In February 2013 J.P. Morgan Chase announced the creation of ChaseNet, a closed-loop merchant processing network. ChaseNet simplifies the traditional payment ecosystem serving as the merchant acquirer, card network, and issuing bank for card transactions between consumers and merchants. The product relies on a ten-year lease of Visa’s processing network (VisaNet) to route transactions made with Chase credit and debit cards. The deal seemed to make sense for a couple reasons: 1) Visa benefits as the partnership allows Chase – its largest card issuer – to shift more transaction volume to Visa rather than competing networks, and 2) Meanwhile, the ten-year fixed rate deal structure lets Chase run incremental volume over ChaseNet with a lower cost than competitors.
Last week, I was reminded of the deal when it was announced Chase added Walmart to an impressive list of large merchants that accept ChaseNet including: Starbucks, Marriott, United Airlines, Barnes & Noble, Rite Aid, and Chevron. Keep in mind the deal only impacts a small fraction of Walmart transactions, say 5%, where Chase serves as both consumer’s issuing bank and the merchant’s acquiring bank. However the pace of merchant adoption is worth mentioning. Let me explain!
Merchants are notoriously hungry to cut costs through card fees. As a refresher, a conservative estimate for the merchant discount rate (MDR) – the fee a merchant pays to the merchant acquirer – is 2.25%. This fee assessed per card swipe is divided among three parties: the merchant acquirer, the card network, and the issuing bank. Typically a merchant acquirer would only capture 20% of the MDR, while another 10% flows to the card network, before the bulk of the transaction revenue (70%) is captured by the card issuing bank. In building a three-party closed-loop network, Chase can capture nearly all of the associated card revenue from ChaseNet merchants. Further, the lower cost structure allows the company to undercut traditional acquirers in negotiations with large merchants. And without those card networks (and their operating rules) acting as intermediaries, Chase can negotiate directly with retailers. For their part, merchants would be wise to note the growing army of deal hungry millennials who are gobbling up the new Chase Sapphire Reserve at a clip 8 to 10 times company projections.
What does all this mean? In the short term, not much. Payment revenues at J.P. Morgan are simply too small to matter against a balance sheet of nearly $2.5 trillion. Nevertheless, the bank appears to have several levers to pry business from traditional acquirers, and the incremental interchange income largely flows to the bottom line and commands a healthy multiple. Who wouldn’t take that in the current rate environment? Meanwhile it’s the kind of business that fits perfectly with a growing consumer card portfolio of young customers who are expected to play a key role in coming wallet wars. Acquirers and closed-loop networks, you were warned!