February 2023 - Anatomy of the Swipe by Ahmed Siddiqui

This month we dive back into the world of payments and take a refreshed look at how payments companies work.

Tech Themes

Authorization. How do credit card’s even work? What is on the magnetic stripe? It turns out that each stripe has an alternating set of tiny magnets on it that produce a magnetic field around the card. The card reader on a POS system is a solinoid; when the magnets swipe through the solinoid it creates a change in the magnetic field also known as magnetic flux. The POS processes the changes in current as its swiped through the Solinoid, and is able to understand the credit card via common card standards, created by ISO. The challenge that existed with the internet, is how to ensure safe transactions when you are paying someone you clearly don’t know. The card companies created something called the card verification value (CVV), an extra number directly intended NOT to be written anywhere except for the back of your credit card. CVV codes were originally created by an Equifax employee in the UK, and initially rolled out by NatWest bank, eventually expanding to Mastercard (1997), Amex (1999), and Visa (2001). However, the early internet still had a massive fraud problem, as Roelof Botha discussed about Paypal in his Tim Ferris podcast appearance. In addition, card authorization was still quite difficult in Europe, where you would frequently have to call to provide authentication for cross-border purchases. In 1993, Europay, Mastercard, and Visa formed EMVco, to add additional fraud protection to cards. They were subsequently joined by other key members including American Express, Discover, JCB International, China UnionPay. Europay eventually merged with Mastercard in 2002 prior to Mastercard’s IPO. EMVco creates a standard for EMV chips, which embed small integrated circuits that produce a single-use cryptographic key for a merchant to decrypt and authorize a transaction. It is also incredibly difficult to clone a chip card, whereas magnetic stripes are fairly easy to copy. The increase in fraud protection was so great that it caused a liability shift, whereby the merchant (rather than the issuer) could become liable for fraud if a EMV chip card was not used, and a swipe was used instead. The latest innovation in card security is 3D Secure 2, which “allows businesses and their payment provider to send more data elements on each transaction to the cardholder’s bank. This includes payment-specific data like the shipping address, as well as contextual data, such as the customer’s device ID or previous transaction history.” The 3D Secure 2 also improves the UX of its “challenge flow,” which is an instance when a frictionless authentication wasn’t possible, for whatever reason. The challenge flow forces the user to authenticate the transaction through their banking application of choice, which is much more secure than just approving every transaction the network sees. Every day payments become more at risk and more secure!
Zelle and banks Funded Payments. Similar to Visa and Mastercard, Zelle is a cash transfer system originally created by a consortium of banks. In 2011, Bank of America, JP Morgan, Wells Fargo, and several other banks built a Paypal competitor called clearXchange. The new company would charge financial institutions to use the service, with most banks assuming the charges on behalf of their consumers. At the time, Venmo was beginning to take off with consumers utilizing its simple Peer-to-peer payments service. In 2012, Braintree acquired Venmo for just $26m. The low purchase price was the result of a lack of coherent business model, given Venmo’s founding by college roommates who were looking to send money easily. Later, in 2013, Braintree was acquired by Paypal for $800m. Braintree is an acquirer processor and introduced a business model to Venmo, namely investing the float of customer funds held in the Venmo ecosystem. In 2016, clearXchange was acquired by another bank run service called Early Warning Service, which provides risk management services to many financial institutions. Early Warning was itself created in 1990 by Bank of America, BB&T, Capital One, JP Morgan, and Wells Fargo. Early Warning launched Zelle in 2017, utilizing clearXchange’s underlying technology. Zelle is now massive, processing over $1m in volume a minute, which is more than competitors Venmo and Cash App. Zelle’s most recent stats are mind-blowing: 2.3B payments with $629B in volume. Look at creation of zelle and other examples of banks creating new companies (like visa/mastercard)
Money for Nothing, SaaS for Free. A new brand of payments companies are popping up that seek to turn a traditional SaaS model on its head. Divvy, the spend management platform, gives its SaaS software away for free, instead monetizing just the payments processed through its product. Its quite wild to see a company build complex software just to give it away, right? This strategy has been copied many times over, as we talked about when discussing Netscape and Slack. Whether its open source or just free commercial software, the free-ness of it makes it attractive. However, if everyone is free, then you still have to compete on merit. Ramp, a competitor to Divvy, raised $750m at an $8.1B valuation in 2022, and processed over $5B in payment volume in 2021. Divvy was acquired by Bill.com in 2021 for $2.5B in a mix of cash and stock. At the time of acquisition Divvy was doing just over $100m of annualized revenue, and about $4B of TPV, suggesting a take rate of ~2.5%. Ramp allegedly did about $100m in annualized revenue in 2022. While Divvy was able to find a successful exit through a willing buyer (a buyer who’s stock has declined 65% from all time highs), I’m not sure Ramp will find an easy buyer at $8.1B, but it may find the public markets if it can market itself as a cost-saving, AI, finance play. I’m just not sure that you can build a really big business by only processing payments and giving away complex software for free. We will see in time!

Business Themes

Issuer, Issuer Processor, Acquirer, Acquirer Processor. The arc of an individual payment can be broken into its constituent parts. The Issuer is normally a bank that issues credit cards to its banking customers. A bank may use an issuer processor to manage a connection to the card networks (like Visa and Mastercard) and accept/decline transactions. Examples of issuer processors include Marqeta, TSYS, and Galileo. Global Payments and TSYS merged in 2019, in an absolutely massive $21.5B deal, after Fiserv acquired FirstData for $22B and Fidelity National Services acquired WorldPay for $34B. 2019 was definitely a banner year for payments mergers, but signs of strain are already happening, with FIS announcing they’d be spinning out WorldPay in 2023. Back to our transaction - the merchant will have a payment terminal of some sort, and will use an acquirer processor like Chase Paymentech, Tabapay, or Fiserv, that will also have a fast connection to the card networks to request approval for a transaction. Lastly, we have the acquiring bank, the merchant’s bank account. When we look back at these big deals, its clear that each player was trying to round out its processing capabilities - TSYS (issuer processor) with Global Payments (a merchant acquirer), Fiserv (merchant acquirer) with First Data (issuer processor), and FIS (issuer processor) with WorldPay (merchant acquirer). FIS, Fiserv, and Global Payments have struggled to win over investors over the last five years, following these big deals.
Chargebacks. When a consumer doesn’t want to pay for an item, it can request a chargeback. The reasons for a chargeback can be numerous and valid, including fraud, item not as described, duplicate transactions, and more. In the event of fraud, a cardholder would dispute the charge with their bank. The bank would freeze their card and file a chargeback with the card network (Visa as an example). Visa would send a provisional credit to the customers card and take the money back from the merchant, then it would send the chargeback request detail to the merchant. If the merchant doesn’t dispute the chargeback, it will be assessed a $25-35 chargeback fee by Visa. However, if it does dispute the chargeback, and correctly can identify that the card actually did purchase the goods, then the issuer, the bank that is “underwriting” credit to the consumer, can be put on the hook for the funds used for the purchase. I never knew that both the merchant and issuer can be on the hook for chargebacks, but not the network! Another way in which Visa and Mastercard make money through the ecosystem!
Marqeta’s confusion. For our first payments book, we took a look at several of the new players in the credit card ecosystem, including Marqeta, Adyen, and Stripe. Its been quite a two years! Marqeta went public in June 2021, valuing the company at $15B. Stripe raised additional funds at a $95B valuation, and Adyen’s valuation hit $98B! But oh how the times change! Just two years later, and Stripe’s valuation is back at $50B, including a massively dilutive $6.5B raise to pay for employee taxes in option conversion. Adyen’s valuation sits at $53B today, a close to 50% decline, despite growing EBITDA 16% to 728M in 2022.. Marqeta may have had the worst time of all, which is said because Ahmed Siddiqui, worked at Marqeta for a number of years. Marqeta’s stock fell 85%, its CEO/Founder left the company, its gross margins have compressed from high 40’s back to down to low 40s, and its main customer Block has become an even larger customer, now driving 77% of its revenue. Marqeta went from next generation issuer processor and Stripe wannabe to an outsourced custom development shop for Block. My guess is its actual reputation sits somewhere in between the two. Expectations for Marqeta have fallen off a cliff, and its market cap sits at a tiny $2.6B. I’m not sure Block would be an immediate acquirer, because the market for issuer processing is incredibly competitive and Block has had its own stock price troubles. A spun out WorldPay could make sense as an acquirer. Visa would have made sense as acquirer, because it owns about 2.5% of Marqeta and has for many years, but their recent acquisition of Pismo, believed to be a LATAM focused and better version of Marqeta. It’s unlikely Marqeta will exist long as a small solo issuer processor!
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November 2019 - Brotopia: Breaking Up the Boys' Club of Silicon Valley by Emily Chang

This book details a number of factors that have discouraged women’s participation and promotion in the tech industry. Emily Chang gives a brief history of the circumstances that have pushed women away from the industry and then covers its current issues - weaving in great insights and actionable takeaways along the way.

Tech Themes

The Antisocial Programmer. As the necessity for technological talent began to rise in the early 1960s, many existing companies were unsure how to hire the right people. To address this shortfall in know-how, companies used standard aptitude tests, like IBM’s Programmer Aptitude Test, to examine whether a candidate was capable of applying the right problem solving skills on the job. Beyond these standard aptitude tests, companies leveraged personality exams. In 1966, a large software company called System Development Corporation hired William Cannon and Dallis Perry to build a personality test that could shed light on the right personalities needed on the job. To build this personality test, Cannon and Perry profiled 1,378 programmers on a range of personality traits. Of those 1,378 profiled, only 186 were women. After compiling their findings, the final report stated: “[Programmers] dislike activities involving close personal interaction; they are generally more interested in things than people.” Furthermore, Cannon and Perry’s 82-page paper made no reference to women at all, referring to the surveyed group as men, for the entire paper. A combination of aptitude tests and Cannon-Perry’s personality test became the industry standard for recruiting, and soon companies were mistakenly focused on stereotypical antisocial programmers. Antisocial personality disorder is three times more common in men than women. Given how early the tech industry was, compared to what it is now, this decision to hire a majority of anti-social men has propagated throughout the industry, with senior leaders continually reinforcing incorrect hiring standards.
Women in Computer Science. According to the book, “there was an overall peak in bachelor’s degrees awarded in computer science in the mid-1980s, and a peak in the percentage of women receiving those degrees at nearly 40 percent. And then there was a steep decline in both.” It was at this time in the mid-1980s that computer science departments began to turn away anyone who was not a pre-qualified, academic top performer. There was too much demand with a constrained supply of qualified teachers, so only the best kids were allowed into top programs. This caused students to view computer science as hyper-competitive and unwelcoming to individuals without significant experience. Today, women earn only 18% of computer science degrees – a statistic that shocks many in the industry. Researchers at NPR found that intro CS courses play a key role in this problem – with many teachers still assuming students have prior familiarity with coding. Furthermore, women are socialized in a number of ways to achieve perfection, so when brand new code is not working well, women are more likely to feel discouraged. It is imperative to encourage women to try computer science if they have interest, to combat these negative trends.
PayPal and Perpetuating Cycles. After the dot-com bubble burst in the early 2000s, several newly minted millionaires did the natural thing after selling a company for millions of dollars, became a venture capitalists. One of the major success stories of the era was PayPal. Among those newly minted millionaires were the PayPal mafia: Peter Thiel, Keith Rabois, Elon Musk, Max Levchin, David Sacks, and Reid Hoffman. Thiel and Rabois have a history of suggesting a meritocratic process of hiring where only the most qualified academic candidate should land the job, not taking into account diversity of any form. Furthermore, in his book Zero to One (which we’ve discussed before), Thiel proposes startups should hire only “nerds of the same type.” The mafia began investing in several new companies, seeding friends who were likely to perpetuate the cycle of recruiting friends and hiring based on status alone. Rabois, who is currently a venture capitalist has remarked: “Once you have alignment, then I think you can have a wide swath of people, views and perspectives.” These ideas seem more like justification for hiring large groups of white males who were friends of PayPal executives than a truly “meritocratic” process, which is not the best way of building a successful, diverse organization. Roger McNamee, founder of technology private equity firm, Silver Lake, suggests: “They didn’t just perpetuate it; they turned it into a fine art. They legitimized it… The guys were born into the right part of the gene pool, they wind up at the right company, at the right moment in time, they all leave together and [go on] to work together. I give them full credit for it but calling it a meritocracy is laughable.”

Business Themes

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The Women at Early Google. A lot of people know the story of Sergey Brin meeting co-founder Larry Page. But few are aware of when Sergey and Larry met Susan Wojcicki, who is now CEO of YouTube. Sergey and Larry were looking for office space, and through a mutual friend, were introduced to Susan Wojcicki, who worked in marketing at Intel at the time. Though she didn’t jump on board immediately, Susan eventually came around and was instrumental in launching two of Google’s most important products: AdWords and AdSense. Wojcicki would soon be working closely with a newly recruited, Marissa Mayer, who after graduating from Stanford with a degree in Symbolic Systems, joined Google to help build AdWords and design Google’s front-end. Wojcicki and Mayer would soon be joined by Sheryl Sandberg, who came to Google in 2001 as Vice President of Online Sales and Operations. Another now-famous early female employee was Kim Scott, author of Radical Candor, who joined the company in 2004. All of these early, powerful female leaders, with the continued urging of Larry and Sergey (who wanted to achieve a 50/50 ratio of male to female employees) helped build a strong culture of female leadership. But as the Company scaled it lost sight of its gender diversity goals – “In 2017, women accounted for 31% of employees overall, 25% of leadership roles and 20% of technical roles.” Google claims it lost touch as it scaled, when the need for hiring outpaced the ability to find qualified and diverse candidates – but that sounds like an easy cop out.
Startups and Party Culture. Atari and Trilogy Software pioneered the idea of a work-hard, play-hard startup cultures. Nolan Bushnell of Atari would throw wild parties and have employees (including Steve Jobs) work late into the night, building for the company. Trilogy, a provider of sales and marketing software, extended this idea even further. It started with hiring, where, according to a former engineer, Trilogy’s ethos was: “We’re elite talent. It’s potential and talent, not experience, that has merit.” The Company regularly used complicated brain-teasers in interviews and attracted swaths of anti-social engineers with young and attractive talent recruiters. Joe Liemandt, the CEO of Trilogy, also moved the company to Austin, Texas; executives likened the tactic to marooning members of a cult. Co-founder Christy Jones remarked: “I didn’t go on vacation. We called holidays competitive advantage days because no one else was working. It was a chance to get ahead.” The Company had a strong drinking and partying culture and bares striking cult-like resemblance to WeWork, except it had a sustainable business model. Other technology companies have mixed constant alcohol and long hours, which has led to numerous assault charges at well-known startups including Uber, Zenefits, WeWork and others. Startup and party culture does not need to be so intertwined.
Hiring Practices to Encourage Diverse Backgrounds. Stewart Butterfield, the founder of Flickr (sold to Yahoo for $20 million in 2005), has focused on diverse hiring efforts at his new company Slack. According to Brotopia, “In 2017, Slack reported that 43.5% of its employees were women, including 48% of managers and almost 30% of technical employees – far better numbers than any tech company in Silicon Valley.” Butterfield, who grew up on a commune in Canada, recognizes his privilege, and discusses its not insanely difficult to create a diverse environment: “As an already successful, white, male, straight – go down the list – I’m not going to have the relevant experience to determine what makes this a good workplace, so some of that is just being open but really just making it an explicit focus.” Slack’s diverse recruiting team was given explicit instructions to source candidates from underrepresented backgrounds and schools for every new role in the organization. More companies should follow Slack’s lead and adopt explicit gender and diversity goals.

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June 2019 - Zero to One by Peter Thiel

Peter Thiel’s contrarian startup classic, Zero to One, is a great book for understanding and building startups.

Tech Themes

Zero to One. As Thiel explains in the opening pages, Zero to One is the concept of creating companies that bring new technology into the world: “The single word for vertical, 0 to 1 progress is technology.” This is in contrast to startups that simply copy existing ideas or other products and tackle problems 1 to n. In Thiel’s view, the great equalizer that allows you to create such an idea is proprietary technology. This can come in many forms: Google’s search algorithms, Amazon’s massive book catalog, Apple’s improved design of the iPad or PayPal’s faster integrated Ebay payments. But generally, to capture significant value from a market; the winning technology has to be 10x better than competition. To this end, Thiel says, “Don’t disrupt.... If your company can be summed up by its opposition to already existing firms, it can’t be completely new and it’s probably not going to become a monopoly.” The true way to become a massively successful company is to build something completely new that is 10x better than the way its currently being done. This 10x better product has to be conceived over the long term, with the idea that the final incremental feature added to the product gives it that 10x lift and takes it to monopoly status.
Beliefs and Contrarianism. Thiel begins the book with a thought-provoking question: “What important truth do very few people agree with you on?” To Thiel, however you answer this question indicates your courage to challenge conventional wisdom and thus your potential ability to take a novel technology from 0 to 1. Extending this idea, Thiel defines the word startup as, “the largest group of people you can convince of a plan to build a different future.” This sort of Silicon Valley contrarianism is exactly the mindset of Internet bubble entrepreneurs. Thiel continues on this thinking, with another question: “Can you control your future?” and to that question he answers with an emphatic, “Yes.” People are taught to believe that “right place, right time” or “luck” is the greatest contributor to individual success. And as discussed in Good to Great, while many CEOs and prominent executives make this claim, they often don’t believe it and use it much more as a marketing mechanism. Thiel firmly believes in the idea of self-determination, and why shouldn’t he? He’s a white male, Rhodes Scholar and Stanford Law School graduate who has now made billions of dollars. In his mind, you either believe something novel and create that future or you waste your time tackling the problems that exist today. This also conveniently mirrors Thiel’s investing focus and he even calls this out in a chapter detailing venture returns. Venture takes informed speculative bets on which technology will ultimately win out in a market – the best bets are the ones that differ so greatly from the established norm because the likelihood of landing in the monopoly position (though still small) is much greater than a Company that is recreating existing products.
Looking for Secrets and Building Startups. The answers to the Thiel question posed above are secrets: knowable but undiscovered truths that exist in the world today. He then poses: “Why has so much of our society come to believe that there are no hard secrets left?” He provides a four part answer:

Incrementalism – the idea that you only have to hit a minimum threshold for pre-determined success and that over-achieving is frequently met with the same reward as basic achievement
Risk Aversion – People are more scared than ever about being wrong about a secret they believe
Complacency – people are fine collecting rents on things that were already established before they were involved
Flatness – the idea that as globalization continues, the world is viewed as one hyper competitive market for all products

Sticking on his contrarian path, Thiel emphasizes: “The best place to look for secrets is where no else is looking…What are people not allowed to talk about? What is forbidden or taboo?” This question is especially interesting in the context of the latest round of startups going public. A lot of people have argued that the newest wave of startups are tackling problems that are of lower value to society, like food delivery – focused on pleasing an increasingly on-demand, dopamine driven world. Why is that? Have we reached a local maximum in technology for a given period? While you may not completely believe Ray Kurzweil’s Law of Accelerating Returns, the pace of technological evolution has probably not hit a maximum. It could be argued that we have enjoyed a great run with mobile as a dominant computing platform (PCs before that, Mainframes before that, etc.) and that the next wave of startups tackling “important" problems could spring out of such a development.

Business Themes

Monopoly profits. Thiel plainly states the overarching goal of business that is normally obfuscated by cult-like Silicon Valley startups: monopoly profits. This touches on a point that has been bouncing its way through the news media (Elizabeth Warren, Stratechery, Spotify/Apple) in recent months with Elizabeth Warren calling for a breakup of Apple, Facebook and Amazon, Spotify claiming the App Store is a monopoly, and others discussing whether these companies are even monopolies. He claims monopolies deserve their bad press and regulation, “only in a world where nothing changes.” Monopolies in a static environment act like rent collectors: “If you corner the market for something, you can jack up the price; others will have no choice but to buy from you.” This is true of many heavy regulated industries today like Utilities. It’s often the case consumers only have one or two providers to choose from at max, so governments regulate the amount utilities can increase prices each year. Thiel then explains what he calls creative monopolists, companies that “give customers more choice by adding entirely new categories of abundance to the world. Creative monopolies aren’t just good for the rest of society: they’re powerful engines for making it better.” Thiel cites a few interesting examples of “monopoly” disruption: Apple iOS outcompeting Microsoft operating systems, IBM hardware being overtaken by Microsoft software, and AT&T’s monopoly prior to being broken up. It should be noted that two of these examples actually did require government regulation – Microsoft was sued in 2001 and AT&T was forced to break up its monopoly. What’s even more interesting, is the prospect of the T-Mobile/Sprint merger being blocked because while the consolidation of the telecom industry could mean increased prices, both T-Mobile and Sprint have struggled to compete with guess who, AT&T and Verizon (who started as a merger with former AT&T company, Bell Atlantic). Whether monopolies are good or bad for society, whether its possible to call tech companies with several different business lines monopolies remains to be seen – but one things for sure – being a monopoly, tech monopoly, or creative monopoly is a great thing for your business.
Prioritizing Near Term Growth at the Risk of Long Term Success. Thiel begins his chapter on Last Mover Advantage with an interesting discussion on how investors view LinkedIn’s valuation (since acquired by Microsoft but at the time was publicly traded). At the time, LinkedIn had $1B in revenue and $21M in net income, but was trading at a value of $24B (i.e. 24x LTM Revenue and 1100x+ Net Income). Why was this valued so highly? Thiel provides an interesting answer: “The overwhelming importance of future profits is counterintuitive even in Silicon Valley. For a company to be valuable it must grow and endure, but many entrepreneurs focus on short-term growth. They have an excuse: growth is easy to measure, but durability isn’t.” Thiel then continues with two great examples of short-term focus: “Rapid short-term growth at Zynga and Groupon distracted managers and investors from long-term challenges.” Zynga became famous with Farmville, but struggled to find the next big hit and Groupon posted incredibly fast growth, but couldn’t get sustained repeat customers. This focus on short-term growth is incredibly interesting given the swarm of unicorns going public this year. Both Lyft and Uber grew incredibly quickly, but as the public markets have showed, the ride-sharing business model may not be durable with each company losing billions a year. Thiel continues: “If you focus on near term growth above all else, you miss the most important question you should be asking: will this business still be around a decade from now?” To become a durable tech monopoly, Thiel cites the following important characteristics: proprietary technology, network effects, economies of scale, and branding. It’s interesting to look at these characteristics in the context of a somewhat monopoly disruptor, Zoom Video Communications. CEO Eric Yuan, who was head of engineering at Cisco’s competing WebEx product, built the Company’s proprietary tech stack with all the prior knowledge of WebEx’s issues in mind. Zoom’s software is based on a freemium model, when one user wants to video chat with another, they simply send the invite regardless of whether they have the service already – this isn’t exactly a google-esque network effect but it does increase distribution and usage. Zoom’s technology is efficiently scalable as shown by the fact that its profitable despite incredibly fast growth. Lastly, Zoom’s marketing and branding are excellent and are repeatedly lauded within the press. The question is, are these characteristics really monopoly defining? Or are they simply just good business characteristics? We will have to wait and see how Zoom fairs over the next 10 years to find out.
Asymmetric Risk & VC Returns. Thiel started venture capital firm, Founders Fund in 2005 with Ken Howery (who helped start PayPal with Thiel). Thiel notes an interesting phenomena about VC returns that several entrepreneurs don’t truly understand: “Facebook the best investment in our 2005 fund, returned more than all the others combined. Palantir, the second best investment is set to return more than the sum of every investment aside from Facebook…The biggest secret in venture capital is that the best investment in a successful fund equals or outperforms the entire rest of the fund combined.” Venture capital investing, especially at the earliest stages like Seed and Series A (where Founder’s Fund invests) is a game of maximizing the chance of one or two big successes. In the past five to ten years, there has been a significant increase in venture capital investing, and with that a focus among many firms to be founder friendly. As discussed before, these founder friendly cultures have led to super-voting shares (like Snap, FB and others) and unprecedented VC rounds. Even with these changes, there is still a friction at most VC-backed companies: the supposedly value added VC board member doesn’t believe that Company XYZ will be the next Facebook or Palantir, and because of that chooses to spend as little time with them as possible. This has fueled the somewhat anti-VC movement that several entrepreneurs have adopted because as with Elon Musk at PayPal and Zip2, being abandoned by your earliest investors can be devastating.