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This Credit Card Stock Is King of the Castle

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Visa (NYSE: V  ) is the biggest credit card company going, but how long can its stranglehold on the competition last? Does it have the edge necessary to stay on top and maintain its economic moat? To evaluate the durability of its competitive advantage, I'm going to flush out four key factors: intangible assets, cost advantages, switching costs, and network effects. These factors can often determine how long a company remains at No. 1 or how quickly it falls from the top.

Step 1: brand = cash
Intangible assets are things such as brands or patents that bring money to a company because they increase a consumer's willingness to pay. Visa has a strong brand, but I'm going to flunk it in this case because it doesn't encourage consumers to pay more solely for the brand. For example, a consumer may choose Visa over American Express (NYSE: AXP  ) because more stores accept Visa, but the same consumer may pay more for a Ralph Lauren T-shirt over an LL Bean T-shirt because it has a logo on it. The brand is the asset for Ralph, but not for Visa.

Step 2: Bigger means better
Cost advantages apply particularly to companies with economies of scale. The bigger you are, the sweeter procurement contract you can often get. Last year, Visa had 1.8 billion cards in use. MasterCard (NYSE: MA  ) , no slouch when it comes to a moat, was next with 966 million, trailed by American Express and Discover (NYSE: DFS  ) with 88 million and 54 million, respectively. Costs affecting the bottom line for everything from advertising to printing cards will hurt Visa less than it will the competition. Visa passes this test.

Step 3: Ball and chain
Switching costs in this industry all depend on the type of credit card you have. Sometimes it's harder to let go of a card than you'd like. For example, take my Alaska Airlines (NYSE: ALK  ) Visa card. There's an annual fee, but the card accrues 1 airline mile per dollar -- 3 miles per dollar if I use it to buy Alaska Airlines airfare. If I canceled the card today, I'd lose close to 30,000 miles. That's enough for a round trip flight from Washington, D.C., to Seattle. The cost of that flight without miles is much more than the annual fee, so I won't cancel the card. And I might as well continue to use it everywhere Visa is accepted if I'm already committed to paying the annual fee.

In the case of credit cards, switching costs don't prevent consumers from using another card; they prevent them from canceling the current one. All credit card companies can benefit from this reality, but Visa passes this test because it has the most cards in circulation.

Step 4: Safety in numbers
Visa is the most-used credit card in the world, based on the most recent transaction numbers. Its 62 billion annual transactions are nearly double MasterCard's 32 billion and obliterate Amex's comparatively measly 5 billion. This network effect is a double-edged sword for the competition. Startup businesses will be more likely to bring on Visa than Amex because they know more people use Visa. Conversely, if more businesses accept Visa, more consumers will opt for that card. This presents a huge barrier to entry for new credit card competition. Visa nails Step 4.

Infinite moat?
Evaluating the durability of competitive advantage is a great way to think about a company beyond the balance sheet, but an economic moat isn't guaranteed to last forever (new ways to pay, for example, could really shake up this industry). As you ponder your company's long-term potential, think about how long you intend to hold the stock. If the moat lasts longer than you wish to hold the stock, great! Or you may only wish to hold the stock for as long as you think the moat will last. Either way, the moat test is key to understanding a company's long-term potential.

Fool contributor Aimee Duffy loves to rock the moat. She doesn't own shares of the companies mentioned in this article. Motley Fool newsletter services have recommended buying shares of Visa and Discover Financial Services. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (1) | Recommend This Article (2)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 10, 2011, at 9:02 AM, lution wrote:

    You hit some good points but missed the hit to margins that the processing companies are taking because of congress limiting credit and debit fees and the fact that the stock only covers cards issued in the US limiting overall growth.

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