American Express’s history helped shape the structure of finance, along with its unique business model. Warren Buffett thinks so highly of American Express that he owns almost 20 percent of the company and remains the largest overall shareholder.

During the salad oil scandal, Buffett began his journey with American Express in 1964. And it was the start of his evolution from cigar butt investing (cheap stocks) to buying wonderful companies at fair prices.

Most of us have heard of American Express, but what do we know about their business model and how much do we understand about how they make money?

In today’s post, we will learn:

• How Did American Express Start?
• What is American Express Famous For?
• What is the American Express Business Model?
• How Does American Express Make Money?
• Investor Takeaway

Okay, let’s dive in and learn more about American Express’s history and business model.

How Did American Express Start: A Brief History

American Express began life in 1850 as an express mail service based in Buffalo, NY. The company earned a reputation as a company people could trust with their valuables while transporting them.

Who started American Express?

The company was a merger of the Wells Fargo company run by Henry Wells, William Fargo, and John Butterfield, which started in 1852, remaining in California, while American Express focused on New York.

In 1878, American Express began introducing financial products to their business. Because of their position in delivery services, American Express built a business-to-business service, with agents buying merchandise for their customers at great prices.

And in 1891, they introduced the Travelers Cheque, helping travelers feel more secure with their money.

At the outbreak of World War I in 1914, the company used its connections abroad to help over 150,000 Americans who were stranded. They helped customers cash their Travelers Cheques and arrange safe passage home.

In 1958, they introduced their first credit card, Charge Card, which gave customers more flexibility than the Travelers Cheques, and helped introduce credit cards to the finance world. And in 1966, the company expanded its credit card offerings to commercial customers with their Corporate Card.

The company’s global outreach began back in 1895, but the company expanded its credit card program abroad in 1972, leading the way for others to expand globally.

1991 was the year of rewards. American Express launched one of the first loyalty programs with their Membership Rewards, giving their customers more benefits and rewards for using their cards. Even today, American Express rewards remain some of the most lucrative.

American Express has expanded its offerings from humble beginnings with express delivery and changed the business model into one of the most recognizable global brands.

When Buffett bought American Express back in 1964, the company was at the beginnings of the change from Travelers Cheques to credit cards, and Buffett saw the writing on the wall. He recognized that the company was on the cusp of becoming a dominant financial player, despite the ongoing scandal.

Today, Buffett’s investment in American Express totals 151.6 million shares, valued at $29 billion. The investment represents his third largest equity investment, trailing Apple and Bank of America.

For more information on the fascinating history of American Express, check out this Wikipedia article.

What is American Express Famous For?

American Express continues as one of the leading issuers of credit cards for:

• Personal
• Small business
• Corporate credit cards

The company’s focus on travel includes travelers checks (yes, those are still a thing), credit cards, corporate and personal concierge services.

American Express has another few unique characteristics in that they both issue credit cards and process those card payments.

Unlike traditional card issuers like Bank of America or Chase, or card networks like Visa and Mastercard, American Express serves both functions of servicing accounts and processing transactions.

American Express also charges the highest transaction fees in the business, also known as swipe fees, than any of the other Big Four:

• Visa
• Mastercard
• Discover
• American Express

Visa and Mastercard process the largest global transactions, with American Express coming in third. But Visa and Mastercard set the swipe rates for most merchants that use their networks. Both Visa and Mastercard have an open network, meaning anyone can take advantage of their system. Alternatively, American Express operates in a closed system, meaning only approved merchants can operate on their network.

Another difference for American Express cards is the focus on higher-net-worth individuals. American Express also only accepts applicants with good to excellent credit scores, creating another level of exclusivity. Unlike most major credit card companies, the final separator for American Express cards, the card balances require full payment at the end of the month.

Despite the long track record and record for excellence, American Express cards remain far behind Visa and Mastercard, both in the US and globally.

American Express has grown its business model to include traditional banking products such as checking and savings accounts. These changes help American Express find new customers and expand its reach while staying relevant in the growing fintech wars.

The most famous credit card in the world remains the “black card” or Centurion, which has a $10,000 initiation fee and a $5,000 annual fee. There are no specific requirements for income minimums or spending minimums, but speculation online clarifying annual spending limits hover around $250-500 thousand. And most importantly: they only offer the card by invitation, making it an exclusive club.

What is the American Express Business Model?

American Express continues as one of the largest global credit card issuers. The company focuses on offering its cardholders premium rewards and its merchants a high credit quality cardholder base willing to spend.

Unlike competitors Visa and Mastercard, American Express charges fees to both cardholders and merchants in exchange for access to its network.

Visa and Mastercard are card schemes, meaning they enable cardholders to process payments across a wide network, but they don’t carry the card balances. Those card balances exist on the card issuer’s balance sheet, banks like Chase and Wells Fargo, for example.

When American Express first began offering its credit card in the 1950s, the company was an innovator, quickly gaining market share and brand recognition, which continues today.

American Express differentiates itself from competitors by focusing on higher net worth individuals. That focus allows American Express to charge merchants higher fees than Visa and Mastercard.

Before diving into the business model, let’s take a moment to understand the flow of credit card transactions.

• The cardholder makes a purchase with their American Express card at a merchant (online or physical)
• The merchant sends the transaction data, including cardholder details to American Express
• The acquirer (American Express) sends the data to verify the transaction details
• The issuer verifies the data and sends it back through the network to the merchant, who processes the transaction

In the normal flow of card payments, the main participants are the network, issuing bank, and acquiring bank. For example, the above example would include:

• Network – Visa/Mastercard
• Issuing bank – Chase
• Acquiring bank – Fiserv

But here’s where American Express differs from its competitors.

They operate in a closed-loop system, and as a vertically integrated business, they compete across the payment value chain.

In the above example, American Express operates as the network, issuing bank, an acquiring bank. American Express operates as an end-to-end, integrated payment platform with direct customer relationships, including cardholders and merchants.

American Express’s customers include consumers, small business, and large corporations.

Today, American Express offers credit card services, plus a host of digital financial services in the consumer retail credit industry.

American Express divides the business into three segments:

• Global Consumer Services Group (GCSG)
• Global Commercial Services (GCS)
• Global Merchant and Network Services (GMNS)

The company breaks the revenue streams into three additional sources:

• Card issuing business
• Merchant acquiring business
• Card network business

Each revenue stream crosses the business segments listed above; for example, they conduct card issuing through both the GCSF and GCS reporting segments.

These segments offer a diverse range of card products with rewards and services for both consumers and commercial customers.

The GMNS segment builds and manages millions of relationships with merchants worldwide that accept American Express cards. That includes encouraging more merchants to sign up, acting as the merchant acquirer, and keeping those fees within the closed-loop.

The card network outsources relationships to third-party banks, for example, Wells Fargo, licensing the brand and extending the company’s reach. In fact, in 2021, the company processed $194 billion in payments through third parties and had over 50 million active cards.

The company also offers other banking (checking/savings) accounts, travel services, and fraud protection.

These services drive various revenue streams, allowing American Express to continue growing, despite the pressures offered by new, startup card processors.

How Does American Express Make Money?

American Express makes money by collecting merchant fees from transactions made through its closed-loop network. The company also generates fees from its fee model for cardholders, such as annual membership fees, interest on outstanding balances, and conversion fees.

The company’s annual report or 10-k highlights the following types of revenues, quoting directly:

• Discount revenue, our largest revenue source, primarily represents the amount we earn on transactions occurring at merchants that have entered into a card acceptance agreement with us, or a Global Network Services (GNS) partner or other third-party merchant acquirers, for facilitating transactions between the merchants and Card Members.
• Interest income principally represents interest earned on outstanding loan balances
• Net card fees represent revenue earned from annual card membership fees, which vary based on the type of card and the number of cards for each account
• Other fees and commissions primarily represent Card Member delinquency fees, foreign currency conversion fees charged to Card Members, loyalty coalition-related fees, service fees earned from merchants, travel commissions and fees, and Membership Rewards program fees

The two big sources of revenue, cardholder and merchant, keep the company chugging along. Let’s explore those a little to understand how they drive revenue.

Cardholder Revenue

American Express carries tens of millions of cardholders through its network. One of the company’s largest revenues streams remains late fees and interest fees charged on outstanding balances.

With over 121 million cardholders worldwide and $1.28 billion in charges across its network, American Express continues as one of the leading players in the credit card industry.

American Express relies on bringing higher spending customers to the merchant, who spend more on average than competitors Visa and Mastercard. American Express initially began as a no-fee model for cardholders, requiring them to pay the bill in full each month.

If the cardholder failed to fulfill the terms, the company would close the account and send it to collections to collect the balance. This model wasn’t sustainable, and American Express needed to change things up to stay competitive.

American Express also collects annual membership fees, ranging from $550 to $5,000 for its Centurion (black) card. That differs from most other card players, who charge little or no annual fees.

But the vast majority of the company’s card revenues stem from the interest income they generate from card balances. These fees stem from most cardholders who still don’t understand how credit cards work. They pay high interest on their ongoing balances, generating more revenue for American Express.

Over time, American Express began expanding its customer base by offering co-branded and entry-level cards through third parties, for example, Wells Fargo.

And recently, the company began offering the no-fee American Express Blue Cash cards to stay relevant in the world of no-fee products.

In 2021, the company generated $5.19 billion in net card fees, good for 12% of the company’s overall revenues.

Merchant Revenues

American Express’s largest revenue source stems from the discount fees it earns from fees charged to merchants. These fees or “swipe” fees are the company’s bread and butter.

As of year-end 2021, the company generated $25.7 billion in discount fees, accounting for 59% of the company’s revenues.

American Express charges the highest fees in the industry, higher than competitors Visa and Mastercard. For example, Visa and Mastercard charge between 1.5-2.5%, while American Express charges 2.5-3.5% to accept their cards.

These higher fees scare some merchants away from accepting the American Express card. For example, a merchant with lower margin products faces deeper cuts in their profits from American Express cards than competitors.

You are probably asking, “why would merchants accept the American Express card with the higher fees?”

The simple answer is that most American Express card holders carry higher credit scores and are wealthier, and it is worth it to the merchant to attract those customers to their stores.

For example, American Express affluent customers tend to buy more goods and services than their cohorts in Visa and Mastercard. These higher spending behaviors attract merchants, making it worthwhile for them to court American Express cardholders.

American Express recently stated their ongoing goals, including the primary goal, increasing transaction volumes, especially in travel and entertainment.

Other future goals include:

• Improving cardholder acquisitions
• Merchant partner expansion
• International growth

They are looking to expand into the SMB (small and medium businesses) industry to stay relevant.

And in response to international pressures and to attract more merchant partners, the company began lowering its discount rates in 2018.

Investor Takeaway

With its long, distinctive history, American Express remains a force in the card processing space. The company continues to innovate and adapt the brand as the industry changes. They continue to remain a niche product, and with their closed-loop system, they differentiate themselves from the competition.

Understanding the business model, how they make money, and a little history helps investors like us make better choices.

I know from experience when first analyzing American Express, it seemed complex and a little above my pay grade. But with time and understanding companies like Visa and Mastercard, I came to understand American Express’s business model better.

American Express checks all the boxes as a distinctive company with a competitive moat; otherwise, Warren Buffett wouldn’t have held the company for this long. There is a lot of competition today with Block, Paypal, Stripe, Mastercard, and Visa. But at this point, the company retains its place in the payment space.

And with that, we will wrap up our discussion on American Express’s history and business model.

Thank you for taking the time to read today’s post. And I hope you find something of value. If I can be of any further assistance, please don’t hesitate to reach out.