How Mastercard Makes Money: Financial Institution Customers Pay Volume Fees

When most people think of Mastercard, Inc. (MA), they think of credit cards. While it’s true that the Mastercard brand is one of the top worldwide labels for debit, credit, and prepaid cards, Mastercard doesn’t consider itself to be a credit card company per se. Rather, Mastercard is a “technology company in the global payments industry,” according to its 2020 annual report.

As such, Mastercard connects the many different participants in various kinds of transactions: consumers, merchants, financial institutions, governments, and more. The large majority of Mastercard’s revenue comes from fees paid by its customers, who are not everyday consumers. Rather, Mastercard’s customers are financial institutions, such as banks, that pay a fee to issue credit and debit cards with the Mastercard brand. These fees can take multiple forms, as we’ll see below.

Much like Mastercard’s perennial competitor Visa Inc. (V), Mastercard enjoyed decades of privately held success before an early 2000s initial public offering (IPO). Indeed, Mastercard actually began as a response to what would eventually become Visa. After Bank of America Corp. (BAC) launched a bank card in the late 1950s, a coalition of regional credit card providers came together to launch Mastercard in 1966. At that point, it was known as “Interbank,” a reflection of the new card’s connectivity across different financial institutions. Since that time the company has gone through numerous expansions and rebrandings, but it has enjoyed consistent popularity among an increasingly global base.

Investors love MasterCard. The credit card operator reported net revenues of $15.3 billion in 2020, a 9% decrease over the previous year, due in large measure to the global pandemic. As of August 28, 2021, Mastercard had a market capitalization of $351.03 billion. Still, for all the investor hype, end users seem equally satisfied. The seamlessness with which you make a Mastercard transaction belies a comprehensive network of merchants, financial institutions, and settlement banks, each of which receives a cut of a process that takes mere milliseconds. 

Mastercard’s Business Model

Mastercard facilitates transactions in more than 150 currencies across more than 210 countries and territories. Though the company does not have a monopoly on the payments industry—not only because of similar operations such as Visa but increasingly also because of new payment service providers as well—it is nonetheless hugely successful across the globe. A big part of this success has to do with the Mastercard brand and the cachet it holds.

A typical Mastercard transaction involves five parties: besides the payments processor itself, the event includes a consumer or account holder and their issuer bank, as well as a merchant and their acquirer bank.

Typically, an account holder uses a Mastercard-branded card to make a purchase with a merchant. Once the transaction is authorized, the issuer bank pays the cost of the transaction (less an interchange fee, also known as a “swipe fee“) to the acquirer bank. The account holder is then charged the cost of the transaction, less a merchant discount. Interchange fees are key in providing value to merchants who accept Mastercard payment products. Mastercard does not generate revenue from these fees. The merchant discount fee helps to cover costs for the acquirer bank.

How Does Mastercard Make Money?

Where does Mastercard earn money in this system? Mastercard charges the financial institutions that issue cards a fee based on gross dollar volume of account holder activity. The company also earns revenue from switched transaction fees covering authorization, clearing, settlement, and certain cross-border and domestic transactions.

Mastercard’s domestic and international fee business

When you make a purchase with a Mastercard, you’re borrowing the funds from the issuing bank whose name is printed on your card. There are thousands of such banks. Mastercard makes money by charging them to use its multi-noded, light-speed payment network.

The biggest distinction in Mastercard’s income statement is between intranational revenue—fees charged to cardholders’ and merchants’ financial institutions, which are processed in the same country in which a transaction takes place—and cross-border volume fees. The former category, officially known as “domestic assessments,” accounted for $6.7 billion of Mastercard’s $23.6 billion in gross revenue for the 2020 fiscal year. As for cross-border volume fees, they totaled $3.5 billion.

Mastercard’s transaction processing fee business

Mastercard’s third major revenue category, called “transaction processing fees,” netted revenues of $8.7 billion in 2020. Those fees are charged to the merchants’ financial institutions and come in two subcategories: “connectivity” and “transaction switching.” Connectivity fees come out of users participating in the Mastercard network charging to use the network and getting a cut of each step in the process.

Mastercard also collects a transaction switching fee every time the issuer receives approval for authorization, every time the transaction information clears between the two parties’ banks, and every time the funds actually settle. Again, these cuts are nanoscopic, but they amass. In fact, Mastercard’s transaction processing fees are increasing even faster from year to year than domestic assessments.

Future Plans

Mastercard believes that one of its major advantages over up-and-coming payments systems is its capacity to be a multi-rail network, covering domestic, cross-border, card-based, and account-to-account transactions. In the future, the company will continue to develop and strengthen each of these channels. For the traditional credit, debit, prepaid, and commercial products, the company will continue to offer consumers and financial institutions a greater variety of options, both in terms of the products themselves as well as in payment plans and systems.

Mastercard International

The key to Mastercard’s growth is diversification across new markets. In 2020, the U.K. service providers promoting Mastercard’s Pay by Bank service, launched in 2016, included Barclays, HSBC, Yoyo Wallet, Global Payments, Wirecard, Worldpay, and Barclaycard, which processes half of all U.K. card transactions. Pay by Bank allows U.K. consumers to purchase goods and services using funds from bank accounts and employing mobile banking apps. Eventually, the intent is to make the app universal, rather than just for the U.K.

Key Challenges

Although Mastercard is a dominant player in the global payments services industry, it nonetheless faces significant challenges. One of the biggest is government regulation: The company has faced numerous antitrust suits throughout its history, and regulation continually changes in many of the regions in which Mastercard does business. It must remain flexible and vigilant to ensure its business thrives. Particularly given the company’s international and cross-border business, this is a crucial component of its continued success.

Maintaining the Mastercard appeal

Mastercard must continue to provide an enticing and worthwhile set of products to each segment of its transaction ecosystem. Financial institutions must continue to believe that it is in their best interest to issue cards with the Mastercard logo, while merchants must be prevented from charging surcharges on products in order to offset fees. Cardholders must find the entire process to be simple, efficient, and competitive when compared with other payment systems.

Finally, given the intense competition from both well-established rivals and new technologies and companies, Mastercard must ensure that its offerings are at least on par with the competition, if not superior.

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