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Visa, Mastercard bet big on different growth strategies

After decades of nearly identical core business models, the two most dominant payments companies in the U.S. are starting to diverge.

Visa Inc. and Mastercard Inc. have a duopoly in the U.S. payments marketplace. Analysts have called them the "crown jewels" of long-term payments and "rarefied air" among current investment opportunities. They are both accepted in virtually every country around the world and have seen consistent growth for years.

Now, the two payments processors are looking to broaden their capabilities as consumers and merchants demand enhanced payment options, with Mastercard focusing its technology on the business-to-business market while Visa aims to improve the way payments move among consumers and between customers and businesses.

The biggest of these opportunities is B2B payments, which Mastercard estimated is a $25 trillion market annually in the U.S.

But the opportunity is complex for three reasons, MoffettNathanson analyst Lisa Ellis said. First, it involves a fragmented set of banks and business software vendors that have to be linked together. Second, B2B payments are very heterogeneous, meaning they "vary dramatically" in size, timing, the complexity of the transaction and whether the parties are known, among other reasons. Third, information about the payment, such as what it is for, needs to move with it or be reconciled, creating complexity with billing and reconciliation. The B2B payments industry will take several years to develop, likely not having an impact on earnings for three to five years, Ellis said in an interview.

At a basic level, Visa and Mastercard are each placing a stronger focus on different technological strategies.

"Mastercard [is] very heavily focused on owning and operating fast [automated clearing house] rails for the purposes of tackling B2B payments specifically," Ellis said. For decades, the ACH payment rails have facilitated transactions between merchants, consumers and financial institutions. Efforts are now underway to make those payments faster and close to real time.

In 2017, Mastercard closed its $1.15 billion acquisition of London-based VocaLink Holdings Ltd., which boasts a software to run on real-time payments networks. In 2019, the card company agreed to acquire the majority of the corporate service businesses of European payments technology company Nets A/S for $3.19 billion. Once complete, Mastercard's largest-ever deal will add instant payment services to its business lines and cement the card company's real-time payments strategy.

Mastercard's focus on fast ACH payments, one of the primary models for B2B payment flows, illustrates its investment in building out B2B capabilities, according to Ellis.

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On the other hand, Visa is placing a much stronger emphasis on its Visa Direct push payment rails, an alternative to fast ACH.

A P2P push payment could be one Venmo user sending money to another, while a business-to-consumer transaction could be Uber Technologies Inc. paying its drivers. In push payments, customers initiate the money movement by instructing their banks to send money to another account. That is the reverse of typical debit and credit electronic transactions, called pull payments, in which the money movement initiates when the merchant's bank requests to pull money from the customer's account to add into the merchant's account.

The fast ACH and push payment methods functionally do the same thing, and they both have a degree of reasonably real-time authorization. But fast ACH rails have a leg up in that they are typically funded or backed by the government. About 30 countries have fast ACH capabilities, and many other countries are investing in them. Push payments have two superior characteristics: they are global and run 24/7, every day of the year. Fast ACH networks are country specific and are limited to bank hours.

Until Visa's acquisition of London-based cross-border payment services provider Earthport PLC, the card company was limited to processing transactions within its own network. Earthport enables Visa to execute a payment in any type of account on any payments rail, as opposed to simply operating within Visa's network. That means Visa could execute a transaction to a Mastercard user or a bank savings account, among other options. Earthport's network connects with local ACH systems in 88 countries, including the top 50 markets. It gives Visa access to 99% of bank accounts in those countries, up from about 50% access before Visa acquired Earthport, Chairman and CEO Alfred Kelly Jr. said on the company's third-quarter 2019 earnings call.

Visa is targeting acquisitions of or partnerships with the networks, while Mastercard is focused on owning the assets to operate the networks itself.

Earthport allowed Visa to further expand its network of payments globally. The pending acquisition of payment processing startup Plaid Inc. will allow Visa to enter the financial information network. Plaid's network links customers' bank accounts to their third-party finance apps, including PayPal Holdings Inc.'s Venmo LLC and Robinhood Markets Inc., among thousands of others.

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Mastercard's recent transactions provided data, analytical and cybersecurity services to merchants, President and CEO Ajaypal Banga said on a call to discuss fourth-quarter 2019 earnings. The chief executive highlighted Mastercard's recent purchases of fraud detection startup Ethoca Ltd. and cybersecurity startup RiskRecon Inc.

On a call to discuss fiscal first-quarter earnings, Visa executives were asked about the increase in the past few quarters in Mastercard's growth rate compared to Visa's. Kelly said through Visa's investments in value-added services and new payment flows, and in working with fintechs and neobanks, "I'm quite confident that, over time, we will close that gap."

Right now, these investments only matter on the margins, since 95% of Visa's and Mastercard's operations are their core businesses, MoffettNathanson's Ellis said. Plus, nothing about these strategies is set in stone.

"All of these things are far enough out that there's no particular reason why one of them couldn't shift and catch up with the other one," Ellis said. "This may be a permanent divergence; it may be temporary."