Network War – Battle of the Cloud Part 4

OLD blog that was all wrong.. kept alive because it shows I’m human

Clusters Form

———————– Update July 2014

I no longer believe in this fragmentation with the exception of JPM. The banks are trying to create an alternative to no avail (over last 5 yrs). I agree with Visa and Charlie here. This bank driven initiative is now dead.. so only read this if you are interested in history of why banks started this thing in the first place.. and worked to keep it a secret from V/MA for 3-4 yrs. The big announcement that changed this entire landscape came in Oct 2013 (Visa, MA, Amex EMVCo token announcement).

— Update

Guys I welcome updates.. If I’m wrong I’ll update. I’m not writing this to destroy Visa, I’m writing this because many businesses are going to be impacted by this change.

Visa itself does not have a complete picture of all of member bank plans, but the obvious assumption is that the banks are looking to create an acceptance and issuance infrastructure which circumvents them. For example, we now see through the secure cloud announcement that Banks are working to replace card numbers with “tokens” (16 digit PAN that is not a V or MA number, but an ISO number owned by the bank and not affiliated with any network).

Visa will continue to own Visa PANs, but are facing new restrictions on routing/switching (data sharing),  AND a world where the issued instrument is NOT their number (ie NFC, TCH “token”). JPM and other banks must consider how the POS operates with their new token network, for multiple form factors (card, mobile QR code, voice print, …). There are many complexities. For example a new Chase card (with no V bug) with a JPM owned PAN.  Does the merchant treat this as a Visa card? Of course not.. JPM wants the merchant to “resolve” this token for another card which is accepted. But in this “resolution” process is Merchant under a new agreement? What control does the merchant have to ensure that they instrument is not resolved to their detriment (ie debit vs. credit)? Why as a merchant would I take a token to a card and not the card?

Visa’s PR implies that they will participate and “support” ChaseNet.  They only have a partial view on what that is.. primarily that there will be new tokens.. JPM is allowing Visa to “switch” these tokens onto a new network. Visa may own Visa transactions.. but they will not own Tokens… it is a give and take. Tokens are NOT V or MA numbers, but issuers can use their same acceptance infrastructure in processing them. The lack of clarity by V is certainly not all of their fault.. as the token project is not quite announced. I doubt if V is full party to bank plans here, as some members may work to have these tokens embedded in plastic. A dual function card? Yes my head is spinning.

(Updated from Visa’s Barclay presentation). Charlie quotes on the new “Chase Net”

  • “Run through the Visa Network, an instance which they can say is theirs. “
  • “we control the network, we control the IP”
  • “Its the Chase acceptance mark, Chase will be on the card, Chase will be the name at the POS,.. but these transactions run through the visa network, an instance that Chase can say is theirs, but they run on the Visa network. “
  • “Its our network… we are not white labeling anything…”


21 March 2013

Battle of the Cloud 4 – Network War

Those that are frequent readers know I’m not a linear thinker. The cloud battle story just took a detour from my earlier note this month Battle of the Cloud Part 3 …the story line of wallets has jumped to shattering changes going on in the networks. .Network Clusters

Biggest news by far is the Visa/JPM deal which I covered earlier. The key “break” here is that JPM will no longer be paying transaction fees for on-us, no longer routing on-us transactions to Visa (note this is disputed) , and will have ability to create their own network with their own rules. You must parse Visa’s public statements very carefully to discern deal terms. Visa’s PR and IR teams get an A+ as they have proven to be masters at obfuscation here. My best guess on deal terms is that JPM has committed to “license” of VisaNet which has NO transactional component. Visa plans to treat this licensing fee as “transaction revenue”, but the revenue has no variable component.  This is where the PR/IR “art” comes in.. JPM’s “licensing of VisaNet” has given VisaNet a double meaning. This new JPM “version” of Visa Net is likely to operate this way in Name only. Visa told analysts that this new version will run within its infrastructure. Ok, but which transactions will run on it? On Us Transaction? “Transactions which conform to a new JPM rule set“? Both? How long will this take place?

Publicly Visa states that transaction revenue will increase. Which is true, at least for next 2 years, as the license revenue will more than cover current “on us” JPM volumes to yield a premium with the addition of non Visa volume (for a net volume increase at a lower per tran cost). However I have yet to see Visa project JPM’s “on us VisaNet” revenue against expected JPM ON US transaction volume. I have 90% confidence we will see a flat line.

Why am I so confident? If there was a 1:1 match of Visa Net transaction rate to JPM On-Us …. the other issuers wouldn’t be beating down the doors of Visa and MA over the last 2 weeks. Everyone in the industry knows what is going on this month.. and also knows what JPM received from Visa…  and they want it toChase Pricing

The Visa Network just shattered. Hence my article yesterday on Visa- Golden Goose is Now on the Menu.  We are evolving from a “star network” to one of clusters. Clusters are Bank led (ie JPM, new US Bank Consortium, EU Bank Consortium, ..), Merchant led (MCX, Amazon, PayPal, Rakuten, WalmartPay, TargetPay,  ..), Platform led (ISIS, Google, Apple, Samsung, …). Each clustering strategy considers relationship w/ consumer, merchant and bank (or clearing). Each cluster performs “on us” transactions and routes selectively (see Least Cost Routing and Business Implications of Tokens, Wallet Strategies).

An institutional investor asked yesterday “Why would Visa do this?” Well they certainly did NOT want to. I know first hand that JPM was quite upset with Visa (Joe Saunders 2011) and were planning to either buy Discover or move their portfolio to Mastercard. Visa’s BOD found out about how badly the Saunders/Buse team were screwing up …. and put in someone that Jamie Dimon trusted, FURTHER giving JPM everything they wanted in a Discover Acquisition with an new “ChaseNet” that allows JPM to keep on us transactions with PaymentTech (less than 17% of acquired volume). (also see Future of Retail Banking, new US ACH system, and  Rewiring Commerce).

Visa did not want to let on us go, or give away its transaction pricing.. and they have gone through extreme contortions to explain away this deal. But it is a major crack in their model.. and every other major issuer must pursue the equivalent. Visa kept them in the tent… well at least they kept JPM wearing the same jersey..

“It allows us to go to merchants and strike our own [deals] with merchants,” Jamie Dimon, chairman and chief executive of J.P. Morgan, said during an interview at the bank’s annual investor day in New York. “We just think it will be a better relationship between us and the merchant.” – Feb 26, WSJ

Implications for the industry

Visa is facing no revenue impact I can see through 2014 because of this. As transaction volumes from on-us will be covered by license revenue (at least in year one). This is how I would construct the deal.. it is my best guess… and it is a guess. I am personally short on Visa.. which may bias me… There are 3 primary drivers which would lead to significant revenue impact for V post 2014

  • On Us volumes will increase (JPM and others) and Visa will receive no incremental revenue. Other issuers will demand similar treatment or go to competing network.
  • New payment networks (Tokens) will form with alternate rules (JPM, MCX, Bank Consortium, EMEA Banks, …). The Consumer and merchant adoption curves of each will be different.
  • On Us will morph into “On We” where clusters route CREDIT outside of Visa. This is place today within the debit world, both US (post durbin) and EU Debit (SEPA DD)

Visa’s long term strategy. Own tokenization and acceptance mechanics.  I see this as rebuilding a generic “TSM” that can support NFC, Tokens or anything else that requires a non-card payment. Visa’s carrot is certification and card present rates.. this may be stronger than anything that bank consortiums could assemble in short term.

We could also see a “rebalancing” of network rules to favor the merchant. Wouldn’t that be funny. My top idea would be for Visa to change rules to force Acquirers and issuers to quote MDR to merchant and allow them to decline cards (or pass along costs) based upon rate. Ok that is my most extreme idea..  Visa can’t continue to live life as an entity that is despised by banks and merchants.. so where will it anchor? Visa’s EMEA news is much more complicated.. yesterday’s WSJ is a good read.

Mobile Payments. As I outlined in business implications of tokens, US mobile payments will have a new “network”, a system to use tokens which are neither V or MA card numbers. Thus Banks need not route these transactions through either V or MA, but will be able to leverage same acceptance infrastructure. Virtual card numbers will be bank numbers that banks resolve.  JPM’s is first to align w/ plastic, leveraging common authorization authentication and other services. THE CONCEPT OF A CARD IS CHANGING in MOBILE.

Every Cluster for themselves.. Each group is working to “lock out” others. Banks are working to lock up the ACH rails, V/MA are placing new network fees and controls, issuers are requiring tokens, retailers are locking up data and delivering financial services, MNOs are pushing SWP NFC. Who owns what rails? who owns customer? who owns data?IPP_3_clusters_labels

Mastercard’s phones are ringing off the hook. Visa subtly told institutional investors this month that JPM was a “special case” and that they had no plans to replicate deal. Top 5 banks don’t like being told they are not special. Pandora’s box has now been opened. The future is brighter for MA as they can only gain in US and international is not currently impacted.

Issuers/Retail Banks. JPM and other top banks really had no choice but to move in this direction. Payments are essential to their business (Banks will WIN in Payments), they created Visa once.. why not do it again? The cost of issuance is dropping to zero, retail banking is fundamentally changing, AMEX and Google are creating retailer value propositions where they can no longer compete, regulators have killed their fees, their brands are tarnished and they are beginning to lose the customer.

Very important to note that the large issuers/retail banks own the rules of most networks. There is a mature strategy here to stop non-bank mobile payments for example (see New ACH).

My belief is that we will see M&A and strategic partnership activity with acquirers and processors, as they become “the belle of the ball” which would enable other entities to compete w/ Amex and JPM/ Chase Paymentech. Clusters will be rather “lumpy” and rather messy but will eventually coalesce into a world where payments look much more like dumb pipes. Processors also have new opportunities in servicing new payment networks and new non-bank customers (retailers).

Platforms. We will see heavy investment to “own” the customer at point of interaction. Apple, Google, Samsung, Amazon should attempt to own customer identification and data needed to authenticate at all costs.

Retail financial services leaders Tesco, Target and Wal-Mart have defined a template which other retailers will follow. Retailers are poised to deliver banking services more cost effectively to the mass market than the banks. (Future of Retail Banking). I expect to see retailers work to acquire banking licenses or operate their consortium within a bank.

Mobile operators have chance to own customer mobile identity and deliver financial services… but must completely reorganize to do so. (see Stage 4 Value ShiftWalled Gardens, Future of Phones – Good Enough)

Start ups are facing life as food trucks driving around in a WWI battle field filled with trenches, landmines and mustard gas. Look at the neat stuff I have to sell.. as the big global powers fight each other. Just look at the impact that Mastercard’s new rules are having on PayPal.

Investors.. ensure your payment start up has a committed partner bank.. forget about MSBs unless you have 100M+ to sink in it.. MSBs still require you to have a bank account and banks are running from this space (in the US). Take a look at Square’s recent issue. Taking credit cards into a pooled account, issuing gift cards or credits..  Assume 100k per year per state in maintaining licenses. Best legal group to help you work through these things is Card Compliant.

I would challenge all participants to think about the credit card product… what delivers value? what about it is unique? how do consumers view it? how is it part of a great consumer experience? When you leave Disney World do you think wow.. buying the ticket with my card was just fantastic? How are new customers acquired? Who benefits when cost of issuance is $0? Is charging the average consumer 12-16% on a card, paying them 0.2% on their savings charging merchant 2% a great model?  Do you think that there is room for improvement? What if credit were free if you shared your data? What if the basis for competition in cards was no longer bank brand and bank loyalty points but retailer loyalty? What makes a consumer loyal?

My favorite example of a future vision is still Square.. even though Starbucks has had a few bumps in the road in implementing it…. It will be a great customer experience… Everyone loves to be recognized.. like walking into the Cheers Bar and hearing “NOOOORRRMMMM”.  I’ll have the same drink I had last time.. and pay with the same card. This is a great consumer POS experience that retailers will jump to support. How does this payment settle? However the consumer and merchant agree.. I expect to see significant degradation in the value of the card product and “plastic”. The metaphor is changing in physical commerce.   Credit access and clearing will become ubiquitous… customer insight and experience will differentiate merchants and product providers.

6 thoughts on “Network War – Battle of the Cloud Part 4”

  1. Good discussion on related topic with Scott Harrison in the “NEW ACH” post.

    Scott, as one of the Visa architects I’ll certainly defer to you on original model. Pre-IPO Visa seems to have had quite a number of unique pricing structures with its owner banks. “On Us” with JPM and BAC were certainly treated differently than other banks. Even Pre-IPO my understanding was that there was agreement by all parties to continue to route all transaction through visa*net, as this was the only way to measure rate tiers. Post IPO my understanding is “uniformity” was put in place with each of the key owners obtaining MFN pricing. All transactions were still routed through VisaNet. What is changing here is that on-us there will be no longer be routed through Visa*net, and JPM will develop seperate scheme rules for their own network.

    I’m not aware of any “on we” pricing post IPO. Perhaps there was a special deal between BAC, JPM and CapOne? I certainly don’t see that reflected in any of their regulatory filings.. In this case I’m implying that there is now potential of on-we with NO ROUTING through VisaNet with multiple new scheme’s

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