MasterCard Clouds on the Horizon?

Implications: The near-term prospects for MasterCard are positive, despite a weak US economy. MasterCard is riding a trend of payment transactions moving from cash and check to card and electronic media. The challenge to MasterCard comes from potentially disruptive regulatory and technology forces that MasterCard must acknowledge and address.

Analysis:

MasterCard has performed exceptionally well post IPO. They are well positioned to take advantage of the global trend of payments moving from cash and check to card and electronic networks.  MasterCard has the scale, brand, transaction network and partner relationships needed to succeed given the current market state.

The pending challenges for MasterCard are not credit risks. They do not take on the transaction payment risk. Their revenue stream is dependent on taking a share of the merchant discount from each transaction. That discount rate is the source of a looming problem for MasterCard.

The discount rate has been challenged successfully by large merchants in the US. A settlement with merchants has not quelled the problem. In both the US and EU regulatory and legislative bodies have taken steps to increase regulation over the merchant discount, a significant threat to the MasterCard business model.

There is a second component to the merchant discount problem, the emergence of alternative payment systems that challenge MasterCard. These alternatives such a Revolution Money, Bill Me Later and potential payment schemes from Google and Yahoo challenge the MasterCard pricing structure, offering merchants a lower rate.

MasterCard needs to respond to both the regulatory and alternative payment challenges with a mix of pricing and product initiatives.

In terms of pricing MasterCard needs to build on its practice of pricing base on the risk and transaction processing cost of specific market segments. This will enable MasterCard to publish a rate schedule that includes low rates that they can use to blunt the regulatory challenge and limit the ability of new entrants to cherry pick market segments.

In addition, MasterCard needs to continue to invest in emerging products and technologies such as prepaid debt, contactless, mobile payments and alternative online payments.

That pricing and production combination can help MasterCard address the challenges to its merchant discount based model.