Financial business

How is Discover Financial’s business model different from Visa’s?

In a recent article, we looked at the business model of the card giant Visa. Company cards are issued by banking partners and used by cardholders to purchase goods or services from a merchant through an electronic transaction. In this article we compare

model with that of another card company, Discover Financial.

Discover has expanded its direct banking services by offering personal, real estate and student loans, but credit cards remain its most important business; credit card loans represent 80% of the company’s loan portfolio.

Our price estimate of $ 46 for Discover Financial implies a 20% discount from the current market price.

See our full review for: Discover Financial|Visa

A summary of the Visa model

Once a cardholder uses a Visa card to complete a transaction, information is transferred through Visa’s network to the issuing bank and the merchant’s bank, known as the acquirer, for authorization. The acquirer sends a clearing file containing the transaction data which is processed for final settlement between the issuer and the acquirer. This three-step process is known as Authorization, Clearing and Settlement and is the primary service that Visa offers through its network. Visa also offers value-added services such as account-level processing, loyalty reporting and dispute resolution.

When a Visa credit card is used by a consumer, they are given a loan, the risk of which is borne by the issuer and not by Visa. The issuer collects interest from the cardholder on the loan and also charges a card fee for using their card. The interest rate and commission are decided by the issuer. The merchant is charged a discount fee by the acquirer. During purchase transactions, acquirers are required to pay an interchange reimbursement commission to the issuing bank. Visa does not charge any of the above fees. Instead, it charges data processing fees and service fees to its financial clients. These fees are charged based on a customer’s processed transaction volume and gross dollar volume of transactions. Visa’s activity is therefore volume dependent; the more the company’s cards are used, the more it earns.

What about finding out?

Discover has a closed loop network, acting as both an issuer and an acquirer. Unlike Visa, Discover issues credit cards directly to consumers, allowing customers to maintain revolving credit card balances on which the business earns interest. This interest income represents over 60% of Discover’s income. Discover also earns discount income from merchants and fees for late payments, cash advance transactions, and cardholder balance transfer transactions. Fees and interest rates are set in contractual agreements with merchants and cardholders.

Discover’s strength

Unlike Visa, Discover’s business is not volume driven, but more dependent on the loan balance the business is able to maintain and the interest it can earn on that balance. Therefore, it is important for Discover to promote the use of its cards over those of competitors. To this end, Discover’s main strength is its Cashback Bonus rewards program, which allows cardholders to earn rewards for using Discover credit cards. Some of the more popular products offered include:

1) The Discover IT Card and Discover More Card, which offer 5% cash back on various categories that change throughout the year.

2) Check out the Open Road Card, which offers 2% cash back on the first $ 250 spent on combined gasoline and restaurant purchases each billing period.

3) Check out the Motiva card, which offers 5% cash back on interest charges each month for making payments on time.

4) Discover Business Card, which offers 5% cash back on the first $ 2,000 spent on office supplies each year.

Note: Discover does not report the money given to customers as an expense item, but records it as a reduction in expense income.

Until 2013, Discover was able to maintain a card receivables growth rate of 4%, above the overall market growth of 1%. The company’s share of total renewable consumer debt outstanding increased from 5.3% at the end of 2011 to 6% in the last quarter and management expects future growth to be at the top of. the target range of 2 to 5%. Discover’s historical performance suggests that it will be able to meet this target as the US economy improves.

The risk

Unlike Visa, Discover has to bear the credit risk on the loans it makes to cardholders. This risk can be measured in terms of the default rate, or the percentage of total loans in arrears, and the charge rate, which is the percentage of loans that are considered non-repayable.

The 2008 recession rocked consumers across the United States as credit card customers began to repay their loans on time to avoid going into debt during the financial crisis. The credit card loan default rate for all commercial banks in the United States fell from 6.76% in the second quarter of 2009 to 2.39% in the fourth quarter of 2013. During the same period, the rate of default Cancellation of credit card loans for the 100 banks ranked by assets in the country fell from 9.59% to 3.28%.

Discover maintained a good risk profile and its net debit rate on its credit cards was 2.09% in the fourth quarter of 2013, while the 30-day delinquency rate was 1.72%. Discover did not sell any of its write-off accounts after the recession and was able to record strong reversals in its write-off inventory as the US economy recovered. As a percentage of average credit cards, provisions were around 2.76% in 2008 but rose to 6.63% in 2010. In 2011 and 2012, the company benefited from the aforementioned reversals and its provisions as a percentage average credit cards fell to 1.54%. However, in the years to come, the company does not anticipate the same level of recovery and makes adjustments to its credit reserves. Provisions for loan losses increased by 27% through 2013. We expect the measure to increase steadily in the coming years as the market normalizes with the economic recovery and provisions reach pre-market levels. recession. You can edit the interactive graph below to gauge the effect that a change in forecast would have on our price estimate.

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