Better Buy: Visa Inc. vs. PayPal

By Markets Fool.com


Image source: PayPal.

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In the world of electronic payments, there's an old guard and a new guard. Visa Inc. is the leader in the legacy credit card industry, commanding a global network that facilitates billions of transactions. The newer player in payments is PayPal Holdings , which piggybacked on the success of e-commerce retail to create a brand new way to pay. For those looking to decide whether to invest in PayPal or Visa, it's important to look at the growth prospects that each company has and whether they'll coexist or clash in the near future. Below, you'll learn more about how Visa and PayPal see themselves finding and taking full advantage of growth opportunities going forward.

What's driving PayPal's growth

PayPal's vision of the future involves a complete transformation in the way that people pay for the things they buy. As CEO Dan Schulman discussed at the company's analyst day earlier this month, the key to change for the payments industry is the explosion in use of mobile devices. In Schulman's words:

Mobile is changing the face of commerce. I would argue that mobile is taking away the distinctions between what were previously separate categories of online, mobile (whether that be in-app or mobile web), and in-store environments. It is blurring the distinction between those. The other thing that mobile is doing is it is putting all the power of a bank branch in the palm of a consumer's hands.

PayPal clearly sees the opportunity to use mobile in the same way that telecom companies have, with the goal of essentially skipping over a generation of now-outdated technology. Some countries went straight from having no reliable telecommunications network to having one based entirely on wireless connectivity. In that way, PayPal anticipates that in the areas that make up most of the 85% of transactions that are still done in cash, consumers can go straight from using paper and coins to using mobile-based payment systems provided by PayPal. If they do so without ever having bothered to set up credit card networks or other legacy technology, then that's so much the better for PayPal in its fight with Visa.

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Yet PayPal has also embraced credit cards like the ones that Visa offers. As Schulman described it, "If we can put customer choice firmly into our business model, it also opens up the opportunity to work with the entire financial services ecosystem, because we can become a great partner for them to drive incremental spend on their cards." That in turn can make companies like Visa potential partners with PayPal if they so choose. So far, the emphasis on choice both among consumers and on the merchant adoption side of the business has worked well for PayPal, and the company anticipates further success in the future.

How Visa hopes to grow even larger

As the champion of the credit card industry, Visa might seem big enough that it doesn't really need to grow. Yet in a rapidly changing industry, Visa isn't sitting still, and it understands the need to adapt and keep finding new opportunities in order to thrive and fend off competition from PayPal and other up-and-coming players in the field.

One way that Visa sees itself doing better is by encouraging more partnerships with card-issuing financial institutions. The nice thing about Visa's business model is that in contrast to card companies like American Express that retain some credit risk by combining the network and financing elements within the same company, Visa gets its issuing banks to take on credit risk. That leaves Visa in a stronger position from a pricing standpoint, as it generally stays clear of competitive pressures between issuers and retailers seeking co-branded card opportunities. Visa therefore benefits when issuers offer rewards to cardholders that result in higher traffic, but it doesn't necessarily have to bear any financial burden in offering those rewards out of its own pocket. As long as that business dynamic lasts, Visa can use its franchise as a cash cow.

At the same time, emerging markets are a key potential source of growth for Visa. As Scharf described at a conference presentation, China is only now looking to open up its market to Visa and other companies, and the process will take a while. In Scharf's words:

We view this as a long-term opportunity. It's going to require some investment, but not a crazy amount of investment. And it's an opportunity where we think we can add value to both the banks and the consumers as well as the merchant community in the Chinese marketplace. But given what the pricing dynamics are, given what the competition is there, we don't expect it to be a significant driver of profit for Visa over the next couple of years. It's a long-term play. We'll see how the market develops.

Visa and PayPal both have strong growth prospects, and they're on a collision course to start hitting each other hard in key areas of the payments market. If PayPal can continue growing at its current pace, then it arguably has the inside track to take full advantage of mobile technology and create a completely different way for people to pay. In the long run, such a success would show up in its share price.

The article Better Buy: Visa Inc. vs. PayPal originally appeared on Fool.com.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool owns shares of and recommends PayPal Holdings and Visa. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.