How MasterCard Makes its Money (MA)

If MasterCard Inc. (MA) has its way, paying with cash will one day seem as prehistoric as using livestock to settle one’s accounts. The venerable credit card operator has grown exponentially since its early days as a cooperative among multiple banks that used a common name to process payments. Much like its perennial competitor Visa Inc. (V), MasterCard enjoyed decades of privately-held success before an early 2000s initial public offering (IPO). If you happened to have bought in when MasterCard went public in 2006, you would probably have few regrets. Since then, the stock price has risen from $39 to $191.06 as of October 29 market close, and the company has a $196.24 billion market cap.

Investors love MasterCard. The company announced its Q3 2018 earnings on October 30, 2018. The credit card operator reported revenues of $3.9 billion, a 14.7% increase from $3.4 billion over the same period last year. In fact, the company has topped revenue predictions every quarter for the last year. But for all the investor hype, end users seem equally satisfied. The seamlessness with which you make a MasterCard transaction belies a comprehensive network of merchants, financial institutions, and settlement banks, each of which gets a cut of a process that takes mere milliseconds. 

Here's how MasterCard makes its money.

MasterCard has almost 2.4 billion cards in circulation, which is something to marvel at the next time you spend all of four minutes on hold waiting for a customer service agent. Over 837 million of those are personal credit cards, with 1 billion debit/prepaid cards and the remainder commercial credit cards. Although MasterCard is popularly identified as a credit card company, that's not likely to be the case for much longer, should current trends continue. MasterCard’s roster of active debit cards is growing seven times faster than that of its personal credit cards, resulting in the number of debit cards outnumbering the number of credit cards.

Despite the high interest rates charged on credit cards, which average about 17% annually, debit cards are actually far more profitable per unit. In 2017 MasterCard’s gross dollar volume was $2,289 billion, compared to $2,369 billion for debit/prepaid cards. The comparable figure for commercial credit cards was $589 billion. Gross dollar volume is a primary metric by which MasterCard charges percentage-based service fees.

What distinguishes a Discover care from the other major credit card issuers (including MasterCard) is that it operates as a bank in its own right. When you buy something with a Discover card, you’re actually borrowing the funds from Discover Financial Services (DFS) until the bill comes due. With MasterCard, you’re borrowing the funds from the issuing bank whose name is imprinted on your card. There are thousands of such banks. MasterCard makes money by charging them to use 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 that are processed in the same country that a transaction takes place – and cross-border volume fees. The former category, officially known as “domestic assessments,” accounted for $5.1 billion of MasterCard’s $18.3 billion in gross revenue for the latest fiscal year. As for cross-border volume fees, they totaled $4.1 billion.

MasterCard's third major revenue category, called transaction processing fees, netted revenues of $6.1 billion in 2017. Those fees are charged to the merchants’ financial institutions and come in two subcategories: "connectivity" and "transaction switching." Connectivity fees come out of users participating in the MasterCard network. charging to use the network, and getting a cut of each step in the process. MasterCard also collects a transaction switching fee every time the issuer receives an approval for authorization, every time the transaction information clears between the two parties’ banks, and every time the funds actually settle. Again, these cuts are nanoscopic, but they amass. In fact, MasterCard’s transaction processing fees are increasing even faster from year to year than domestic assessments, growing 20% in the 2017 fiscal.

The U.S. is by far MasterCard’s largest market, quadruple the size of the next largest. A fun fact the next time the revolving credit category comes up in your weekly trivia night: the three currencies that MasterCard does the most business in are the U.S. dollar, the euro, and the Brazilian real. Not surprisingly, MasterCard’s most burgeoning region is Asia, the Middle East, and Africa, where revenues have gone up double digits year-over-year.

It’s tough to explain just how revolutionary credit cards were when they debuted. Yes, there was a time when if you wanted to buy anything, you carried cash and/or a checkbook with you. But even the simplicity of a lightweight, plastic rectangle has managed to give way to yet more convenient ways of making payments. With MasterCard now among the first corporations to adopt fully digital payment, from the tap of a smartphone button, the company’s expenses should continue to decrease while revenues rise, making it a sharp investment for years to come.