When looking at the leading payments companies where I’ve worked (MasterCard, PayPal, Payoneer) and the myriad clients I’ve engaged with across the fintech world, I found that almost all of them fall within three primary business models: credit / debit card interchange; cross-border currency exchange; and financing. Interestingly, each of these business models cut across B2B and B2C segments and are found in a wide range of market verticals.
For established companies extending into new markets, or startups looking to build the next fintech unicorn, understanding these different business models is a critical component to a successful market entry strategy. Some companies derive revenue directly from these business models, while others choose to follow more of a “pick and shovel” approach, providing the enabling technology and platforms. However, whether directly or indirectly, the foundation of most fintech companies is built upon one of these three models.
This is the first of a series of posts digging into each of these fundamental fintech structures. If, as suggested by the VC firm Andreessen Horowitz, “every company will become a fintech company”, then innovative companies looking to build new fintech revenue streams will most likely fall into one of these three models.
Part 1: Card interchange
The credit card industry is, fundamentally, built upon banks and the networks like Visa and MasterCard that connect them. However, an impressive number of fintech companies have emerged that provide an additional layer of value to business and consumer customers on top of the banking card network. These types of fintech companies are driven by revenue derived from interchange on credit or debit card transactions that they enable.
At a basic level, interchange refers to the fee that merchants must pay in order to accept credit and debit card payments. When a merchant accepts a credit card payment for a purchase of $100, they may only receive around $97, with the balance split between a number of different parties including the network, the issuing and acquiring banks, and other providers such as the payment processor. It is this fee that has spawned literally thousands of fintech companies looking to take a piece of interchange revenue.
There are actually two sides to this interchange-based business model, card acceptance and card issuance, and either can be an effective monetization strategy.
Companies focused on card acceptance help businesses accept payment via credit and debit cards. Historically, the process for a business to start accepting cards in-store or online was cumbersome and time consuming. Emerging over ten years ago, fintechs like Stripe and Adyen have built multi-billion dollar companies by dramatically improving and streamlining the path for businesses to accept cards. However, there have been a number of innovations that expand or improve on the traditional merchant card acceptance use case.
For example, Square (now Block) lowered the bar to accept card payments and enabled small and micro-businesses to process payments through a dongle that attaches to a smartphone. With Square, any mom-and-pop art fair vendor or fruit stand seller could accept card payments. Square and their simple dongle dramatically increased the number of card-accepting merchants by extending card acceptance to the long tail of small sellers.
Another example of innovation referred to as a PayFac has juiced the world of selling software as a service (SaaS) by adding interchange revenue to their traditional subscription fee revenue. The first wave of SaaS companies offered online software through a monthly subscription fee to help other companies manage their business – for example, software for a fitness studio to manage registration for their yoga classes. Through becoming a Payment Facilitator (aka “PayFac), the SaaS software provider can now enable their customers to accept payment from end users. So, the fitness studio would be able to use the SaaS software to not only manage class registration, but also accept payments from their yoga enthusiasts. Now, the SaaS software provider receives a portion of interchange revenue on each payment processed across their platform, in addition to subscription revenue. Voila, the SaaS company is now a fintech.
Since the dawn of credit cards, plastic Visa and MasterCard cards have been issued solely by banks. That’s still the case. However, more recently, innovative fintechs have built new card issuing services on top of the core banking network, extending how and where cards can be issued and used.
The usage of virtual cards, particularly in B2B use cases, has exploded. When I was at MasterCard 10 years ago, I led a product team working on the earliest versions of virtual credit cards called MasterCard InControl. A virtual card functions like a credit card, but actually is a 16 digit randomly generated number that is linked behind the scenes to a real credit card number. The virtual card can be generated on demand, and can have unique controls based on parameters such as single-use or maximum value. Ten years ago, we had little idea how pervasive the use of virtual cards would become.
Fintech companies such as Brex, Divvy, Coupa, AvidXchange and others have built multi-billion dollar businesses leveraging virtual cards to help companies better manage their corporate expenses. Employees using these tools can request and be issued a virtual card on demand for business purchases, allowing their company unprecedented controls and visibility over these purchases. And for every purchase conducted on a virtual card, the fintech that generated that card (through a banking partner in the background) receives a share of interchange revenue.
Even the process of issuing cards has been transformed. Fintechs like Marqeta and Galileo are providing the infrastructure to expand card issuing beyond banks. For example, Coinbase is using Marqeta to offer users a physical Visa debit card tied to their crypto holdings. Through this Coinbase-branded card, issued by a banking partner in the background and enabled by Marqeta, Coinbase receives a portion of interchange revenue on each purchase, opening a new revenue stream.
While interchange is probably the most prevalent business model for fintechs, innovative companies have created significant value leveraging other revenue sources, in particular cross-border currency exchange or financing. My next posting will dig deeper into these other business models currently driving growth in the fintech world.