They say, “imitation is the sincerest form of flattery that mediocrity can pay to greatness”. Perhaps we can alter the phrase to say “[adaptation] is the sincerest form of flattery…” as I’d like to mold a well-known talk Charlie Munger gave on July 20, 1996. In it, Charlie posed the below question of how to present a business plan to turn $2 million into $2 trillion over 150 years, using only “rudimentary mental models”. The purpose of this exercise was to connect with the fundamental characteristics of high-quality products or services and explain how the educational system falls short in equipping business leaders with the tools to evaluate human psychology. I’ve always felt that Charlie’s mental model for evaluating ideas should be applied broadly. At the end of the day, psychology drives all human decisions. The more we can use elementary tools to step into the minds of the people that comprise a system, the better decisions we will make.
So, with that, let’s apply Charlie’s talk to a fascinating business, Visa, and see what we can learn about the company, the industry it created, and human psychology while we’re at it.
Charlie introduced the following practical problem at the beginning of his talk (Poor Charlie’s Almanack, Talk 4: “Practical Thought About Practical Thought”):
“It is 1884 in Atlanta. You are brought, along with twenty others like you, before a rich and eccentric Atlanta citizen named Glotz. Both you and Glotz share two characteristics: First, you routinely use in problem solving the five helpful nothings, and, second, you know all the elementary ideas in all the basic college courses, as taught in 1996. However, all discoveries and all examples demonstrating these elementary ideas come from dates before 1884. Neither you nor Glotz knows anything about anything that has happened after 1884. Glotz offers to invest two million 1884 dollars, yet take only half the equity, for a Glotz Charitable Foundation, in a new corporation organized to go into the non-alcoholic beverage business and remain in that business only, forever. Glotz wants to use a name that has somehow charmed him: Coca-Cola. “
Adapting the problem.
It’s 1968. You are brought, along with twenty others like you, before the CEO of BankAmerica Corporation, Rudolph Peterson. Both you and Peterson share two characteristics: First, you routinely use in problem solving the five helpful nothings, and, second, you know all the elementary ideas in all the basic college courses, as taught in 2021. However, all discoveries and all examples demonstrating these elementary ideas come from dates before 1968. Neither you nor Peterson knows anything about anything that has happened after 1968. Peterson offers to invest two million 1968 dollars, yet take only half the equity, for BankAmerica Corporation, in a new corporation organized to go into the transaction card network business and remain in that business only, forever. Peterson wants to use a name that has somehow charmed him: Visa. Peterson will give the other half of the business to the person who presents the best business plan for Visa that captures all basic notions to create the next $2 trillion company in 75 years. Businesses move a bit faster in modern times, Charlie, so we’ll only need half the time.
You have 15 minutes to pitch Peterson.
Well, Mr. Peterson, we aren’t going to create a business worth $2 trillion by selling something generic. Therefore, we need to trademark the name “Visa”, so that it is legally protected. Second, we can only get to $2 trillion by starting in Washington, where BankAmerica licensed its card network technology, expand to the rest of the United States, and then world — opening our network up to all global financial institutions of repute. This will require our product possessing universal trust and appeal. If we anchor the brand on the notion that it is “Everywhere You Want To Be”, we can signify that the brand stands for acceptance, security, convenience, speed, and reliability — something highly valued when confronting humans with the loss aversion related to separating them from their physical currency. We will seek to make our brand so associated with integrity that consumers will rate merchants who accept this means of commerce as more secure and reputable. These are the elemental forces that will capture universal appeal.
Now having established the universal appeal of our business to create the largest possible addressable market, we must now follow Carl Jacobi’s advance, “invert, always invert”. We can guess reasonably that by 2043, 75 years from 1968, the world population will be about 9 billion, up from 3.5 billion. By 2043, it would be safe to assume that at least three quarters of global consumers possess a bank account and transaction card of some sort. If these 6.8 billion consumers were to spend ~$750 / month on their transaction cards out of all payment methods (cash, check, transfer), then the global payments industry would be processing $60 trillion of total volume for consumers. It would be safe to assume that businesses, seeing the benefit of transaction cards to consumers, would contribute a similar amount of volume to the industry. So, in total, the global payments industry could process at least $120 trillion of transactions annually. If Visa’s brand and improved transaction experience could sway half of all consumers to join its network, then Visa could earn $120 billion of revenue and $80 billion of earnings assuming we charge each customer a small fee of 0.20% per transaction and take home as earnings 0.13% of each transaction. That will be enough, if our business is still growing at a good rate, to make it easily worth $2 trillion. Thinking in reverse, we will be charging customers roughly $1 per month to provide a better transaction experience — one that earns them cash rewards, uplifts consumer purchases at the cash register, and reduces theft and fraud, while facilitating commerce by shifting money between bank accounts. Given consumers will likely become wealthier at a notional rate of approximately 4% annually, the median US consumer will be earning $150,000 per year, up from $7,800 in 1968. Thinking in reverse, this means Visa will be charging customers 0.01% of their annual earnings — a small and manageable price to pay for such a convenient service. It even seems reasonable to exceed the 1968 target.
Deciding that the market opportunity is an attractive one, let’s now set about solving the problem of universal appeal. There are two big challenges we must tackle, first serving ~75% of the world’s population with a payment card, and second, ensuring that our competitors are left with only half of the market share. These would be “lollapalooza” results, as Charlie Munger says, the combination of several powerful factors that we desire. But how do we go about it? We are creating a network business, so we must incentivize both sides of the network to come together with Visa as the centerpiece.
First, we need to start with the brand. Visa must become a no-brainer solution for all consumers with bank accounts seeking to move funds from their account to a merchant’s in exchange for goods and services. An introductory course in psychology would tell you to get into the business of creating and maintaining conditioned reflexes, such that Visa acts as a stimulus during the process of a purchase. We want customers to be rewarded for using Visa, which would create operant conditioning and thereby classical or Pavlovian conditioning. The combination of these two effects on consumers will create lollapalooza effects for our product.
Regarding operant conditioning, we want to provide consumers the maximum rewards for our product. We also want to minimize the possibility that competing products will extinguish our operant conditioning of consumers. So, Visa, through our partners, will provide consumers cash rewards for using our product. We will distribute billions of our cards for free to any consumer with a bank account around the world and then offer these same consumers rewards through our financial institution partners each month. Our rewards, in the form of actual cash back to customers, will provide psychological benefit to consumers as well. Everyone knows the loss aversion principles from elementary courses. Humans would much rather avoid losing $100 than gain $100. By removing the physical currency from the process of transacting and providing a cash reward concurrent with the purchase, Visa can provide consumers significant psychological comfort as they buy goods.
Further, we’ll label each card with the Visa trademark, to encourage the Pavlovian conditioning required to dissuade competitive solutions. In this “monkey see, monkey do” aspect of human nature that psychologists often call “social proof”, we’ll encourage imitative consumption triggered by the sight of consumption. “Reward envy” shall we say, should deter customers from finding alternatives to our product. These “point” rewards will lock in the operant conditioning rewards, but how will we ensure that no other competitors take our place.
We will make it a permanent obsession of the company that our brand and service, will be “Everywhere You Want To Be” throughout the world. As Charlie said, “After all, a competing product, if it is never tried, can’t act as a reward creating a conflicting habit. Every spouse knows that.” In order to scale as fast as possible to serve consumers who will be richly rewarded for using our product, we need to increase merchant acceptance as quickly as possible. As such, Visa will set the prices to accept credit cards for the entire payment ecosystem — we will call it interchange. With the hopes of encouraging independent sales organizations to scourer the earth to hand merchants payment terminals, we will allocate approximately half of all the interchange fees we charge to merchants to these acquirers of merchants. If we assume that by 2043 we reach ~$120 trillion of transaction card volume, then the total revenue opportunity for merchant acquirers will be $1.2 trillion or 10x Visa’s potential revenue. This should provide the necessary incentives to attach our payment terminals at the front of nearly every cash register in the world.
But how will we incentivize merchants to pay for the increase in costs associated with card acceptance? Well, we should highlight that the reduction in loss aversion by consumers resulting from the digital exchange of currency will result in an increase of consumer spending with credit cards that will more than compensate for the merchant fees. The uplift from customers more easily parting with their cash, will more than offset the 2.5% card acceptance fees paid by merchants. Introducing the lollapalooza effect, when nearly all merchants join the transaction card network, as all costs in the global economy will be 2.5% higher, reflecting the merchant’s cost of card acceptance.
Lastly, we will have to incentivize our financial institution partners to provide credit to these billions of consumers as well. Visa as the network will not want to take credit risk on any individual customer. In exchange for approximately half of all the interchange fees charged, financial institutions will take the credit risk for individual customers. The risk of loss will be much lower than the 1% charged to consumers, however. Given the universal adoption of credit cards, debts incurred by credit card consumers will not have the same credit risk typically associated with unsecured consumer credit, as there is no negative selection bias in those seeking credit cards. Similar to healthy, young people subsidizing healthcare costs for older, less healthy insured, so will healthy consumers subsidize the cost of unhealthy consumers falling into debt. Charging all of society for the credit risk of a very small group of consumers, ones that you could deny subsequent extensions of credit, will make credit cards one of the most lucrative products in bank portfolios. As such, banks will aggressively compete to issue new credit cards, further expanding the size of our network.
Lollapalooza results when:
1. Consumers are bribed for using a card that removes the loss aversion inherent in commerce (not realizing they’re the ones paying for the cost of acceptance through broadly higher costs of goods and services charged by merchants)
2. Merchants see an uplift in sales as a result of the removal of loss aversion (and a subsequent fear of lost sales from customers that abandoned cash)
3. Financial institutions / sales organizations are incentivized to propagate our network around the world through enormous high margin revenue opportunities
As we can see, in the resulting lollapalooza effect, everyone involved with the Visa product will be better off. This lollapalooza effect will make the Visa product so irresistible. With this pitch, Mr. Peterson granted us the ability to form a company that would distribute the Visa product.
The actual story is obviously based on the above. In 1968, Dee Hock convinced BankAmerica to give up ownership and control of their BankAmericard credit card licensing program to form a new company, National BankAmerica, that was owned by its 10,000 member banks. There were a number of similar products at the time captive within different financial institutions, but Dee had the foresight to understand that only an independent network could capture the massive potential presented. The name was changed to Visa in 1976, for the same reasons described above. Today, Visa maintains nearly 50% market share by purchase transactions. In order to reach the $2 trillion valuation described above, Visa’s market capitalization must grow 6% annually through 2043 — a pace it typically eclipses every five months or so.
Practical applications for Practical Thoughts
What can we all learn from our adaptation of Practical Thought About Practical Thought? From a business perspective, we like to approach each problem through its elemental characteristics.
· Who is the customer and what problem can they not solve on their own?
· Why do they buy from us?
· Why us versus a competitor?
· What is the total size of the market opportunity?
· How will we attack it over time while our competitors attempt the same?
· Are there lollapalooza effects?
The practical application of Charlie’s message is simple, a lot can be understood about the world if we slow down our thinking to include psychology. Each decision we make can and should be reduced to its elemental characteristics. One of the largest, highest quality network-based businesses in the world was constructed by maximizing the psychological rewards to three distinct sets of participants. The mastery of human psychology explains the success of Visa and Coke. Perhaps you should try out Charlie’s framework the next time you’re confronted with a big decision.