Fiat money is a 4,000 year old socio-cultural institution. The modern credit card system, on the other hand, is only about 40 - 60 years old.
Fiat money is a 4,000 year old socio-cultural institution.
The modern credit card system, on the other hand, is only about 40 - 60 years old.
This short history has still lead to an unwieldy, sprawling system managed by institutions that haven't contributed a major technology innovation to the space since 1974, despite being plagued with inefficiencies and levels of fraud that would be intolerable in other arenas.
This is my humble attempt to explain how we got here.
It was necessary to re-conceive, in the most fundamental sense, the nature of bank, money, and credit card; even beyond that to the essential elements of each and how they might change in a microelectronics environment. Several conclusions emerged: First: Money had become nothing but guaranteed, alphanumeric data recorded in valueless paper and metal. It would eventually become guaranteed data in the form of arranged electronics and photons which would move around the world at the speed of light. - Dee Hock (1974)
In 1968, Dee Hock was an Assistant Vice President at a small Bank of America affiliate branch in Washington.
Dee was only 38 years old, but he was already establishing a reputation as a maverick. Raised in the mountains of Utah, Dee grew up far more interested in history and philosophy than finance. He says it was this background that helped him come up with the structure for Visa.
"I was struck by how dysfunctional most business organizations really were, how they crushed the human spirit and how often people were in severe conflict with the organizations of which they were part. I started studying history to see where the idea of corporation came from, what it was based on, why our institutions were as they were. I became convinced over the years that all of our present societal institutions were essentially dysfunctional."
At the time, Bank of America owned a small credit card business. Though the business was growing quickly, it was going to be limited by the size of Bank of America's customer base.
Dee proposed a radical idea: spin the credit business out as an independent organization with a set of approved members. By doing this, Bank of America could grow its credit card business exponentially faster.
After months of internal argument, the board agreed, and Visa was born.
Dee Hock became the CEO of this organization and in 25 years, he grew it faster than any financial institution in history, to a thousand times its size. In 1974, he completed the implementation of the Base I and Base II systems (more on this below), which computerized the credit card transaction.
Today, Visa connects 1 billion people via a payment network and has an annual sales volume of $1.8 trillion. The story of Visa is not that of a powerful entity consolidating control and becoming more and more powerful - rather, it's one of the most compelling case studies of success decentralization in corporate history.
It seems so obvious that Visa and Mastercard should have been member-controlled organizations in retrospect. How else could the credit card system conceivably work? Yet at the time, this was a radical innovation.
Dee called his strategy the "chaordic approach", an ideal mix of organizational chaos and hierarchical order necessary to do innovative work. He explains Visa's structure, but it also seems like he was looking into the future...towards something like a blockchain:
"It’s what you might call a reverse holding company, in that the core doesn’t own the parts; the parts own the core. If you examined it, it would look very much like the organs in a body, then the cells within the organs and the nucleus within the cells.”
The “chaordic approach” worked.
"In three decades these organizational concepts took the enterprise from a hemorrhaging industry on the verge of collapse to what is now arguably the largest commercial enterprise on earth, and the largest single block of consumer purchasing power on the globe."
Ultimately, Dee was unhappy with what Visa became. He felt that it became too centralized and slow moving…to much like the original corporation that spawned it.
"You want to keep in mind that Visa is not a good model. It is fundamentally flawed in many ways. It is no more than an archetype of the kind of organizations I believe in; merely something to study and improve upon. The best way I could articulate it at the time–remember, I was only 38 and trying to find my way in these new concepts and ideas–was 'to create the world’s premiere system for the exchange of value.'
When I began reading about the history of the credit card, I expected to find its founders to be a bunch of traditional financial suits who golfed and yelled at their kids when they listened to Jimi Hendrix; I didn't expect to get to its center and find a deeply introspective thinker whose ideas ran counter to everyone around him - definitely then...and in most cases, now.
Dee Hock believed that organizations should be as leaderless as possible. He believed that pushing empowerment to the edges of a system give it the best chance to survive and thrive in the modern day. He feels that the job of leadership is to spend the time necessary to establish a driving purpose and a set of rules...and then get out of the way.
Dee Hock and Satoshi would have gotten along just fine.
"Only fools worship their tools." - Dee Hock
Americans had access to consumer credit decades before the credit card, in the form of installment plans offered by individual stores. After the Civil War, the installment trend really caught on, and by 1930, 90% of all furniture was purchased on installment, as were 75% of washing machines, and 65% of vacuum cleaners.
During this time, the idea of buying on credit became an intrinsic part of the American cultural ethos. Here’s a quote from a historian whose name I could not find (if you know, please help me out so that I can give them credit):
"Buying on credit would become as American as baseball or jazz, and this 'impatient optimism' would grow even more quickly as the country made its way out of the Great Depression. As stores opened more locations or expanded beyond just a few employees, they needed a way to track their customers beyond personal familiarity (the original "facial recognition" technology ). This lead to the invention of simple hardware.”
In 1928, stores began to emboss metal with customer information.
These things are beautiful. In this era of retro-modern chic, I'm surprised that no store has figured out a way to modernize and bring them back.
The customer would present their "charge coin", and the merchant would use the identifying number to charge the appropriate customer's account. However, since the coin itself had no personal information on it, there was no way to prevent wanted or unwanted use of a duplicated or stolen charge coin.
In order to reduce fraud, merchants eventually began to produce metal cards that contained personal information, like this one:
Not as beautiful, but definitely more secure. By World War II, "charga-plates" were commonplace, though they were still proprietary to individual stores. Charge coins and charga-plates solved the first major scaling problem credit cards ever had: how do you identify someone when personal familiarity doesn't exist? You put a piece of identifying hardware in their hands. Over 65 years later, we still use a version of this seemingly rudimentary solution.
The practice of installment buying initiated newcomers into the possibilities of immediate acquisition and familiarized them with the impatient optimism that characterized the American consumer.
In 1949, legend has it that Frank McNamara was out alone at a restaurant when he realized that he had forgotten to bring his wallet with him. In that moment, he supposedly had the idea for a credit card that could be used at more than one merchant.
Most famous company stories usually turn out to be the fabrications of savvy PR people, and I assume the Diner's Club story is no different (Frank was already the President of an New York-based credit/lending company)...but hey, it's a fun one.\
After the supposed snafu with his wallet, Frank persuaded fourteen restaurants to pay him 7% of each transaction, if he could send them more business. Frank got his swanky friends to sign up for these cards as well, they told others, and within a year, he had 42,000 customers. Three hundred more merchants signed up within that time as well.
The "general purpose card" was here, and the modern credit card industry was officially born. In terms of hardware, it's basically the same as the charga-plate, with the exception of a prominently-featured expiration date.
It wasn't until 1958 that a large regional bank got in the game. Bank of America (fun fact: BofA was originally called "Bank of Italy" when it was founded) got a few hundred merchants to sign up for their BankAmericard initiative in Fresno, California. In order to seed the market, they sent cards to 60,000 existing customers. This had mixed results. People began using the cards happily, but fraud was rampant and the number of delinquent accounts were far higher than expected. However, they kept iterating, and by 1961, the project was profitable and growing quickly.
Bank of America was a regional (California) bank, which gave them smaller reach than a national company like American Express. Originally started as a private mail company, American Express had already experienced unprecedented success with the "traveler's cheque", a more convenient version of the Post Office's money order. In 1951, American Express sold a whopping $6.5 billion dollars in traveler's cheques, so it was no wonder that they saw the credit card as a potential threat. American Express launched their own nation- wide card a few months after Bank Of America, and after a few initial struggles, the company had 900,000 cardholders and 82,000 merchant locations by the end of 1962.
Regional or national, both BofA and Amex would be limited in their ability to expand, unless they figured out how to scale distribution beyond their own corporate borders. This lead to the testing of a few different models and eventually leads us to the concept of independent, member-controlled institutions.
Mainstream air travel (at least for certain segments of society) was a driving force for the expansion of the credit card system.
In 1966, the credit card industry was mature enough for its next stage of evolution. American Express, Diner's Club, and Carte Blanche had established themselves as upscale, "travel and entertainment" cards used by wealthy folk and business travelers, whereas Bank of America and its rivals had created a regional solution that was more mainstream.
Having established themselves, all the leading players now felt a need to expand both nationally and internationally. They first attempted a franchise model, which allowed other banks to issue their cards, in exchange for a franchise fee. This model succeeded initially, and by 1970, the BankAmericard was up to 27 million cardholders and 565,000 merchants.
However, it was starting to become clear that the franchise system was a losing proposition for the smaller banks. In a traditional franchise system, like a McDonalds, the brand actually helps an anonymous entrepreneur become more successful. However, in this case, regional banks typically had strong brand names, which they were sacrificing in order to offer a credit card. Executives like Dee Hock were beginning to realize that an entirely new model was going to be necessary - one in which everyone agrees to abides by certain rules to make the entire system work, but without any single entity owning the system itself. So, Dee and a few of his peers succeeded in turning systems like BankAmericard and MasterCharge into independent entities that existed solely to enforce system rules and empower its members to offer a semi-decentralized platform (because you still need a centralized authority for enforcement) that enabled credit cards to work seamlessly. This was called "co-opetition" and gave us what would eventually become the Visa and Mastercard payment networks.
Under the "co-opetition" model, the banks continue to compete for cardholders they can issue to and merchants they can acquire. They are empowered to operate independently as nodes in the network, but they also agree to a set of operating principles that enable their shared use of a card system.
This model proved to be another key innovation in the growth of the credit card industry. However, there were other obstacles in the way, and it would take much of the flower-power decade to get them figured out.
"Credit is the latest ally of the devil. It is the great tempter. It is responsible for half the extravagance of modern life. The two words “charge it” have done more harm than any others in the language. They have led to a vast amount of unnecessary buying. . . . They have created a large and growing sisterhood and brotherhood of deadbeats. They have led to bankruptcy and slow pay and bad debts. They have raised the cost of everything." - Irving Bachellar
American attitudes about short-term lending have religious and cultural underpinnings...so much so, that the legal term for capping interest rates, "usury", actually comes from the Bible. In the 70s, our long-standing attitude towards lending had crystallized into law and began to create open conflict within the credit card industry. In the United States, each state had its own "usury" laws, which capped the maximum interest rate that a bank could charge. Given the wide range of interest rates across state lines, it was virtually impossible for a bank to have a national strategy.
The technology and the rules that governed it were ready to function consistently and uniformly at the national, and to an extent, the international level. The network had simple rules that could lead to unprecedented improvement in the American system of commerce, but unless the laws got out of the way, it was going to choke on itself.
On top of that, the economy was starting to sputter, which reduced spending and increased fraud. Large and small banks took massive losses during this time, and the credit card business seemed to have a very shaky future. Marketing tactics didn't help the situation: the norm at the time was to mail fully approved cards en massive, often with cursory (or non- existent) credit checks. In 1970, American charge-offs were at $440 million, or 3.4% of total loans!
The one bright spot during this time was continued improvement of the technology. Dee Hock lead the implementation of the Base I and Base II systems, using these new things called computers (Visa's computers were provided by the Digital Equipment Corporation). From the book Paying with Plastic:
The system allowed a merchant’s authorization request to be transmitted over phone lines from the merchant to the cardholder’s bank, with Visa providing backup when the cardholder’s bank was closed.
The Base I and Base II projects cost Visa $30 million dollars, but they saved its members over $100 million in fraud in just the first year of operation! Mastercard quickly followed suit with their own solutions, Banknet and I-Net.
In 1978, the Supreme Court decided to make a ruling that forced the states' hands and changed the trajectory of the credit card industry forever. The Bank of Omaha had been charging its cardholders in Minneapolis interest rates that were allowed in Nebraska, but not in Minnesota. They were challenged by a Minnesota bank, which eventually lead to Marquette National Bank v. First of Omaha Service Corp. In a landmark decision, the Supreme Court ruled in favor of the Bank Of Omaha, arguing that as a national bank, it should be able to set its rates nationally based on where it was located regionally. The court ruled in favor of the system.
This lead to tectonic shifts in the credit card industry. To take advantage, banks like Citibank started moving their headquarters from New York to South Dakota, to take advantage of the most favorable usury laws they could find. The states quickly realized that they were going to lose some of their most important taxpayers and began to revise their laws as quickly as possible.
With usury laws no longer a constraining issue, the credit card market was poised to explode; a boom in the economy didn't hurt things, either - between 1982 and 1990, consumer spending in the United States grew from $3.4 Trillion to $4.8 Trillion.
When Dee Hock retired (and disappeared from public life for ten years) in 1984, there was no argument that the credit card was an intrinsic part of American life.
This decade also lead to a number of product marketing innovations. Non-bank issuers, affinity programs, and frequent flyer miles were all born during this era. These innovations increased the number of institutions that offered cards and also created new gamified incentives that served to further increase usage and demand for different types of credit cards. The system was secure enough to allow massive innovation at the edges of its network - by 1983, no fewer than 1,500 companies offered a credit card program, and many of these companies offered cards for both the Visa and Mastercard networks.
Americans went all in. By the early 90s, 62% of American households had a credit card, and 2.5 million merchants accepted Visa. The average American household now had over $2,430 in credit card debt. Sears also launched Discovercard during this time, growing their business from nothing to third place (22 million cards!) in a matter of 2 years flat.
By the 1990s, European banks were issuing more debit cards than credit cards (83% of all cards in Germany were debit cards). Yet in the US, debit (or "charge") cards were only really used by business spenders. This was all about to change. Merchants began to install equipment that allowed ATM cards to be used as debit cards, and Visa began an aggressive campaign to get banks to begin offering check cards to their customers.
By the early 2000s, almost a third of all payment card volume came from the debit card.
The 1990s also spawned the financial instruments that would do serious damage in ten years. Credit card lenders now had a mechanism they could use to de-risk their debt holdings, in the form of "securitized" assets. They could package these debt holdings along with other forms of debt and sell them to organizations better-equipped (or so we thought) to manage the risk. These securitized holdings (on the mortgage side of things) would lead us into 2008 and the Great Recession.
There was also a trend towards consolidation in the financial industry. More than fifty large banks in 1990 would go through a series of mergers and acquisitions that would leave only eighteen total entities by 2003. This massive consolidation would also expose the entire industry to greater risk and the collapse of a few of its most iconic names.
This little strip of plastic, and the unique global partnership that supports it, has transformed the way we shop. The way we pay our bills. The way we bank. The way we travel. The way we live. - Paul Chutkow, Visa: The Power of an Idea (2001)
In 2016, 1.6 billion people spent almost 2 trillion dollars online, using a numeric identification system that was essentially developed back in the 1920s. When you buy something on Amazon today, you are essentially leveraging a digitized version of the same exact system that was in place using a metal plate in the 1920s - the fundamental concept hasn't really changed at all (you are tied to a number, which is tied to an account).
Without intrinsic innovation to the system, it has become bloated. Today, both online and offline purchases require no fewer than 7 "trusted third parties” to authorize each transaction and facilitate a transfer of funds from one bank to another.
Could cryptocurrency help? Or perhaps more accurately, was the credit card system an actual step on the way towards something like cryptocurrency? It was only by decentralizing control of payment networks that credit cards were able to become ubiquitous. If everyone had tried to "go-it-alone" a la American Express, the credit card probably wouldn't be accepted everywhere from Tulsa to Tamil Nadu.
By de-centralizing ownership in the network, every individual node on the network (e.g. issuing and acquiring banks) is incentivized to play their role appropriately and efficiently. Since there was no blockchain in Dee Hock's time, we now have behemoths like Visa that can bottleneck innovation and have incentives that aren't in line with the larger network.
Could a public blockchain with strong transaction throughput provide a better solution?
If so, the short history of the credit card may end up being a footnote in the 4,000 year history of the evolution of fiat money.
Sandeep: Tell me a bit about the early part of your career.
Tom: I spent a decade helping to build start-ups focused on application and database software. This was where I learned how to sell and do business development. I was fortunate to be part of one company going public and another being sold to IBM.
Sandeep: What is something you learned during this time that helped you with consulting?
Tom: I began to appreciate how different customers achieved varying levels of success with the same foundational technology. This made me understand just how critical getting your team and process right can be.
Sandeep: This is something I only came to appreciate years into consulting, especially after the sale of my first consultancy to Capital One.I saw teams in different parts of the company trying to solve challenges like real-time messaging. Same corporate culture, same technology, same internal support mechanisms. Night and day outcomes.
Tom: We saw a lot of the same thing after selling our practice to EMC (sold to Dell in 2015). This is probably the thing I'm most proud of when it comes to the teams I've helped to build: the ability to perform well in a variety of contexts, sometimes in ways that inspires the client team to up their game as well.
Sandeep: Yes. It's particularly cool to see your team succeed in individual ways after an acquisition...consulting skills definitely translate into the corporate environment.
Tom: Totally. We have people who've stayed on at Dell and risen up the ranks, while others took the opportunity to become successful executives at other Fortune 100 companies....or to start their own agencies and startups.
Sandeep: We've both been around a while. My first consulting project was a Y2K thing for Cisco back in 1998. You've been around a little longer than that :). How do you think consulting has changed most during the past five years?
Tom: I think because there is so much infrastructure available now, consulting has become more delivery and outcome-oriented. A better blend of strategic and tactical. Public Cloud has also enabled velocity to increase at a pace unfathomable 5 years ago.
Sandeep: What has stayed the same?
Tom: It's still mostly about people. People who thrive on change and are focused on their personal and professional development. I love that this has not and will not change...it's what I love about consulting.
Sandeep: I know you're adjusting your work style to COVID. You're still a dude who clearly prefers to drive an hour for a socially-distanced hike or outdoor meeting over Zoom any day of the week :) But personal styles aside, what is specifically compelling about a remote agency during the era of COVID?
Tom: Kunai has been remote for years, which gives them an inherent advantage. There is something about the communication and management styles that just works in a way that other organizations are still figuring out.
Sandeep: Yeah, I think what a lot of people fail to realize is that remote work isn't just office work over Zoom. it's an entirely new paradigm. There needs to be an understanding for asynchronous efficiency...and this just takes time and effort to develop. How do you approach remote work and family? What are you learning about separating work and personal time?
Tom: No matter what the form of interaction, Focus. Be present. Quality over quantity. The best weeks are the weeks where I proactively schedule work and personal time. Neil (Kunai's Head of Delivery) shared a great quote with me "With discipline comes freedom." When I am proactively addressing the majority of my professional and personal commitments, I find I earn a little flexibility. A little freedom.
Sandeep: Tell us about a business hero of yours that I may not have heard of before.
Tom: Paul O'Neill is someone you may not know. His work in both the public and the private sector created a profound impact
Sandeep: We are both over forty years old :). How have you learned how to work smarter during the past decade or so? What do you wish you knew about consulting when you were 25 that you know now?
Tom: Consultants want to make lasting change. Lasting change is often not the act of a single person. Today I work much harder bringing others along on the journey.
Sandeep: Last question. What are you doing here? :) Why join a small consulting company this late in your career when you could have a cushy job somewhere else?
Tom: I love a good challenge personally and professionally. When I turned 40, I decided I would run a 10K every Thanksgiving weekend and try to have my finishing time be less than my age. With the exception of one year where I did not run due to a health issue, I have met the goal. I also recently completed the Leadville 100 Mountain Bike race. So, I guess I'm here because I'm a glutton for punishment :) Jokes aside, our customers have a job to do and I intend to put Kunai in a position to execute flawlessly on their behalf. I love committing jointly to audacious goals for our customers and our business.
Ninety percent of e-grocery customers will continue buying food online even after the pandemic. What does this shift mean for other merchants and their payment networks?
To compete in the digital market, financial apps and websites require secure and seamless onboarding experiences. Tech companies have risen to the challenge.