New Age vs. Stone Age: Payments in the Digital World
Douglas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Joseph Schumpeter’s concept of creative destruction rarely proceeds along a clean or linear path. This idea, for all of the non-economics-geeks, states that in order for new economic developments to take root, they must, by definition, destroy those that came before them. In the context of digital payments, this means that in order for systems like Google’s (NASDAQ: GOOG) digital wallet to succeed, it must destroy the old guard – Visa (NYSE: V) and MasterCard (NYSE: MA) – in the process.
It is in recognition of this spirit that companies like Discover Financial Services (NYSE: DFS) and eBay’s (NASDAQ: EBAY) PayPal are forming critical partnerships; it is the old way of doing things that must be destroyed, not necessarily the companies that employ the outdated processes.
The Classic Way
Under the existing model, electronic payments are dominated by Visa and MasterCard. These two companies make a profit by charging the retailers that accept credit card payments processed by the companies a per-transaction fee. The practice has allowed these two players to dominate the industry for decades.
Unfortunately, Visa and MasterCard seem to have only recently become aware of Mr. Schumpeter and his concept. Several major retailers have initiated lawsuits against the credit card processors alleging that some of the fees being charged constitute unfair business practices.
A Non-Linear Path
Where the transition from the old to the new takes an unfathomable turn is encapsulated in one of the potential settlement offers being considered by Visa and MasterCard. Under the proposal, a special fee would be levied on consumers using credit cards. The fact that the deal is being discussed suggests that the retailers consider it viable. This means that those involved consider only two possibilities regarding this type of fee: either it will be levied and the cost of shopping with a credit card will increase or it will be rejected and the cost will not be passed on to the consumer.
Assuming that the fee will be disclosed, a very reasonable third option has been ignored by the parties involved, and most everyone who has written about the situation: the fee will be levied and consumers will revert to paying cash in order to avoid a charge that many will see as purely unacceptable.
This third option exemplifies the non-linear path of creative destruction. As consumers make the transition from classic credit cards to digital wallets, there may be a reversion to a mostly-cash economy as the old players cling to antiquated business practices. Visa and MasterCard do not need to perish in the transition, but as history has shown, those who do not adapt, die.
The Next Generation of Payments
As the destructive part of the equation plays out between the credit card processors, retailers and the public, others are working feverishly on the creative side. While Google is racing to make its digital wallet a viable option, competitors are taking big steps forward. The union between Discover and PayPal could give the partnership a major first-mover advantage. Under the terms of the agreement, PayPal will now be able to be used at the nearly seven million vendor locations that Discover has in place.
Coming Full Circle
While there may be a lag between new options gaining universal acceptance and the current modes of payment becoming less dominant, the change is already in the works. If Visa and MasterCard blindly fight to preserve their existing business model, it is likely that within the next few years, each of these American business icons will see their revenues come under serious pressure.
While it is too soon to abandon either stock based on this trajectory, this is the factor to watch when considering investments in any of the companies mentioned herein. If, or when, one begins to see softening in the numbers posted by Visa or MasterCard, while simultaneously seeing growing acceptance of alternate forms of payment, it will be time to transition one’s portfolio away from the destructive and toward the creative.
Mr. Ehrman has no positions in the stocks mentioned above. The Motley Fool owns shares of Google and MasterCard. Motley Fool newsletter services recommend eBay, Google, and Visa. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.