Visa (Audio)

1. 0:00 – 5:03

   Visa as invisible global infrastructure: what it is (and isn't)

   1. BGBen Gilbert0:00

      It's funny, when we picked this episode, I was like, "Oh, this is gonna be pretty down the middle and easy." And then, of course, as we get into the research, as always, it's like, "Oh, nope, big story here." [chuckles]

   2. DRDavid Rosenthal0:09

      Yep, there's always a story.

   3. SPSpeaker0:11

      Who got the truth? Is it you, is it you, is it you? Who got the truth now? Is it you, is it you, is it you? Sit me down, say it straight. Another story on the way. Who got the truth?

   4. BGBen Gilbert0:28

      Welcome to Season 13, Episode 4 of Acquired, the podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert.

   5. DRDavid Rosenthal0:36

      I'm David Rosenthal.

   6. BGBen Gilbert0:38

      And we are your hosts. Today, we tell the story of an absolutely incredible system. You can show up anywhere in the entire world with a piece of plastic and transact for anything you want in any currency. The merchant doesn't need to know you or trust you, and you do not need to know or trust the merchant. And Visa, along with just one other competitor, MasterCard, has tirelessly spent decades stitching together all the banks, merchants, and the relationships with consumers to make this possible. Now, this is just the rosy side of the story, and merchants may harbor far less rosy feelings about Visa, given how much of their profits go to interchange fees. But the duality of the story is what makes it so interesting to understand. Today, we will explore how the whole thing came to be and try to understand the value that the credit and debit card system creates, compared with how much it captures and by whom, in what situations. So here are some astonishing stats on Visa. It is the 11th most valuable company in the world. It is worth more than any bank in the world, including every bank involved in creating it. Visa's brand is among the very most trusted in the world, associated with reliability and security. But that said, if you asked most people what Visa does, they could not actually articulate it. Visa does not extend credit. They do not issue cards. They do not work directly with merchants. They do not work directly with consumers. They are not a bank or a financial institution. They don't ever bear any risk. They are merely a network connecting banks to other banks. David, it is insane.

   7. DRDavid Rosenthal2:20

      This is such an insane story. I can't believe we're all the way in season 13, and we haven't talked about this company yet. But as we will get into, it's always been overlooked and underrated.

   8. BGBen Gilbert2:30

      Well, perhaps not underrated the last decade or so. If you listeners want to know every time an episode drops, you can sign up for email updates at acquired.fm/email. Two new fun things: one, emails now include little hints and some teasers about what next episode will be. So if you wanna play the guessing game, sign up at acquired.fm/email, and the emails have another new feature. We are including follow-ups from previous episodes when we learn new things from you after release. Come talk about this episode with us after listening at acquired.fm/slack, and if you want more from David and I outside of these big, long, main Acquired episodes, check out ACQ2, our interviews on a second podcast feed. Now, without further ado, this show is not investment advice. David and I may have investments in the companies we discuss, and this show is for informational and entertainment purposes only. David Rosenthal, where are we starting today?

   9. DRDavid Rosenthal3:28

      Well, we are starting, actually, with a big thank you to Dave Stearns, author of what is undeniably the very best book on Visa and its history, Electronic Value Exchange. And we owe a thank you to Dave, both for writing the book and for talking to us as we researched and helping us sift through everything as we're preparing here.

   10. BGBen Gilbert3:46

       Fellow Seattleite, and the book, which is so wonderfully, esoterically named Electronic Value Exchange, was his, I think, PhD thesis that they sort of turned into a book.

   11. DRDavid Rosenthal3:55

       Correct.

   12. BGBen Gilbert3:56

       All right, take us back in time.

   13. DRDavid Rosenthal3:59

       So Dee Hock, the founder of Visa, who we will talk a lot about as we go along here, he told this great story of how after his time at Visa, in his kinda older age, he would start his speaking engagements with a little thought exercise for the audience. He would get up on stage, he'd hold up his Visa card, and he would ask, "How many of you recognize this?" And of course, every single hand in the room would go up, as I assume all of yours listening are going up now, too. Then he would say, "Okay, now, how many of you can tell me who owns this company?" And every single hand in the room would always go down. And then he would say, "How did this company start?" No hands. "Who runs it and who governs it?" No hands. "Where is it headquartered?" No hands. It's just wild, as we were saying in the intro, how important this company is, and yet still, to this day, I think, you know, maybe a few more people than in Dee's time know the answer to these questions, but not many.

   14. BGBen Gilbert4:56

       Yeah, it's one of these things, too. It's, like, one of the only essential pieces of financial infrastructure in the United States that is not run out of New York.

2. 5:03 – 10:57

   1958 Fresno ‘The Drop’: Bank of America mass-mails credit cards

   1. DRDavid Rosenthal5:03

      So our task today is to tackle these questions, and we start where some of you, I suspect, know, but the vast majority of you, I also suspect, don't. We start in 1958 in Fresno, California, with the drop.

   2. BGBen Gilbert5:21

      The drop. This is the name of the title in this fantastic book, A Piece of the Action: How the Middle Class Joined the Money Class, and it is Chapter One: The Drop, 1958. The drop has become... Like, if you say the drop to someone in the fintech industry, they're like, "Oh, September 1958, Fresno."

   3. DRDavid Rosenthal5:39

      Yep. [chuckles] And the rest of the world has no idea.

   4. BGBen Gilbert5:43

      Yep.

   5. DRDavid Rosenthal5:44

      All right, so what happened? Well, the then-largest bank in America, the San Francisco-based Bank of America, which formerly was called the Bank of Italy, both of which were total misnomers, because it was actually more accurately the Bank of California. It was illegal to operate banks across multiple states back then, as we will discuss.

   6. BGBen Gilbert6:07

      ... And the reason it was named Bank of Italy was it was started by an Italian immigrant who wanted to create something for the underbanked Italians in his California community.

   7. DRDavid Rosenthal6:15

      Yeah, mostly farmers and merchants in San Francisco. It really started as, like, the bank of the little guy. So Bank of America decides that they are going to mail out little rectangular pieces of plastic to every single one of their sixty-five thousand customers in the city of Fresno, completely unsolicited. Now, a couple things about this. One, it's wild. I think the Fresno population at this point in time was, like, maybe two hundred, two hundred and fifty thousand people, so, like, a huge portion of the city of Fresno banked with Bank of America, and that was true for all of California at the time. Two, they just send these things out. Obviously, these are credit cards. People don't know what they are. They have no idea what to use them. Mass chaos ensues.

   8. BGBen Gilbert7:06

      Well, and certainly nobody asked for them. There's this great quote, again, from a piece of the action that describes it and says, "There had been no outward yearning among the residents of Fresno for such a device, nor even the dimmest awareness that such a thing was in the works. It simply arrived one day with no advance warning, as if it had dropped out of the sky."

   9. DRDavid Rosenthal7:25

      All right, so to explain how we got here, we need to spend a few more minutes on Bank of America's history and the history of banking and payment industries in the US more broadly. So like we said, B of A was the biggest bank in America in the 1950s, but it was not like all the other big banks at the time. It was a consumer bank. The other large and influential banks in America back then were, like, the JP Morgans. They were white-shoe corporate banks based in New York. We talked about this a lot in the Nike episode. It was illegal for banks to operate across state lines until much, much later in history. So for banks back then, the only way that you could actually get big for just about everybody else in the industry was to go the corporate route and to go the investment banking route because you could service very large corporations that obviously were large themselves, would generate lots of deposits, lots of lending activity. The investment banking activities around that were obviously very lucrative. That's how the JP Morgans, you know, the Morgan Stanleys, et cetera, of the world came to be. For the most part, consumer banks were kinda backwater, small. There was no way to aggregate enough customers that you could get big enough.

   10. BGBen Gilbert8:38

       Well, and in most states, they would have restrictions on the number of branches that banks could actually have. In some states, I think Texas was one of them, you literally could only have one branch. Other states would limit them as something like three. Other states would limit them and say none outside the city, so you were sort of a bank of a city. You could almost think about these more as credit unions than these sort of big banks that we think about today. California happened to be unique in that you could actually have branches all over the state, and California happened to have quite a large population, so it was kind of the only place you could pull off a large consumer bank.

   11. DRDavid Rosenthal9:16

       Yes, exactly. California was already the second-biggest state in the nation at that time, behind New York, but the New York banking industry was super fragmented. Because Bank of America, starting as Bank of Italy with all these immigrants, had built up a consumer base, they really were unique. So, you know, the business of banking is, well, banking. You take deposits, you make loans, you make your money on the loans. B of A was doing tons and tons and tons of small, little, and disparate consumer loans and lending, so obviously, mortgages and car loans, like, those still exist today, but they were doing, like, washing machine loans.

   12. BGBen Gilbert9:57

       They were doing, like, buy now, pay later, but instead of on the website, you would go to your local bank branch, you would schedule a time, you would sit down with the bank manager, and he would authorize you to go spend a hundred and fifty dollars at some merchant and make you a loan that you would come pay back over the next few months in installments. And every single time that you wanted to buy something now and pay for it later, you would repeat this very physical, one-off manual process.

   13. DRDavid Rosenthal10:22

       Yeah, and for specific items, to, like, go buy a refrigerator.

   14. BGBen Gilbert10:26

       Wild.

   15. DRDavid Rosenthal10:26

       It was just wild to imagine today. So you can see why for a bank like Bank of America that is doing this at such large scale, the idea of a consumer credit card, well, it's pretty awesome because you can take all of these disparate lending programs, consolidate it into just one card, cut out a ton of overhead fees, and make it way more efficient. So this is what they are launching, first in Fresno as the pilot market, and they call it the BankAmericard.

   16. BGBen Gilbert10:57

       Beautiful name.

3. 10:57 – 26:50

   Before cards: checks, charge accounts, Diners Club, and Amex’s fast follow

   1. DRDavid Rosenthal10:57

      Beautiful name, and it would survive for quite a long time. Now, this wasn't exactly a new idea on the part of Bank of America. Charge cards and credit cards had been around for decades. What was new was this was the first time that a bank had entered this market at scale. So let's talk about the history. Historically, in the US, transferring money was actually not that easy. You had two options: You could use cash, or you could use checks. And checks worked, but they also had a bunch of problems. One, until the creation of the Federal Reserve in the 1910s, the parties cashing the check, receiving the check, didn't actually receive the full face value of the check because there was a bunch of work and, like, mailing stuff around, traveling around the country that had to be done, and that was taken as a discount out of the check.

   2. BGBen Gilbert11:48

      And this is super important. This thing that we have today, interchange rates on credit cards, that was happening with checks, too. There was really a lot of expense and risk in processing checks when they first got started, and, like, of course, you would take a discount out of the fact that you're taking risk and you're spending money to go and make sure that this check that someone handed you eventually turned into dollars that you could have in your possession.

   3. DRDavid Rosenthal12:11

      Totally. So problem number one, you didn't get all the money. [chuckles]

   4. BGBen Gilbert12:15

      Right.

   5. DRDavid Rosenthal12:16

      Problem number two, also a big problem-... It took a really long time. Imagine, you know, we're talking like the 1800s, early 1900s, this stuff was on the Pony Express, you know, pieces of paper going around a really, really big country. Not ideal.

   6. BGBen Gilbert12:31

      Yeah, and until ACH, where the banks would sort of all meet once a day and decide, "Okay, how much do I owe you? How much do you owe me in aggregate? Okay, let's just settle one transaction, and then we'll figure out all of our internal accounting ourselves," they were literally like, check by check and saying, "Okay, I have this check, so you owe me $6 and 8 cents. Okay, next check. Oh, I owe you $4 and 20 cents." And it was this crazy system of individual couriers bringing checks from the person who, uh, gave it to the merchant for the merchant to go and track down the money and bring the money back.

   7. DRDavid Rosenthal13:05

      Totally. And spoiler alert, ACH doesn't get developed in the US until the 1970s.

   8. BGBen Gilbert13:11

      Wow!

   9. DRDavid Rosenthal13:12

      Humans, though, are quite ingenious creatures at solving their problems, particularly when motivated by money. So there is sort of an obvious solution to this for merchants and their sort of usual, regular customers, and that is credit accounts, charge accounts. Rather than giving me money or a check, let me just keep tabs on a ledger of what you bought, what the value is. I'll tab it all up, and then at the end of the month, you'll come give me a check or cash for it. I remember even me growing up in the 1980s, we had this at our local gas station near our house.

   10. BGBen Gilbert13:48

       Really?

   11. DRDavid Rosenthal13:49

       We had a credit account, and it was just like whenever any of our family would go to this gas station, we would get the gas, and then we'd go inside and be like, "Oh, we have an account here," and they'd just write down what it was, and then at the end of the month, I assume my dad would go give them some money.

   12. BGBen Gilbert14:05

       Which saves on operations for everyone. It's, uh... "Oh, great, now we only need to move money once. We move it at the end of the month, and I trust you because I've seen you lots."

   13. DRDavid Rosenthal14:13

       So from charge accounts at individual gas stations or individual branches of a grocery store chain or something like that, it's not a leap to think the next stage of evolution would be, oh, a card or account that would work at all the branches of a given brand. So, like, the gas stations get into this in a big way. Standard Oil gets into this in a big way.

   14. BGBen Gilbert14:33

       Yes!

   15. DRDavid Rosenthal14:33

       There are lots of Standard stations across the country. You can have an account that works at all Standard stations.

   16. BGBen Gilbert14:40

       Yep. In 1939, Standard Oil of Indiana sent 250,000 unsolicited cards directly to all of their customers.

   17. DRDavid Rosenthal14:49

       Yeah, making the Fresno drop look like a- [chuckles] ... uh, drop in the bucket, shall we say?

   18. BGBen Gilbert14:53

       Well, and interestingly, this is 20 years before, but again, this is not a bank. This is a single merchant mailing it out to all of their customers exclusively for use at their facility.

   19. DRDavid Rosenthal15:04

       Yep. So there was that phase. Then pretty quickly, in a given local area, some of the retailers would get together and be like, "You know, we compete with each other, but it sucks running these charge account programs on our own. We could collaborate and have a standardized charge account system that we could share."

   20. BGBen Gilbert15:32

       And just literally to simplify the back office as the first value proposition here.

   21. DRDavid Rosenthal15:36

       Yep, and for consumers, that's also pretty awesome because do you really wanna carry around 57 different charge cards in your wallet, or would you rather have one that would be like, you know, your Visa to everywhere you wanna be?

   22. BGBen Gilbert15:51

       Yes, and not to mention, on top of this, there is the huge benefit of a shared credit history. Now, all these merchants who were losing money on people coming and getting a loan from them in the form of, "I'm gonna buy some goods, I'll pay you back later," but it turns out they had run up a tab all over town and weren't paying their bills anywhere. Now, with this idea of a shared card, you actually can have a shared notion of who a consumer is across locations and across different retailers.

   23. DRDavid Rosenthal16:19

       Yep, so this comes to be kind of post-Depression in the 1930s, 1940s in the US, and this really is starting to sound a lot like Visa, except, as you point out, Ben, there is a problem here. As the size of any given network of retailers that are collaborating on this grows, so does the intensity of competition within that network. So once you get to a certain scale, nobody's really incentivized to keep making this work: A, because now you're enabling people to shop all your competitors, but also, B, once you get past, I don't know, a couple hundred, a thousand participants here, like, are individual merchants equipped to manage a network like this? No, they don't have the resources to do this.

   24. BGBen Gilbert17:07

       Right. So you have to spin up some kind of, like, shared organization that all the merchants are pooling their capital into in order to run the network on behalf of all of the merchants. It gets messy.

   25. DRDavid Rosenthal17:17

       Or there could be an independent third party, for-profit network that does this, and this is when Diners Club and American Express arrive on the scene. So Diners Club was first, and people might know and have heard of Diners Club. It still exists today. It's like a sub-brand of Discover.

   26. BGBen Gilbert17:36

       Totally.

   27. DRDavid Rosenthal17:37

       There's a very famous, legendary origin story behind Diners Club, and it goes like this: In 1949, you know, post-World War II, economic prosperity, beginning of the Mad Men years in New York and Manhattan, a New York businessman named Frank McNamara is hosting a lavish business dinner in downtown. Halfway through the dinner, he realizes that he forgot his wallet at home. He does not have cash to pay for the dinner, so he excuses himself. He goes to the payphone. He calls his wife at home on Long Island. She speeds into the city with enough cash in time-... to pay the bill for the dinner, and, you know, face is saved, his reputation as a erudite businessman is preserved. And then afterwards, you know, he's, like, talking to his wife. He's like, "Oh, there's gotta be a better way to do this. There really should be a businessperson-focused charge card network that would work at all the restaurants in Manhattan where business people host dinners."

   28. BGBen Gilbert18:40

       So nobody ever needs to bring their cash, and, you know, you could just imagine that, like, we're all in this club of diners, where anywhere we dine, we can stand up, we can authorize the bill, we can leave, we can pay no dollars out of our pocket that moment, and we get one nice statement at the end of the month that, importantly, we do need to pay in full. We cannot roll it over into a loan. We must pay it, but that's nice because all of my business transactions are on one single statement. It's easy for my expense reports. It's easy for me to not have to carry a wallet around, and of course, I get to look super awesome in front of all of my colleagues.

   29. DRDavid Rosenthal19:15

       I think there are two really important points here. One, you said, "I pay it." I don't pay it, my company pays it [laughing] You know? I don't care. Two, the most important point, I get to look super awesome in front of all my colleagues and customers and people that I'm trying to impress. I don't need to bring cash. They know me here. I'm good for it.

   30. BGBen Gilbert19:35

       And just to start tracking a certain number here, when we were talking about checks earlier that were getting a discount, and even in this era of early Diners Club, early American Express, we're talking about a five to seven percent discount of what actually got remitted ultimately to the restaurant or the retailer versus what the bill was originally that the consumer authorized.
4. 26:50 – 36:35

   BankAmericard’s key innovation: revolving credit + bank distribution

   1. DRDavid Rosenthal26:50

      So this brings us right back to Fresno in 1958 because the timelines match up exactly. This is crazy. Amex launched their charge card program in 1958. B of A sees what's happening. They, of course, had seen everything else going on in the industry before. They understand the transformative power that this can have for their scaled consumer banking business in California, and they're like, "Okay, the time is right. Let's do credit cards. Let's go to Fresno." But hopefully, as we've painted the picture, their motivation and Diners Club and Amex and even the merchants' and retailers' motivations are very different. B of A wants two things out of this: one, like we were saying earlier, they want to streamline and simplify all their wildly diverse lending programs. This is gonna be huge operational savings for the bank if they can pull this off. Two, though, the bigger opportunity for B of A is, "What can this do for our banking business itself?" Because remember, how do banks make money? They make money on loans, and this is going to enable so much more effective loan volume to flow through our system that we can make money on.

   2. BGBen Gilbert28:10

      So this is where B of A, informed by their previous business model of lending to consumers, really paves the path of what credit cards would become today. Often, in the past, before the BankAmericard, what would happen is you'd have this charge card, not a credit card, and the bill would arrive at the end of the month, and then you would pay it. The innovation baked into the BankAmericard is they say, "Well, after the 30 days, you can get your statement, you can pay it in full, or you can roll it into a loan, and we love loans. We would be happy to extend loans to our customers. We can learn a lot about them. We can make good amount of money on that interest," and so the modern credit card is born.

   3. DRDavid Rosenthal28:53

      And it was already happening at B of A. They were doing these loans. This wasn't actually, like, new behavior. It was just a way easier, way more streamlined on-ramp into this consumer lending that turbocharged it.

   4. BGBen Gilbert29:06

      This product is the combination of three things: the charge card that had been happening over in Diners Club, Amex, the gas stations, the retailer land, then the second pillar is this consumer lending, and the third thing is it is now from a real and proper bank that you already have your primary financial relationship with, not from some industry association or a hodgepodge of retailers, but now this is issued by your bank. The big takeaway for BankAmericard is it really bundled two different things together. One was convenience, and the other is credit.

   5. DRDavid Rosenthal29:43

      And there's one more really, really important subpoint here to what this loan is, and it relates to the banks and why this is so powerful for B of A and for all banks. Think back to the old way that B of A was doing this. A California, you know, homeowner wants to go buy a new refrigerator. They walk into a B of A, talk about it with the lending officer, blah, blah, blah, a bunch of operational costs. Who cares about that? At the end of the process, B of A gives them the money. The money is now out of B of A's hands. It's out the door. The consumer then goes to the merchant and gives the merchant the money and buys the refrigerator.... What's happening now with credit cards is actually a little different. The consumer goes to the store, the consumer buys the refrigerator with the credit card. No money has left B of A's hands yet. They get to keep the money!

   6. BGBen Gilbert30:38

      Right. A transaction has been authorized, but yes, they get to keep the money.

   7. DRDavid Rosenthal30:43

      And 'cause we're talking about California here, there is a very high likelihood chance, and I think at the beginning, I suspect a one hundred percent chance, that the merchant also banks with B of A. So that money is [chuckles] never leaving Bank of America's hands, which frees up more capital, which frees up flow, which is just like the B of A management must have been besides themselves with glee about this.

   8. BGBen Gilbert31:07

      Well, in theory, if they manage to put any sort of financial controls or proper risk underwriting on this whole thing, but it turns out, David, as I'm sure you are about to tell us-

   9. DRDavid Rosenthal31:16

      That's exactly where we're going

   10. BGBen Gilbert31:17

       ... When you mail sixty-five thousand cards indiscriminately with the same credit limit to every single customer and say, "Have at it, guys," and this is a brand-new consumer behavior that they've heard about or they might have witnessed in one form or another, but now they have a bona fide ChargePlus credit card sitting in their hands, uh, you're gonna lose a lot of money at first.

   11. DRDavid Rosenthal31:38

       Yeah, because there's another more pernicious way that this type of lending is different than the previous type of lending that B of A was doing: it's unsecured. If you give a customer a loan to go buy the refrigerator, you don't wanna go repossess the refrigerator, but push comes to shove, you can go repossess the refrigerator. This whole consumer credit card land is unsecured lending.

   12. BGBen Gilbert32:01

       So you probably shouldn't apply the assumptions about your loss ratios from secured lending to unsecured lending, but that is exactly what happened.

   13. DRDavid Rosenthal32:10

       And this all comes back to why it really had to be Bank of America to start this program, because they do this, they do the drop in Fresno, sixty-five thousand unsolicited cards go out to unsuspecting consumers. Fraud is out of control. Twenty million dollars of fraud within the first pilot program. Twenty-two percent of the credit that they issued to that initial Fresno cohort ends up being default or delinquent, which I think is, like, five or six times what their delinquency rate was before on traditional lending.

   14. BGBen Gilbert32:47

       Yeah, it is pretty crazy. So it's worth pointing out, you know, we're talking a lot about credit and debt at this point in time, and now in 2023, some of these kind of sound like bad words, and frankly, it's because of the situation that the society has sort of, like, pushed Americans to. But it was a very different time back when credit cards were first getting started and when this sort of practice of installment loans was extremely common in the pre-card era. So I want to read-- There's a great passage from A Piece of the Action that I mentioned earlier that I just want to read here: "Despite the denunciations, despite the free-floating anxiety, Americans have always borrowed money to buy things, if not from a bank, then from somebody, from a finance company or a credit union or a department store or a loan shark, for that matter. There isn't another Western country that has relied so heavily on consumer credit. Between 1958 and 1990, there was never a year where the amount of outstanding consumer debt wasn't higher than the year before. Years later, a Bank of America executive could look back on his lifetime in the credit card industry and say proudly, 'Consumer credit built this country.' Whatever one's feelings about personal debt, it is difficult to disagree with this assertion." So interestingly, what's basically happening here is people are using debt not because of this bleak, horrible time that they're in. It's actually because of their optimism. They believe that the future is brighter than the present, and so they're fine taking on debt, and that is sort of what has sort of led us to today, where because the growth of the American economy and the global economy has been so strong, people have always generally been fine, or at least we exist in a system that teaches you you should kind of be fine betting that the future is gonna be better than today.

   15. DRDavid Rosenthal34:37

       Such a good point. As long as growth is happening in an economy, a society, industry, whatever, you should absolutely use capital to fuel into that growth.

   16. BGBen Gilbert34:49

       Yep, and that may not be true on an individual basis, but it is absolutely true on a societal basis.

   17. DRDavid Rosenthal34:55

       Yep. So back to what I was saying about why B of A is so important. B of A can absorb this loss. No other consumer bank at the time, if they had seen twenty million dollars of losses in, like, a set of months, they would've pulled the rip cord immediately. B of A, though, they can absorb this loss, no problem, and they know if we can make this work, this is gonna transform our business. So rather than pulling the rip cord, they expand. They roll it out quickly across the whole rest of California. Over the next year, all within the first year, they sign up twenty thousand merchants in California, and get this: Do you know how many cardholders they sign up in that first year?

   18. BGBen Gilbert35:39

       No.

   19. DRDavid Rosenthal35:39

       Two million California cardholders signed up using the card in the first year. It took Diners Club years to get to a million. Amex was so proud in the first year or two, they get to seven hundred thousand. B of A instantly, at scale, is the largest charge card, credit card program certainly in America, I suspect in the world, and that's one year and one state.

   20. BGBen Gilbert36:07

       This is like Meta launching Threads or Microsoft launching Teams. You can sort of sit back for a while and watch the innovation and figure out what the very best product is that people want, and then you can go ram it through your distribution channels when you invent one of your own.

   21. DRDavid Rosenthal36:23

       Yep, and it's even more than that. As we said, this really was a big innovation. Like, it wasn't just that they-... Copy Diners Club or anything else. Like, they were adding credit to this. This was a huge innovation.

   22. BGBen Gilbert36:34

       Yep.

5. 36:35 – 56:24

   From secret success to nationwide franchising—and a scaling crisis

   1. DRDavid Rosenthal36:35

      So by 1961, year three of the program, they're able to get fraud under control enough that the whole program is profitable.

   2. BGBen Gilbert36:43

      But they keep that under their hats.

   3. DRDavid Rosenthal36:45

      Yes, yes. They don't want anybody else to know about this.

   4. BGBen Gilbert36:47

      So there's been all these newspaper articles about all this money that B of A is losing. So many banks that had been thinking about launching a similar program abandoned it, 'cause they were like, "Oh, man, we thought this was gonna work, but clearly it's not working for B of A." So people were shutting down their efforts. There was rumors that another bank was gonna launch in LA, in San Francisco, and B of A had actually rushed theirs to market to go be sooner than these other banks that actually never ended up launching, because the market perception was that it was such a gigantic failure. Here's a crazy stat: From 1960 to 1966, so this whole era is actually a profitable era for B of A, but no one else knows it, there were only 10 new credit cards introduced in the entire United States, because they did such a good job keeping what became a cash gusher for them quiet. But secret comes out in 1966, and from 1966 to 1968, just two years, approximately 440 credit cards were introduced by banks large and small throughout the country.

   5. DRDavid Rosenthal37:51

      Yes, and it is specifically 1966 when the secret gets out, because phase two of Bank of America's grand master plan here gets unveiled, which is maybe worth a quick setup. As we said, this was transformative for their business in California, but they're the biggest bank in America, and they have been itching for any kind of way to expand to truly be the Bank of America. Like, why the hell did they change the name to Bank of America? It's not 'cause they wanted to be the Bank of California. So they're like, "Maybe this is our path," and California is only, like, 10% of the US population. In 1966, they create the BankAmericard Service Organization with the express purpose of licensing out the BankAmericard program and network to banks across the country, across all 50 states, and this is the seed of Visa.

   6. BGBen Gilbert38:52

      But listeners, before we talk about how the BankAmericard Licensing Association morphs into Visa, now is the perfect time to tell you about one of our favorite companies, Blinkist, and their new parent company, GoOne, where David and I are proud angel investors.

   7. DRDavid Rosenthal39:08

      Yes. Blinkist, as you know, takes books and condenses them into the most important points, so you can read or listen to the summaries. It's great if your job, unlike ours, isn't just to sit around and read books all day-

   8. BGBen Gilbert39:18

      [laughing]

   9. DRDavid Rosenthal39:19

      ... but you still want the amazing insights. So as Blinkist has been doing throughout the season, they are creating Blinks of our research books for each episode and making them available to you all for free. You can find our material for this episode, including Dave's awesome book and Dee Hock's memoir, One From Many, at blinkist.com/visa.

   10. BGBen Gilbert39:39

       Yep, and they have also created something very cool that I never thought anyone would ask for from us. They created a page that represents David and my bookshelves. So if you want to read our favorite books broadly, having nothing to do with this episode, but, like, literally what's behind me on that bookshelf that I feel are kind of our trophies from all the episodes that we have researched, you can go to blinkist.com/acquired and look at Ben and David's bookshelf, and you can get those for free. So beyond that, Blinkist is always giving Acquired listeners an exclusive 50% discount on all their premium content, which is really great stuff, all these summaries and especially the audio summaries of really important books.

   11. DRDavid Rosenthal40:18

       Yeah. So many of you may be wondering: Why is Blinkist giving such an awesome deal to the Acquired community? I don't say that tongue in cheek, it really is. The reason is that GoOne, where we're investors and which acquired them this year, is an amazing corporate learning and development content platform, that if you're a L&D manager, a team lead, or a founder, which obviously many of you are, you should absolutely go check out. GoOne is the one subscription, one billing, one-stop shop to get literally all of the content that you need for your workforce at companies. So this is HR trainings, specific skill set development classes, everything you need across your whole company. They're the leader in the space. They're just an awesome company that you should definitely work with if you are not already.

   12. BGBen Gilbert41:03

       Yep. Our huge thanks to Blinkist and GoOne. Go take advantage of all this free content by clicking the link in the show notes. Okay, David, so how do we get to Visa? You have been telling me about the BankAmericard from Bank of America, and I opened this show saying Visa's not a bank, and Visa doesn't have direct relationships. It's this big, indirect thing where they work with other banks. This is a big mismatch.

   13. DRDavid Rosenthal41:28

       This story is so wild, because this first chapter that we just told, there's only one entity in the world that could have done this: Bank of America. In this second chapter, there is also only one person in the world that could have taken BankAmericard and turned it into Visa, and that is Dee Hock. So here we are in 1966. B of A now starts going around to all the other consumer banks in other states and selling them on joining the network as BankAmericard licensees, and the deal is that you pay B of A a $25,000 franchise fee to get your franchise [chuckles] of the BankAmericard.

   14. BGBen Gilbert42:10

       [chuckles]

   15. DRDavid Rosenthal42:10

       This is like a Wendy's or something. Plus, then, you pay them a percentage of the gross transaction revenues. It literally is like a McDonald's. This is wild. I mean, I get it. The executives must have just been throwing party after party, because, A, this whole thing turbocharged their own business. B, now they're like, "Oh, we're gonna make [chuckles] all the other consumer banks in the country essentially into like serfs on our kingdom here."

   16. BGBen Gilbert42:35

       ... Right, and one of the assumptions they made was correct, and the other one was too hubris. The first assumption is a good business model decision, which is, okay, we've now created this distributed asset, which is all these customers with our card that want to use our card at lots of merchants. People still weren't using credit cards the way we do today, just treating it like cash and using it for coffees and little things here and there. It was still sort of treated as, this is the card for big purchases, some of which I may want to finance and decide later.

   17. DRDavid Rosenthal43:05

       It was also an intensely, like, private thing, kind of taboo thing, right? Because when you were using a credit card in these days, you were implicitly saying, "I'm using debt to buy this transaction." And so you didn't want other people to necessarily know that.

   18. BGBen Gilbert43:19

       Right. It's a bit odd, but consumers clearly did want to use this thing for some subset of the purposes that they did today. And so Bank of America's kind of leaning into it and saying, "We've got this asset. Surely, we can leverage that for great gain." But the specific implementation of it was a bad assumption, where they said, "The way that we can take advantage of the fact that now all these consumers have the card and all these merchants out there and accept the card is this weird franchising thing."

   19. DRDavid Rosenthal43:45

       Well, the bad assumption was that other banks would consent to basically being serfs in their kingdom.

   20. BGBen Gilbert43:52

       Yes.

   21. DRDavid Rosenthal43:53

       But at the outset, these other banks see the power, and now that B of A is telling them of what this has done for B of A, and they're like, "Wow, this is already the biggest charge card credit network in America, if not the world. We can now bring this to our state." And I think B of A offers exclusivity to banks in geographic areas, too, to start. That eventually, of course, gets dropped, but it does tempt a lot of people. So within two years, by 1968, a couple hundred banks have signed up. There are six million cardholders across the country and beyond the country. Actually, Barclays Bank in the UK had signed up to be a franchisee of BankAmericard back in the day.

   22. BGBen Gilbert44:34

       Whoa! What year is this?

   23. DRDavid Rosenthal44:36

       This is, like, in the, you know, mid-'60s.

   24. BGBen Gilbert44:39

       Whoa, that's way earlier than I realized for international expansion.

   25. DRDavid Rosenthal44:42

       Yeah, it was already out of the US, 'cause the system is a great system, but as this expands beyond B of A, it becomes clear that a bunch of stuff that were either just assumptions or ways of business within B of A or things they didn't have to worry about ain't gonna scale to hundreds of banks, all fifty states, multiple countries around the world. One of the examples, I alluded to this earlier, in California, in the Bank of America-owned and operated BankAmericard system, usually, all parties in the transaction were Bank of America customers. So, like, there wasn't really any difference between the bank of the consumer, the cardholder, and the bank of the merchant, and B of A controlled both sides. Once they expand the network and let other banks in, all of a sudden, that's almost never the case.

   26. BGBen Gilbert45:39

       Right. You know, B of A realized the sort of cardinal sin of many entrepreneurs, which is my particular situation, is actually not a pattern of several other customers. It's actually an N of one. I'm idiosyncratic, so when I'm just making the same assumptions about all the future customers about serving my own needs, that's actually a false assumption.

   27. DRDavid Rosenthal45:57

       Yep. So B of A has no distinction between what ultimately now in the Visa network and MasterCard and others is called issuing banks, these are the banks that give the cards to the customers, and merchant banks that are the banks of the merchants. It's all just one for B of A.

   28. BGBen Gilbert46:13

       Yes, and these merchant banks, we'll come back to some of this terminology later, has gone on to become the acquiring bank because this is the bank that acquires the merchant relationship as a customer.

   29. DRDavid Rosenthal46:23

       So now, in this new world, where there's different banks on each side of the transaction, this creates the need for a network and operational services to settle those transactions. This comes to be known as interchange, and interchange fees are obviously what Visa does today.

   30. BGBen Gilbert46:43

       Yeah, and this is the first moment that we start to see a departure from what American Express was doing. The original BankAmericard was very similar to American Express and Diners Club, where they were closed-loop systems. It was a bank that issued a card to be used at a payment terminal that all stayed within the bank's closed-loop network. And now, with this new BankAmericard licensee system that they're starting to sort of develop here that would become Visa, it's an open-loop system. It's, "Hey, there's one bank on one side who owns the customer, who owns the cardholder, and one bank on another side, and we're gonna enable those systems to talk to each other, but they're not the same party. This is open-loop now."
6. 56:24 – 1:09:33

   Columbus, Ohio 1968: the summit that births Visa’s new governance

   1. DRDavid Rosenthal56:24

      So all of these tensions come to a head in October 1968, when the licensees, all the franchisees of Bank of America, all these other banks across the country, they demand a summit. They need to air their grievances with, you know, the parent, with Bank of America. "This is untenable. We can't operate like this. We gotta fix this." B of A says, "Okay, fine. We'll all get together in Columbus, Ohio."

   2. BGBen Gilbert56:52

      Really? No way!

   3. DRDavid Rosenthal56:52

      In the middle of the country. You didn't know this?

   4. BGBen Gilbert56:54

      No.

   5. DRDavid Rosenthal56:54

      Oh, amazing. I thought you knew this. Yeah, Columbus, Ohio. Ohio State.

   6. BGBen Gilbert56:58

      Oh, wow. Amazing.

   7. DRDavid Rosenthal57:00

      This is where the birth of Visa happens. So the summit gets organized, and for the franchisee banks, this is sort of becoming existential for their businesses. They're racking up such huge losses. This is such chaos. They're sending senior representatives from the banks, everybody running their card programs, everybody's converging in Columbus. B of A sends two, like, mid-level marketing managers to go face the angry mob.

   8. BGBen Gilbert57:26

      [laughing]

   9. DRDavid Rosenthal57:26

      None of the senior executives from B of A could be bothered enough to go deal with this-

   10. BGBen Gilbert57:31

       Wow

   11. DRDavid Rosenthal57:32

       ... which just says everything. And these poor guys who show up, I mean, they are literally facing, like, pitchforks. The franchisees are incensed, and they're incensed both 'cause the situation sucks, and they're like, "Goddamn it, B of A, take us seriously. You have meddled in our entire businesses. This is in chaos. Like, we gotta fix this." So what do these two poor B of A guys do? Right before lunch on the second day, they're like: "Yo, we gotta save our skins. We gotta get out of here. Let's do the smart thing to make sure that everybody gets placated, but nothing actually happens," 'cause they don't have any authorization from Bank of America to do anything. They're just, uh, people sent to face the mob. "Let's appoint a committee- [laughing]

   12. BGBen Gilbert58:19

       [laughing]

   13. DRDavid Rosenthal58:19

       -of licensees to, quote, unquote, 'investigate all of the operating problems and report back to us.' You know, they can come out to San Francisco. They can meet us at B of A headquarters, and we'll listen to their problems." [chuckles]

   14. BGBen Gilbert58:34

       Wow.

   15. DRDavid Rosenthal58:35

       But unfortunately for their goals, their very narrow goals, that particular morning, but very, very fortunately for all involved, the franchisees, the world, consumers-

   16. BGBen Gilbert58:48

       In the long term, at least.

   17. DRDavid Rosenthal58:49

       In the long term, and also Bank of America in the long term, one of the people that gets put on that committee is the BankAmericard franchisee program manager from a small bank in Seattle, the Seattle National Bank of Commerce, which would go on to become Rainier Bank, and then, ironically, do you know what happened to Rainier Bank? You can't make this stuff up.

   18. BGBen Gilbert59:14

       No, I don't, but I can guess where this is going.

   19. DRDavid Rosenthal59:16

       Yep. Once interstate banking regulations get loosened up, they get acquired by Bank of America, of course, in the 1990s. [laughing] But for the moment, the person running their BankAmericard franchisee program is one Dee Hock, and I think you could really say on this day, the founder of Visa.

   20. BGBen Gilbert59:40

       And one of the most interesting characters in anything we've ever studied because he's not a tycoon the way that most of these people are.

   21. DRDavid Rosenthal59:50

       No, and we're gonna talk much more about Dee in a minute, but just to keep the story going so we don't leave you all in suspense on this day, during the lunch break, Dee has gotten put on this committee. He goes up to the two B of A guys, and he's like, "Hey, rather than us just putting together a list of grievances and reporting back to you at B of A, what if instead, we do examine all the problems in this system, but what if we ourselves, this committee, we design and propose a new way of operating the whole thing?" And after some convincing, the B of A guys are like, "Eh, sure." I mean, they're not agreeing to anything. Their goal is just to escape the mob anyway. They're like, "Whatever, if this makes you happy, if this lets us escape back to California, sure." And probably, almost assuredly, I mean, this is a committee we're talking about, nothing is gonna come of this.

   22. BGBen Gilbert1:00:50

       Yep.

   23. DRDavid Rosenthal1:00:51

       ... So the whole summit reconvenes after lunch, and Dee gets up on stage, not the Bank of America guys, and he proposes this idea to the group. Say, "Hey, we've got this committee. Rather than us taking a list of grievances back to B of A, what if we try and design a new way that the system could operate and operate better for everyone?" They take a vote on it. Everybody agrees, mostly, I think, just 'cause they wanted to get out of there, go back home, and away from this disaster of a meeting. They all get on planes. They all leave, most of them probably thinking that nothing is ever gonna come of this. Certainly, the B of A guys thinking nothing is ever gonna come of this. But Dee kind of thinks he just got authorization to go create Visa.

   24. BGBen Gilbert1:01:43

       Whole new system, and he has no power at this point, but he kind of thinks he does. And listeners, now is a great time to tell you about our next favorite company, Crusoe.

   25. DRDavid Rosenthal1:01:55

       Yes, Crusoe, as you know by now, is a cloud provider specifically built for AI workloads powered by clean energy. Today, right in theme with Visa, we are talking about reliability and some of those details of Crusoe's infrastructure. So by this point, you know that their cloud is run on wasted, stranded, or clean energy, and they can provide significantly better performance for your dollar than traditional cloud providers.

   26. BGBen Gilbert1:02:19

       So how do they do it? It is a little bit more than just saying they put data centers next to natural gas flares or stranded energy from wind turbines. I mean, that insight alone has value, but this is insanely difficult to pull off, to build this multi-tenant architecture at scale and implement things like InfiniBand with rail optimization. So here are some of the things that Crusoe's team has had to do and why it required people with backgrounds in data centers, oil fields, utilities, networking, software, and manufacturing all working together to do it. So one, they have to trench high-bandwidth fiber themselves, and as you might imagine, putting a data center in a remote location, that is not just magically next to an ISP that you get to plug it into and have redundancy. Two, rugged infrastructure. Not only do they need to custom-design the data center architecture to let customers eke out every ounce of performance, it also needs to work in these locations. They initially worked with external vendors, but they've now started something called Crusoe Industries, which manufactures a majority of their mobile and modular data centers and electrical equipment themselves. And three is operations. Things go wrong out in the field, especially in remote locations, and Crusoe has a fault-tolerant organization that is able to plan for the maintenance and repairs and manage the failures when they do inevitably happen. So the team has deep data center operations expertise to ensure that customer AI workloads operate seamlessly when minimal disruption, and they really do plan for these things to happen and have great redundancy in place.

   27. DRDavid Rosenthal1:03:49

       It's so cool. I mean, ultimately, this results in a huge win-win. They take what is otherwise a huge amount of energy waste and environmental harm, and they use it to power massive AI workloads. How could you do any better?

   28. BGBen Gilbert1:04:00

       If you, your company, or your portfolio companies could use lower-cost, more performant infrastructure for your AI workloads, go to crusoecloud.com/acquired, C-R-U-S-O-E cloud.com/acquired, or click the link in the show notes. Okay, so David, Dee Hock thinks he's got a mandate to go change things up in a big way and create some big, crazy, new proposal.

   29. DRDavid Rosenthal1:04:21

       [chuckles] Yeah, and he's not wrong. [chuckles] Uh, fortune favors the bold, you know, might you say?

   30. BGBen Gilbert1:04:27

       Yes.
7. 1:09:33 – 1:15:43

   Dee Hock: unlikely founder, master persuader, incentive architect

   1. DRDavid Rosenthal1:09:33

      few words about Dee, because this situation is nuts. Dee is a banker. He is running the BankAmericard franchise program at what would become Rainier Bank in Seattle. But he's an outsider, he's kind of a nobody, he's not senior in a small bank in Seattle. He was raised in rural Utah, basically in poverty during the Depression. He didn't go to a four-year college. He only has an associate's degree. He bounced around in a bunch of random consumer finance jobs on the West Coast, all of which he got fired from because he's too insubordinate. He, now walking into the boardroom in Bank of America, which is what he's gonna do, and standing toe-to-toe with the vice chairman of Bank of America and saying, "I think you should give me the BankAmericard program [laughing] because it is in your self-interest to do so," which almost literally are the words that come out of his mouth in that boardroom, is just absolutely wild.

   2. BGBen Gilbert1:10:39

      Fortune favors the bold.

   3. DRDavid Rosenthal1:10:40

      Fortune favors the bold.

   4. BGBen Gilbert1:10:42

      Importantly, though, fortune favors the bold who have done the work to figure out how to align incentives such that a logical person will think through and come to the same conclusion he has.

   5. DRDavid Rosenthal1:10:52

      And this is the thing, Dee is an odd duck, for sure, but he is amazingly smart. He's, like, basically all self-taught. He's incredibly well-read. He started reading every book on, you know, his little farm in Utah that he could get his hands on when he was seven years old. Super importantly, you know, this is a Steve Jobs, "You can only connect the dots looking backward," moment. He was not very good at sports in high school, so he got into debate instead. And then he also did debate in college when he did his associate's degree, and so he uses all of the techniques that he learned from competitive debate and persuasion. He has this amazing quote. He says, "During my years of college debate, I held fast to the notion that until someone has repeatedly said no and adamantly refuses another word on the subject, they are in the process of saying yes and don't know it." [laughing] I mean, Dee basically is the prototypical Silicon Valley founder. He's just a generation too early and in the wrong industry.

   6. BGBen Gilbert1:11:54

      I once had a Silicon Valley founder give a talk at a startup week, and I ran ten, twelve years ago, who said, "Until your company shuts down, you are just in the act of succeeding."

   7. DRDavid Rosenthal1:12:03

      Totally. [chuckles] I mean, cut from the same cloth-

   8. BGBen Gilbert1:12:07

      Yep

   9. DRDavid Rosenthal1:12:07

      ... right down to every single stitch. There's one other important aspect to Dee that I think we should highlight here that enables him and all of Visa to succeed, and that's that he's about as far from the man and image of J.P. Morgan as you could imagine. That is what enables this, because if he were the CEO of another bank or a senior executive or some well-respected person marching into the Bank of America boardroom and standing toe-to-toe with their board and saying, "I want you to give me your very precious crown jewel," there's no way it would work. Of course, Bank of America would say, "What's in it for you? I don't trust you. I don't believe you." Even if they did trust and believe this person-... they would lose all of their face and reputation if they were subordinating themselves to somebody who could conceivably be their equal. So Dee's just gone into B of A with this grand vision of, like, "You should give me this incredible asset because the value that it will create outside of your hands, and your fractional ownership thereof, will be so much greater than what it could be on its own." And miraculously, that works!

   10. BGBen Gilbert1:13:27

       Like, would you rather own a few percent of something that is the default global way that commerce is produced, or would you rather own 100% of, you know, BankAmericards?

   11. DRDavid Rosenthal1:13:38

       Yep. Totally incredible that Dee actually convinces Bank of America to do this. Nobody in the world would have thought that this could happen. But now the work is sort of just beginning, because there's two things now that he needs to do. One, he hasn't actually figured out how to architect this thing such that it works, so he's gotta go do that. Two, though, then, now he has to go back to all of the soon-to-be former franchisee banks and convince them why they should do this, and this is a different argument from what he made to B of A. B of A, he's trying to get them to give him the asset. With the other banks, he actually needs to get them to change their behavior. He needs to be able to go to, say, the couple banks in Illinois that are existing franchisees of the BankAmericard system and say, "Hey, the new regulations, the new operating laws for this organization are gonna be all the banks in Illinois can join, and we actively want to go convince all of your competitors to come join this system."

   12. BGBen Gilbert1:14:41

       I see. So he's basically coming to them with a waiver and saying, "I want you to waive your exclusivity to some territory, because in our new construct here where we're all working together, you and everyone else is agreeing that it's good for the value of us all if we waive our exclusivity."

   13. DRDavid Rosenthal1:14:58

       You know what this is like? This is like back in our NFL episode-

   14. BGBen Gilbert1:15:02

       Yes, that's exactly right

   15. DRDavid Rosenthal1:15:03

       ... when the NFL started negotiating national television rights collectively as an organization.

   16. BGBen Gilbert1:15:09

       Yep.

   17. DRDavid Rosenthal1:15:09

       A bunch of the individual teams hated that, 'cause they were like, "If I'm the Jets, I'm making more money in my New York Metro area doing my own TV deals than I'm gonna get as a share from you, the NFL, of a national deal." But in the long run, it was absolutely the right decision and value accretive to everybody, including the Jets, that the NFL centralized this.

   18. BGBen Gilbert1:15:30

       You'd rather be the Jets with their proportional share of the $14 billion a year TV deal that the NFL has today than, uh, whatever their very fat contract was alone in the, what, the '60s, '70s?

8. 1:15:43 – 1:23:07

   Designing NBI: the for-profit, non-stock, democratic ‘reverse holding company’

   1. DRDavid Rosenthal1:15:43

      Totally. It is exactly the same thing here. Okay, so how's this whole thing gonna work? Dee and a few of his other fellow committee members, they go to Sausalito, California, just north of San Francisco, just across the Golden Gate Bridge, and they do an off-site for a couple days at a hotel in Sausalito, and there they come up with a number of operating regulations, guidelines for this hypothetical new entity, four of which we're gonna talk about here that are super critical. One, ownership of this new organization that's gonna be called National BankAmericard Inc, the new owner of the BankAmericard program, is going to be in the form of irrevocable, non-transferable rights of participation. So you're not gonna own stock in this thing. There's no equity. The way that you have ownership, and the percentage ownership that you have in the network, is by participating in it and the amount of volume that you are contributing to the network.

   2. BGBen Gilbert1:16:47

      Oh, interesting.

   3. DRDavid Rosenthal1:16:49

      So this means a couple things. One, it's sort of like a representation and ownership according to value contributed. Two, it's non-transferable, so you can't sell it. Any individual bank, if they were to say, like, "Ooh, this is valuable now, I'm gonna go sell it, and then I no longer have any incentive to participate in the network," if that starts happening, then it'll lead to a cascade for the exits and the network will lose value. So there's no way to do that.

   4. BGBen Gilbert1:17:16

      So it's basically designed for you to kind of break even on it. If you're putting in 17% of the transactions on the whole network and you're paying in fees on 17% of the transaction, well, good news, for all of the leftover profits from running the network, 17% of them go back to you.

   5. DRDavid Rosenthal1:17:31

      You're making the assumption that this is a cost-only organization. You're forgetting the fact that it is one of the greatest business models and revenue generators- [laughs]

   6. BGBen Gilbert1:17:40

      [laughs]

   7. DRDavid Rosenthal1:17:41

      ... of all time. [laughs] You are contributing 17% of the volume to this. You are entitled to 17% of the profits-

   8. BGBen Gilbert1:17:47

      I see

   9. DRDavid Rosenthal1:17:47

      ... that we are extracting from the merchants and the cardholders.

   10. BGBen Gilbert1:17:51

       Yep. Because this is the natural business model of interchange, to do the exact same things that was being done with the sales drafts, where you sort of give a discount to the retailer, and when I say discount, I don't mean a beneficial one, I mean I'm discounting the amount of money that I am giving you, uh, off of the 100% that you would have received by the customer. Basically taking that old check courier business model and carrying it into sort of a network form.

   11. DRDavid Rosenthal1:18:16

       Yep, exactly. So the actual legal structure that Dee and his fellow committee members land on for this is a for-profit, non-stock, membership corporation.

   12. BGBen Gilbert1:18:28

       That is a mouthful.

   13. DRDavid Rosenthal1:18:29

       It is. There's a myth out there that Visa was originally a nonprofit and then was converted to a for-profit before the IPO in 2008. That's not true. It was always for-profit. It was just a non-stock membership corporation.

   14. BGBen Gilbert1:18:44

       Hmm.

   15. DRDavid Rosenthal1:18:45

       And that was to get around banks selling their interest. So you don't participate in it, you don't own it.

   16. BGBen Gilbert1:18:51

       So say it one more time. It is a for-profit...

   17. DRDavid Rosenthal1:18:54

       A for-profit, non-stock, membership corporation. Your ownership is your membership.

   18. BGBen Gilbert1:19:02

       ... fascinating.

   19. DRDavid Rosenthal1:19:03

       It's like a co-op. It's like REI or something like that.

   20. BGBen Gilbert1:19:06

       Yeah, yeah.

   21. DRDavid Rosenthal1:19:06

       The way that Dee describes it to all the other banks is, it is a reverse holding company. The parent entity is owned by the subordinate members, as opposed to the top-level holding company owning all the subordinates.

   22. BGBen Gilbert1:19:18

       There's actually another NFL analogy here. The NFL doesn't own the teams, the team owners own the NFL.

   23. DRDavid Rosenthal1:19:24

       Yes, but the NFL sets all the regulations for how the game is played, and all the teams submit to it.

   24. BGBen Gilbert1:19:30

       That's actually probably the best analogy for Visa, is the NFL league organization.

   25. DRDavid Rosenthal1:19:35

       I think it totally is. Okay, so that's point number one, maybe the most important one. Point number two, it is a self-organizing body with irrevocable governance rights for each member, and this is ... well, I guess also how it's like the NFL. Basically, this means this is a democracy. Every member has a vote in determining how this organization runs. Anything that you could conceivably have a vote on, changing our regulations, setting them in the first place, budgets, fees, all this stuff every single member bank will have a vote, and importantly, every single member bank can call a vote at any time. I mean, it's literally like a pure democracy.

   26. BGBen Gilbert1:20:21

       Wow! You could imagine nothing happening if everybody has the right to do that.

   27. DRDavid Rosenthal1:20:26

       Well, they set the threshold at 80% for anything to happen. [chuckles]

   28. BGBen Gilbert1:20:29

       I see.

   29. DRDavid Rosenthal1:20:29

       So there's a strong incentive not to call a vote and waste everybody's time, unless you really think you can round up 80% of the votes.

   30. BGBen Gilbert1:20:36

       Fascinating.
9. 1:23:07 – 1:25:50

   Winning banks and regulators: tipping the network and getting DOJ clearance

   1. DRDavid Rosenthal1:23:07

      That is exactly the pitch, and amazingly, e- even describing this now, having done all the research, read all the books, written the script that we're talking about here, I still can't believe this actually happens. Dee goes on, like, a tour across the country. He goes and meets with all the banks. Bank of America helps him out. They bring senior executives, too, to help convene, you know, meetings with all the banks to persuade them. Every single member bank of the previous BankAmericard franchisee organization, every single one of them signs up for the new organization led by Dee. Not a single person jumped ship.

   2. BGBen Gilbert1:23:47

      How many banks were at this point?

   3. DRDavid Rosenthal1:23:48

      Over 200.

   4. BGBen Gilbert1:23:49

      Wow!

   5. DRDavid Rosenthal1:23:50

      Isn't that wild?

   6. BGBen Gilbert1:23:52

      I mean, once you get to, like, 70 or something, then it kinda seems likely that everyone's gonna tip. But in those first 20, the fact that nobody was out is crazy.

   7. DRDavid Rosenthal1:24:01

      Totally, and Dee writes about this, too. Bank of America helped him out. They identified the 13 most influential banks, and they convened the first summits with them of, like, "Hey, what do we gotta do to horse trade to get you guys involved?"

   8. BGBen Gilbert1:24:15

      Wow.

   9. DRDavid Rosenthal1:24:15

      And then you kinda spiral out from there. But yeah, every single one, nobody jumped ship.

   10. BGBen Gilbert1:24:20

       And when is this? Like, 1970-ish?

   11. DRDavid Rosenthal1:24:22

       The process starts in 1968. It all wraps up in either 1970 or 1971.

   12. BGBen Gilbert1:24:27

       Hmm.

   13. DRDavid Rosenthal1:24:28

       Importantly, we've talked about antitrust and DOJ a bunch here. You would think that this would be setting off massive alarm bells in Washington [chuckles] and with the Department of Justice. They get ahead of this. So Dee goes to see them, and he gives the same pitch to the government. He says, like: "Look, obviously, this is the whole industry, all the competitors in the industry colluding to work together. That's the whole premise of the organization. But what we can create by doing this would not be possible otherwise, and it will be so profoundly useful and important to the American consumer and American businesses, that it is worth you letting us do this." So they actually get a letter from the DOJ saying, like-... hall pass, you're good on this one.

   14. BGBen Gilbert1:25:14

       Wow!

   15. DRDavid Rosenthal1:25:15

       Yeah.

   16. BGBen Gilbert1:25:15

       It's just like the presidential exceptions for the NFL, like an antitrust exemption, where, yeah, we're amenable to the fact that you're collaborating, potentially colluding, but it is actually one of the things that we believe will make the country better, so go for it.

   17. DRDavid Rosenthal1:25:28

       America wants both its football and its credit cards. [laughing] Amazing. And that was a key point in then going and convincing all the other banks to sign up for this, 'cause that was one of the first questions they asked: "Hey, if we do this, aren't we inviting the DOJ on our backs?" And Dee is able to say, like, "Nope, got the letter right here. We're good."

   18. BGBen Gilbert1:25:48

       Wow, amazing.

10. 1:25:50 – 1:38:25

    Going global and rebranding: from BankAmericard to Visa

    1. DRDavid Rosenthal1:25:50

       So very shortly after this, after the creation of NBI, National BankAmericard Inc., Dee, in 1972, he's thinking globally from the get-go. He goes and creates a parallel, similar organization of international banks using the BankAmericard system. Visa was global from basically day one, and it wasn't just Barclays in the UK, it was Sumitomo Bank in Japan, it was other banks throughout Europe, it was Canada, it was Latin America. We won't go into all the detail here, except one amazing story we're gonna tell. This was actually harder to pull off, if you can imagine that, than forming NBI, because it really is not clear for some of these international banks that it is better for them to be part of the global network than if they could run the table on their entire country. Say you're, I don't know, I'll pick Sumitomo Bank in Japan. You have to decide, do I wanna buy Dee's pitch of it's worth it to me to be a proportional owner of Visa, or I could be the singular dominant credit card network in my own country? Which is more valuable?

    2. BGBen Gilbert1:27:00

       And for many of them, they'd be right in saying it actually would be better to be singular and dominant. Like, you look at China UnionPay, I mean, that is the dominant way of payments flowing in China. That was, for them, the right move.

    3. DRDavid Rosenthal1:27:12

       Totally. So once again, in Sausalito, this all comes to a head. Dee knows that probably not all of the international banks are gonna agree to this, and some of them are gonna go their own way. So he calls, you know, a final summit in Sausalito. They're gonna vote the next morning, final vote, on who's gonna join the soon-to-be Visa network and who's gonna go it on their own. And Dee gives this nostalgic speech at the end of dinner saying, like, "Here in Sausalito, looking out at the bay, this is where me and my colleagues, we dreamed up the original vision for what this could be. And it's sad that this won't be extended to the whole world in a true global payment monetary system. But we're all gathered here. We should celebrate having accomplished so much and had a chance at this dream. Just having the chance is worth it." [chuckles] He's really good with his debate skills. And then he's like, "So before we meet one more time tomorrow to obviously disband this whole venture and have the dream just be a memory, we have one more thing for you." One more thing. He's like Steve Jobs. "A small gift of appreciation for you giving your valuable time and effort as part of this global undertaking. Please take this little box out from under your seats." Everybody takes a little box out from under their seat. They unwrap it, and inside are a pair of pure gold cufflinks, that on each of the two cufflinks, there is one half of the globe, and under one side it says, in Latin, "Studium ad prosperadam," which translates as "The will to succeed," and the other side says, "Voluntas in conveniendum." Apologies to Latin speakers out there, that I'm butchering that. Translates as "The grace to compromise." [laughing] And Dee explains this all, and somebody from the crowd yells out, "Dee, you miserable bastard!" [laughing] Because he just pulled on everybody's heartstrings.

    4. BGBen Gilbert1:29:18

       Oh.

    5. DRDavid Rosenthal1:29:18

       And, like, he gets the votes! And the next morning, all the holdouts reverse course, they all join, and-

    6. BGBen Gilbert1:29:25

       What?

    7. DRDavid Rosenthal1:29:26

       You can't make this stuff up. It literally happens. The cufflinks are out there. You can Google them. He did this.

    8. BGBen Gilbert1:29:31

       So he's basically saying, "Hey, whether you voted for this or not, you're getting to leave with something saying, 'I'm so great, I had the will to compromise,' even if you didn't, and you are the reason that you killed it."

    9. DRDavid Rosenthal1:29:42

       Dee is just such a character. So the other thing along these lines that he does, which is just hilarious, once this is all set up, this, the international part of Visa, becomes first Ibanco, I-B-A-N-C-O. Shortly after this, they rebrand the whole thing into Visa, which we'll talk about in a minute. For the board, the board is huge because it's, like, all the representatives from every region, from every country. There's, like, twenty-five people on the board. Dee holds board meetings all around the world, you know, different city all the time. It's a global organization, whatnot. He invites the spouses of all the board members to come to each location. He's, "Oh, it's a family trip," you know, et cetera. And then he gets the idea, he invites the spouses into the board meeting itself.

    10. BGBen Gilbert1:30:29

        Oh, what a nightmare. [laughing]

    11. DRDavid Rosenthal1:30:31

        So twenty-five board members, plus their spouses, in his board meeting. This means two things: one, nothing is gonna get done. There are fifty people in the room. Two, though, he needs all these people to behave well together and, you know, be generous and gallant. What better way to make sure they're on their best behavior than to have their spouse sitting behind them? [chuckles]

    12. BGBen Gilbert1:30:50

        Wow!

    13. DRDavid Rosenthal1:30:51

        So, like, are you really gonna act like an asshole in front of not only your spouse, but the spouses of all these other global bank heads?

    14. BGBen Gilbert1:30:58

        That's so funny. I'm gonna start doing that.

    15. DRDavid Rosenthal1:31:01

        We should have our wives in the room while we record. [chuckles]

    16. BGBen Gilbert1:31:03

        Definitely not.

    17. DRDavid Rosenthal1:31:05

        Oh, amazing. Amazing.

    18. BGBen Gilbert1:31:06

        I think neither would join for that.

    19. DRDavid Rosenthal1:31:08

        Totally, no. They'd be like, "No way."

    20. BGBen Gilbert1:31:09

        [laughing] Okay, so how does the name Visa come about? How does the sort of joining of the international and the domestic...

    21. DRDavid Rosenthal1:31:16

        Okay.... Visa is so important. It's not just a rebrand. It has to happen once this international organization is set up.

    22. BGBen Gilbert1:31:25

        Yeah, America can't be in the name.

    23. DRDavid Rosenthal1:31:26

        Yeah, BankAmericard ain't gonna work, and importantly, as we'll get into in a little bit, this is a huge problem for American Express, too. The soon-to-be Visa knows if we're really gonna realize this global vision, we need a truly global brand and mark. Remember, back to the blue, white, and gold three stripes. That's iconic. It works internationally. Obviously, the name does not. So Dee holds a contest internally within NBI/I Banco to generate a new name, and he offers a $50 prize for the winning entry [chuckles] that is chosen, and as legend goes, there are so many submissions of the name Visa that when they finally unveil it, Dee makes a big deal and writes out a $50 check. Check? Why are they using a check? Made out to everyone in the company. [laughing]

    24. BGBen Gilbert1:32:14

        [laughing]

    25. DRDavid Rosenthal1:32:15

        Which is funny, but then they change the name to Visa. Visa, it's the most incredible name ever created. I mean, Nike was so great. This is, like, even better. You cannot have a better name for what this is.

    26. BGBen Gilbert1:32:30

        It's interesting it's in English. I mean, I guess it makes sense. It's the most spoken language, but-

    27. DRDavid Rosenthal1:32:34

        Well, no, it's not just in English. The name Visa in every, if not almost every language, on Earth-

    28. BGBen Gilbert1:32:40

        And when you're traveling, and you need a visa for a country, they call it a visa in other languages, too?

    29. DRDavid Rosenthal1:32:44

        That's what it is. But when you are traveling internationally, when you're going through customs in any country, it is identified as a visa. That is the name.

    30. BGBen Gilbert1:32:52

        Yeah, the universality, it's sort of a presumptive close 'cause at this point, you know, they've got, what, three, four, five hundred banks? You know, and they have 16,000 today. It's quite the presumptive close that it will be universally accepted everywhere, the way that, uh, Visa would imply.
11. 1:38:25 – 1:46:38

    Open-loop beats closed-loop: why Visa/MasterCard outscale Amex

    1. BGBen Gilbert1:38:25

       Yeah, and it's worth a moment on Amex here, because I would have thought, just like Facebook or WhatsApp or Google, when you have this sort of winner-take-all, massive network effect business, that the single centralized player network effect would win. Why wouldn't Amex win with their closed-loop system, where they own the whole thing end to end and can provide the most incredibly custom experience for everyone on their platform, on the merchant side and on the consumer side? And one of the answers of why this open-loop system beat the closed-loop system is Visa adopts this strategy of the network of networks. They go sign up one bank, that bank can go sign up, you know, 100 million customers or 2 million merchants. They get so much scale leverage on signing up just one bank, that this strategy makes it so that they have far more scalability than something like Amex. Amex also is a bank themselves, so is highly regulated, and they're a bank, by this point in history, I believe, on both sides of the transaction. So they're both a card issuing bank, and they are a merchant acquiring bank. And so in terms of scaling internationally, you mentioned their name holds them back. Also, they have to become a bank in another country in order to expand to that country, whereas Visa just needs to go tap a few banks and say, "Why don't you go figure out how to grow for us there?" So this network of networks thing, the open-loop system, while it creates a little bit more of a kludgy user experience because there's sort of the lowest common denominator of data getting passed through the network, it's sort of open source versus something that's wholly owned and operated by a company or a protocol versus fully owned application. Anytime that you have something that's more distributed, you're gonna be compromising a little bit on the user experience because you can't sort of rule by fiat when you wanna make a change, but it does potentially come with much better scalability, which is the reason why Visa and MasterCard have become the dominant way versus the closed-loop systems.

    2. DRDavid Rosenthal1:40:33

       Yep. It's also worth closing the loop on MasterCard here, too. I mentioned that the DOJ eventually came after both Visa and MasterCard and prevented them from being exclusive systems. That does happen in 1975, and so this concept of duality takes hold for the banks, duality meaning they can multi-home on both Visa and MasterCard. In all the testimony and case with the DOJ, Dee is obviously 100% against this happening. He doesn't want his banks to be able to join MasterCard, too, but he also makes the surprisingly correct argument. He's like: "Look, this would be a huge mistake, because, US government, if you do this, you are going to freeze the payment networks in the US. Nobody is ever gonna develop a new competing open-loop payment network, because now there's no more competitive vector between Visa and MasterCard. We'll all have the same features. Banks will be members of both. They're kinda gonna operate in lockstep."

    3. BGBen Gilbert1:41:33

       The prices should be identical for both.

    4. DRDavid Rosenthal1:41:36

       All this stuff, and the DOJ is like, "No, no, no, no, we're gonna do it anyway." Irony of ironies, later, in 1988, the DOJ again sues Visa and MasterCard for being a duopoly [chuckles] and not competitive enough. So Dee was right, Dee was right.

    5. BGBen Gilbert1:41:51

       And to this day, Dee has been right. There have been many attempts that we'll talk about toward the end of this episode of displacing Visa and MasterCard or inventing new payment systems, and, like, they never work, or they haven't worked yet.

    6. DRDavid Rosenthal1:42:03

       Great point. They're in the process of working. [laughing]

    7. BGBen Gilbert1:42:06

       [laughing]

    8. DRDavid Rosenthal1:42:07

       So great.

    9. BGBen Gilbert1:42:08

       It's probably actually worth sharing the Amex thing. So Amex tried this crazy strategy in the '80s, and now I'm flashing forward ten years here, but they [chuckles] would basically cut their interchange, the discount rate that they were charging merchants, massively if those merchants would go exclusive to Amex. And this actually continued until 1991 for many of their merchants, [chuckles] and for Costco, went all the way to 2016, where they had the exclusive agreement with, uh, Amex, and if you were gonna use a credit card at Costco, it had to be Amex. But interestingly, Visa and MasterCard cried foul when, uh, you know, all of their banks were multi-homing, and Amex, with their virtue of a slightly different business model, was allowed to go and try to lock up merchants to be exclusive to them. So eventually, the whole thing kinda stopped and, you know, flash forward to today, all cards are accepted at basically all locations.

    10. DRDavid Rosenthal1:43:02

        Yep. So this basically concludes the full Visa story. Like, how did this incredible thing happen? You know, we've answered Dee's questions. Who owns this? Who runs it? How did it start? We could end the episode here, but we've actually really only told you half the story.... What we've told you is all the incredible business, organizational, social, human behavior innovations that Visa Inc. created.

    11. BGBen Gilbert1:43:35

        Yeah, as Dave puts it in Electronic Value Exchange, there's a sociotechnical aspect to this company, and we've talked about the socio, but not the technical.

    12. DRDavid Rosenthal1:43:44

        Something that is also true, and also I think really underappreciated about Visa, is it's also a technology company, and there is a whole technology story in parallel with this, too, that enabled the Visa we know today. To Dee's question of where is Visa headquartered and nobody knowing that, it's headquartered in the Bay Area. It's a Silicon Valley company. It was started in the same place and time as Intel, Atari, Apple. The only thing that is different about it versus those other companies is it wasn't funded by venture capital, and it thus didn't make anybody rich, except the banks who owned it, and thus were already rich. But there's an incredible technology story.

    13. BGBen Gilbert1:44:28

        Yeah, great point. All right, so what is it?

    14. DRDavid Rosenthal1:44:30

        Well, that's a great question, Ben, and before we get into it, this is actually the perfect time to talk about another great technology company and leader, one of our favorite ones, in fact, Statsig.

    15. BGBen Gilbert1:44:42

        Who has also built a tremendously powerful piece of infrastructure, focused, just like Visa, on reliability. As we will talk about later this episode, Visa never goes down, or basically never goes down, and that was a super important part of their strategy. But it is extremely hard for most companies to achieve this level of reliability in their technical infrastructure.

    16. DRDavid Rosenthal1:45:03

        Yep. Building reliable infrastructure is a very broad topic, obviously, but one easy way to improve reliability is staged rollouts. So a lot of times, what leads to downtime is unexpected interactions from new releases, which crash a component of your app or service. By rolling out a new feature in stages, first to employees, then to an increasingly broad set of users, you can test for bugs in a production environment before you actually launch the feature. Most companies don't do this, however, largely because, unlike, say, Facebook, they don't have the right tools.

    17. BGBen Gilbert1:45:35

        Yep. Thanks to Statsig, though, it is now super easy to do this the right way. If you're building software products, Statsig is the one-stop platform you need for feature flagging, product experimentation, and analytics. The product just works. It makes it super easy to roll out features in stages and provides data on the impact at every stage of the rollout. Statsig is a critical part of how companies, including financial ones like Brex and also like Notion, launch their features to hundreds of millions of users without causing outages or hurting core metrics.

    18. DRDavid Rosenthal1:46:08

        Yep, it's super impressive. So if you're a startup, they have a generous free tier and a special program for venture-backed companies, and if you're a large enterprise, like those companies Ben just mentioned, they have transparent and non-seat-based pricing. Acquired community members can take advantage of a special offer, including five million free events a month and white glove onboarding support. Just go visit statsig.com/acquired. That's S-T-A-T-S-I-G.com/acquired to get started on your data-driven journey.

12. 1:46:38 – 1:59:40

    Visa the technology company: BASE authorization, VisaNet, and data centers

    1. BGBen Gilbert1:46:38

       Okay, so David, what does Visa's technical infrastructure look like, and how did this come to be?

    2. DRDavid Rosenthal1:46:44

       So everything we just described up until now, amazing, incredible, unlikely, one in a million, but all it really bought Dee and Visa was the opportunity-

    3. BGBen Gilbert1:46:59

       Yes

    4. DRDavid Rosenthal1:46:59

       ... to actually realize what he sold to Bank of America and the other banks of a instant global payment network that a large percentage of global commerce runs on. You had to build a lot of technology to make that happen, and if you asked the question of Dee back in nineteen sixty-eight, "Okay, let's assume we do this, and we put one of these soon-to-be Visa cards in the hand of every consumer on the planet. Do they actually want to use them instead of cash and checks?" And the answer to that was probably not.

    5. BGBen Gilbert1:47:43

       Fascinating.

    6. DRDavid Rosenthal1:47:44

       Now, they wanted to use them in specific use cases. Like Ben, you pointed out, when you wanna make a credit purchase, when you wanna essentially do what installment financing was before, when you have any number of XYZ other set of factors, in the case of Diners Club and Amex, when you wanna impress your colleagues and your business partners. There were use cases, but it wasn't like it is today, where obviously you're gonna use your credit card, which is probably a Visa and maybe a MasterCard, to pay for everything that you do everywhere instantly.

    7. BGBen Gilbert1:48:17

       Yes, and to illustrate, we will link this in the show notes, but there is an old TV segment from nineteen ninety-three, not that old, pretty recent-

    8. DRDavid Rosenthal1:48:27

       Ben, I've really sad news. Nineteen ninety-three was thirty years ago. [chuckles]

    9. BGBen Gilbert1:48:32

       Yeah.

    10. DRDavid Rosenthal1:48:32

        We remember it-

    11. BGBen Gilbert1:48:33

        I know, right?

    12. DRDavid Rosenthal1:48:33

        ... but it's old now. Nineteen ninety-three to today is like the nineteen fifties were to us when we were kids.

    13. BGBen Gilbert1:48:39

        Not good. Not good, David.

    14. DRDavid Rosenthal1:48:41

        Not good. [chuckles]

    15. BGBen Gilbert1:48:42

        This nineteen ninety-three TV segment, the news is that Burger King has just rolled out credit cards. That should tell you a lot. Burger King, prior to nineteen ninety-three, did not accept credit cards, or at least this commercial makes it seem that way, and they interview this woman, and she says, "I think it's pretty sad when you have to use a credit card when you go to a fast food restaurant." That was a view of someone just sitting in a Burger King in nineteen ninety-three, and a second guy is interviewed and says something to the effect of, "I just hope it doesn't slow things down, 'cause, you know, they'll have to call New York, and then they'll have to do the thing, and I just hope it doesn't slow things down." And it's like the prevailing idea is that cash is fast, cash is easy-

    16. DRDavid Rosenthal1:49:28

        Cash is respectable. Credit cards are debt. What this woman is saying, "It's really sad if you need to use debt to buy a burger."

    17. BGBen Gilbert1:49:35

        ... Yes, but even at this point in history, it was viewed as this cumbersome thing rather than a convenient thing to bust out the card rather than, you know, like, I actually think Burger King corporate crunched the numbers, and they were like, "Geez, for the amount of time we spend handling change, we just wanna encourage everyone to be swiping the card all the time, even if they're, you know, losing some money on the interchange."

    18. DRDavid Rosenthal1:49:54

        It's crazy. That was 1993. I mean-

    19. BGBen Gilbert1:49:57

        Yeah.

    20. DRDavid Rosenthal1:49:58

        Compare that to today, and, I mean, I don't know about you, but I get pissed when somebody ahead of me in line starts breaking out cash and coins. I'm like, "Oh, my God!"

    21. BGBen Gilbert1:50:06

        Ugh, what are you doing? So start us back. I think the last time we checked in on how the settlement worked was around literally collecting paper sales drafts and then starting to mail it around.

    22. DRDavid Rosenthal1:50:17

        Yes. So to get from there to today, three major pieces of technology needed to be built by Visa. One was transaction authorizations. So when we were talking about transactions happening earlier, and the person in Burger King was referencing, like, "Oh, they got to call to New York, and they got to authorize the transaction," and all that, we glossed over one sort of stopgap slash band-aid that Visa and other credit card networks implemented around authorization. They didn't actually authorize every transaction. So when you paid for something with a credit card in a store, all merchants had what was called a floor limit, and the floor limit was any transaction over that limit could not be authorized directly on the floor. And say it was, I don't know, fifty bucks or something like that. Anything paid with a credit card under fifty dollars, it was basically within the judgment of the cashier to-

    23. BGBen Gilbert1:51:19

        Oh, wow

    24. DRDavid Rosenthal1:51:19

        ... say yes or no. [chuckles] And so everybody just said yes. I mean, the reality was this was the threshold below which the banks and Visa were willing to say, "Okay, we'll accept a certain amount of fraud."

    25. BGBen Gilbert1:51:31

        Interesting.

    26. DRDavid Rosenthal1:51:31

        And then above that limit, the cashier had to go call up the merchant bank, say, "Hey, we got a card here. It's this number. Somebody's buying a refrigerator." Then that merchant bank would have to look up that card number, figure out, based on the card number, what bank issued the card to the cardholder, call up the cardholder bank-

    27. BGBen Gilbert1:51:53

        Oh, my God.

    28. DRDavid Rosenthal1:51:54

        -get somebody on the horn there, say, "Hey, I've got your cardholder, Benjamin Gilbert. His card number is XYZ, you know, one, two, three. Can you look up his credit? And, you know, he wants to buy a five-hundred-dollar refrigerator. Can you tell me if he's good for it?"

    29. BGBen Gilbert1:52:10

        Right. And this effectively would be like, have they hit their limit yet?

    30. DRDavid Rosenthal1:52:13

        Yes. Have they hit their limit? The issuing bank would go look that up, the person there, literally the person, talk on the phone to the person at the merchant bank, give them the answer. The merchant bank then switches the line back to the cashier at the store and says, like, "Yeah, Ben is good for it," or, "No, Ben is not good for it."
13. 1:59:40 – 2:07:18

    BASE II settlement: Visa builds its own ACH-like clearinghouse

    1. BGBen Gilbert1:59:40

       I see. So how does the settlement happen at this point in history?

    2. DRDavid Rosenthal1:59:43

       So that's what's next. That's the next big operational, technical problem that Visa needs to solve.

    3. BGBen Gilbert1:59:49

       It's, like, literally moving the money when it needs to be moved.

    4. DRDavid Rosenthal1:59:52

       Reconciling the transactions, moving the money, getting everything wrapped up at the end of the day, week, month, sending out statements, all this stuff. You could sort of think of the first piece that we just described as the authorization as sort of the front end of a payment card system. The settlement is the back end. You know, the front end piece consumed a lot of phone time and people. The back end piece consumed a lot of paper and time, too. Maybe more time, but, like, a lot of paper.

    5. BGBen Gilbert2:00:22

       'Cause you're effectively mailing checks.

    6. DRDavid Rosenthal2:00:24

       And even more perniciously, as the network grew, and at this point in time, soon-to-be Visa is growing explosively, the complexity of this settlement piece also grows sort of exponentially. Every new bank node that you add into the system now has to interact with all the other bank nodes, and so, like, this is a hard computer science problem.

    7. BGBen Gilbert2:00:50

       It's an N-squared problem.

    8. DRDavid Rosenthal2:00:51

       Well, it's a problem that is easily solved by computers, but when you're doing all this manually with paper, this is a big, big problem.

    9. BGBen Gilbert2:00:59

       N squared is much worse when you're doing it with paper than with computers.

    10. DRDavid Rosenthal2:01:02

        Yes. So what you really need to do this efficiently, to bring it all the way back to the beginning of the episode, is a clearinghouse. You need an automated clearinghouse, and this is unbelievable. A few people had referenced this to us as we were doing the research, but I kind of forgot about it till the end when I got to this point, and I was like, "Holy crap!" Visa builds an automated clearinghouse for themselves to do settlement electronically over the network. They end up calling this project Base Two after Base One, which was the first thing doing authorizations.... This happens at the exact same time and place as when the Federal Reserve is building their own ACH system for checks, you know, automated clearing house, ACH-

    11. BGBen Gilbert2:01:52

        Yeah

    12. DRDavid Rosenthal2:01:52

        - everything in the banking system. That was built by the San Francisco branch of the Federal Reserve in the exact same years-

    13. BGBen Gilbert2:01:59

        Whoa!

    14. DRDavid Rosenthal2:01:59

        - in the '70s, when Visa was building their own essentially automated clearing house system.

    15. BGBen Gilbert2:02:05

        That is wild.

    16. DRDavid Rosenthal2:02:06

        Now, I've never read anything, I couldn't find anything, I've never heard anybody say that they, like, talked to each other, that they knew anything about what was going on, that they were sharing practices. I assume they probably didn't, but it's wild. The same place, the same time.

    17. BGBen Gilbert2:02:20

        Solving the same problem.

    18. DRDavid Rosenthal2:02:21

        Solving the same problem.

    19. BGBen Gilbert2:02:23

        Which, again, the problem is this gigantic list of a whole bunch of transactions just happened. People just agreed to make them happen, and now we need to settle up at the end of the day, and if you paid me 100 bucks 500 times, and I paid you 100 bucks 400 times, what is the net that actually needs to get transferred? And that is a far more efficient way, you know, batching them up is a far more efficient way than transferring the money back and forth every single time, but still can be a complicated problem, especially when you have thousands of banks on each side of that equation.

    20. DRDavid Rosenthal2:02:57

        It really is, like, the exact same problem that both of these teams are solving, and with the same users, the same banks. It's totally wild. Once Base Two is done, and again, it also happens in less than a year, that it's live and up and running, average settlement time for transactions on the Visa network go from taking a week on average to happening in batch overnight, every single night. Every transaction on the network settled every single night. So the speed is super important. This has lots of implications for float amongst the banks, you know, like, some good, some bad, between the banks, between the merchants, the issuing banks.

    21. BGBen Gilbert2:03:35

        Right, if you're the one that owes the money, you kind of want the payment to take more time.

    22. DRDavid Rosenthal2:03:38

        Yes, exactly. Exactly. Also, importantly, this is from Dave's book, it ends up saving about $15 million in labor and postage costs to the banks by automating this just in year one.

    23. BGBen Gilbert2:03:52

        Wow.

    24. DRDavid Rosenthal2:03:53

        And imagine if this were done manually today. It wouldn't be possible to do this manually today.

    25. BGBen Gilbert2:03:58

        No. You needed the technology solutions that they've put in place to enable the commerce scale that flows on this network today.

    26. DRDavid Rosenthal2:04:04

        Yep. It is also during this project that one of the most famous Visa tech team stories in history happens. [chuckles]

    27. BGBen Gilbert2:04:15

        This is a good one.

    28. DRDavid Rosenthal2:04:16

        This is in Dave's book. So one of the guys, I think he was working on Base One and then maybe got transferred into Base Two, he is thinking about the system, and reliability is so important, you know, this network can't go down, and he's like, "Huh, we actually have a pretty serious vulnerability in this system." So he goes to see Dee, and, I mean, the whole Visa organization, I think, is, like, less than 50 people at this point in time.

    29. BGBen Gilbert2:04:46

        Wow.

    30. DRDavid Rosenthal2:04:46

        Just wild. And he's like, "Dee, you know, all this technology we're building, you know, we've got authorizations running, we're in the middle of getting settlement running. Like, the whole Visa network now depends on this technology. We're providing the service off of one computer in one data center, which is made out of wood and sits on a hillside that has dry grass, right by a freeway, below a parking lot that is perched on a cliff, and we're also about a mile from the San Andreas Fault." [laughing]
14. 2:07:18 – 2:16:41

    Digitizing the point of sale: magstripe, Verifone, CompuServe, fraud reduction

    1. DRDavid Rosenthal2:07:18

       And, of course, this is now how every data center in the world runs today. Pretty amazing. So that was data center innovation, which sort of happens in concert with settlement digitization. The third big leg of the technology stool that Visa builds is finally digitizing the point of the transaction itself, and that requires both figuring out some way to make the cards digital-... or capable of being read in a digital manner, and digitizing the point-of-sale terminal in the merchants.

    2. BGBen Gilbert2:07:54

       Those Verifone, you know, traditionally, they had a huge market share.

    3. DRDavid Rosenthal2:07:58

       Well, this is when Verifone gets built. There was no Verifone before this.

    4. BGBen Gilbert2:08:03

       Yep.

    5. DRDavid Rosenthal2:08:04

       This is huge. This is the Holy Grail. The Base One authorization system, that was still only for transactions above the floor limits at the merchant, so, you know, above 50 bucks or 100 bucks or whatever. It replaced the need for phone calls, but it didn't digitize the transactions themselves.

    6. BGBen Gilbert2:08:23

       So this is actually every transaction now is running digitally for authorization over the network.

    7. DRDavid Rosenthal2:08:29

       Exactly. Not only authorization, but just think about all the things that happen digitally around transactions, the data, you know, everything. This is the beginning of it all. So the first step to doing this, as we mentioned, is digitizing the cards, and that really meant making them machine-readable. So before this, the cards were just pieces of plastic with embossed numbers on them. Like, you had to say or type the numbers into something.

    8. BGBen Gilbert2:08:56

       And the nice thing about the embossing is that if you run a shunk-shunk on it-

    9. DRDavid Rosenthal2:09:00

       A zip zap.

    10. BGBen Gilbert2:09:01

        With the, uh, the zip zap or the card imprint reader, you actually can get the numbers off of it without writing it down yourself. That was a huge productivity gain when they launched the sort of imprint reader machines.

    11. DRDavid Rosenthal2:09:14

        Yep. So Visa makes the decision. They end up going with the magstripe technology. This is the magnetic strip on the back of, still to this day, almost everybody's cards out there. There's a whole bunch of drama around this. Citibank had financed a proprietary magnetic solution that they were trying to push on the industry, that I think there are a bunch of lawsuits.

    12. BGBen Gilbert2:09:35

        And didn't they try to, like, hack the magnetic stripe, and then they did just to prove that, like, the proprietary thing would have been more secure?

    13. DRDavid Rosenthal2:09:42

        Yes, but it was proprietary, so Visa's like: "Hey, we're not gonna pay you, Citibank, a skiff on everything that we do here. W- we take the skiff."

    14. BGBen Gilbert2:09:49

        You pay us a skiff on everything. [laughing]

    15. DRDavid Rosenthal2:09:50

        You pay us a skiff. [laughing] Exactly. Uh, so they standardize on the magstripe for the cards. The next step then is they have to create a digital point-of-sale terminal. Now, this is pretty far outside the scope of what Visa itself could do, like mass produce a small, inexpensive piece of hardware that needs to get distributed to millions of merchants around the globe.

    16. BGBen Gilbert2:10:15

        That is outside their circle of competence.

    17. DRDavid Rosenthal2:10:17

        Yes. We mentioned earlier, and you alluded to, this is when Verifone takes off. So what Visa does is they create a spec. They're like: "This is the spec of what we kinda need to be created," and they invite different technology vendors to bid on it. Verifone ends up becoming the large, dominant... I actually don't know what their market share was or is.

    18. BGBen Gilbert2:10:39

        I think they had, like, two-thirds of the market at peak.

    19. DRDavid Rosenthal2:10:41

        Yeah, and it's pretty crazy. They come up with this sub $500 device that can sit pretty easily on a merchant countertop that already has a bunch of other stuff on it and not a lot of space, and get it distributed and, uh, installed at all these merchants. Now, the merchants didn't exactly want this thing necessarily, [chuckles] but the way Visa incentivized them to get it is they gave merchants who used it a discount on transaction fees, I think for a period of time, for transactions that happened digitally over the digital network.

    20. BGBen Gilbert2:11:16

        I see. If you use this instead of the zip zap, you'll get cheaper fees.

    21. DRDavid Rosenthal2:11:19

        Yep, exactly.

    22. BGBen Gilbert2:11:21

        Which that business model carries through to today. I mean, the way that you charge a card massively affects the interchange that gets charged, whether it's keyed in with numbers or whether it's swiped or whether it's an e-commerce transaction.

    23. DRDavid Rosenthal2:11:33

        Totally. One really fun piece of implementation, uh, detail around this, just like with Base One and authorization, where Visa had to build out a telecommunications network amongst all the banks, now Visa needs a telecommunications network amongst all the merchants around the whole world, the, the country and the world. That's another whole step change.

    24. BGBen Gilbert2:11:56

        That's like single-digit millions of nodes.

    25. DRDavid Rosenthal2:11:58

        Yes. So what are they gonna do? For the pilot program, they work with one of the big telecom vendors and essentially, like, build it out themselves. We're now in the 1980s here, but they realized during this that there's this new fledgling kinda consumer networking service out there called CompuServe.

    26. BGBen Gilbert2:12:19

        [chuckles]

    27. DRDavid Rosenthal2:12:20

        And for folks who either weren't alive in the US at this time or are not Americans, CompuServe was like an AOL competitor in the early days of the internet.

    28. BGBen Gilbert2:12:28

        I think they invented the GIF.

    29. DRDavid Rosenthal2:12:30

        Ooh, I think that might be right. Yeah.

    30. BGBen Gilbert2:12:32

        Yep.
15. 2:16:41 – 2:24:44

    Brand dominance: Olympics sponsorship and ‘everywhere you want to be’ positioning

    1. DRDavid Rosenthal2:16:41

       Yeah. There's one more really fun marketing piece that I wanna come back to before we move on to today, and that's the Olympics. A lot of people, probably everybody listening now, knows Visa is associated with the Olympics.

    2. BGBen Gilbert2:16:57

       They're probably the most associated brand, other than NBC.

    3. DRDavid Rosenthal2:17:02

       But that's only in America. NBC doesn't mean anything around the globe. Visa is the Olympics everywhere. So this happens right around the same time as the digitization of point-of-sale and the cards. It's 1986. The Olympics, for the first time, they are going around to companies and offering a global Olympic sponsorship. This is just like the NFL episode. Before this, you could sponsor the Olympics in specific countries. You could sponsor whatever broadcast, whatever television, radio was covering the Olympics in certain countries. You could have billboards and whatnot, but you couldn't do a global sponsorship, and there's no event like the Olympics that could really do this. I mean, certainly not the Super Bowl, not even the World Cup. You're missing a large part of America. Like, this is the only thing where you're gonna reach everybody in the world. And up until this point, one of the mainstay, largest Olympic sponsors in America was American Express. [laughing]

    4. BGBen Gilbert2:18:07

       [chuckles]

    5. DRDavid Rosenthal2:18:07

       'Cause this fits perfectly with American Express. It's for American business people who are traveling abroad. Olympics, great, amazing. The Olympics, uh, the IOC, goes to Amex to try and sign them up to take this marquee global sponsorship slot. They think it's a no-brainer. They give Amex a sweetheart introductory offer deal. "You're the first people we're going to, fourteen million dollars." Amex declines.

    6. BGBen Gilbert2:18:33

       Whoa!

    7. DRDavid Rosenthal2:18:34

       So they had their bite at the apple, and they missed it. A couple years before this, right as the Visa empire was being completed with the full digitization of the network, Dee ends up getting ousted from the company. I think, you know, if he were still alive today, he would probably agree with the characterization that Dee was one of the most amazing zero-to-one entrepreneurs in history, not so much a one-to-N kinda guy, especially when the industry in which you're going from one to N, and your shareholders and board is all some of the most conservative financial institutions in the world. [chuckles] A lot of conflict starts to erupt, ends up with Dee leaving the company in 1984. After this happens, Visa brings on a new global chief marketing officer, a guy named John Bennett, who came from twenty years at American Express. So he and his team see that Amex has passed on this new, amazing global opportunity with the Olympics. They're also formulating the new Visa marketing strategy. Up until that point, the marketing strategy had been mostly generate category awareness for consumers around the world. To the extent we competed with anybody, we competed with MasterCard, so we positioned against them. John comes in, and he's like: "No, no, no.... The path to victory here is not positioning against MasterCard. The path to victory is positioning against American Express.

    8. BGBen Gilbert2:20:09

       Hmm.

    9. DRDavid Rosenthal2:20:09

       Not because we wanna kill American Express. We don't actually care. We're way, way, way bigger than American Express, but we need global ubiquity and adoption, and people to get comfortable with using Visa and using credit cards. Remember, there's still this social stigma, that woman in 1993 in Burger King who's like, "Oh, it's sad if you're using debt to buy a hamburger."

    10. BGBen Gilbert2:20:33

        Which is so interesting because a signature piece of the BankAmericard since it launched was that it is actually a charge card, where at the end of the first month, you have the option to turn it into a loan, but I have never elected that option. I hold these things called credit cards, but that's a misnomer. I've never once used any credit.

    11. DRDavid Rosenthal2:20:52

        Right. And if this were certainly 1986 and still 1993, you would not feel that way. You might feel that way about your American Express card, but you wouldn't feel that way about your Visa card.

    12. BGBen Gilbert2:21:03

        Right. Although, I should say, it's probably false to say I've never used any credit. The bank does float you the money for a month, but they have a one-month grace period where you have no interest.

    13. DRDavid Rosenthal2:21:11

        Yes, you are using debt, you're just not paying interest.

    14. BGBen Gilbert2:21:14

        Yes.

    15. DRDavid Rosenthal2:21:15

        Which, you know, hey, that's a great thing to do.

    16. BGBen Gilbert2:21:17

        That's a amazing gift that these banks give the world.

    17. DRDavid Rosenthal2:21:20

        It's the American way. So John had just started. The strategy is use American Express to eliminate the stigma around Visa and, by association, paint MasterCard as having that stigma, 'cause we're not even bothering to talk about them. So how do we go after American Express? Well, the network is much smaller. The American Express merchant network at the time was about 25% the size of Visa's. So they design a whole marketing campaign around going after American Express, and the tagline of the campaign, you know, they show these exotic locales, the, the type of customers who would be using American Express, that they would be dining at these restaurants, or going to these events, or going on these vacations. In the end, folks who are of our similar age probably remember exactly the words here, "If you go there, remember to take your Visa card, because they don't take American Express." So great, and then the second tagline to it was, "Visa, it's everywhere you want to be." So the Olympics come up. After Amex declines, John and the team get in touch with the IOC. The price tag has gone up to $17 million just for the rights. That's before any media buys. No advertising, that is just for the right to be a global sponsor of the Olympics. They pull the trigger, they become the founding, like, global Olympic sponsor. They spend another $23 million in media for the 1988 Olympics, so $40 million in total on one global event. Well, two, there's the Summer and the Winter Olympics, but, like, one year of global events.

    18. BGBen Gilbert2:23:04

        That's about $110 million in today's dollars.

    19. DRDavid Rosenthal2:23:07

        Yeah, wild. Way more than they spent on any of the technology projects that we were just talking about.

    20. BGBen Gilbert2:23:13

        I mean, yeah, R&D costs money, but go-to-market costs more.

    21. DRDavid Rosenthal2:23:16

        Yeah. [chuckles] What's the line? Uh, first-time founders focus on technology, second-time founders focus on distribution?

    22. BGBen Gilbert2:23:22

        Yep.

    23. DRDavid Rosenthal2:23:23

        And then the real kicker, they, of course, become the exclusive payment provider at the Olympics. So everybody now coming to the Olympics, which is, like, a lot of people from around the world that are going to the Olympics, the only payment card provider accepted there is Visa. So they're training all these people that are going to the Olympics year after year after year. It has now been 37 years that Visa is the exclusive payments global sponsor of the Olympics. They're contracted through 2032, so it will be at least 46 years [chuckles] where Visa is the only card accepted at the Olympics.

    24. BGBen Gilbert2:24:07

        Which that's not that big a deal, 'cause there's not that many people that go relative to the people that see the media and understand the brand association.

    25. DRDavid Rosenthal2:24:14

        Of course, of course, but the reason we're talking about this, A, it's an awesome story, but, two, the last outstanding piece of enabling the global Visa empire, this last thing is the stigma. How do they get rid of the stigma of I can use my credit card and not feel like it's a taboo? This was it, position against Amex, go to the Olympics. It's the perfect event. You're around the world. The type of people who go to the Olympics, the type of people who use Amex, they use their Visa cards, and they're proud of it.

16. 2:24:44 – 3:15:08

    IPO and modern economics: interchange splits, astonishing margins, and value-added services

    1. BGBen Gilbert2:24:44

       Love it. So, David, take us to the IPO. This thing was an organization that was owned, but not with stock.

    2. DRDavid Rosenthal2:24:53

       A for-profit, non-stock membership organization.

    3. BGBen Gilbert2:24:56

       Right, and now they're an enormously profitable public company. So how did we get from there to here?

    4. DRDavid Rosenthal2:25:01

       Yep, just about a half a trillion dollar market cap. So the precipitating event wasn't actually the banks trying to get greedy and monetize their asset, although they did monetize the asset.

    5. BGBen Gilbert2:25:14

       They were monetizing it just fine the way that they currently owned it.

    6. DRDavid Rosenthal2:25:16

       Yes, the profits being spit out of the system were just fine. In 2005, there finally was another huge antitrust lawsuit, I think against both Visa and MasterCard.

    7. BGBen Gilbert2:25:29

       It actually is a class-action lawsuit-

    8. DRDavid Rosenthal2:25:32

       Ah.

    9. BGBen Gilbert2:25:32

       -that the merchants brought, and they basically got fully fed up with interchange. And, you know, every 10 years or so, there's some meaningful merchant push to try to change interchange, and they either do it in Congress, or they do it in a class action case. You know, there's a variety of different ways, and this particular class action suit in 2005 is still running today, and the numbers have mostly been figured out of how much Visa will owe.... from a 2012 ruling that then got appealed, so it's sort of still going on. But basically, there was a lot of uncertainty in the 2005 and '06 time frame of, "Geez, what's the liability here going to be?" And MasterCard had gone public and did not sort through this issue at all. They just said, "Oh, we're going public, and shareholders, yep, there's lots of uncertainty in our future, and, like, we'll see, but buy our stock." And that, as you can imagine, did not go well at all. And so as they're getting ready to go public for lots of reasons, basically, it was time. They wanted to have some liquid currency that floated for acquisitions. They had to be competitive with MasterCard, who was going public. Amex was already public. You know, you can reward and retain talent easier. There's just, like, lots of reasons why you would want this thing to be sort of a standalone entity, especially at this point in history. And what they had to do was they created these B shares, and they isolated all the liability from this class action suit to the B shares. So while MasterCard had a pretty flubbed IPO, Visa had a great IPO because they said, "Whatever the courts rule, the banks who own the B shares, the preexisting shareholders, will own all that liability and all the A shares, the, the new people who are coming in as owners of the company, will be protected."

    10. DRDavid Rosenthal2:27:18

        Oh, that's awesome. I didn't realize that in the research. It finally happens in 2008. Visa goes public right as the financial crisis is starting, which obviously wasn't planned, but ends up being great for the banks and probably for Visa, too. It becomes the largest US IPO in history up to that point. They raised eighteen billion dollars at a ninety billion dollar initial market cap, but that eighteen billion dollars wasn't primary capital to the company's balance sheet because, obviously, Visa was incredibly profitable, did not need capital.

    11. BGBen Gilbert2:27:54

        It prints money. Why would you want to raise capital and dilute?

    12. DRDavid Rosenthal2:27:56

        That eighteen billion dollars was secondary selling to the banks that owned the company, which I think, for many of them, proved to be a total lifeline through the financial crisis that helped them survive.

    13. BGBen Gilbert2:28:11

        Yep. I mean, now Visa is owned mostly by big institutional shareholders, the Vanguards and Fidelities of the world, and the banks are much smaller shareholders.

    14. DRDavid Rosenthal2:28:20

        Well, at this point, Visa's market cap is significantly larger than any of its former member banks.

    15. BGBen Gilbert2:28:27

        It's wild. I mean, Dee Hock basically was right. That's the TLDR on this, is this thing, this information network, that doesn't have to take on any of the risk of any of these transactions, it's purely about connecting buyers to sellers and moving information back and forth, has proven to be maybe the best business model ever. And let's go through the shape of the business today, and listeners, you can decide. So David and I have made passing references to the idea that this is this ludicrously cash-generative business, and I think it's time to actually examine interchange fees today, how they've changed over time, how they flow, who benefits, what's Visa's cut, all of that, so you can kind of understand it. So Visa's business model. The first thing to know is almost nothing has changed since the '80s to today on how the transactions work. So the authorization flow is exactly the same as it was, where all the auth flows upstream, the merchant runs the card, checks with their bank, who checks with VisaNet, who checks with the issuer's bank. Is this account in good standing to make this transaction or not? And once they get the yes, then the response flows all the way back down the chain in the order that ultimately the flow of funds will happen later on, and, you know, within milliseconds, unbelievably short period of time, no matter where you are in the world, and no matter what currency you are transacting in, your transaction can happen. Pretty unbelievable. Amazing that within seconds you can know for certain that someone is vouching for the customer's money and paying in full. Well, nearly in full, minus a merchant discount rate. So what is this merchant discount rate? There are a few things at play here. There are interchange fees, and those interchange fees go to the issuing bank. There are assessment fees or network fees, and that network fee goes to Visa, MasterCard, et cetera. And then there are payment processing fees, and those go to the acquiring bank, the bank that acquired the merchant, this is the merchant's bank, and the technology provider of whatever they're using to process their payments. So three fees: interchange, network fees, payment processing fees. Here's what those could look like, and again, I say could because they are different in every scenario. There's a very long PDF on Visa's website that is available with every different concoction you could imagine. So here's an example of a large merchant in the United States, so no foreign transaction, accepting a credit card. It is obviously different whether we're talking debit, smaller merchants, but large merchant, US credit card. The merchant is charged a two percent discount off the sale price. So if it was a hundred dollar pair of shoes, you're now making ninety-eight dollars, and what happens to that two percent? So that two percent, the lion's share of it is the interchange, the one point six percent. That goes to the bank that issued the card.

    16. DRDavid Rosenthal2:31:27

        To the cardholder, to the consumer.

    17. BGBen Gilbert2:31:30

        Right. So when everybody on the planet is marketing credit card offers to you, they get the lion's share of the interchange. So they actually have a lot to play with in customer acquisition for their cards because they make the lion's share of the transaction, the interchange. There's a lot of costs in there, too, because they bear all the fraud risk. There's a lot of things they gotta do, but, you know, they get most of the money. A small amount, on the order of, like, point two percent, or, uh, twenty bips for you finance people out there, goes to the bank that acquired the merchant. This could be Chase, Fiserv, Wells Fargo. This is, you know, the merchant's bank.... It is important to know this may also get split with a technology provider. So sometimes the financial institution directly has technology that you can use, but other times, the checkout terminal or software that you're using is not actually the financial institution behind it. So that point two percent can kind of get split between the financial institution and the technology provider.

    18. DRDavid Rosenthal2:32:30

        And those are folks like First Data and stuff like that, right?

    19. BGBen Gilbert2:32:33

        Yes. Point one five to point two percent goes to the network. This number is actually quite hard to find. You read Visa's entire annual report, and you're like, "Wait, but what part of the split do you actually get?" And it's because they get it in a variety of different ways. I would say, I don't know if the Visa people would tell you this is intentionally obfuscated or if it just ends up being kind of obfuscated, but it's not super easy to figure this out. So Visa, let's round it to point two percent, gets twenty cents of that hundred dollar shoe sale. But the cool thing about their twenty cents is there's basically no variable costs.

    20. DRDavid Rosenthal2:33:15

        Yes.

    21. BGBen Gilbert2:33:15

        It's not dealing with fraud. It's not moving heavy data around. I mean, merchants are allowed to have a twenty-character name in Visa's network. Like, this is tiny amounts of data. Stack as much metadata as you want on top of that, we are not shipping around huge payloads here. There is not, like, NVIDIA chips that need to run in these data centers to do any crazy LLM processing. Like, this is just shipping very small pieces of information around. The payload size of the data has remained infinitesimally small relative to the amount that technology has progressed. This point two percent, the twenty cents on the hundred dollar transaction, very low variable costs associated with that. So a few caveats on this. Debit is significantly less in most cases, and often thanks to regulatory reasons. And the logic here is nobody's actually taking any risk to extend credit, so banks should not get to make a bunch of money on debit. It's literally just moving money out of your account and into the merchant's account, so debit cards are gonna be less. Smaller merchants often pay closer to three percent than two percent because they're just doing lower volume. And for these small businesses, the acquiring bank actually has to do a lot more work. Think about how difficult it is to market a credit card to an individual. Well, small businesses kind of behave like individuals, so because the acquiring bank actually has to do a lot more work and incur costs, they get to make more money. So there's sort of this very interesting thing that has happened where interchange is intentionally quite flexible. This is a playbook theme that I want to pull forward. This business is probably the greatest masterclass in the entire world on incentive alignment. And I was talking with Lisa Ellis at MoffettNathanson, who sort of woke me up to this idea. The interchange pool has an elegance to it. Since the money never actually gets sent to the merchant, the network and its partner banks or constituent banks can kind of figure out exactly how it should flow in each of these particular types of transactions. It's an envelope of value that the whole ecosystem can sort of play with, and I think that's an important thing to realize about interchange, is that it's intentionally flexible.

    22. DRDavid Rosenthal2:35:37

        Yep, which brings up, you know, an obvious point that we perhaps didn't highlight as specifically as we should have earlier. This network is actually a five-sided system. There's the consumer that is buying something. There's the merchant that is selling that something to them. There's the Visa network in the middle, that's the third party. But then there also are the fourth and the fifth parties, which are the banks for each of the consumer, the issuing bank, and the merchant, the merchant bank. So this sort of envelope-of-value concept makes sense because those three parties in the middle, Visa and the two banks, they need to split up the value, and depending on who is doing what work, it should be split different ways.

    23. BGBen Gilbert2:36:23

        And Visa has created these products where, you know, it's not just a Visa card. You might get a Visa Signature or a Visa Signature Business or a Visa... I don't even know what they are. But they basically have said, "Why don't we come up with other types of Visa cards that just have higher interchange?" And merchants are like, "What do you mean, just have higher interchange?"

    24. DRDavid Rosenthal2:36:43

        Your new product is you're charging me more?

    25. BGBen Gilbert2:36:45

        And Visa says, "Well, the cool thing about higher interchange is that there's more money in the envelope to play with to reward other constituents in the transaction." And so let's say we want to tell the issuing bank, "Hey, for this tier, this Visa Signature, you actually get more money." Well, then they turn around and say, "Cool, I'm gonna go, and I'm gonna give better rewards to higher-spending, you know, more creditworthy customers." And then Visa's argument back to the merchant is, "Well, hey, because we're actually taking more money on this fancier card, you're getting access to customers that we've now brought onto our network who are much better customers that you really want to have at your establishment." And so it's this very interesting, again, envelope of value, I think, is the way to describe it, where, you know, I'm sure the merchants wish they could be more a part of the decision process, but it does theoretically enable incentives to be spread around that benefit everyone in the ecosystem.

    26. DRDavid Rosenthal2:37:50

        Yep, and for merchants of scale today, they're cut in on this, too, right? There's the Alaska Airlines mileage card. There's the Costco card. Like, merchants are able to, by working with banks, be part of this discussion, too, if you're of a certain size.

    27. BGBen Gilbert2:38:10

        ... Right. In the olden days, you know, if you're the affinity logo that got printed in the top stripe, the way that works today is you have a special deal with the issuing bank, where you're gonna say, "Hey, we're gonna help you get more card members by putting our logo on the card. And so even though oftentimes we're the merchant, well, actually, what we're doing is we're helping you distribute cards [chuckles] on the issuing side, and maybe there's cool things we can do when those cards are spent at our establishment, where we give extra rewards." But it's effectively a marketing channel for the issuing bank, so they get to split some of those economics.

    28. DRDavid Rosenthal2:38:48

        And I guess at the absolute, very highest levels of scale, you have something like the Amazon and JPMorgan Chase relationship, where JPMorgan Chase is the merchant bank, and JPMorgan Chase is one of the largest issuing banks for cards in the world. And so the Amazon Chase credit card that I have, and I do all my shopping on Amazon with and all my shopping at Whole Foods with, is able to give me five percent cashback rewards. So Amazon or JPMorgan, and in this case, the two of them working together, represent three of the five parties in this transaction. The only people not party to this are the consumer and Visa, the network itself, and so thus, that's how they're able to do so much special stuff. They can control so much of that envelope of value.

    29. BGBen Gilbert2:39:37

        Yes. It is worth pointing out, the system today is pretty tough to change, absent government intervention. Consumers who spend the most love the system the way that it is. A huge amount of the fees that merchants pay come back to these consumers in the form of rewards. So the issuers and the networks end up with the consumer as their advocate for the system as it exists today, and meanwhile, no retailer owns enough of the total transactions to actually go invent their own better system. So when merchants have tried to go and get consumers to go direct and give them their bank account information, typically, consumers won't do it unless they get some very high number percent back, and that's actually more expensive than the interchange. The way that you end up having to pay your consumers in order to change their behavior away from credit cards that they love the rewards so much on is to do something non-economic. Like, you have to believe that there's some long-term benefit to doing it.

    30. DRDavid Rosenthal2:40:36

        Yeah, and famously, Walmart, and Target, too, I think, have been trying to do this for years and years and years, and they never can make it work.

Episode duration: 3:43:24