The payments system has become a very confusing space that involves many different players working for and against each other. With the pandemic significantly accelerating the use of digital payments, the industry is heating up as well as getting even more complicated.
In light of its complexity, it might be helpful to compare and contrast some of the big traditional players like Visa (V -0.48%) and Mastercard (MA -1.19%) with a big alternative payment provider like PayPal Holdings (PYPL -1.83%). Let's review their business models, how they compete, and also how they sometimes work together.
Image source: Getty Images.
The differing business models
Visa and Mastercard are card networks that facilitate payment transactions among all of the key players in the payments process including the merchant acquirers, the card issuers, the payment gateways and processors, and the independent sales organizations. As the two biggest card networks Visa and Mastercard essentially run a duopoly that operates an open-loop payment network. That means they work with lots of intermediaries like banks and payments processors to help carry out multiple parts of the payment process. In general, they operate the most widely accepted payment methods across the world.
Image source: Visa's 2021 annual report.
As you can see in this diagram above, Visa is firmly in the middle of the payments process, collecting the transaction data from the merchant and its processing bank and then confirming that transaction with the consumer's issuing bank to get the transaction authorized. Mastercard's process follows the same path. For performing this service, Visa and Mastercard earn fees on each transaction. They both operate in more than 200 countries and process some 90% of global card payments outside of China.
PayPal, on the other hand, plays many of the roles in the traditional payment system on its own, although it is a closed-loop payments system, so consumers and merchants have to join the network and can only interact with others who have signed up for a PayPal account. PayPal has 426 million accounts on its platform, 392 million consumer accounts, and 34 million merchants in over 200 markets.
Image source: PayPal Holdings.
How they compete
You'll hear a lot of people equate Visa and Mastercard to the tolls on the highway. Because the two giants essentially built the infrastructure that almost everyone needs for commerce, they basically collect a tax every time someone uses their infrastructure, akin to a tollbooth on a highway.
PayPal has its own payments system and it also collects fees on payment transactions. But payments can also flow through PayPal from debit and credit cards, which are likely from Visa and Mastercard. When that happens, those companies are now in the mix and, as such, are entitled to certain fees as payments roll through their system. When PayPal can manage to keep payments within its own ecosystem, either from existing PayPal balances or from a linked checking account using a traditional automated clearing house (ACH), the company is able to essentially exclude Visa and Mastercard and therefore doesn't have to share the fees. For ACH, there are fees PayPal must pay, but they are lower than going through the credit card network.
Because of this, PayPal has more incentive to create a larger network to keep more money within its ecosystem. The company has built out a number of solutions to achieve this, including peer-to-peer transfer capabilities through subsidiaries such as Venmo, cross-border shopping and commerce, lending products, its own branded debit and credit cards, the ability for consumers to buy and sell cryptocurrencies, and lots of exclusive offers from merchants. PayPal primarily earns revenue by charging fees on payment transactions, as well as fees on foreign currency conversion, and instant transfers from PayPal or Venmo to consumers' debit card or bank accounts.
How they work together
In 2016, Visa and Mastercard were not happy with PayPal because it was incentivizing customers to fund their PayPal accounts through ACH and therefore away from the card networks. Visa's CEO at the time, Charlie Scharf, who now runs Wells Fargo, essentially declared war on PayPal and said that if something didn't change, Visa would "go full steam and compete with [PayPal] in ways that people have never seen before."
Eventually, PayPal would squash the beef with Visa and Mastercard, signing a deal that essentially agreed to stop discouraging users from funding PayPal accounts with Visa and Mastercard cards. In return, Visa agreed to compensate PayPal for driving more transactions through its network. However, PayPal also scored a major win in the deal. In the agreement, Visa allowed PayPal to leverage its technology to enable its own customers to use PayPal to complete transactions in physical stores. Previously, PayPal had largely been an online payment solution but at the time wanted to make its payment options more widely available and get into transactions at brick-and-mortar stores.
Since then, PayPal has continued to partner with Mastercard and Visa. Each has agreed several times to further highlight one another's various payment capabilities to their prospective customer base. PayPal has also selected Mastercard to run its PayPal-branded credit card and Visa to run its Venmo-branded credit card.
Why the partnerships are helpful
Overall, while PayPal in one sense could make more money by keeping money in its ecosystem and funding more accounts through ACH, Visa and Mastercard likely have the financial resources to compete. In the end, these three payment companies can help one another, with PayPal allowing customers to fund their accounts with Visa and Mastercard debit cards, and Visa and Mastercard making it easier for PayPal to offer more in-store checkout options. The more choice in terms of payment that consumers and merchants have, the more volume they are likely to generate. Plus, by competing with each other less, PayPal, Visa, and Mastercard can focus instead on their other competitors in the payments space.
