Business Over Easy

Mastercard doesn’t issue your card, care about your credit, or even take a majority of those card fees you pay at the restaurant. It operates the toll road that every transaction on their cards must travel on.

You tap your card to pay for your $9 coffee. The screen thinks for two seconds, flashes APPROVED, and you’re out the door.

Unless you’re some kind of nerd, you didn’t even think twice about the conversation that just took place between four separate parties to approve that transaction. You’re probably thinking more about why the hell coffee is $9 now. But a fairly elaborate process is taking place every time you swipe that card:

Put simply, Mastercard runs the rails that money travels on. Put also simply but in a more fun way, Mastercard is the “straw that stirs the drink” when money needs to move between your bank and the merchant’s bank.

If you’re like most people, you make two assumptions about Mastercard and don’t know much else about the company (or card networks in general). That’s completely understandable, because why would that possibly be something you spend your free time on? Sports and free will exist. 

Assumption #1: When you use a Mastercard credit card, Mastercard fronts the money for the purchase, and makes its money by charging you interest.

Assumption #2: Mastercard pockets the entire 1.5 to 3% “swipe fee” associated with any purchase on a Mastercard.

The reality is, both of these assumptions are wrong. 

Your bank, not Mastercard, issues the credit card. Your bank decides whether to approve you, sets your credit limit, lends you the money, sends you the bill, and charges you interest. It takes all of the credit risk that you might never pay it back.

Mastercard doesn’t care one bit whether you carry a balance for six months or pay the card off the next day. That’s between you, your bank, and your credit score.

All Mastercard cares about is usage. It wants you swiping, tapping, and typing in the numbers on a Mastercard-branded card. They get paid for helping make the transaction happen, not for taking any risk as a part of it.

The fee side is where things get a little more confusing, mostly because “swipe fee” is used as a catch-all phrase for several different charges.

You know that 3% “credit card fee” that you see added to your bill at a restaurant? That charge is called a surcharge. This is the merchant’s attempt to recover the cost of accepting your card payment. Behind the scenes, the merchant has to pay its bank or payment processor a card acceptance charge known as the “merchant discount rate”. Because of this, some stores and restaurants will pass that cost on to the customer.

This merchant discount rate gets carved into several pieces.

The largest piece is often called interchange. This generally goes to your bank, the bank that issued you the card. Another piece goes to the merchant’s processor or acquiring bank. Mastercard keeps its own, smaller set of network and processing fees for carrying the transaction between the institutions, and helping authorize, clear, and settle it.

The flow looks something like this:

You pay the restaurant’s surcharge

⬇ 

The restaurant uses it to offset its total card-acceptance cost

⬇ 

Your bank receives the interchange
The processor or acquirer receives its portion
Mastercard receives its network fees

Here’s where the system really starts feeding itself.

The interchange revenue received by your bank helps pay for the exact card program it’s trying to convince you to use. That includes cash back rewards, airline miles, customer service, and covering fraudulent purchases. To make a complex process seem pretty simple…

Better rewards attract more cardholders. More cardholders create more transactions. More transactions means more fees moving through Mastercard’s network.

Mastercard sets the default interchange rates, but doesn’t earn the interchange itself. Its job, and its main sales pitch, is keeping the whole ecosystem attractive to both sides: banks need a reason to issue Mastercard-branded cards, while merchants need customers who carry cards they can’t afford to reject.

Mastercard’s own cut for each card purchase may be small, but its real superpower is collecting that tiny cut across an insane number of transactions every single day.

The simplest way to think of it is that Mastercard is a toll road.

A toll road doesn’t care whether you’re making your car payments, why you’re driving, or whether you total the car that night. It cares that you use the road and pay the toll. Once you pass through, they’re onto the next car.

Mastercard works the same way. It charges for the passage, not the destination. 

A toll doesn’t mean much if everyone just takes a different road, does it? Mastercard keeps cars passing the toll booth (customers swiping their cards) 24/7 in two ways. The first is by keeping the “toll” almost unnoticeably small. You’re not going to reroute your entire trip just to avoid a 50-cent toll along the way, just like you’re not going to carry around a duffle bag of cash at the store to avoid a 3% fee. 

The second is simple as well: because they already spent the immense time, money, and effort to build the “road”. There aren’t going to be a huge wave of builders springing up roads right next to theirs in the future. Visa and a select few have built the same “roads”, but fortunately for Mastercard, and unfortunately for us, they have to charge tolls as well. Because of this, nearly half of every dollar that Mastercard makes in revenue becomes profit. Waving cars through the toll booth is a high-margin activity. 

Mastercard’s business is booming, but just like any business on earth, there are risks and threats to the business.

Mastercard’s line of work isn’t exactly “flashy”. It takes decades of time, money, and effort to establish a colossal payment network like this one. So what makes it such a lucrative and successful business model?

Mastercard isn't the flashiest business on the planet, and that's exactly the point. The best businesses aren't always the ones swinging for the fences. Sometimes they're the ones quietly standing in the middle of something everyone already does, taking a sliver of a purchase millions of times a day. You'll probably tap your card again before the day is over. Next time, you'll know exactly who's collecting, and who isn't.

Now that you know the toll booth from the bank: which one do you think has the better business model, Mastercard or the banks collecting the interchange? Hit reply and let me know!

Got a business model that confuses you? Reply to this email! It might just be next week’s issue.

Until next time,

Brandon

Business Over Easy