When most people use Mastercard, Inc. (MA) think, they think of credit cards. While it is true that the Mastercard brand is one of the best global labels for debit, credit and prepaid cards, Mastercard does not consider itself a credit card company in its own right. According to the 2020 annual report, Mastercard is more likely to be a “technology company in the global payments industry”.
As such, Mastercard connects the many different participants in different types of transactions: consumers, merchants, financial institutions, governments and more. The vast majority of Mastercard’s revenue comes from fees paid by its customers, who are not everyday consumers. Mastercard’s customers are more likely to be financial institutions, such as banks, that pay a fee for issuing Mastercard-branded credit and debit cards. These fees can take various forms, as we will see below.
Key learning points
- Mastercard generates revenue by charging financial institutions that issue Mastercard-branded payment products a fee based on the gross volume of activity in dollars.
- Consumers do not pay Mastercard directly for the costs they incur; rather, these are paid to the issuing financial institution.
- A typical Mastercard transaction involves four other parties: the account holder or consumer, the issuing bank, the merchant, and the merchant’s acquiring bank.
Just like Mastercard’s eternal competitor Visa Inc. (V), Mastercard enjoyed decades of private success before an initial public offering (IPO) in the early 2000s. Mastercard actually started out as a response to what would eventually become Visa. After Bank of America Corp. (BAC) launched a bank card in the late 1950s, in 1966 a coalition of regional credit card providers came together to launch Mastercard. At the time, it was known as ‘Interbank’, a reflection of the new card’s connectivity between different financial institutions. Since that time, the company has undergone numerous expansions and rebrands, but it enjoys constant popularity with an increasingly global base.
Investors love MasterCard. The credit card company reported net sales of $15.3 billion in 2020, down 9% from the previous year, largely due to the global pandemic. As of August 28, 2021, Mastercard had a market cap of $351.03 billion. Yet, despite all the investor hype, end users seem equally satisfied. The seamlessness with which you execute a Mastercard transaction belies an extensive network of merchants, financial institutions and settlement banks, each receiving part of a process that takes mere milliseconds.
Mastercard’s business model
Mastercard facilitates transactions in more than 150 currencies in more than 210 countries and territories. While the company doesn’t have a monopoly on the payments industry – not only because of similar activities like Visa, but increasingly because of new payment service providers – it is nevertheless hugely successful around the world. Much of this success has to do with the Mastercard brand and the cachet it possesses.
A typical Mastercard transaction involves five parties: In addition to the payment processor itself, the event involves a consumer or account holder and their issuing bank, as well as a merchant and their acquiring bank.
Typically, an account holder uses a Mastercard-branded card to make a purchase from a merchant. Once the transaction is authorized, the issuing bank pays the cost of the transaction (minus an interchange fee, also known as a “swipe fee”) to the acquiring bank. The account holder will then be charged the cost of the transaction, less a trade discount. Interchange fees are essential to provide value to merchants accepting Mastercard payment products. Mastercard does not generate any income from these fees. The merchant discount helps to cover the costs for the acquiring bank.
While Mastercard is known for its credit and debit cards, it considers itself a “technology company in the global payments industry.”
How does Mastercard make money?
Where does Mastercard make money in this system? Mastercard charges the financial institutions that issue cards a fee based on the gross dollar volume of the account holder’s activity. The company also earns income from exchanged transaction fees for authorization, clearing, settlement and certain cross-border and domestic transactions.
Mastercard’s Domestic and International Fees Business
When you make a purchase with a Mastercard, you borrow the money from the issuing bank whose name is printed on your card. There are thousands of such banks. Mastercard makes money by charging them for using its multi-noded, light-speed payment network.
The biggest distinction in Mastercard’s income statement is between intra-national revenue – fees charged to cardholders’ and merchants’ financial institutions, which are processed in the same country where a transaction takes place – and cross-border volume fees. The first category, officially known as “domestic reviews,” accounted for $6.7 billion of Mastercard’s $23.6 billion in gross revenue for fiscal year 2020. In terms of cross-border volume fees, these totaled $3. .5 billion.
Mastercard’s transaction processing fees
Mastercard’s third major revenue category, called “transaction processing fees,” generated revenue of $8.7 billion in 2020. Those fees are charged to the merchants’ financial institutions and are divided into two subcategories: “connectivity” and “transaction switching”. Connectivity fees arise from users joining the Mastercard network, charging fees to use the network, and getting a share of every step in the process.
Mastercard also collects a transaction exchange fee each time the issuer receives authorization approval, each time the transaction information is cleared between the two parties’ banks, and each time the funds are actually settled. Again, these cuts are nanoscopic, but they pile up. In fact, Mastercard transaction processing fees are rising from year to year even faster than domestic ratings.
The four currencies in which Mastercard does the most business are the US dollar, the euro, the Brazilian real and the British pound.
Plans for the future
Mastercard believes that one of its main advantages over emerging payment systems is that it can be a multi-rail network, covering domestic, cross-border, card-based and account-to-account transactions. Going forward, the company will continue to develop and strengthen each of these channels. For its traditional credit, debit, prepaid and commercial products, the company will continue to offer consumers and financial institutions a wider variety of options, both in terms of the products themselves and in payment plans and systems.
The key to Mastercard’s growth is diversification across new markets. In 2020, UK service providers promoting Mastercard’s Pay by Bank service launched in 2016 included Barclays, HSBC, Yoyo Wallet, Global Payments, Wirecard, Worldpay and Barclaycard, which process half of all card transactions in the UK. Pay by Bank allows UK consumers to buy goods and services using money from bank accounts and mobile banking apps. Ultimately, the aim is to make the app universal, rather than just for the UK
While Mastercard is a dominant player in the global payment services industry, it nevertheless faces significant challenges. One of the biggest is government regulation: the company has faced numerous antitrust cases throughout its history, and regulations are constantly changing in many of the regions in which Mastercard does business. It must remain flexible and vigilant to ensure that its business thrives. Especially given the company’s international and cross-border activities, this is a critical part of its continued success.
Maintaining the appeal of Mastercard
Mastercard must continue to offer an enticing and valuable array of products to every segment of its transaction ecosystem. Financial institutions must continue to believe that it is in their best interest to issue cards with the Mastercard logo, while merchants must be prevented from applying surcharges on products to offset costs. Cardholders should find the whole process simple, efficient and competitive compared to other payment systems.
Finally, given the fierce competition from both established rivals and new technologies and companies, Mastercard must ensure that its offering is at least comparable to, if not superior, the competition.