Afterpay’s relationship with Visa and Mastercard

Afterpay is a battleground stock, I get it. BNPL is a battlefield. Without wanting to pick sides I wanted to make a few observations about BNPL and the role Visa and Mastercard play as I see it.

Scott Galloway, fresh off his claimed victory of WeWork has made some interesting comments recently on the BNPL space, specifically mentioning Afterpay, Affirm and Klarna. See link here.

These comments caught my attention:

“These stocks (of Buy Now, Pay Later firms) will likely be halved in the next 12 months as Visa rolls out its product and the entire market begins to shudder with yet another duopoly firm crushing competition.”

“The key lesson here, a smart product reformat of no interest payments and strong marketing aren’t enough to sustain companies against bigger incumbents. Companies need moats, competitive advantages that aren’t easily replicated by competitors especially when your competitors are well financed duopolists”.

He seems to be implying that Visa and Mastercard will crush the BNPL space and will compete hard against them. On this basis he believes the BNPL space is “likely” overvalued and could fall 50%.

Now he may be right, APT’s share price may half over the next twelve months or it may not. That’s the beauty of using the word “likely”. If it happens you get a victory lap, if it doesn’t well I only said it was likely not guaranteed.

To claim that Visa (V) and Mastercard (MA) will crush them is from my understanding missing the point of the role V and MA play in the financial space.

Visa and Mastercard strategy

I am sure we are all aware of this but let me point it out one more time. V and MA are not providers of credit. They leave the capital intensity and the debt entrapment to issuers.

V and MA core function is to provide a network to connect institutions and settle transactions with these institutions around the world. These are commonly referred to as payment rails. V and MA also set the rules of the network and how all the players must play to use their network.

V and MA also want to keep their networks open loop as opposed to a closed loop network like American Express. They want as many people to join from both the customer, merchant and issuer side.

Their goal is to have as many nodes on their network to enable the flow of funds globally. These nodes are cards, banks and merchants etc. The more nodes on the network the bigger the network effect.

V and MA do not compete with APT directly. V and MA competition vector is not to compete and kill nodes and endpoints on their network, of which APT is one. V and MA compete to sign up as many players on their network thus benefiting their respective network health.

As V points out partnerships are a force multiplier to drive growth in credentials, add more points of acceptance and develop more use cases on their rails. V and MA compete with each other to provide a mechanism to connect institutions and settle transactions with other institutions around the world.

As per the Q4 2019 earnings call Visa points out that it is building partnerships with numerous players in the BNPL space:

The (inaudible) part of that text was Klarna and PayD. The important message here is that Visa is not in the business of picking winners and losers, they will open up their rails to anyone and let products fight amongst themselves.

I think it is worth pointing out that the acquisitions V and MA make are to enhance their network capabilities. Earthport, Rambus and Verifi are some of V’s more recent acquisition which all build out its endpoints or its token and dispute resolution process. I would be amazed if either V and MA place a bet through anyone in the BNPL space whether equity or debt. Why would they bother.

V and MA are competing heavily at the moment to build out a real time payments network to expand their traditional market of credit and debit to real time payments. Just look at V buying Earthport, MA buying Vocalink and recently MA buying Nets to offer bill payment capabilities. Their focus is to build a network of networks.

So that brings us back to APT and Galloway’s assertion that this “credit card” duopoly will crush the BNPL space. V and MA are not competing with APT. They will not crush APT or others in the BNPL space. They want as many players to sign up to their rails and fight it out, let the free market decide the winner.

Now V and MA instalment product offering may enable competitors to launch products to compete but this is not V and MA competing directly. The competition will come, if at all, from the legacy incumbents with different models built on generating revenue from lucrative card fees. Whether the issuers can change their model time will tell.

APT vector of competition is not with V or MA it is with incumbent issuers, specifically the credit issuers. APT are competing on a specific vertical not on a horizontal level across all payment options. APT is trying to build a network ecosystem within the ecosystem of V and MA.

Any competitor in BNPL will have to build a network of merchants and a network of users. Networks are hard to build. There may be a winner emerge but this relies on a strong distribution channel and aligning your model to change the point of competition. Whether this is Afterpay, Klarna or Affirm or another player we do not know, but we know it will not be V or MA.

Afterpay may half over the next year and Scott Galloway may be proven correct, but for the wrong reasons. But when you are in the forecast business that’s not the point is it?