🗞 Visa: Building the World's Largest Toll Road

Happy Sunday! 👋 

This week we’re taking a look at the origins behind one of the most profitable businesses on the planet, Visa.

Let’s dive in!

Visa: Building the World’s Largest Toll Road

Nowadays, Visa often gets referred to as the “toll road” for global commerce.

Every time someone swipes their card, Visa collects a $0.07 fixed fee and 0.11% of the transaction amount. On average, that shakes out to about $0.15 on every swipe.

And there are a lot of swipes. A lot.

Visa powers more than half of all credit card transactions globally, which means they process 783 million transactions every day, or more than half of a million transactions every 60 seconds.

Pretty nice business model, huh?

But how did Visa even come to exist? And why are customers and merchants willing to pay a chunk of every transaction to this organization?

To properly understand the role Visa plays in the modern payments ecosystem, we have to go back in time.

Installment Credit

In the early 1900's, installment credit was popularized.

This meant that merchants and manufacturers started letting people buy items without putting all the money down at the time of the purchase. This certainly wasn't ideal.

Merchants had to assess each individual customer's credit-worthiness and bear the risk of a late repayment, along with all the back office work of managing each account.

Due to these headaches, most banks at the time refused to write installment loans. Except for one, Bank of America.

BankAmericard

In 1958, Bank of America introduced the BankAmericard credit card. To get people to actually use it, Bank of America performed what's now referred to as “The Fresno Drop".

They pre-approved and sent cards to everyone in Fresno, California as 45% of the residents there already banked with Bank of America. That solved the consumer side of the equation, but the merchant side still remained.

For a credit card to be accepted, you not only need consumers to use it, but you need merchants to accept it. Fortunately, merchants were more than happy to offload the headache and back office work associated with managing installment credit themselves.

With the merchant and consumer sides of the equation solved, BankAmericard had officially found its footing in Fresno. From there, Bank of America successfully expanded the operation into other cities throughout California.

But when they attempted to expand nationwide, they began running into problems.

Due to regulation born out of the Great Depression, banks weren't allowed to have out-of-state customers, so Bank of America was forced to franchise the BankAmericard program out to other banks. This made authorizing transactions very difficult.

A Typical Transaction

Imagine you were a New York resident buying an expensive coat from a department store while on vacation in Florida. You and the department store would likely have different banks.

If you went to checkout with your BankAmericard, assuming the cost of the coat exceeded what was called the “floor limit”, an attendant at the department store would have to call their bank, who would then put the attendant on hold while they called your bank. Then your bank would put the department store's bank on hold to go see if you had a large credit limit to approve the purchase. And throughout that whole process, you would just be waiting there at the checkout stand.

This was just the authorization phase.

Behind the scenes, at the end of the day, the banks were sending reams of sales receipts and reimbursements to one another to actually settle the transactions. The entire system was wildly inefficient and costly for the banks involved.

So much so that the licensing banks nationwide were threatening to abandon the BankAmericard program altogether.

The New Solution

In 1968, Bank of America held a meeting with all its licensee banks to sort out the issue.

At the meeting, a VP at the National Bank of Commerce in Seattle, WA, Dee Hock (shown above) expressed his frustration of the current system and encouraged the formation of a separate organization that would be co-owned by all the member banks and solely focused on automating the backend.

In his biography Hock wrote: “Any organization that could guarantee, transport, and settle transactions in the form of arranged electronic particles twenty-four hours a day, seven days a week, around the globe, would have a market—every exchange of value in the world—that beggared the imagination."

By the end of the meeting, Hock was tasked with building it. And after about a year and a half, the base for this business was established. This organization would come to be known as Visa.

A Network Effect for the Ages

As more and more banks adopted Visa to offload the burden of authorizing and settling transactions, Visa added increasingly more “rails" between banks.

With each bank that joined the Visa network, it became that much more enticing for the next potential bank to join. These banks began slapping the Visa logo on customer credit cards so that merchants knew all the authorization and settlement would be done on the Visa network.

This has become the self-reinforcing cycle that still powers Visa today.

That’s all for this week. 

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