Electronic Value Exchange

Electronic Value Exchange Plot Summary

Introduction

In the late 1960s, the American payment landscape was in chaos. Banks were mailing unsolicited credit cards to consumers, fraud was rampant, and merchants struggled with mountains of paper sales drafts that needed to be processed manually. Behind the scenes, a remarkable transformation was taking place that would forever change how money moved around the world. This story begins with a failing credit card program licensed by Bank of America and follows its evolution into the world's largest electronic payment network. The history of Visa represents one of the most significant yet least understood technological and organizational revolutions of the 20th century. Through this historical journey, readers will discover how competing banks learned to cooperate while still competing, how electronic authorization and clearing systems were built from scratch, and how a visionary leader named Dee Hock created an entirely new type of organization. This narrative offers valuable insights for anyone interested in payment systems, organizational design, or how technological innovation transforms industries and societies.

Chapter 1: From Paper to Organization: The Crisis of 1970

In 1970, the American banking industry faced a crisis in their credit card operations. The BankAmericard system, which had expanded rapidly through licensing agreements with banks across the country, was plagued with operational problems that threatened its very existence. The system lacked standardized rules, suffered from inefficient paper-based processes, and struggled with mounting fraud losses. Most banks were losing money on their credit card programs, with some industry experts predicting the entire venture might collapse. At the center of this turmoil emerged a visionary named Dee Hock, an executive from a small Seattle bank. Hock recognized that the fundamental problem wasn't just operational inefficiency but the organizational structure itself. The Bank of America's licensing system created an environment where banks had little incentive to cooperate. When Hock was appointed to lead a committee of licensee banks to address these issues, he saw an opportunity to create something entirely new - a member-owned cooperative organization that would balance competition with collaboration. This reorganization represented a radical departure from traditional corporate structures. Hock designed a system where competing banks would cooperate just enough to make the payment system work efficiently while still competing vigorously for customers. The new organization, National BankAmericard Inc. (NBI), was formed as a non-stock membership corporation owned by its member banks. This structure ensured that no single bank, not even Bank of America, could dominate the system. The governance structure was carefully crafted to balance power among banks of different sizes and regions. Voting rights were distributed to ensure representation for smaller institutions while preventing any single member from gaining control. This democratic approach was revolutionary in an industry dominated by hierarchical structures and powerful money-center banks. As one executive noted, "Dee structured the Board in such a way that he ran the company and there was no question about it." Within just 90 days of beginning the formation process, all 200 licensee banks had agreed to join NBI. The Bank of America relinquished control, becoming just another member, though they retained five special seats on the Board initially to recognize their contribution in creating the original system. This transformation laid the groundwork for what would eventually become a global electronic payment network, though few at the time could envision just how revolutionary this organizational innovation would prove to be.

Chapter 2: Building the Electronic Backbone: BASE I and II (1971-1974)

By 1973, the newly formed NBI had addressed many organizational issues, but still faced critical operational challenges. The most pressing problem was authorization - the process of verifying that a card was valid and the cardholder had sufficient credit. The existing system required merchants to make time-consuming phone calls for transactions over their "floor limit," often waiting several minutes for approval. This delay frustrated both merchants and customers, threatening the system's growth. Hock made a bold decision to build NBI's own electronic authorization system rather than purchasing an existing solution. When vendors' proposals proved too expensive and time-consuming, Hock declared that NBI would design and build their own system within the budget and timeframe already approved by the Board. He assembled a talented team led by Aram Tootelian, who had experience with IBM's Sabre airline reservation system and high-reliability aerospace projects. The team was given just nine months to build what became known as BASE I (BankAmericard Authorization System Experimental). BASE I was revolutionary in its design. It created a real-time electronic network connecting all member processing centers, allowing authorization requests to be routed instantly to the appropriate card issuer. The system reduced authorization time from minutes to just 56 seconds - fast enough to make credit cards a viable competitor to cash and checks. As one executive noted, "it was the difference between deciding to use a credit card and deciding that it was easier to use cash." Following the success of BASE I, NBI quickly began work on BASE II, which automated the clearing and settlement of transactions. Previously, acquiring banks had to physically sort and mail paper sales drafts to each issuing bank - a process that took 6-8 days and was prone to errors. BASE II transformed these paper drafts into electronic records that could be cleared and settled overnight. This dramatically reduced float time, labor costs, and reconciliation headaches for member banks. The impact of these systems extended far beyond operational efficiency. They created a technological infrastructure that allowed the network to expand rapidly without being constrained by paper-based processes. They also provided a platform for future innovations, as the network could now handle any type of data exchange between members. Most importantly, these systems demonstrated that electronic value exchange was not just a theoretical concept but a practical reality that could transform how money moved throughout the global economy.

Chapter 3: Going Global: The Transformation to Visa (1974-1977)

By 1974, the BankAmericard licensing program had expanded internationally, with banks in 15 countries participating. However, these international licensees faced the same organizational problems that had plagued the domestic program before NBI's formation. After observing NBI's initial successes, they asked Hock to help create an international version of the organization. Creating a global organization proved far more challenging than establishing NBI. The international licensees operated in different currencies, banking systems, and cultures. Many feared that one country would amass too much political power over the system. After two years of negotiation, a new organization called IBANCO was formed in June 1974. Like NBI, it was structured as a for-profit, non-stock Delaware corporation, with NBI becoming just one member among many national associations and individual licensee banks. A pivotal moment came during the final meeting in San Francisco, when several critical issues remained unresolved. Hock presented each representative with custom-designed cufflinks featuring the Latin phrases "Studium ad prosperandum" (the will to succeed) and "Voluntas in conveniendum" (the grace to compromise). His emotional appeal worked - the next morning, the licensees reached consensus on every outstanding issue, including the contentious question of allowing competitors to join the system in their respective countries. In 1976, another significant transformation occurred when NBI lifted its ban on dual membership after a lengthy legal battle. Previously, banks could not be members of both NBI and Interbank (later MasterCard). This change, combined with the adoption of the new name "Visa" in 1977, catalyzed explosive growth. The name change was strategically important - it freed the organization from geographic associations and allowed international members to adopt a common identity. The implementation of the Visa name was carefully orchestrated. When the ban on dual membership was lifted, NBI approached strategic Interbank members, inviting them to join. After announcing the new Visa name, these new members began sending applications to consumers offering to convert them to "this new Visa card they were hearing so much about." This forced existing BankAmericard issuers to quickly reissue their cards with the Visa name to avoid losing customers. By the first quarter of 1978, Visa had surpassed Interbank's sales volume both in the US and worldwide, becoming the dominant card system globally.

Chapter 4: Beyond Credit: Debit Cards and Point-of-Sale Revolution (1975-1980)

By the late 1970s, Visa had successfully automated authorization and clearing between member banks, but the point of sale remained largely manual. Most merchants still referenced dense lists of invalid card numbers, telephoned for verbal authorizations, and manually completed paper sales drafts. This inefficiency was not only costly but allowed approximately one billion dollars in annual fraud losses. A critical debate emerged regarding how cards should be encoded to make them machine-readable. Two competing technologies existed: Optical Character Recognition (OCR) and the magnetic stripe. The retail and oil industries preferred OCR, while banking and airline industries favored the magnetic stripe. After extensive testing, Visa mandated in 1979 that all cards bearing their mark issued after 1980 must include a magnetic stripe encoded to their standard, effectively ending the card-encoding debate. With the encoding standard established, Visa turned to developing affordable point-of-sale terminals. In 1979, they launched a project to define requirements for terminals that every merchant could afford. Instead of producing the terminals themselves, Visa established specifications and worked with multiple vendors to develop compliant devices. The requirements were simple: the terminal must authorize transactions over standard telephone lines, be small enough for merchant countertops, and cost less than $500. To encourage merchant adoption, Visa introduced a powerful economic incentive - a reduced interchange fee for transactions authorized through these terminals. This Terminal Interchange Reimbursement Fee (TIRF) was 20% less than the standard rate, providing a compelling reason for acquirers to push the terminals to their merchants. For merchants, the combination of lower discount fees, reduced chargebacks, faster authorizations, and affordable equipment made the terminals attractive. The results were impressive. Merchants participating in the pilot test authorized every transaction rather than just those above the floor limit. Over 3,000 cards were recovered by participating merchants during the test, and more than 10,000 transactions were declined that would have been allowed under existing procedures. One bank reported that "incidents have already occurred in which a thief, upon seeing his stolen card being put through the terminal, has turned and literally run from the store." By the mid-1980s, these terminals evolved to support data capture, storing transaction details and transmitting them electronically to the acquiring processor each night. This completely eliminated the need for paper sales drafts and card imprinters, fulfilling Visa's vision of a fully electronic payment system. The widespread adoption of these terminals transformed not just how transactions were processed, but the entire economics of the merchant acquiring business.

Chapter 5: Power Struggles: Organizational Tensions and Leadership Change (1980-1984)

The early 1980s marked a period of significant organizational tension within Visa as the central organization and its member banks negotiated their respective roles and powers. These tensions culminated in the departure of Dee Hock, the visionary founder who had shaped the organization from its inception. One of the first major controversies of this period was Visa's entry into the travelers cheque market in 1980. Travelers cheques had long been a profitable business for American Express, which had dominated the market since inventing them in 1891. Visa saw an opportunity to leverage its global network to offer a competing product that would be backed by the thousands of financial institutions in its system rather than a single company. The introduction of Visa Travelers Cheques created immediate tension with member banks, particularly those that already offered American Express cheques. These banks earned commissions from selling American Express products and feared that Visa's entry would cannibalize their existing business. There were also concerns about Visa overstepping its role as a payment processor and becoming a direct competitor to financial products offered by its members. After intense negotiations, Visa proceeded with the launch, but with compromises that addressed some member concerns. The product was successful, capturing a significant share of the market within a few years. However, it also established a precedent for Visa expanding beyond its core transaction processing role, a precedent that would lead to further conflicts. Perhaps the most controversial move during this period was the "JC Penney deal" in 1982. JC Penney, then the third-largest department store chain in the United States, had traditionally refused to accept bank cards, preferring to offer its own store credit. Visa USA negotiated directly with JC Penney to accept Visa cards, bypassing the merchant acquiring banks that would normally handle such relationships. The deal outraged many member banks, who saw it as a direct encroachment on their merchant acquiring business. They feared that Visa would continue to sign large merchants directly, eventually eliminating the need for acquiring banks altogether. The controversy highlighted the fundamental tension in the Visa system: was Visa simply a processor that served its member banks, or was it an independent entity with its own strategic interests? These controversies were symptoms of a deeper issue: Hock's increasingly imperial management style and his ambitious vision for Visa's future. By the early 1980s, Hock had begun planning for a massive new headquarters at 101 California Street in San Francisco, a project that many board members saw as unnecessarily extravagant. He had also established Visa subsidiaries in various business areas and was exploring opportunities far beyond the core payment processing business. The board became increasingly concerned about Hock's empire-building and what they perceived as his disregard for their authority. In 1984, matters came to a head, and Hock was forced to resign. Chuck Russell, his long-time operational deputy, took over as CEO, bringing a more pragmatic and bank-friendly approach to the organization.

Summary

The transformation of the BankAmericard system into Visa between 1970 and 1984 represents one of the most significant innovations in financial services history. What began as a troubled credit card licensing program evolved into the world's first global electronic value exchange system. This evolution was driven by a powerful combination of organizational innovation and technological development, each reinforcing the other to create something entirely new. The central tension throughout this period was between centralization and decentralization. Dee Hock's genius lay in creating a system that balanced these opposing forces - centralized enough to establish common standards and infrastructure, yet decentralized enough to allow for local innovation and competition. This balance extended to the relationship between the central organization and its members, which was often contentious as Hock pushed boundaries that many member banks preferred to maintain. The story offers profound lessons for today's digital economy, where similar tensions exist in platform businesses and network enterprises. The most successful systems are those that create the right balance of rules and freedoms, allowing participants to both compete and cooperate effectively. Like Visa, they establish just enough centralized control to make the system work while preserving the autonomy and incentives that drive innovation and growth.

About Author

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David L. Stearns

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