The Power of Exponential Growth

Introduction

During my trip to Penang, I had an excellent opportunity to interact with high-level investors and I’ve glimpsed a bit from their knowledge.

Introducing the concept of Exponential Growth. It was first introduced by Hemant Amin of Asiamin Capital.

An example of linear growth is something like…

2 + 2 = 4
2+ 2 + 2 = 6

How about exponential growth?

2 x 2 = 4

2 x 2 x 2 = 8

Full credits to Ben Sternke

This is the result of exponential growth. It compounds and accelerates. If you take 30 steps, you will cover 30 metres. If you take 30 exponential steps, one, two, four, eight, sixteen, thirty-two, you will encircle the planet 26x times.

The best company to illustrate exponential effect is Visa. It is around 294.3b in market cap. Can it still grow? My answer is yes.

According to Statista, there are 755m (international) and 342m (United States) Visa cards.

Visa’s Strategy

Visa’s growth comes from three folds – [1] increased cards in circulation both debit and credit [2] increased in spending per card user [3] gaining market share from Mastercard.

Payment volume (interchange, merchant discount, card networks, processing fees) is something very critical for the growth of any payment network. For facilitating the transfer of value among consumer, merchants, financial institutions plus prevent fraud, Visa gets a good cut out of it.

When someone’s disposable income rises, he/she spends more. Visa eats a cut out of that. For someone who spends $1,000 per month, Visa will share the 1-3% of the $1,000 with card issuer (bank) and processor. Visa is the network.

A year later, the same individual got a big promotion. He increases his spending to $2,000 per month. The same story repeats. Visa will share the 1-3% of the $2,000 with card issuer and processor.

As long as the strategy I outlined above is taking place, Visa will get a cut out of any value of the transactions without doing anything extra.

1. When a new cardholder latches onto the entire Visa’s network, Visa earns a cut.
2. When he earns more and spends more, Visa earns a cut.

Around the world, it is rumoured that there are 24,000 Visa transactions per second. Just imagine the cut that Visa is getting? HUGE!

The same thing happens for Tencent. For someone paying through WeChat for his/her daily activities, WeChat gets a cut from the various transactions.

Payment Network

From the chart above, despite the emergence of many fin-tech companies, you do not have many companies coming into the space of “Payment Networks” in the payment industry. It is tough to link the entire merchants and banks globally. Visa took years to achieve their scale. Visa relies on “network effects” through increased acceptance around the world.

It is no wonder even if fin-tech start-ups do venture into the payment industry, they venture into issuer processors, acquirer processors, merchant aggregators, terminal providers and not into payment network. It would probably be very difficult for a new competitor to compete with Visa’s low and competitive transactional fees.

Surely, the rise in popularity in blockchain currencies threaten Visa and Mastercard. What blockchain currency can do is to eliminate the need for middlemen like Visa and Mastercard to make a transaction. This will diminish Visa’s competitive advantage of being a toll gate.

However, blockchain currencies are incapable of processing transactions at the rate which Visa can. Bitcoin currently can at most process 7 transactions a second while the quickest cryptocurrency, Ripple can process 1,500 transactions a second. This is a far cry from what Visa can do; Visa is able to process 24,000 transactions a second.

Till the day blockchain can prove that it is scalable, I do not think payment network companies like Visa and Mastercard must worry about their future and their growth trajectory should still be intact.

Within the payment industry, excluding the issuers like banks, the payment network segment has one of the highest market capitalisations because the value it has created for customers and its partners.

In fact, the payment network segment makes up ~72.3% by market capitalization, a stunning proportion out of the whole payment industry.

Source: https://www.fiverr.com/yh_shanto/integrate-payment-gateway-with-php-website

To understand how payment network companies are involved in the whole process, follow the blue arrows then the green arrows in the diagram above. When a customer buys a product or service from a merchant, the transaction is transmitted to the merchant’s bank (aka acquiring bank). The transaction is then relayed through Visa or Mastercard’s network to the customer’s bank (aka issuing bank). If the customer has enough funds in their account, the issuing bank authorizes the transaction and the acquiring bank of the merchant will receive funds.

In the process of being a middleman for the acquiring and issuing bank, Visa gets a cut of about 0.11% + $0.0195 of the transaction. You can see this is a small amount and the only way for Visa to survive is to play the volume game. In 2017 alone, Visa processed 8.8 trillion USD worth of transactions. This is huge!

From the statistics, we can conclude that Visa is a tollgate. For every transaction coming through its doors, Visa will inevitably get a cut from it. This gives Visa’s business a huge competitive advantage.

Some personal and course update:

1. I spotted a payment processor company that uses Visa’s network to grow exponentially. It meets my criteria and it has been growing more than 40% for the past 6 quarters. I am going to do a sharing on it to my GIM community very soon.
2. I worked with Value Investing College to produce a video on Best World. I am happy to know some of my friends have made more than 60% returns on Best World! Check out the video I did by clicking here.
3. I corrected my views on China Sunsine on this article. It is up 25% now.

If you wish to know more about my course offering, drop me an email at kelvesy@gmail.com.

My reference:

http://www.valuewalk.com/wp-content/uploads/2017/05/Payments-Industry-SLIDE-DECK-05.12.2017.pdf