The business model of the payments industry has come within the sights of technology start-ups in Silicon Valley. One reason is the extremely wide profit margins earned by the likes of Visa (NYSE:V). Its operating margin last year was a staggering 65%, which leaves even companies as profitable as Google (NASDAQ:GOOGL) (NASDAQ:GOOG) in the dust.
In this segment of Industry Focus: Financials, The Motley Fool's Gaby Lapera and John Maxfield discuss the competitive dynamics that underlie these highly favorable economics.
A transcript follows the video.
This podcast was recorded on Feb. 29, 2016.
Gaby Lapera: AmEx, Visa, MasterCard, you're probably sitting there thinking, "Yeah, I've already heard of all these companies. These facts you're telling me are very interesting, but what are the opportunities here? Are there any opportunities for disruption? What are the competitive advantages of each relative company?" That's probably, I hope, what you're thinking, because that's what we're going to talk about next. (laughs)
John Maxfield: Yeah, and just to tee up this conversation, let me put all this in perspective. Visa's operating margin, which is basically their revenue minus all their operating expenses, is 65%. Now, when you think in your head, is 65% good or bad, well, let's compare it to another company that probably has really, really good margins. Let's compare it to Google. Google's operating margin is 27%. OK? So, again, Visa's operating margin is 65%. Google, which, according to Charlie Munger, probably has the greatest competitive moat of any company of all time, their operating margin is 27%. So, this just goes to show how powerful of a position these three companies, Visa, American Express, and MasterCard have in that market.
Lapera: Yeah, and it's easy for them. One, they have this huge amount of market share. But it's also easy for them to have such a large operating margin, because it's not like it's a high cost for them to provide the services. Once you have the infrastructure in place, they can make bank, which is what they're doing.
Maxfield: That's right, and a really good lesson here is that, it's almost like a software company. Once you've made the software -- in Visa's case, once you've established that infrastructure -- then it's just a matter of scaling. So, if you can scale up to $1 trillion worth of payments as opposed to $100 billion, or, $4.7 trillion, you're just going to make a lot more money, but your expenses aren't going to racket up very quickly at all.
Lapera: Right, they're not going to rise at the same rate as the amount of money that you're bringing in, which is huge for Visa.
Lapera: And this is actually one of the competitive advantages that Visa and AmEx and MasterCard do have, is that they do have these established infrastructure networks.
Maxfield: Right. I mean, you know, when you think about competitive advantage, the network effect is the one that really comes to mind with these companies. They already have all of these merchants tied into it, they already have the big banks tied into it. So, they have those relationships and those networks that just make it easy. Because what Visa really does is it provides clearing and settlement services. And that requires people on both sides of the transaction to trust the person that's providing that service. And Visa has established that. So, that network effect is clearly very, very powerful when you consider how wide that margin is, and thus, how seemingly prone to disruption this industry is, but yet, this fact that it's still not been disrupted.