Visa Fends Off Usurpers by Joining Apple in Pay System


A 4-foot-tall robot with a video screen for a head swerves past an orange couch and bumps into the wall of a conference room. A few feet away, an engineer tests a virtual reality headset that can allow a coffee-shop owner to forecast hot-chocolate sales during a blizzard.

This is Visa Inc.’s new outpost in San Francisco -- part executive office, part design laboratory and entirely the brainchild of Charlie Scharf, Visa’s chief executive officer.

Scharf, who this July day had unveiled the latest version of the company’s digital wallet, is sitting in an office overlooking San Francisco Bay one floor above the lab. He’s wearing jeans, loafers and a gray shirt with no tie. One leg is propped up on his desk.

Moving into the heart of the city, 23 miles (37 kilometers) from Visa’s suburban headquarters in Foster City, California, and three blocks from a Google Inc. office, is a statement about how Scharf is seeking to embrace the new technologies transforming the way consumers make payments, Bloomberg Markets will report in its November issue.

“We have to think and act much more like a technology company than we have before,” Scharf says a few weeks later at a restaurant in Sag Harbor, New York, where he’s on vacation with his family. “The payments world is changing. There are new entrants, new opportunities for people to get into our business and other opportunities for us to grow our business in ways that didn’t exist before.”

Dimon Protege

Visa runs the world’s largest payments network, and Scharf, 49, the quiet, methodical former protege of JPMorgan Chase & Co. CEO Jamie Dimon, is fighting to ensure that the 56-year-old company stays relevant and ubiquitous as more transactions are made online or by mobile phone and other digital devices.

Visa and its smaller competitor MasterCard Inc. control 87 percent of global credit- and debit-card transactions and profit from fees banks pay them to process those payments. Once associations owned by the biggest U.S. banks and now independent companies, they act as middlemen between lenders that issue credit, merchants that accept electronic payments and consumers who use cards to make purchases. Although the model has been profitable, some investors say it also can be inflexible and outdated, making the networks vulnerable to disruption.

“Visa and MasterCard are holding on for dear life,” says Josh Siegel, CEO of StoneCastle Partners LLC in New York, which invests in financial firms. Scharf “has to figure out how to take this cash cow -- which does have massive market power -- and either stifle or acquire technology to maintain the status quo or become that renegade and totally overhaul the company.”

Bitcoin, PayPal

The disruptions Scharf faces include virtual currencies such as bitcoin, alternative online-payments systems like PayPal that can bypass credit cards and new methods for enabling mobile-phone transactions. He’s also battling competing networks, fending off lawsuits over swipe fees with retailers such as Wal-Mart Stores Inc. and contending with rules in China and Russia that restrict what foreign firms can do.

In Scharf’s two years at the company, his strategy has focused on opening Visa’s network to new technologies. That has included collaborating with the likes of Apple Inc. and Google; giving developers and startups such as Square Inc., which helps small businesses accept cards, access to Visa’s systems; and investing in firms like LoopPay Inc., whose software allows customers to store credit-card data on their phones.

Apple Pay

That strategy paid off in September, when Apple announced it was turning its new iPhone into a mobile wallet that makes in-store payments possible with the tap of a finger.

Instead of developing Apple Pay on its own, the company partnered with Visa, MasterCard and American Express Co., piggybacking its technology onto already existing payments systems. The phone uses wireless near-field communication to deliver a digital identifier called a token, which helps prevent hacking by eliminating the need for merchants to have access to account numbers. Companies including McDonald’s Corp. and Target Corp. have agreed to accept Apple Pay.

The systems required to process bank-card payments and the security needed to protect consumer data are potent weapons for defending Visa’s business model.

The company’s primary command center, at a location in the Washington area that Visa asked Bloomberg Markets not to identify, is guarded by a moat, features floors that are 4 feet (1.2 meters) thick and has enough food and water to supply 120 employees for 45 days in an emergency. There are four backup sources of water to cool machines the size of cars whose data are duplicated at another center. Computers track more than 70 billion transactions a year, displayed on 40-foot-wide screens.

‘Nearly Impossible’

“For another company looking to break into the payments business, it’s nearly impossible for them to replicate the systems that Visa has in place,” says David Ellison, who oversees more than $5.5 billion, including Visa shares, at Hennessy Advisors Inc. in Boston. “Keeping their network secure is key to sustaining their high multiples and sustaining the economy. They are probably one of the most important financial companies outside of the Fed.”

Although Scharf won’t provide specific forecasts, he says the technology and security investments he’s making will translate into revenue increases in the next 2 1/2 years. And his efforts to collaborate with retailers and startups will contribute to earnings growth during the next four, he says.

Profit Margins

Visa’s profit margins show how resilient the network has been to disruption as consumers replace checks and cash with electronic payments. Net income in the first six months increased 19 percent from the same period a year earlier, and the average operating margin was 64 percent. That compares with MasterCard’s 12 percent gain in profit and 59 percent operating margin.

While Visa’s margins have helped its shares gain 377 percent since the company’s 2008 initial public offering, compared with a 36 percent increase for the Dow Jones Industrial Average, the stock has slipped 5.7 percent this year, making it one of the worst performers in the index.

Investors pulled back after the company cut its global revenue growth forecast for the 12 months ended in September to between 9 percent and 10 percent, the smallest increase since 2009, citing geopolitical risks and a strengthening U.S. dollar. In the fiscal year that ended in September 2013, Scharf’s first as CEO, for which he was awarded a $10.5 million pay package, net operating revenue increased 13 percent.

‘Doing Differently’

Scharf, who has a bachelor’s degree in social and behavioral sciences from Johns Hopkins University in Baltimore and a Master of Business Administration from New York University’s Stern School of Business, has built a career on corporate turnarounds. In 1987, his father, then a stockbroker, helped get his resume in front of Dimon, who hired Scharf as an assistant at Commercial Credit Corp., a consumer finance firm where Dimon was chief financial officer and Sanford “Sandy” Weill was CEO.

Dimon, who says he likes that Scharf “isn’t a bulls-- tter,” recalls how he’d send him to failing companies to run the numbers, relying on his intellect and attention to detail. “He would always be pointing out things we could be doing differently,” says Dimon, whose bank is the biggest U.S. issuer of Visa credit cards.

Scharf remained loyal to Dimon for 25 years, following him to Citigroup Inc. to help build what would become the largest U.S. bank and then to Bank One Corp. in Chicago, a regional lender later acquired by JPMorgan. There, he rose to chief of the retail bank and helped arrange the takeover of the biggest failed U.S. lender, Washington Mutual Inc., during the 2008 financial crisis.

Wal-Mart Lawsuit

Since joining Visa in November 2012, Scharf has been shaking up the company’s culture. For years, Visa had focused on the interests of its clients, the biggest banks, viewing new technologies as threats to its model and fighting with retailers over swipe fees.

“It was deeply embedded in the culture that we would only talk to the traditional players,” Scharf says over a croque-monsieur at Sag Harbor’s American Hotel. “When I got to the company, I learned there are a number of merchants out there that don’t just not like us; they hate us.”

Those tensions have fueled lawsuits, most recently in March, when Wal-Mart sued Visa for $5 billion for allegedly conspiring with banks to fix transaction fees, a case Visa says it’s working to resolve. Target and Wal-Mart are among retailers developing their own payments networks designed to give them more control of processing costs. Visa and MasterCard also are adjusting to new regulations, such as the 2010 Dodd-Frank Act, which cut the average debit-card swipe fee by almost half to about 24 cents.

Management Overhaul

Scharf, who had been a Visa board member, was tapped by directors in 2012 to replace retiring CEO Joseph Saunders. He began by overhauling management, hiring Ryan McInerney, who had worked with him at JPMorgan, as president, and Ramon Martin from AmEx to lead Visa’s first team dedicated to merchant services. He modified roles for others, putting then–Chief Legal Officer Ellen Richey in charge of risk and Jim McCarthy, head of innovation, in a role working with technology companies and startups. Scharf fired outside consultants and retooled struggling projects such as, a system designed to make online purchases easier that hadn’t caught on with merchants.

In November 2013, Scharf invited two Visa antagonists to a leadership meeting in Half Moon Bay, California: Michael Cook, assistant treasurer at Wal-Mart, and John Donahoe, CEO of EBay Inc., whose PayPal unit is one of Visa’s biggest competitors and clients. In front of more than 100 Visa employees, Cook talked about how the network’s rules made Visa frustrating to work with, and Donahoe described how PayPal’s creative culture allowed employees to recognize opportunities to make online payments easier.

Best Frenemies

“Everyone is a frenemy in the payments world,” says Donahoe, who recalls how during his first dinner with Scharf, at a restaurant above a grocery store in San Mateo, California, he was stunned when Scharf suggested their firms meet quarterly. “He understands that of course technology is going to change our payments over time, but he wants to embrace that and innovate around that, rather than protect the past.”

Donahoe said Sept. 30 that EBay plans to spin off PayPal as a separate public company. The deal could make PayPal a tougher competitor to Visa while boosting payments volume on Visa’s network, according to analysts including Keefe, Bruyette & Woods Inc.’s Sanjay Sakhrani.

“In more cases than not, PayPal is enabling transactions on the networks, so it really benefits the networks if PayPal has a more focused strategy,” Sakhrani says.

China UnionPay

Scharf’s management style is understated. He used to unwind by building furniture in a woodshed in his Scarsdale, New York, backyard before moving to an apartment and now relaxes by practicing acoustic and electric guitar.

“He is more reserved; he’s not so much an extrovert,” says Gordon Smith, CEO of JPMorgan’s consumer bank, whose office was next to Scharf’s for about six years. “Because he’s quieter, it takes a while to get to know him.”

Now, Scharf is applying his methodical approach to addressing the challenges Visa faces outside the U.S.

In China, Shanghai-based payments processor China UnionPay Co., founded by the State Council and central bank, dominates in the world’s second-largest economy. UnionPay had the highest percentage increase in purchase transactions among global networks last year, according to the Nilson Report, an industry newsletter that tracks network data.

MasterCard Edge

Earlier this year, as tensions between Russia and the U.S. intensified, Visa and MasterCard stopped processing payments at some banks after the U.S. imposed sanctions, prompting laws restricting foreign networks.

MasterCard CEO Ajay Banga, who worked in a different business at Citigroup than Scharf in the late 1990s, faces similar challenges. Still, some investors say the smaller firm is better positioned in overseas markets.

The majority of non-U.S. transactions are made with cash, presenting an opportunity for the card companies to benefit from the shift to electronic payments. Volume is growing faster on MasterCard’s network than on Visa’s in Asia and Latin America. In Europe, Scharf can’t compete with Purchase, New York–based MasterCard because a separate company owned by banks handles Visa’s European transactions.

Global Growth

“If you want to invest in a global business, you can’t do that with Visa because they don’t have Europe,” says Tom Russo, whose Lancaster, Pennsylvania–based Gardner Russo & Gardner manages more than $9 billion in assets, including shares of Visa and MasterCard. “There’s a belief that MasterCard is potentially better suited for the great global growth.”

Geopolitics explains why one of the fastest-growing divisions at Visa is government relations. Scharf has hired lobbyists in Washington and country managers in places such as Canada and Russia as lawmakers consider changing swipe-fee rules, look for ways to make transactions safer and try to generate more tax revenue. Visa also has partnered with governments in Rwanda and China to help citizens who don’t have access to traditional banks.

Data Breaches

“It’s ultimately about supporting the financial institutions,” says William Sheedy, Visa’s head of corporate strategy, mergers and acquisitions and government relations. “If you can keep the flow of commerce in banks, then the regulatory monitoring systems that governments have, locally and globally, will work really well.”

Heightened awareness about privacy has spurred Visa to move forward with advances Scharf says are critical for growth and data security. U.S. retailers and banks have squabbled for years over costs, slowing adoption of some security technologies. Data breaches like the ones at Home Depot Inc. and Target have increased pressure to implement more-secure systems, including chip cards with so-called EMV technology, named for developers Euro-Pay International, MasterCard and Visa.

Twitter Inspiration

“We need to be as relevant, if not more relevant, in the digital world as we have been in the physical world,” says McInerney, Visa’s 39-year-old president. “We are going to have to partner with the types of players in the payments industry that we haven’t historically.”

Visa’s San Francisco outpost is the embodiment of that new attitude. Scharf, who helped find the One Market Plaza location and design the two-story space, was inspired to build the office after meeting with Jack Dorsey, co-founder of Twitter Inc. and payments company Square, whose offices are nearby. On the July day when Scharf introduced a new version of Visa’s digital wallet, employees were still moving in and dusty scaffolding lined the walls of what was once the headquarters of the Southern Pacific Railroad.

“The world is changing around us dramatically,” Scharf says. “We have to evolve and change. I just come in to work every day and ask, ‘Are we doing enough, fast enough?’”