Visa’s IPO Could Set It up To Be a Super Discounter Visa Inc. is going to take some getting used to. And if some observers are correct, alternative-payments processors may have as rough a time adjusting to the reality of a publicly owned Visa as the banks that have owned and controlled it for decades. Here’s why: in the opinion of some industry watchers, a Visa no longer beholden to banks could become the Wal-Mart of transaction processing. Think everyday low prices for, say, micropayments or online bill payments. “I see Visa exercising its market power in new ways and in new directions,” says Steve Mott, an electronic-payments expert and principal of consultancy Better Buy Design, Stamford, Conn. If you’re a merchant, you have litigation to thank for this possible turn of events. Facing many of the same pressures that led its rival MasterCard Inc. to go public earlier this year, Visa announced last month it plans to scuttle the membership-association structure that has characterized it throughout its 36-year history in favor of a sweeping reorganization that will lead to ownership by the public. Visa says it expects the process, which will result in a company to be called Visa Inc., to take anywhere from 12 to 18 months to complete. The plan calls for five of the six international regions to merge to form Visa Inc. These regions include Visa USA and Visa Canada, as well as the operating regions of Visa International: Latin America and the Caribbean; Asia-Pacific; and Central and Eastern Europe, Middle East, and Africa. Visa Europe will remain a bank-owned association and will become a licensee of Visa Inc. In the end, the new company will have a new board of directors and a chief executive from outside the ranks of the San Francisco-based association. It may also have a new mission, one aimed squarely at promising new transaction markets. To begin with, in subjecting itself to the forces of the capital markets, Visa is likely to become more innovative, some experts say, a process MasterCard is already going through. “The organization will become more competitive over time,” says Eric Grover, a former Visa International executive and principal at Intrepid Ventures, a Menlo Park-based consulting firm that follows payments processing. “No one will ever mistake either [Visa or MasterCard] for Silicon Valley, but they will get better.” On the whole, Grover says, the ultimate market valuation for Visa should be “very healthy.” That could fuel a lot of enterprising ambition within the company, which laid off staff and put a number of initiatives on hold after getting hit with a $2 billion settlement cost in the Wal-Mart case back in 2003, says Norman G. Litell, an industry consultant and former Visa executive. “Going to the public markets may give them the opportunity to go back to that overall set of payment products and initiatives,” he says. But what about pricing? Visa executives won’t say what’s in store, beyond pointing out how the new capital will allow the company to invest more heavily in technology. How the organization will change the way it sets interchange pricing—if at all—is unclear. “It’s too early to tell on that front,” says Cheryl Heinonen, head of global corporate relations for Visa International. But Visa admits the raft of anti-trust lawsuits merchants have filed in the past year over interchange played a role in its decision to reorganize—as it did earlier with MasterCard. “It’s something we’ll need to address,” says Heinonen. After all, that litigation has raised the possibility of billions of dollars in liability for the associations and their members. Those who buy stock could end up sharing in the cost of an adverse verdict. So does Visa see an opening? Could it weaken the merchants’ case and siphon transactions to its own brand at the same time by offering cut-rate pricing to new markets? In a membership association owned and controlled by interchange-earning banks, such an idea would die aborning. But for a Visa owned by the public, the story could be different, contends Mott. “They’d no longer be hindered by banks looking only for interchange income,” he says. What that will mean, he argues, is that you can expect Visa to come after promising new payments markets, such as contactless, online bill payments, and small-value transactions, with a pricing vengeance, undercutting existing processors to move volume on to its branded cards before established transaction patterns harden. Look for billers to receive Visa signature-debit card rates lower than what they pay for PIN-less debit, for example. That would price check cards at less than 50 cents per transaction. Visa’s current utilities rate for credit and debit is 75 cents. “Visa would act as a network with complete pricing power,” Mott says. A not incidental by-product of this strategy could be to undermine the merchants’ interchange case. Mott figures that, while the merchants are certainly looking for the associations to write them a large check for damages, what they really want is an overhaul of interchange. By doing an IPO and introducing cut-rate pricing, Visa may cause at least some of them to conclude they’ve accomplished what they went to court to do. “What they really want is long-term structural change,” notes Mott, though he says Visa may also have to change its rules to allow merchants to surcharge to get completely off the hook. Not so fast, says the lead attorney for the merchants. “I would like to see how they’re going to solve the problem of keeping the banks issuing Visa cards if they lower interchange rates,” says K. Craig Wildfang, a partner at Robins, Kaplan, Miller & Ciresi. After all, the banks may cease to own Visa, but they will continue to be customers of Visa Inc., which will be dependent on them to get its cards out. And don’t forget that the merchant plaintiffs sued MasterCard after its IPO, arguing the transaction was anti-competitive. Wildfang says it’s “premature” to speculate on Visa’s plans for public ownership and what response it might draw from his cli ents. Litell, the former Visa executive, doesn’t see Mott’s scenario playing out quite the same way. Banks will still expect healthy flows of interchange income, and all the more so now that they’re free to issue cards from American Express Co. and Discover Financial Services LLC, he says. But what could happen is that Visa will be able for the first time to negotiate directly with chains and other major retailers rather than work through its members. “Now [with the IPO] you create more opportunity for direct relationships with large merchants,” Litell says. The result? Observes Litell: The big-box merchants at a minimum will bring pressure to bear on Visa to get “beneficially low rates for acceptance.” But that doesn’t mean Visa will dominate new markets like small payments with heavy pricing discounts, Litell argues. With issuers footing the bill for expensive cardholder protections, the extent to which Visa can discount for low-margin payments is limited. “You can’t possibly give all the [same] protections under the regulations and under the brand to small-value payments as for largevalue transactions without compensating for it,” he says. “Visa’s not that stupid, and neither is MasterCard.” Still, Visa has shown an aggressive pricing stance in recent years when it felt it had to. What will happen post IPO? Says Mott: “As they used to say in the Marines, stand by to stand by.” Puzzlement Over How To Profit From M-Payments When PayPal Inc. launched its mobile payments service this spring, its status as a major online processor cast a spotlight on a business that has been attracting a seemingly endless list of entrants. These days, names like TextPayMe, KushCash, iSelfPay, H2 West, Obopay, and Tyfone are popping up with the frequency of text messages to offer an m-payments product. Obscure today, but maybe one of them is tomorrow’s PayPal. But look closer at this carnival of startups and you’ll find a welter of pressing questions about the business case for allowing consumers to use their cell phones to pay merchants and each other. Now, the business appears to be resolving one of these questions, a big one, while opening yet another, even bigger, one. Take short-message-service (SMS) transmissions. Most of these startups are really person-to-person payment services, much as PayPal was when it began, and rely on the text-messaging capability of handsets to trigger transfers to other subscribers. Even PayPal Mobile uses SMS. It’s a little clumsy, what with those puny keys, but it works well enough to settle shares of a lunch bill or pay for a sofa from somebody you found on craigslist. Trouble is, it’s hard to build a business on P2P. There’s a reason PayPal abandoned the idea of “beaming” money from one handset user to another shortly after its launch, and settled into the more lucrative business of handling payments for eBay sellers. That reason is fees. It’s hard to charge individual consumers enough to make a going concern out of P2P processing. Beyond that, teens may have no qualms about text messaging, but most adults won’t bother with all that clicking and fussing. “SMS is a solution for today, but it’s not a scaleable solution,” pronounces Mohammad Khan, president and founder of ViVOtech Inc., a maker of wallet software for mobile payments. For this reason, Khan and others see the business moving away from P2P and toward a link-up with merchants at the point of sale. Even PayPal Mobile offers movie studios and other companies the ability to promote their products in ads and on billboards for on-the-spot purchases. Want to buy that DVD right now? Just whip out your phone, enter the short code you find in the ad, and PayPal Mobile’s Text to Buy takes care of the transaction. But the technology Visa USA, MasterCard Worldwide, Motorola Corp., ViVOtech, and several of the m-payments startups are looking at isn’t short codes. It’s near-field communication (NFC). With NFC, banks can enable customers to use their phones to pay at the point of sale with a wave rather than a swipe, just as they can with contactless cards. NFC got a big boost when a nine-month trial of the technology, involving 150 Cingular Wireless subscribers and the controlled environment of an Atlanta sports arena, ended this summer with positive consumer feedback. Already, the new mobile processors are climbing on the bandwagon. Obopay Inc., formed only in 2005, has said it will make its application work on ViVOtech’s wallet software next year to allow its users to pay at the point of sale. In this way, the Redwood City, Calif.-based company, which relies on prepaid accounts linked to MasterCard debit cards, would look like another account in the phone’s payment menu. “We think NFC is the way to go,” says Howard B. Gefen, executive vice president of marketing and business development at Obopay. For strictly P2P payments, Obopay lets customers use SMS but also offers its application, which users download for free into their handsets. This bit of code automates the payments process, eliminating the need to fiddle with text messages. It even offers a third alternative: pay by logging into the company’s Wireless Application Protocol (WAP) site. So far, the application works on phones linked to Amp’d Wireless, with more wireless deals to come, Gefen promises. With mention of the wireless carriers, though, comes a much larger question than SMS vs. NFC. What the carriers want to know is, what’s in it for us? In the Atlanta pilot, POS transactions didn’t even involve the operator’s network. So -called service discovery, in which users could download digital content via NFC chips embedded in posters displayed in the arena, did at least let the carrier, Cingular, bill for certain content and for data usage. But that’s a new and gimmicky product, making revenue har d to forecast. “It’s a little harder for [carriers] to get their heads around how to make money from that,” says Stuart Carlaw, principal analyst at ABI Research. Nor are the banks likely to be in a sharing mood. “No bank is going to let an operator touch” transaction fees, says Sarab Sokhey, director of business development for network services at cell-phone giant Motorola, which has developed wallet software for mobile payments. So, how to get the wireless operators to play? One way is to build the NFC capability into the SIM card that comes with the phone. That little piece of circuitry is controlled by the operator, which means the network could charge a toll to banks and merchants for payments. That would build a business case pretty fast. Problem is, the banks don’t like the idea. The SIM card, they say, doesn’t meet association security requirements. They like having the payment application on a separate chip, linked to the NFC chip. The result is a stand-off, and one further complicated by the age-old and somewhat emotional issue of just whose customer the handset user is. Banks are accustomed to issuing cards they emboss, brand, and program, but with phones they lose that control. Carriers, on the other hand, are loath to cede control of the customer at a time when users routinely switch networks. “There’s very little brand loyalty, so to hold on to what’s left is pretty important to these guys,” says Michael Friedman, director of the emerging technologies practice at Mercator Advisory Group. ViVOtech’s Khan says the solution is to keep payments off the SIM card but to hand carriers the “key” to the separate security processor that controls the application. To unlock the application, banks and merchants would pay a fee to the carrier. Banks in turn would hold the key to the wallet and all payment data on the secure processor. “This will serve the purpose of getting the market going,” says Khan. ViVOtech, he says, has already begun shipping servers to issuers to run their side of this delicate mobile minuet. Motorola doesn’t buy it. After all, there has to be a business case for handset makers, too, says Sokhey, and right now the best chance of that seems to lie in leveraging the SIM card. Once there’s a proof of concept for NFC, perhaps the application can move to a purposebuilt processor, he argues. That may not be long in coming: Motorola plans to start testing NFC payment on Moto phones in a 1,000-user U.S. pilot next month. Says Sokhey: “As soon as NFC takes off, we will provide an upgrade to the operators to have the capability built in.” Why First Data’s in the Terminal Business It’s no secret that mega-processor First Data Corp. wants to get more business from small merchants, which generate higher profits per transaction than do large, national merchants. To do that, First Data needs independent sales organizations, the sentries that control payment access to millions of small businesses. Edward Labry, the head of First Data’s Commercial Services unit, the division that oversees merchant processing, has said little publicly about the processor’s small-merchant strategy, but major elements of his plan are coming out piecemeal. The first was First Data’s summer initiative with Discover Financial Services LLC in which new small merchants signed by First Data entities will offer Discover acceptance automatically along with Visa/MasterCard processing services (“Trends & Tactics,” October). In late September, First Data unveiled another component—a new point-of-sale payment terminal dubbed the FD-100. The terminal, a replacement for the AIO device from First Data’s in-house terminal maker Linkpoint, is loaded with features, runs on a Microsoft Corp. operating system, and reportedly is priced competitively with boxes from rival manufacturers such as VeriFo ne Inc., Hypercom Corp., and Ingenico. The intended users are mom-and-pop merchants and small chains with up to five lanes in each store. The terminals will be distributed through Tasq, a First Data -owned reseller. The catch: if you own an ISO, you can’t just go out and buy FD-100s and then sell or lease them to your merchants. You’ve got to have a relationship with one of First Data’s many processing subsidiaries or affiliates first. That tactic raises a potential problem for First Data. It’s often difficult to get ISOs to switch existing relationships with their sponsors, the merchant-acquiring banks that submit transactions from their ISOs’ merchants into the payment networks. Many sponsors demand exclusivity from their ISOs. Of course, there are plenty of terminal-sales opportunities within First Data’s sprawling empire that includes a 49% stake in Chase Paymentech Solutions, the nation’s largest acquirer; Cardservice International, a giant ISO; a number of so -called merchant alliances with banks, and First Data’s traditional third-party processing relationships. “The response has been terrific,” says Barry McCarthy, senior vice president of product and business development. In reporting its third -quarter earnings in late October, First Data said 11,000 FD-100s already were in the marketplace. But will the FD-100 bring new ISOs to First Data? Consultant Jamie Savant, a partner with Omaha, Neb.-based The Strawhecker Group and a Cardservice executive in the mid-1990s, has his doubts. Most ISO agents, Savant notes, want to minimize the time they must spend training merchants on how to use a new machine. Why go through that hassle if you have to change sponsors? “ISOs are looking for equipment that is feature-rich, inexpensive, and easy to use in terms of training and merchant use,” he says. According to McCarthy, however, the FD-100 is all three, though he wouldn’t share price data. The 9-by-5-inch machine weighs less than two pounds, and it runs on Microsoft’s Windows CE 4.2 operating system, which McCarthy says gives it an advantage over terminals that run on proprietary operating systems. The FD-100 can handle credit, debit, and prepaid cards in addition to electronic checks. The terminal is Internet Protocol-enabled and supports dial-up communications, and can accommodate modules for Wireless Fidelity (Wi-Fi) capabilities. The device has 64 megabytes of memory and can download IP applications in six to 10 seconds. It comes with a thermal printer and five USB ports, which means just about any peripheral device, including PIN pads, check readers, or wireless-device readers, can be plugged into it. Savant believes it will take significant price concessions to motivate outside ISOs to change their existing processing relationships in order to get the FD-100 through a First Data acquiring entity. And a good terminal alone is not enough to attr act and keep ISOs. Acquirers also must get new merchants onto the network quickly, and competently provide gateway, risk management, and account services. “A terminal’s one thing. It’s the whole servicing of a small ISO,” he says. The biggest question about the FD-100 may not be how well it works, but whether its developer wants to be a processor or a terminal manufacturer.