Open-Loop and Closed-Loop Networks
What Snowflake, American Express, and Starbucks have in common
Mapping Open-Loop and Closed-Loop Networks. The major credit and debit card providers (Visa, Mastercard, American Express, China UnionPay, and Discover) all compete for the same spots in customer wallets but have unique and differing backgrounds and mechanics. The first credit card on the scene was the BankAmericard in the late 1950’s. As it took off, Bank of America started licensing the technology all across the US and created National BankAmericard Inc. (NBI) to facilitate its card program. NBI merged with its international counterpart (IBANCO) to form Visa in the mid-1970’s. Another group of California banks had created the Interbank Card Association (ICA) to compete with Visa and in 1979 renamed itself Mastercard. Both organizations remained owned by the banks until their IPO’s in 2006 (Mastercard) and 2008 (Visa). Both of these companies are known as open-loop networks, that is they work with any bank and require banks to sign up customers and merchants. As the bank points out, “This structure allows the two end parties to transact with each other without having direct relationships with each other’s banks.” This convenient feature of open-loop payments systems means that they can scale incredibly quickly. Any time a bank signs up a new customer or merchant, they immediately have access to the network of all other banks on the Mastercard / Visa network. In contrast to open-loop systems, American Express and Discover operate largely closed-loop systems, where they enroll each merchant and customer individually. Because of this onerous task of finding and signing up every single consumer/merchant, Amex and Discover cannot scale to nearly the size of Visa/Mastercard. However, there is no bank intermediation and the networks get total access to all transaction data, making them a go-to solution for things like loyalty programs, where a merchant may want to leverage data to target specific brand benefits at a customer. Open-loop systems like Apple Pay (its tied to your bank account) and closed-loop systems like Starbuck’s purchasing app (funds are pre-loaded and can only be redeemed at Starbucks) can be found everywhere. Even Snowflake, the data warehouse provider and subject of last month’s TBOTM is a closed-loop payments network. Customers buy Snowflake credits up-front, which can only be used to redeem Snowflake compute services. In contrast, AWS and other cloud’s are beginning to offer more open-loop style networks, where AWS credits can be redeemed against non-AWS software. Side note - these credit systems and odd-pricing structures deliberately mislead customers and obfuscate actual costs, allowing the cloud companies to better control gross margins and revenue growth. It’s fascinating to view the world through this open-loop / closed-loop dynamic.
