MasterCard (NYSE:MA), one of the biggest payment processing companies in the world, has delivered solid double-digit revenue growth the last few years. The company is expected to report earnings for the fourth quarter of 2012 next week, and we believe this is the perfect time to evaluate its business model.
MasterCard’s customers are banks and financial institutions who issue credit, debit or prepaid cards carrying the MasterCard logo to their customers, the card-holders. These institutions are called issuers. The card-holders can then use these cards to carry out a financial transaction, with a merchant at the point-of-sale (POS), online or to withdraw money via an ATM. The merchant’s financial institution is termed as the acquirer. MasterCard does not earn any money from the card-holders or the merchants but instead charges fees from the issuer and the acquirer.
The fees charged are dependent on a number of factors, including the type of authorization used -PIN-based or signature-based, the geography where the transaction originated and the place where the transaction is completed. The fees can be classified into three broad classes: assessment fees, transaction fees and cross-border fees. In this article, we will focus on assessment fees and transaction fees, which together account for 65% of MasterCard’s revenues.
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A similar structure is used by MasterCard’s main competitor Visa (NYSE:V), but other similar companies like Discover Financial (NYSE:DFS) and American Express (NYSE:AXP), generally issue their own cards.
Assessment fees are charged when the issuer and acquirer are based in the same country. These fees account for around 35% of MasterCard’s revenues and are charged to issuers and acquirers as a percentage of the billing currency (generally U.S. dollars) equivalent to transactions carried out by the institution using MasterCard products. The fee charged is based on factors like number of cards issued by the bank, the development of merchant relationships, brand promotion at point-of-sale, cross-border usage and other marketing developments.
The average assessment fee is around 0.1% of the gross dollar volume of transactions. MasterCard has benefited greatly from worldwide adoption of credit and debit cards as people prefer to carry cards than cash in their wallets and has seen double-digit growth in gross dollar volume (GDV) in the last three years. The GDV grew by 11% in the first nine months of 2012, on a U.S. dollar conversion basis.
Transaction fees account for 30% of the company’s net revenues and are charged on both domestic and cross-border transactions based on the number of transactions processed for each customer. The fee has four components:
1) Authorization fee: This is charged to issuers for transactions where an issuers system is unavailable to approve a transaction. In this case, the transaction is routed to MasterCard, which makes a decision based on the issuer’s instructions or applicable rules.
2) Clearing fee: This is charged to issuers after a transaction has been successfully completed for the exchange of financial information between the issuer and the acquirer.
3) Settlement fee: This is also charged to issuers after the authorization and clearing processes have been completed for facilitation of exchange of funds between parties by MasterCard. MasterCard provides a daily reconciliation to each customer detailing the net amount for each transaction and the final financial position of the customer.
4) Connectivity fee: This is charged to both issuers and acquirers for providing access to MasterCard’s network and transmission of authorization and settlement messages.
MasterCard charges an authorization, settlement and clearing fee of around $0.08 per transaction and a connectivity fee around $0.015 per transaction. The company has seen double-digit growth in the number of transactions processed and has benefited by the Durbin amendment to the Dodd-Frank bill. The bill requires banks with more than $10 billion in assets to use separate payment processing networks for signature authorized and PIN authorized debit card transactions.  As a result, MasterCard was able to siphon market share from Visa, which accounted for over two-thirds of all cashless transactions in 2011. MasterCard reported a 15% increase in debit and prepaid transactions in the first nine months of 2012.Notes: