When it comes to security in their financial transactions, American consumers want it all. In Total System Services, Inc.'s 2016 U.S. Consumer Payments Study, a whopping 74% of all respondents said they would choose the credit card with the best security features over the credit card with the best rewards. Payment networks like Mastercard Inc. have done their best to respond.
In the past couple of years, Mastercard has experimented with a number of cutting-edge security initiatives. These innovations have included everything from an app that allows cardholders to take a selfie for payment authentication to a wearable band that uses the account holder's unique heartbeat as authentication.
Late last month, Mastercard introduced its latest pioneering security platform, Decision Intelligence. According to the press release, this program "uses artificial intelligence technology to help financial institutions increase the accuracy of real-time approvals of genuine transactions and reduce false declines." The service leverages machine learning so that each transaction is assigned a score, which is then used to help judge future payments.
False declines are a big problem
This service is not only being launched to help root out fraud, but to help prevent another huge problem haunting the payments industry: purchases declined for fraud when customers are in fact making legitimate purchases. False declines hurt everyone from consumers to merchants to card-issuing banks.
For consumers, a card deactivation can follow a false decline, meaning cardholders must deal with the extra hassle of ordering a new card and waiting for the replacement to arrive before using it again on top of the annoyance of having to wait to complete a purchase.
Retailers lose an estimated $118 billion per year on false declines. Adding insult to injury, over a third of shoppers will not return to a merchant after being falsely declined at a physical location or website.
For card-issuing financial institutions, the problem of false declines might be the most serious of all. According to a 2015 study by the research consulting firm Javelin, about 15% of all cardholders have experienced a false decline for a legitimate purchase. Of these cardholders, nearly 40% abandoned their card after the false decline.
Criticism of the service
Just days after the press release announcing the launch, an article appeared in Computerworld criticizing the service. The piece centered on two criticisms: 1) Mastercard is only one of several card issuers and so has access to only a minority of credit card purchases to learn from; and 2) Even if Mastercard's service worked perfectly, merchants would still have to utilize additional antifraud measures for purchases made via other payment methods.
While it is way too early to judge the effectiveness of Mastercard's Decision Intelligence service, these two criticisms almost completely miss the point of the program. First, Mastercard processed nearly 14.5 billion transactions in its most recently reported quarter. That should provide more than sufficient data to properly educate its machine-learning program.
Second, while it is true merchants must use other measures to cut down on fraud and false declines for purchases made by other payment methods, Mastercard's immense volume should guarantee a significant reduction of fraudulent purchases and false declines over time.
Why this matters to Mastercard investors
Critics are overlooking who this platform was designed to serve. It isn't primarily intended for consumers or merchants (though it does offer benefits to both those groups), but for Mastercard's card-issuing banks.
A little over a year ago, Mastercard lost USAA's credit and debit card portfolio to Visa. USAA had been Mastercard's largest debit card issuer, and the two companies had enjoyed a 30-year relationship. And while investors are not privy to all the details of the split, they do know that as a result of this loss, Mastercard projects a drag on its earnings and revenue for at least a few more quarters.
While the USAA break was a rare one for Mastercard, it shows how devastating the loss of a major card issuer can be for a payment-network company. This is why Mastercard has spent the past several years developing in-house platforms and acquiring companies designed to make it much more difficult for financial institutions to leave the Mastercard ecosystem.
These services include fraud-protection services like Decision Intelligence, and other services such as consulting and research, loyalty and reward program management, and data analytics. Importantly, the services are a growing revenue source for Mastercard; collectively, they grew revenue by 23% year over year, in Mastercard's most recently reported quarter, to a total of $620 million.
But even more important to Mastercard than these growing sources of revenue is the value they add to the company's relationship with its card issuers. Its services are often prized by financial institutions, as many of them fall far outside their core competencies. When card-issuing banks and credit unions begin to rely on Mastercard to provide essential services, it cultivates an incredibly sticky relationship. This, of course, makes it harder for a competitor to poach that customer and supplant Mastercard...as Visa did with USAA.
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