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Vocalink is a payments-technology company that was set up by 18 UK banks and building societies to run the UK’s network of cash machines. In 2016, Mastercard paid 700 million pounds for the company that processes about 11 billion transactions a year, to beef up its presence in the UK and add real-time payments to the services it offers worldwide.

Mastercard’s history of acquisitions and innovations such as ‘virtual cards’ – where one-time card numbers are issued for specific transactions at specific merchants – have helped the New York-based company become the second-largest global payment network in a world that is using less cash and fewer cheques each year.

The company that was formed in 1966 when some US banks created a card network earned US$15 billion in revenue in 2018, up 20% from the previous year. Over the 12 months, this revenue was generated from handling US$5.9 trillion in payments from 2.3 billion cards in more than 150 currencies conducted within 210 countries and territories.

Mastercard has enjoyed strong share price gains in recent times because investors assess that it’s likely to keep posting strong earnings growth in coming years. Mastercard shares rallied 134% in the five years to 2018 compared with a 48% gain in the S&P 500 Index.

The beauty of Mastercard’s business model is twofold. The first is that demand for its services is strong because e-retailing, tap-and-go and mobile payments are taking off in a world where more than 80% of transactions are still in cash and cheque. Another boost is that governments keen on ‘inclusive growth’ are pushing for financial services to reach more people. The other is that Mastercard’s competitors outside of China are likely to remain the existing payments companies namely, American Express, PayPal and Visa, the largest payments company. This is because the payment companies enjoy the strong protections of the network effect that links consumers, merchants and banks – where each additional user boosts the benefits of a network for all users. The businesses of Mastercard and its three competitors are largely impregnable from newcomers. (China has a unique payments ecosystem that is difficult for Mastercard, Visa and others to penetrate.)

To take market share from the four incumbents, any newcomer to the global payments business would need consumers and merchants to simultaneously accept its card. 

To achieve that, the entrant would need to achieve mass awareness, offer a simple means of payment, have ubiquitous technology, be trusted (even though the issuing bank bears the risk of theft and fraud), meet regulatory requirements in every country it wished to operate, and fulfil arduous customer and merchant servicing needs.

Thus far it has even been too hard for the likes of Apple, Facebook, Google and Samsung. Rather than pose threats to the payments status quo, Apple Pay, Samsung Pay and Android Pay are piggybacking the infrastructure set up by the payment companies. That means that the growth of mobile payments offerings by the tech giants helps Mastercard and its three peers. Cryptocurrencies are no threat either because payments this way are, so far, too slow and insecure to take market share and they face major regulatory impediments. Their volatile prices are another risk too.

Mastercard faces risks, of course. The payment companies are reliant on consumer spending for fees so their share prices can lag if investors become pessimistic about the economic outlook. American Express, PayPal and Visa could dent Mastercard’s market share, even if no newcomer is likely to. Another risk is excessive regulation as governments move to protect privacy and competition – evidence of this is that the EU this year fined Mastercard US$650 million for stopping merchants from clinching better deals from banks in other member countries. Another risk is cybersecurity breaches that dent people’s faith in mobile payments. Then there is the limit to Mastercard’s growth due to China blocking the entry of the US payments companies.

But while the world outside China keeps expanding, societies go more cashless and mobile remains a secure way to pay, Mastercard and its competitors are likely to enjoy buoyant times.

Beyond core

Mastercard nowadays describes itself as a “technology company in the global payments industry”. The emphasis on technology is to highlight that Mastercard connects financial institutions, partners, merchants and others worldwide so they can use electronic forms of payment.

Mastercard’s core role is to authorise, clear and settle payments through its global payments network. A typical transaction on Mastercard’s core network involves four players plus Mastercard. These four are the account holder, the card issuer, the merchant and the merchant’s bank or financial institution.

The company does not issue cards, extend credit, set or receive revenue from interest rates and other charges. These functions are handled by the financial institution that issues cards bearing the interlocking red and yellow brand mark. Mastercard derives most of its revenue from a fee on the gross dollar volume (value) of activity on the products that carry its brands.

For consumers, the company that adopted the name Mastercard in 1979 is a one stop for secure domestic and cross-border transactions. Fees on cross-border transactions – a measure of cardholders’ spending abroad – account for about 33% of Mastercard’s revenue. Also of note is that about 17% of Mastercard’s revenue last year was derived from developed countries.

The company is always trying to expand beyond its core services. That’s where fits in the Vocalink acquisition that was finalised in 2017. Last year, Mastercard started promoting the real-time accounts-based payments capabilities acquired with Vocalink. These efforts included the launch of a service in the US (with The Clearing House) that enables people and businesses to send and receive immediate payments. It all helps Mastercard cement its number two spot in a lucrative industry.

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