Credit Card Processing is a Hard Business

Braintree sold to PayPal (Ebay) this morning, which reminded me that I am a payments skeptic and especially skeptical of credit card processing.

Credit card processing is a commodity business. Companies advertise fees like 2.9% but the vast majority of that goes to the card networks and to the issuing and acquiring banks. On top of that, the majority of processing does not actually happen anywhere near the posted rates. Most processing is by large merchants (following the ubiquitous 80-20 rule) and those merchants get volume pricing and other discounts.

The margins in the card processing business are incredibly small. A company would be very lucky to make .5%. That’s not discounting the money lost to risk or the cost of acquiring customers.

Let’s take the biggest online example. PayPal processed $144.973B last year. If that was entirely processed over credit cards than they would have made - assuming 0.5% - $0.724B on processing itself. $724 million isn’t all that much.

PayPal actually made more like $5.6B last year because they make most of their money by having people use electronic checks (ACH) while charging them credit card like fees, and by charging customers high, and opaque, foreign exchange and transfer fees.

Compared to the high margins of other software companies it isn’t all that great to be in the credit card processing business. One needs a lot of infrastructure to make not all that much money, and ultimately the biggest player in online processing business gets most of their revenue from other parts of their business.

Braintree is processing $12B a year with few revenue streams outside processing. A generous reading of their net income would put them at $60M a year. I doubt they are actually near that number and, as mentioned in the press, I assume that their purchase price is so high because of a generous understanding of the value of the Venmo network.

A bunch of folks have asked me what the acquisition means for Stripe. Having worked at Stripe I think they are the best online processor on the market. They have the best solution and certainly the best team.

But is the acquisition good for Stripe? Yes and no. Yes because over the next few months Stripe is going to have an influx of great customers and their transactional volume.

The one caveat is that, inside payment circles, Braintree was known for bidding ridiculously low in bake-offs between them and other processors for hot companies like Github, Airbnb, etc. So low that they might be losing money on the deals just to secure them. Some of these customers might not move over to Stripe exactly because they’re being given an unreasonable deal, one that PayPal can sustain. Those companies have also already built their payments systems on top of the Braintree’s infrastructure.

On the other hand, this deal pegs Stripe’s short-term market value. Stripe is growing faster than most YC companies but let’s assume, given their time in market, that they are processing single digit billions a year. If Braintree sold for $800M and is processing $12B than the deal depresses Stripe’s implied valuation. I don’t think that matters since they have plenty of cash but the sale highlights how hard it is to be in the processing business. And, Stripe is the best there ever has been in the business.

I actually think that there are two interesting places to play in the credit card processing system these days. One is to be what I call a vertically specific payments company. That’s Airbnb, Uber, and Eventbrite and a different blog post entirely. The other is if you can own more than one layer of the processing stack like Credorax does in Europe.

 
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