would go sign up a merchant in their local Town 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 card holder Banks to get the money and they just the way they financed all this was a discount fee just like checks back in the day like oh hey this Sales draft is for $100 this is all really hard to figure out 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 so the sales drafts get handed to the lensey 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 after a whole day of sales you've got a bunch of sales

drafts where you say all these customers came in with Bank America card they said they're good for the money so I gave them the goods and now I'm holding the sales drafts 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 so then the bank is responsible probably yeah so the Merchant Bank that acquiring Bank mails all those effectively invoices to all the other banks that the people who bought the goods there to their banks with their cards and there was no standardized discount H this is ludicrously expensive totally I mean it's chaos people are so pissed and again BFA is like yeah whatever yeah whatever for us we just moved a few numbers internally we actually didn't

have to do any of this 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 a light you know like I said nobody knew this is the first time that a banking charge card credit card system is operating at scale in the country and even though bank americard had been operating for a couple years internally to BFA in California now it's going across state lines this had never been a problem before you know the merchant Banks versus the consumer Banks the issuing Banks Etc right so all of these tensions come to a head in October 1968 when the lies all the franchises of Bank of America all these other Banks across the country they demand a summit 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 BFA says okay fine we'll all get together in Columbus

Ohio really way in the middle of the country you didn't know this no Oh amaz 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 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 everybody's converging in Columbus BM sends two like mid-level marketing managers to go face the angry mob none of the senior Executives from BFA could be bothered enough to go deal with this WOW which just says everything and these poor guys who show up I mean they are literally facing like pitchforks the franchises are ins sensed and they're insens both because the situation sucks and they're like godamn it BFA take us seriously you have meddled in our entire businesses this is

in chaos like we got to fix this so what do these two poor BFA 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 let's do the smart thing to make sure that everybody gets plated 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 let's appoint a committee of lenses 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 BFA headquarters and we'll listen to their problems wow but unfortunately for their goals their very narrow goals that particular morning but very very fortunately for all involved the franchises the world consumers in the long term at least in the long term and also Bank of America in the long term one of the people that gets put on that committee is the bank

americard franchisee program manager from a small Bank in Seattle the Seattle National Bank of Commerce which would go on to become reineer bank and then ironically do you know what happened to ber your bank 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 but for the moment the person running their Bank America card franchisee program is One D Hawk and I think you could really say on this day the founder of visa 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 no and we're going to 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 he goes up to the two BFA guys and he's

like hey rather than us just putting together a list of Grievances and Reporting back to you at BFA 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 BFA guys are like sure 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 and probably almost assuredly I mean this is a committee we're talking about nothing is going to come of this yep 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 rather than us taking a list of grievances back to BFA 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 mostly I think just cuz they wanted to get out of there go back home and away from the 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 certainly the B OFA guys thinking nothing is ever going to come of this but D kind of thinks he just got authorization to go create Visa whole new system and he has no power at this point but he kind of thinks he does and listeners now is a great time to tell you about our next favorite company cruso yes cruso as you know by now is a cloud provider specifically built for AI workloads powered by Clean energy today right in theme with Visa we are talking about reliability and some of those details of kuso's infrastructure so by this point you know that their cloud is run on wasted stranded or clean energy and they can provide significantly

better performance for your dollar than traditional Cloud providers so how do they do it it is a little bit more than just saying they put data centers next to Natural Gas flares or stranded energy from wind turbines I mean that Insight alone has value but this is insanely difficult to pull off to build this multi-tenant architecture at scale and Implement things like infiniband with rail optimization so here are some of the things that kuso's team has had to do and why it required people with backgrounds and data centers oil fields utilities networking software and Manufacturing all working together to do it so one they have to trench high bandwidth fiber themselves and as you might imagine putting a data center in a remote location that is not just magically next to an ISP that you get to plug it into and have redundancy two rugged infrastructure not only do they need to Custom Design the data center

architecture to let customers eek out every ounce of performance it also needs to work in these locations they initially worked with external vendors but they've now started something called cruso Industries which manufactures a majority of their mobile and modular data centers and electrical equipment themselves and three is operations things go wrong out in the field especially in remote locations and cruso has a fault tolerant organization that is able to plan for the maintenance and repairs and manage the failures when they do inevitably happen so the team has deep data center operations expertise to ensure that customer AI workloads operate seamlessly when minimal disruption and they really do plan for these things to happen and have great redundancy in place it's so cool I mean ultimately this results in a huge win-win they take what is otherwise a huge amount of energy waste and environmental harm and they use it to

power massive AI workloads how could you do any better if you your company or your portfolio companies could use lower cost more performant infrastructure for your AI workloads go to cruso cloud.com acquired cruso cloud.com acquired or click the link in the show notes okay so David dhawk thinks he's got a mandate to go change things up in a big way and create some big crazy new proposal yeah and he's not wrong uh fortune favors the Bold you know might you say yes so to say a few more words about why this is so hard to organize these 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 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 bank americard payment Network which is intimately linked with their banking operations 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 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 whereas when you think about growing the value and power of the network you want as many merchants and card holders in the system as possible and the merchants obviously want as many card holders as possible and the card holders 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 and you basically want it to happen as fast as possible so maybe if you only allow you know 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 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 baking relationship they already have one they're good 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 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 but also if they're going to make this thing actually work they need to collaborate and work together and that sounds like a really really really ult problem to solve 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 okay if though if we could do this what is the opportunity 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 and the the world what it has done for Bank of America but 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 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 and frankly all powered by the fact that this is what consumers want yes absolutely 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 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 and if we could grow the pie enough would BFA be comfortable not owning the whole thing that's the bottom line here 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 amazing 24 hours a day 7 days a week around the globe would have a market every exchange of value in the world that beggared the imagination 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 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 jointly they could do it but how it would require a transcendental organization linking together in wholly new ways an unim complex of diverse institions and individuals 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 he is running the Bank americard franchise program at what would become reineer Bank in Seattle but he's an outsider he's kind of a nobody he's not senior in a small Bank in Seattle 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

associates degree 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 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 americ 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 fortune favors the Bold fortune favors the Bold 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 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 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 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 associates degree and so he uses all of the techniques that he learned from competitive debate and persuasion 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 I mean d basically is the prototypical Silicon Valley founder he's just a generation too early and in the wrong industry I once had a Silicon Valley founder give a talk at a startup weekend Ian 10 12 years ago who said

until your company shuts down you are just in the act of succeeding totally I mean cut from the same cloth yeah right down to every single stitch there's one other important aspect to D that I think we should highlight here that enables him and all of visa to succeed and that's that he's about as far from the man and image of JP Morgan as you could imagine that is what enables this 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 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 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 so de's just gone into B OFA 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 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 Amer cards yep totally incredible that D 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 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 and this is

a different argument from what he made to BFA BFA 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 he needs to be able to go to say the couple banks in Illinois that are existing franchises of the bank of card system and say 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 I see so he's basically coming to them with a waiver and saying I want you to wave your exclusivity to some territory because in our new construct here where we're all working together you and every everyone else is agreeing that it's good for the value of us all if we wave our exclusivity you know what this is like this is like back in our NFL episode yes it's exactly right when the NFL started

negotiating National Television rights collectively as an organization yep 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 then I'm going to get as a share from you the NFL of a national deal but in the long run run it was absolutely the right decision and value a creative to everybody including the Jets that the NFL centralized this you'd rather be the Jets with their proportional share of the $4 billion a year TV deal that the NFL has today than uh whatever their very fat contract was alone in the what the' 607s totally it is exactly the same thing here okay so how's this whole thing going to work de and a few of his other fellow committee members they go to Salo 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 Salo and there

they come up with a number of operating regulations guidelines for this hypothetical new entity four of which we're going to talk about here that are super critical one ownership of this new organization that's going to be called National BankAmericard Inc the new owner of the bank americard program is going to be in the form of irrevocable non-transferable rights of participation so you're not going to 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 oh interesting so this means a couple things one it's sort of like a rep representation and ownership according to Value contributed two it's non-transferable so you can't sell it any individual bank if they were to say like o this is valuable now I'm going to go sell it and then I no longer have any

incentive to participate in the network 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 so it's basically designed for you to kind of break even on it 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 you're making the assumption that this is a Coston organization forgetting the fact that it is one of the greatest business models in Revenue generators of all time you are contributing 17% of the volume to this you are entitled to 177% of the profits I see that we are extracting from the merchants and the card holders yep because this 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 100% 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 yep exactly so the actual legal structure that de and his fellow committee members land on for this is a for-profit non-stock Membership Corporation that is a mouthful it is there's a myth out there that Visa was originally a nonprofit 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 H 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

it's like a co-op it's like REI or something like that yeah yeah the way that D 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 there's actually another NFL analogy here the NFL doesn't own the teams the team owners own the NFL yes but the NFL sets all the regulations for how the game is played and all the teams submit to it that's actually probably the best analogy for Visa as the NFL league organization I think it totally is 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 basically this means this is a democracy every member has a vote in determining how this organization runs 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 and importantly every single member Bank can call a vote at any time I mean it's literally like a pure democracy wow you could IM imine nothing happening if everybody has the right to do that 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 fascinating 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 point three we've basically already discussed and that is that the mission of this organization is to facilitate cooperation and Trust trust among competing institutions to grow the bank americard payment Network larger than any one institution could on

its own 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 so to borrow like a crypto phrase here like no side chains allowed everything happens on the Network I see so none of these banks are members of inbank at this point these banks are exclusively members of whatever the heck Visa's predecessor name is National Bank America card Inc National Bank americard in 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 NBI exclusively you don't go join inbank 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 this a big contract to sign

totally again this is why de 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 there will be a singular Universal set of operating and governing procedures that much like the US Constitution is infinitely modifiable by a threshold vote of all members this is the 80% I talked about and two also like the US 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 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 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 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 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 he goes and meets with all the banks Bank of America helps him out they bring senior Executives to to help convene you know meetings with all the banks to persuade them every single member Bank of the previous Bank americard franchise organization every single one of them signs up for the new organization led by D not a single person jump ship how many banks were at this point over 200 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 totally and D writes about this too Bank of America helped them 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 and then you kind of spiral out from there but yeah every single one nobody jump ship and when is this like 1970 is the process starts in 1968 it all wraps up in either 1970 or 1971 H importantly we've talked about antitrust in 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 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 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 so they actually get a letter from the doj saying like Hall Pass you're good on this one wow 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 collabor potentially colluding but it is actually one of the things that we believe will make the country better so go for it 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 hey if we do this aren't we inviting the doj on our backs and D 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 America card Inc D in 1972 he's thinking globally from the get-go he goes and creates a parallel similar organization

of International Banks using the bank americard system Visa was Global from basically day one and it wasn't just Barclays in the UK it was sumomo 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 were going to tell 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 say you're I don't know I'll pick sumomo Bank in Japan you have to decide do I want to buy D's 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 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 totally so once again in selo this all comes to a head D knows that probably not all of the International Banks are going agree to this and some of them are going to go their own way so he calls you know a final Summit in Salo 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 and D gives this nostalgic speech at the end of dinner saying like here in Salo looking out at the bay this is where me and my colleagues we dreamed up the original vision for what this could be 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 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 like Steve Jobs 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 everybody takes a little box out from under their seat they unwrap it and inside are a pair of pure gold cuff links that on each of the two cuff links there is one half of the globe and under one side it says in Latin studium ad prosperity which translates as the will to succeed and the other side says volas inum apologies to Latin speakers out there that I'm butchering that translates as the grace to compromise and T 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 and the next morning all the holdouts reverse course they all join and what you can't make this stuff up it literally happens the cuff links are out there you can Google him he did this 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 were the reason that you killed it D is just such a character 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 I banko IB NCO 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 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 because oh it's a family trip you know Etc 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 they're 50 people in the room 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 wow so like are you really going to act like an in front of not only your spouse but the spouses of all these other global bank heads that's so funny I'm G to start doing that we should have our wives in the room while we record

definitely not oh amazing amazing I think neither would join for that totally no they'd be like no okay so how does the name Visa come about how does the sort of joining of the international and the domestic okay 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 the name yeah Bank americard ain't going to work 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 G to realize this global vision we need a truly Global brand and Mark remember back to the blue white and gold three stripes that's iconic it works internationally obviously the name does not so D holds a contest in internally within NBI ianko to generate a new name 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 D makes a big deal and writes out a $50 check check why are they using a check made out to everyone in the company which is funny but then they changed 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 it's interesting it's in English I mean I guess it makes sense it's the most spoken language but well no it's not just in English the name Visa in every if not almost every language on Earth 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 that is the name yeah the universality it's sort of a presumptive close cuz at this point you know they've got what 3 four 500 Banks

you know and they have 16,000 today it's quite the presumptive close that it will be universally accepted everywhere the way that Visa would imply 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 the actual definition of the word Visa that 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 yeah so the Visa name brand everything there's two more levels at which it becomes really important they do something really really really smart so we talked about the need for the universality of a mark and why early inner bank 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 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 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 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 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 yep and this is kind of the Brilliance of the Visa model they were like it's open you do whatever you want up there right

that seems good for us we're happy with that 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 do whatever you want wow and that's how I end up with bb8 on my uh card today amazing 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 there the new operating regulations now that mandate that all cards out there all the previous Bank Amer cards need to be migrated to Visa cards I think within like 2 years of this being declared or something something like that some banks start to see this as an opportunity to go poach card holders from other Banks so the

competition within the network obviously this still exists because consumers now they know and Visa runs a national advertising campaign hey your bank of Marica card is going to switch to Visa so some banks in a verion of the Fresno drop they start sending unsolicited letters to Consumers who are already Visa Bank America customers with another bank they're like oh hey it's time to switch over to your Visa card here's the application sign up with this nice of them to at this point in history offer applications I think a 100 million cards got dropped in the United States before the uh government made it illegal to just start randomly issuing credit to people without their awareness or asking for it totally wild but because of this a whole bunch of consumers start sort of unconsciously switching the bank that issu isues their Visa card 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 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 a system by the way this is the thing that pushes Visa ahead of what was I believe then called Master charge yes the in bank had changed to Master charge they hadn't yet turned it to Master Card but in 1976 Master charge was actually bigger they had 7400 Banks and at this point in history Visa had about 7,000 Banks Master charge also had more cardholders 37 million versus Bank America cards 31 million before they changed to Visa so this despite all the deck chair rearranging between the member banks it

was great for visa to LEAP ahead of MasterCard totally so that was number of member banks Grows by 20% the number of active card holders 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 they're already way bigger than AMX because MX 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 yeah and it's worth a moment on AMX 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 why wouldn't AMX win with their closed loop system where they own the whole thing end to end and can provide the most in incredibly custom experience for everyone on their platform on the

merchant side and on the consumer side 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 they go sign up One bank that bank can go sign up you know 100 million customers or 2 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 AMX AMX 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 and they are a merchant acquiring bank and so in terms of scaling internationally you mentioned their name holds them back 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 say why don't you go figure out how to grow for us

there so this network of networks thing the open loop system well it creates a little bit more of a clui user experience because they're sort of the lowest common denominator of data getting passed through the network it's sort of Open Source versus something that's wholly owned and operated by a company or a protocol versus fully owned application 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 but it does potentially come with much better scalability which is the reason why these and MasterCard have become the dominant way versus the Clos Loop systems 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 and so

this concept of Duality takes hold for the banks Duality meeting they can multi-home on both visa and MasterCard in all the testimony and case with the doj D is obviously 100% against this happening he doesn't want his Banks to be able to join MasterCard 2 but he also makes the surprisingly correct argument he's like look this would be a huge mistake because US Government if you do this you are going to freeze the payment networks in the US 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 we'll all have the same features banks will be members of both they're kind of going to operate in lock step 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 later in 1988 the doj again sues visa and MasterCard for being a duopoly and not

competitive enough so D was right d was right and to this day D 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 and like they never work or they haven't worked yet great point they're in the process of working so great it's probably actually worth sharing the MX thing so MX 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 Merchant massively if those Merchants would go exclusive to AMX and this actually continued until 1991 for many of their merchants and for Costco went all the way to 2016 where they had the exclusive agreement with AMX and if you were going to use a credit card at Costco it had to be AMX but interestingly ven MasterCard cried foul when uh you know all of their Banks

were multihoming and MX with their virtue of a slightly different business model was allowed to go and try to lock up Merchants to be exclusive to them So eventually the whole thing kind of stopped and you know Flash Forward to today all cards are accepted at basically all locations yep so this basically concludes the full Visa story like how did this incredible thing happen you know we've answered D's questions who owns this who runs it how did it start 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 V and D created 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 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 to D'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 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 but there's an incredible technology story yeah great Point all right so what is it well that's a great question Ben and before we get into it this is actually the perfect time to talk about another great technology company and leader one of our favorite ones in fact stat Zig who has also built a tremendously powerful piece of infrastructure focused just like visa on reliability as we will talk about later this episode Visa never

goes down or basically never goes down and that was a super important part of their strategy but it is extremely hard for most companies to achieve this level of reliability in their technical infrastructure yep building reliable infrastructure is a very broad topic obviously but one easy way to improve reliability is staged rollouts so a lot of times what leads to downtime is unexpected interactions from new releases which crash a component of your app or service by rolling out a new feature in stages first to employees then to an increasingly broad set of users you can test for bugs in a production environment before you actually launch the feature most companies don't do this however largely because unlike say Facebook they don't have the right tools yep thanks to stat Sig though it is now super easy to do this the right way if you're building software products stat Sig is the One-Stop platform you need for feature

flagging product experimentation and analytics the product just works it makes it super easy to roll out features in stages and provides data on the impact at every stage of the roll out stattic is a critical part of how companies including Financial ones like brex and also like notion launch their features to hundreds of millions of users without causing outages or hurting core metrics yep it's super impressive so if you're a startup they have a generous free tier and a special program for Venture packed companies and if you're a large Enterprise like those companies Ben just mentioned they have transparent and non seat based pricing acquired community members can take advantage of a special offer including 5 million free events a month and white glove onboarding support just go visit stat.com acquired that's stats.com acquired to get started on your datadriven journey okay so David what

does Visa's technical infrastructure look like and how did this come to be so everything we just described up until now amazing incredible unlikely one in a million but all it really bought DN Visa was the opportunity yes 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 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 and the answer to that was probably not fascinating now they wanted to use them in specific use cases like Ben you pointed out when you want to make a 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 in the case of Diner Club at AMX when you want to impress your colleagues and your business partners there were use cases 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 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 been a 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 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 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 that was a view of someone just sitting in a Burger King in 1993 and a second guy is interviewed and says something to the effect of I just hope it doesn't slow things down cuz you know they'll have to call New York and then they'll to do the thing and I just hope it doesn't slow things down and it's like the prevailing idea is that cash is Fast Cash is easy cash is respectable credit cards are debt what this woman is saying is really sad if you need to use debt to buy a burger 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 gez for the amount of time we spend handling change we just want to encourage everyone to be swiping the

card all the time even if they're you know losing some money on The Interchange it's crazy that was 1993 I mean yeah compare that to today and I mean 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 oh 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 so to get from there to today three major pieces of Technology needed to be built by Visa one was transaction authorizations 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 stop Gap SL bandaid that visa and other credit card networks implement around

authorization 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 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 anything paid with a credit card under $50 it was basically within the Judgment of the cashier to oh wow say yes no and so everybody just said yes 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 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 then that Merchant Bank would have to look up that card number figure out based on the card number what bank issued the card card to the card

holder call up the card holder Bank oh my god get somebody on the horn there say hey I've got your card holder Benjamin Gilbert his card number is XYZ you know 123 can you look up his credit and you know he wants to buy a $500 refrigerator can you tell me if he's good for it right and this effectively would be like have they hit their limit yet 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 The Merchant Bank give them the answer 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 so you had Banks talking to Banks people at Merchants talking to people at their Bank talking to people at the card holders bank and then reversing the whole chain but importantly you had a person at the Merchants Bank calling a person at the card holders Bank yes

today that is known as as visanet there's this piece of technology that sits in the middle that eliminates that bank-to-bank phone call 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 so say you know now that bank of Marica Kart is Nationwide soon to be International imagine you're trying to buy something in Japan and the Japanese Merchant Bank calls your card holder Bank back in America closed for business just no way for that transaction to happen wow that's crazy not good definitely not good so dmva know that this is like the first thing that they have to address in 1971 right after NBI is formed D starts a project called the bank americard authorization system experimental or BC base to build technology to address this problem

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 there's something you need to know oh God that's always fun before a first board meeting and they're like well it's kind of hard to tell you we've been in secret negotiations with American Express for months 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 so you know D if you want us to remain part of NBI remember this is Bank of America the most important part of NBI oh my God I know you know that part of the operating agreement is like you know we can't really operate outside of the

bounds of MBI but this isn't really outside the bounds of the NBI 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 so not good and it's true it's not really like they're issuing new cards or acquiring new Merchants they're being a technology provider because they and American Express both see that hey this is a really really really valuable piece of technology h d is of course pissed but what's he going to do B OFA says take it or leave it D takes as D then tells the story Bank of America and AMX go out and they try and Pitch the other banks in NBI and in bank 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 maybe maybe that might be part of the story the other thing that happens is interbank and MasterCard actually get

involved in the project the whole thing then morphs into a tripartite Consortium of inbank American Express and Bank of America and thus by association NBI our old friends 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 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 they put out an RFP to folks like IBM systems integrators you know the accent of the day to go build this technology for them go build a computerized authorization system for the bank of maricard Visa Network 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 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 tulan d goes back to him and he's like I like you you come work for me leave TRW I'm gonna 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 slva Aram comes and joins and starts the core of the Visa Tech Team D gives him 9 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 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 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 Sano campus 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 Sano where they build the data center 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 um Mission Bay H so miraculously Aram and his new tiger Visa Tech team they do it they do it in nine months and it works so Dave Sterns 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 so he always

insisted on shorter projects with uncompromising deadlines they will just consume it they'll just consume it 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 yep direct networking amazing and so they're just operating the whole network out of this data center in California yep now importantly this is only for transaction authors ations 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 the Visa builds 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 that's the next big operational technical problem that Visa needs to solve is like literally moving the money

when it needs to be moved reconciling the transactions moving the money getting everything wrapped up at the end of the day week month sending out statements all this stuff 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 the backend piece consumed a lot of paper and time too maybe more time but like a lot of paper cuz you're effectively mailing checks and even more perniciously as the network grew and at this point in time soon Tob Visa is growing explosively the complexity of this settlement piece also grows sort of exponentially 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 nsquared problem well it's a problem that is easily

solved by computers but when you're doing all this manually with paper this is a big big problem N squared is much worse when you're doing it with paper than with computers 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 clearing house you need an automated Clearing House and this is unbelievable 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 Visa Builds an automated Clearing House for themselves to do settlement electronically over the network they end up calling this project base two After Base one which was the first thing doing authorizations this happens at the exact same time and place as when the Federal Reserve is building their own a system for checks you know automated Clearing House a everything in the banking system

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 Clearing House system that is wild now I've never read anything I couldn't find anything 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 this same place the same time solving the same problem solving the same problem 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 and if you paid me a 100 bucks 500 times and I paid you a 100 bucks 400 times what is the net that actually needs to get transferred and that is a far more efficient way you know 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 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 once base 2 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 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 bank right if you're the one that owes the money you kind of want the payment to take more time yes exactly 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 it wouldn't be possible to do this manually today no you needed the Technology Solutions that they've put in place to enable the Commerce scale that flows on this network today 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 2 he is thinking about the system and reliability is so important you know this network can't go down he's like huh we actually have a pretty serious vulnerability in this system so he goes to CD and I mean the whole Visa organization I think is like less than 50 people at this point in

time wow just wild 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 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 and we're also about a mile from the San Andreas fault so you know we really want to think about having some sort of redundant parallel site uh data center out there and uh d uh it his very D way he thinks about it 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 your marching orders 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 6 months months and invent the technology to keep these things synchronized so they are actually redundant yes so now D is not technical enough to uh talk about that but this is super important up until this point in time state-of-the-art in the sort of fledgeling data center world was yes to have redundant other location backups 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 they were like dormant backups that only were there to come online if you had to fail over from the primary system 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 so they re

architected base one and completed architecting base 2 to run concurrently across multiple data centers as like shared operations running across multiple data centers which I think 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 this whole data center world was still pretty new and Visa definitely like through Ingenuity invented a way to do this it's fascinating and of course this is now how every data center in the world runs today pretty amazing 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 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 those verone you know traditionally they had a huge market share well this is when verone gets built there was no verone 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 merchant so you know above 50 bucks or 100 bucks or whatever it replaced the need for phone call but it didn't digitize the transactions themselves so this is actually every transaction now is running digitally for authorization over the network exactly 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 and that really meant making them machine so this the cards were just pieces of

plastic with embossed numers on them like you had to say or type the numbers into something and the nice thing about the embossing is that if you run a shun shun on it a Zip Zap with the uh the Zip Zap or the card imprint reader you actually can get the numbers off of it without writing it down yourself that was a huge productivity gain when they launched the sort of imprint reader machines 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 City Bank had financed a proprietary magnetic solution that they were trying to push on the industry there I think they a bunch of law suits 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

so Visa's like Hey we're not going to pay you City Bank skiff on everything that we do here we take AIP exactly 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 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 we mentioned earlier and you alluded to this is when verone 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 verone ends up becoming the large dominant I actually don't know what their market share was or is I think they had like two-thirds of the market at Peak 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 uh installed at all these Merchants 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 happen digitally over the digital Network 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 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 one really fun piece of implementation uh detail around this just like with base one and authorization where Visa had to

build out a telecommunications Network amongst all the banks now Visa needs a telecommunications Network amongst all the merchants around the whole world the country and the world that's a another whole step change that's like single- digit millions of nodes yes so what are they going to do for the pilot program they work with one of the big Telecom vendors and essentially like build it out themselves 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 you serve and for folks who either weren't alive in the US at this time or not Americans comp you serve 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 yep so as a consumer you would pay a monthly fee to comp you serve 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 so they somehow get in tou 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 the rest of the day they've got all this capacity that's unused sitting on their Network Visa ends up renting compus serve network capacity to send their digital transactions from Merchant point of sale Terminals and I think this goes on for like years 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 so it's kind of amazing to find two complimentary use cases for the same infrastructure that when one is waxing the other's waning 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 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 now because it's all digital and instant they can figure out whether that's fraudulent or not H 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 just like a massive amount of fraud gets eliminated 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 in many ways that hey we're going to you know reward you with

lower Interchange to install these terminals like at the end of the day Visa probably could have maintained maintained a margin and all the banks could have maintained a profit margin and not lost any margin percentage cuz just implementing this technology lowered the cost of running the whole thing 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 you walk up to a terminal you double click your Apple watch or you insert a card or you tap a whatever and it just works and it gets authorized and you get your thing immediately this is the backbone to all that being possible 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 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 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 now the toll booth is fully built it is a high functioning toll booth yeah it's a immovable to it's digitized it doesn't no longer has a human sitting there H they've got the pass system or whatever 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 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 yeah there's one more really

fun marketing piece that I want to come back to before we 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 they're probably the most associated brand other than NBC 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 in the cards it's 1986 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 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 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 and up until this point one of the main stay largest Olympic sponsors in America was American Express because this fits perfectly with American Express it's for American Business people who are traveling abroad Olympics great amazing the Olympics the ioc goes to to try and sign them up to take this Marquee Global sponsorship slot they think it's a no-brainer they give AMX a sweetheart introductory offer deal you're the first people we going to $14 million AMX declines whoa so they had their bite at the Apple and they missed it a couple years before this right as the Visa Empire was being completed with the full digitization of the network D ends up getting getting oued from the company I think you know if he were still alive today he would probably

agree with the characterization that D was one of the most amazing zero to1 entrepreneurs in history not so much a on to nend kind of guy especially when the industry in which you 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 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 so he and his team see that AMX has passed on this new amazing Global opportunity with the Olympics they're also formulating the new Visa marketing strategy 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 Master Card so we positioned against them 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 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 that woman in 1993 in Burger King who's like oh it's sad if you're using debt to buy a hamburger which is so interesting because a signature piece of the bank Amer 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 but I have never allowed Ed that option I hold these things called credit cards but that's a misnomer I've never once used any credit 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 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 yes you are using debt you're just not paying interest yes which you know hey that's a great thing to do that's an amazing gift that these banks give the world it's the American way so jna 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 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 so they design a whole marketing campaign around going after American

Express And the tagline of the campaign you know they show these exotic locals that 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 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 it's everywhere you want to be so the Olympics come up after MX 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 no advertising this is just for the right to be a global sponsor of the Olympics they pull the trigger they become the founding like Global Olympic sponsor they spend another $23 million in media for the 1988 Olympics so $40 million in

total on one Global event well two there's the summer and the Winter Olympics but like one year of global events that's about $110 million in today's dollars yeah wild way more than they spent on any of the technology projects that we were just talking about I mean yeah R&D costs money but go to market costs more yeah what's the line uh 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 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 so they're trading all these people that are going 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 they're contracted through 2032 so it

will be at least 46 years where Visa is the only card accepted at the Olympics 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 hey it's an awesome story but to the last outstanding piece of enabling the global Visa Empire 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 this was it position against AMX go to the Olympics it's the perfect event you're around the world the type of people who go to the Olympics the type of people who use MX they use their Visa cards and they're proud of it love it so David take us to the IPO this thing was an organization that was owned but not with stock a for-profit non-stock membership organization right and now they're an

enormously profitable public company so how did we get from there to here 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 they were monetizing it just fine the way that they currently owned it yes the profits being spit out of the system were just fine in 2005 there finally was another huge Anti-Trust lawsuit I think against both visa and MasterCard it actually is a class action lawsuit oh that the merchants brought and they basically got fully fed up with interchange and you know every 10 years or so there's some meaningful Merchant push to try to change interchange and they either do it in Congress or they do it in a class action case you know there's a variety of different ways and this particular class action suit in 2005 is still running today 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 there was a lot of uncertainty in the 2005 and six time frame of gez what's the liability here going to be and MasterCard had gone public and did not sort through this issue at all they just said oh we're going public and shareholders yep there's lots of uncertainty in our future and like we'll see but buy our stock and that as you can imagine did not go well at all 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 AMX 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 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 so while MasterCard had a pretty flubbed IPO Visa had a great IPO because they said whatever the courts rule the banks who own the B shares the pre-existing 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 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 it becomes the largest US IPO in history up to that point they raised $8 billion at a 90 billion initial market cap 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 in delute 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 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 well at this point Visa's market cap is significantly larger than any of its former member banks it's wild I mean dhawk basically was right 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 and let's go through the shape of the business today and listeners you can

decide 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's visas cut all of that so you can kind of understand it so Visa's business bottle the first thing to know is almost nothing hasang changed since the 80s to today on how the transactions work so the authorization flow is exactly the same as it was where all the oth flows Upstream the merchant runs the card checks with their Bank who checks with visanet who checks with the issuers bank 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 and you know within milliseconds unbelievably short period of time no

matter where you are in the world no matter what currency you are transacting in your transaction can happen 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 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 and then there are Payment Processing fees and those go to the acquiring Bank the bank that acquired the merchant this is the Merchants Bank and the technology provider of whatever they're using to process their payment 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

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 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 a $100 pair of shoes you're now make a $98 and what happens to that 2% so that 2% The Lion Share of it is The Interchange the 1.6% that goes to the bank that issued the card to the card holder to the consumer right so when everybody on the planet is marketing credit card offers to you they get the Lion's Share of The Interchange so they actually have a lot to play with in customer acquisition for their cards because they make the Lion Share of the transaction The Interchange there's a lot of costs in there too

because they Bear all the fraud risk 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 uh 20 bips for you finance people out there goes to the bank that acquired the merchant this could be Chase ferve Wells Fargo this is you know the Merchants Bank it is important to know this may also get split with a technology provider 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 so that 0 2% can kind of get split between the financial institution and the technology provider and those are folks like First Data and stuff like that right 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 I would say I don't know if the Visa people would tell you this is intentionally obus skated or if it just ends up being kind of obus skated but it's not super easy to figure this out 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 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 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 very small pieces of information around the payload size of the data has remained infantes small

relative to the amount that technology has progressed this. 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 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 merchants account 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 think about how difficult it is to Market a credit card to an individual while 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 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 this business is probably the greatest masterclass in the entire world on incentive alignment and I was talking with Lisa Ellis at moff at Nathanson who sort of woke me up to this idea The Interchange pool has an Elegance to it 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 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 yep which brings up you know an obvious point that we perhaps didn't highlight as specifically as we should have earlier this network is actually a

five five-sided system there's the consumer that is buying something there's the merchant that is selling that something to them 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 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 and Visa has created these products where you know it's not just a Visa card you might get a Visa signature or 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 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 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 and so let's say we want to tell the issuing Bank hey for this tier this Visa signature you actually get more money well then they turn around and say cool I'm going to go and I'm going to give better rewards to hire spending you know more creditworthy customers and then visas argument back to the merchant is well hey 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 and so it's this very interesting again envelope of value I think is the way to describe it where you know I'm sure the merchants wish they could be more a part

of the decision process but it does theoretically enable incentives to be spread around that benefit everyone in the ecosystem Y 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 have a certain size right 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 and so even though often times we're the merchant well actually what we're doing is we're helping you distribute cards on the issuing side and maybe there's cool things we can do when those cards are spent at our establishment where we give extra rewards but it's effectively marketing

channel for the issuing Bank so they get to split some of those economics and I guess at the absolute very highest levels of scale you have something like the Amazon and JP Morgan Chase relationship where JP Morgan Chase is the merchant bank and JP Morgan Chase is one of the largest issuing banks for cards in the world 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 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 and so thus that's how they're able to do so much special stuff they can control so much that envelope of value yes 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 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 and meanwhile no retailer owns enough of the total transactions to actually go invent their own better system 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 percent back 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 rewards so much on is to do something non-economic like you have to believe that there's some long-term benefit to doing it 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 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 and the merchant in most cases is really the only party that is not thrilled with this Arrangement totally I mean the most negative way someone could paint the ecosystem as it exists today is that the whole credit card system is a widescale bribe of the American Consumer to like extort the world's retailers using the retailers own money but that is like a very cynical way to view it yeah 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 so that's a strong argument there's been independent research firms that have looked into

this and basically determine that this is a reverse Robin Hood scenario that the wealthiest consumers are the ones who have rewards cards and because all the goods are marked up to accommodate interchange right no matter who's buying the goods are marked up right if you aren't someone that has a rewards-based credit card then your stuff just got more expensive and so the research firm that uh 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 cuz all prices no matter how you pay have to go up in order to make it so that paying in cash and cards 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 but a card using household receives $1,100 in

value $1,100 I mean I guess that makes sense I think about the value of the rewards I get every year it's on average what is it 2% of everything you put on your card yeah which I mean it's especially us running a business like yeah we put a lot of stuff on cards 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 the other reason why it's really hard to change the system is this whole thing is a chicken of the egg problem I mean every two-sided Marketplace is a chicken of the egg problem Bank Amer card 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 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 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 and without a new paradigm emerging this is the system i' 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 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 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 uh 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 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 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 yep and if you're saying you better come in here bearing cash or a cashier's check you're going to have way fewer customers not to mention like there's totally a cost of facilitating cash 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 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 like make time to go to the bank to deposit it 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 and so am I saying that the cost is 3% or in the old days 5% or 7% no absolutely not but there certainly is some cost no matter what form of payment is used absolutely so the business today what does Visa look like well last year Visa processed $14 trillion of volume through their Network which is a almost meaninglessly large number how do you even think about that one fun way to think about that that

calculated is if you start from 1971 the First full year that the bank americard 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 oh my God wild it turns out the world eventually did want to pay with frictionless fast and often credit extending methods yep wow 17% compounded for 51 years yeah I mean this is like Berkshire levels of compounding that is happening here yep and it's not like you know people may think oh 17% like oh I'd have seen irrs greater than that have you seen them greater than that over 51 years 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 hey man young children require a lot of Commerce let me tell you so I hear there are 4.1 billion Visa

cards in circulation their net revenue is $29 billion 29 that's up from 22 billion 2 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 yeah 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 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 so look at their overall Revenue number of 9 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 so of the 30ish billion that they made in Revenue their net income was 15 yeah 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 perhaps the largest market out there certainly one of them Global Commerce both e and non-commerce and as Visa would argue both consumer but also B2B Commerce yeah 50% net income margins on 30 billion in Revenue there it is 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 85% their gross margins are 98% unreal there are no variable costs in this business 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 I don't know of any other businesses of this size or even like five or 10 times smaller that have over a 50% net income margin including MasterCard which is 43% and just to throw some numbers out for people that are like not you know

looking at financial statements all the time Microsoft 34% net income margins Microsoft sells software they ship bits Apple 25% 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 and involved in that business 21% net income margins wow I would have thought Google would be higher as we were talking in my mind I was like well Google's probably the only one that can come close but wow Microsoft is higher I didn't realize that 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 interestingly there is another company that we have talked about recently on required that does $30 billion in revenue and has 27,000 employees do you know what it is

David that would be Nvidia yeah 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 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 that's a unbelievably impressive thing with almost no downtime it is 99.999% uptime which I'm not a site reliability engineer but I think that is 59s which is wild I mean you hear about AWS going down more frequently than you hear about Visa going down totally that's 16,000 banks in 200 countries they have six data centers distributed across the world world it's kind of amazing it's only six to be honest with that kind of reliability and up time 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 this is not YouTube yeah the transactions themselves in part because this was all architected in the 70s 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 we're stuck with a lowest common denominator protocol that we're shipping very crude pieces of information across yep 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 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 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 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 but I'm not just going to like turn customer to your customer why would I do that 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 but when Visa first tried to introduce them this was one of the things that led to De Hawks ouster H the banks were like no no no no no debit cards that sounds like banking relationships banking relationships are my domain that's where I make my money

those are my deposits you look like you're trying trying to reach your hand across from being in service of us into competing with us uh-uh and obviously debit cards did eventually become part of the system but not in the way that you know it was looking like d initially wanted them to 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 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 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 right that was

the domain of the banks and actually there was a big fight between visa and all the ATM networks and D wanted your Visa card to also be your ATM card makes sense right like why would you have different cards mine is today they basically are now but for many many years they weren't and they certainly weren't back in dday right 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 cash 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 us

Merchants paid an estimated 93 billion in visa and MasterCard credit card fees last year according to the Nelson report in Industry publication that 93 billion was up from 33 billion in 2012 wow that's a lot more billions that's a lot more billions so we've talked a lot here about The Interchange and how Visa makes money in the transaction I will say half of Americans carry a credit card balance which is absolutely brutal since those interest rates right now are around 22% o 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-user laws like no one was allowed to make us serious loans and North Dakota was the first to drop them 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 so that's the sad

history of why your credit cards always get mailed from there and there's no denying that is really sad and unfortunate on the Consumer Debt side of all this 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 but transaction value has meaningfully gone up too like grow volume is way up 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 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 so does it makes sense that the credit card networks and

their Associated parties take more value in that world I think so 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 that downward pressure has been easy to give on by visa for things like in-person transactions with card present 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 so Visa is sort of a master of packaging figuring out you know 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 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 say you're only cash or check 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 there's plenty of cash only bars 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 right I mean you could use PayPal I guess 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 it's worth sharing so while we're in the revenue streams here the money that card issue ERS make only a minority of it is actually from The Interchange 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 right 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 it's take in deposits make loans with them make money on the interest rates on those loans nothing has changed in the banking industry totally visas incentives are more transactions because we want more 0.2% and the issuers incentives are carry a balance because that's where we make most of our money yes because even though they're getting the Lion Share of the transaction fee that's going all right back to the consumer in the form of rewards 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 is doing in value added services 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 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 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 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 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 uh business we're talking about but you know 11th largest company in the world valued at half a trillion dollars round 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 mindblowing 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 iata this is net income crazy all right David power does that sound good to you oh let's talk power all right so listeners this is where we talk through Hamilton helmer's seven Powers framework which 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 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 cuz together they're like this government enabled duopoly and the way that we did this in the 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 entrance and I think that's the right thing to do here with visa and MasterCard 2 at the end of the day visa and MasterCard have basically no sustainable competitive advantage over each other 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 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 I do think Visa made a genius move positioning against American Express going upm Market in perception and partnering with the Olympics it's funny even though it's a commodity like them and MasterCard are commodity they somehow position themselves as more premium well sugar water is a commodity too that's why brand matters in these markets 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 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 no they're just not differentiated enough to demand it I just so don't see that

any consumer ever has sway there I got the chase SA fire reserve card 5 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 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 I think today that's true but I do think based on the research and this may be 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 yeah it's interesting 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 yes totally agree 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 Master Card I don't know I don't care it's the Alaska card yep I think there's totally also a story that's beyond the scope of this episode but how Banks and in particular Chase eight American Express's customer base over the last set of years yeah I mean in part that's just bad strategy on amx'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 and so how do you win as a niche player you need to retain your highest value customers and your highest margin customers well they miss the generational transfer I think they did retain their highest value highest margin customers I think those customers are just 80 years old now yeah it's true I think there are less affluent people

in our generation who have amx's versus the premium products from Banks or Merchants yep okay so visa and MasterCard together which of the seven powers do they have today 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 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 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 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 tell me if you think otherwise on this I think there's basically like a law of economic nature that if your gross margins exceed call it 75 80% and you are of a certain Revenue scale threshold like our gross margins exceed 75 80% but like we're a two person company with a you know di Minimus amount of Revenue in the global economy but say you're you know in the billions of dollars of Revenue scale you must have scale economy power 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 yeah but yeah you must you simply must if you have those margins at that Revenue scale have scale economies right that's a great Point okay explain to us the network economies well I mean this is even better than the classic two-sided

Network this is the classic five-sided Network effect 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 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 networ Network 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 a second side but everybody's the same node in the network 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 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 right cuz they're way hard to pull off but they're so locked in once they're in yes 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 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 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 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 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 this is true after the first antitrust lawsuit when Duality was introduced and Banks could multi-home before then yes after then zero well yeah I mean before then there's interesting analysis to do between visa and MasterCard now there is none Y which is exactly what dhawk predicted yep but yeah is there switching cost 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 I mean I guess there's discover no that's a closed loop Network too oh yeah right they are their own bank yep pretty interesting nobody else counter positioning the last one none now I think right you almost can't have it as an incumbent 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 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 Market was so fragmented there that none of the banks had enough power to pull this off they were literally the only one who could do this yep it's absolutely right all right I think that's it for power yep Playbook let's do it 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 I'm going to do my best Charlie Munger I have nothing to add on that that one there you go the next one that I think is pretty interesting is Visa so 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 and everything that is good for consumers often for security and privacy is also good for Visa that is sort of the Playbook that Visa runs as 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 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 is it moving for them that's my main one I've got more analysis to do in bearbull but uh what do you have the two that jump out to me are one just like our NFL episode just like our Benchmark episodes communist capitalism yes the best example 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 you're going to laugh at this that I force out 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 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 yeah this is our whole Global Financial infrastructure that has decided to do this together right 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 know you and me together like acquired as communist capitalism for sure if we were starting a capital firm with three of our friends could we pull it off with five people sure could we pull this off with 200 banks no right especially when you're

not starting from scratch I mean the 200 banks that they pulled it off with they all had a agreement in place where they owned a franchise 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 and Bank of America the franchise or 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 and then the other twoo you know I think it's the twin stories of innovation here which you know really hat tip to Dave Stern for tipping us off on here 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 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 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 uh but that's what I find so funny nobody knows that this is a Silicon Valley company do you ever like run into Visa people hanging out around San Francisco exceedingly rarely H 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 you know the legacy of Bank of America absolutely in that world 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 like there are a lot of Visa people in that

world here it's funny though that like you would think it would have bled more into the Silicon Valley world but it really hasn't 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 it's fascinating all right you want to do value creation value capture yes so originally interchange was supposed to cover the cost of operating the network creating a trusted system preventing fraud offering Innovation every few years to improve the system 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 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 we're looking for high gross margins to invested right exactly but it's interesting that because of the multi-layer 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 the free market is clearly not playing out and other than a big Technology Innovation that shifts the Paradigm in a huge way these entities have massively optimize 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 yep seeming indefinitely there's a lot more to talk about in bearb there 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 uh small transaction items so like coffee shops there's an example of a piece that we'll link to in the episode sources of a uh 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 wow that's crazy even large retailers that run at pretty thin margins it is often the case that their EA is the same size as their card processing fees I mean anytime where your average transaction value is less than 10 bucks that 30 cents is a killer that's where the 30 cents kills you but anytime that you are a low margin business which many retailers are if you're discount counter if you're a Walmart you're paying 2 3% of the whole transaction 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 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 but if you're selling too high priced of goods then you often get into a scenario where you know you are doing less frequent transactions more considered purchases and you can go around the system this is a bare case on Visa is are they ever going to participate in real estate or cars or no not at these interchange rates why would anyone ever Buckle to pay these sorts of things for things that cost $ thousand doll or more yeah well before we go into bar and bware I know you and we have a lot to talk about what could potentially disrupt visa and MasterCard I I think it is worth just one minute on the value creation side of this and I really think 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 there's a lot of value capture that Visa is doing in MasterCard 2 on the other hand I don't think Ecommerce really would have happened you know alone there's plenty of other value creation out there too 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 cuz 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 Y 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 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 they have penetrated America they are deep in terms of people's preferred payment method which was something I've been kind of blind to really oh I missed that in the research that's quite surprising to me yeah well that leads us right into Baron bull 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 yeah okay barar and ball let's do it well okay bear and before I actually go into it a tongue and cheek joke is if they ever get to stop making the insane margins that they do on FX transactions that's the ultimate be case it's something like a hundred times the margin that they make on domestic ones wow 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 so that's like worth knowing when you're trying to understand the shape of the business is the more International the better for them but my real bease 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 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 but we will start decelerating because we've already shifted more than half the payments to happen on cards right we're on the back half of the adoption curve right so that is this Tailwind that has been with Visa forever like anytime you

could come up with any bease it was always just trumped by the idea that 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 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 yep my next one is closed loop systems like alipay and 10 cense 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 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 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 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 totally that is not bad for them at all 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 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 technology infrastructure got built out afterwards whereas It All Happened Al together in

China two though maybe more important is just the government influence right I doubt the Chinese government wanted visa and you know ostensibly American corporation powering their payments there's actually this really interesting weird deal that got cut between China union pay and Visa where yes yes if you use a cup card in China cup it uses the cup rails but if you go internationally where like there is no China union pay terminal at you know my local coffee shop here in Seattle if you were to travel here and swipe it it runs on Visa but they sort of have the national security benefit and the economic benefit of four people in China transacting in China that runs on china-owned payment rails yeah which you know I mean I guess that is an Associated bease right China in and of itself and could other governments around the world start adopting similar postures yep the next one is similar but

a little bit different realtime payment networks are starting to become a thing the instant Bank transfers that these provide are not exactly a payment system 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 charge back or 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 so in the US of course we have fed now 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 P has had very fast uptake UPI in India is another one 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 and so that is a method of transferring money between countries that has nothing to do with Visa 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 and you know I mean technology and infrastructure and ecosystem is getting built on this obviously around the world and here too me great friends of the show modern treasury like they are enabling a lot of this totally yeah apple I just think is like a general be 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 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

Merchants Bank and the one to go to Visa itself 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 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 as it happens right now you need to have a card issued by a bank that likely is issued on Visa or Mastercard or AMX or discover and then it goes over those payment rails 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 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 verone or a legacy provider they could create their own closed loop Network where they're Act the payment method and the merchants technology provider y I actually don't even think they 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 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 M yeah true true like what else are you going to do with 250 billion of cash yep I mean maybe they would try but apple is not going to be in the business of directly having a Salesforce to sign up all these

Merchants I don't think agreed I have a Counterpoint to that but I'll save it for the bull Side Of The Ledger here okay I mean the other thing the lighter weight thing on Apple is even if they don't try to build their own Clos Loop thing who really cares what's in your wallet when your wallet is your phone 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 autopay it 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 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 y

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 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 right Google pay is very popular too yeah yeah yeah but like what else I mean there've been other alternative Payment Systems over the years and none of them match at least domestically in the US Apple and Google p yep so my tldr on the be case is the core business matures so that hwind lessons the uh 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 and they spend a bunch of wasted money trying to figure it out but I don't know those are the best bare cases I can come up with 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 Baron Bull on Visa basically everyone just gave us a be case cuz they're like the bull case is obvious yeah totally and I think the obvious bull case is this is just an incredibly powerful Network effect that's 50 years in the making and his five-sided and Lord knows I can't think of any other five-sided Network effects riding a secular increasing Market yeah riding a secular wave and nobody has ever broken it and past performance is a strong indicator of future performance in this

domain yep the correlat 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 like none of those things have come true Visa has just continued to grow at you know low double digit percent growth every single year or I guess to your calculation of 177% over 51 years people in the past have said many of these be cases but uh have never come true 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 I mean we talked about all the way from 7% down to two and change and so they do these interesting other things one 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 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 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 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 there was sort of more optionality with it when you had the raw information and now Visa is 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 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 so 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 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 uh Tam y so here's Visa's version payments 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 that B2B payments is about 120 trillion if they can access it B2B Commerce is actually just much larger than b Toc Commerce if you think about the amount of money that flows over invoices that are uh paid via

a or wire Visa I think is intensely aware that they're not going to take 2 and half% in change on a company invoicing another company for a million dooll Services provided thing 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 that's a B2B transaction 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 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 and you can think of that as like uh insurance company needs to like pay a payout after a car insurance and they need to make that happen fast or uh refunds let's say you never bought

anything but a company still needs to send you some money or like uber needs to pay their drivers this sort of thing is there's a whole buiness 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 and then the last one is just expansion of crossb payments if they can do more International transactions that is hugely hugely profitable so those are my uh that is me trying to Faithfully represent the bull case that Visa paints for their shareholders because David these bull cases are so easy you should read the annual report the whole thing's a bull case yeah right one other additional I said I was going to add on bull case sort of as a resp response to the apple and by association Google bease you know pretty much everybody we talk to pointed out as the number one most obvious be case for Visa right now is Apple and Google and

the incredible progress and inroads that they have made into rails and transactions but as you say all those transactions are still just tokenized Visa Mastercard cards right it's a bull case today 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 okay we want to go after Visa I'm not sure how Apple could actually do that really without becoming a bank themselves you know yeah MX 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 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 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 it depends

Apple will eventually saturate their market and they are looking for what the next Frontier is and2 200 trillion dollars of volume moving around the global economy I think yes absolutely and so I'm not saying this won't happen but Tim Cook board level discussion on this right let's play out the dhawk thought exercise Apple succeeds they do it they eat Visa Visa's market cap is now added to Apple's market cap great Apple's market cap just grew by 25% 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 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 going to do a car or they're going to go into payments right they got to keep going after bigger and bigger markets 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 true I'm not making the argument that they's still the Cute Apple I'm just saying like I think actually entering this Arena introduces a significant am of risk to the whole franch that they have to weigh in a way that some of these other markets don't 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 America card today I did not is it like a branded Visa product from Bank of America it is a branded product from Bank of America available on Bank of america.com there's no annual fee click on their website to apply now and the Beautiful irony that will tie a bow on this whole episode is the bank americard credit card by Bank of America

runs on MasterCards at work well as you s started to set that up I was like I know where you're going with this I know where you're going with this interbank for the win we'll link to it in the show notes get yourself a Bank America card and run your transactions over mastercard's beautiful Stellar Network wow unbelievable that is hilarious what a great place to leave the story there can't be that many people that are applying for this thing and you would think that viso would try to go get this deal done just for Nostalgia purposes that's a crime against internet and business history what a story man H 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 it's like three comedy sketches with a guy named Tim Robinson is 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 if I were you listeners and you haven't watched this yet I would go to season 3 episode 1 my favorite skit of them all starts approximately 6 minutes in actually the whole episode's good but the skits 2 and three are the uh truly unbelievable ones but it's just he's so outlandish and so I don't know 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 it's just really good ah it's amazing I have to check it out my carve out is a book I think this is

my first fun fiction 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 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 PNE the founder of sneak last time we got together which was super fun sneak is an amazing very large cyber security 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 and Francisco 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 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 well we definitely have a few thank yous on this one uh huge thank you to Dave Sterns for spending the time with us and recanting his academic thesis and it was just awesome reading the book 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 Moffet Nathanson Lisa did an amazing interview with Ben Thompson a few weeks back if you are a tech subscriber that is totally worth reading and I prefer listening so go listen to that 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 huge thanks to her 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 idon who is a former product person from stripe our

huge thanks to blinkist stat Sig and cruso click the link in the show notes to get access to each of their awesome offers 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 he the follow-ups and corrections after we learn them from you should join the slack acquired. fm/ slack you should check out aq2 in particular our next episode it is not out yet is going to be a follow-up to this episode on Visa our buddy garv from Thrive capital is joining us for a follow-up to analyze the payments landscape today and gorov 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 so check out aq2 search unsubscribe to any podcast player and then the next week maybe two weeks our uh interview with gorov will come out

and be sure to check it out with that check out the merch store acquire. fm/ store can support some of this sweet uh 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 we'll see you next time who got the truth is it you is it you is it you who got the truth now

huh