American Express

American Express (often abbreviated as Amex) is a global financial services powerhouse, famous for its iconic charge cards, credit cards, and traveler's checks. Unlike its main competitors, Visa and Mastercard, which operate as open payment networks for thousands of banks, Amex runs a “closed-loop” system. This means it acts as the card issuer (the bank), the network (the payment processor), and the acquirer (the merchant's connection) all in one. This integrated model gives Amex direct relationships with both its cardmembers and the merchants who accept its cards. The company primarily targets affluent consumers and businesses, building its brand around premium service, rewards, and a sense of exclusivity. Its revenue is a powerful trifecta of fees from merchants on every transaction (the merchant discount rate), annual fees from cardholders for its premium products, and interest income from balances carried on its credit cards and other lending products.

The secret to understanding Amex lies in its unique structure, which sets it apart from the rest of the payment industry and forms the foundation of its enduring success.

Imagine a private club. Amex essentially operates one for payments. In the “four-party” or “open-loop” system used by Visa and Mastercard, there are four players: the cardholder, the cardholder's bank, the merchant, and the merchant's bank. Visa and Mastercard simply provide the network that connects the two banks. Amex, on the other hand, uses a “three-party” or “closed-loop” system. The players are simply:

• The Cardmember (the customer)
• The Merchant
• American Express

By cutting out the intermediary banks, Amex owns the entire value chain. This provides two critical advantages:

• Rich Data: It sees every detail of every transaction, allowing for sophisticated marketing, fraud prevention, and personalized offers that build incredible loyalty.
• Brand Control: It controls the entire customer experience, from the look and feel of the card to the quality of the customer service, reinforcing its premium brand identity.

This control allows Amex to charge merchants a higher fee than its competitors. Why do merchants pay it? Because Amex cardholders are, on average, more affluent and spend significantly more than other cardholders, making them a customer base that merchants can't afford to ignore.

Amex's business is fueled by three main engines:

• Discount Revenue: This is the fee Amex collects from merchants every time a cardmember swipes, taps, or clicks to pay. It is the company's largest source of income.
• Net Card Fees: These are the annual fees cardmembers pay for the privilege of carrying Amex's premium products, such as the coveted Gold and Platinum cards, which come with a host of travel and lifestyle perks.
• Net Interest Income: Unlike Visa or Mastercard, Amex is also a lender. It earns interest on revolving balances on its credit cards and provides loans to its customers, creating a substantial and recurring revenue stream.

For value investors, Amex is a classic case study in competitive advantages, or what Warren Buffett calls an economic moat.

Amex's moat is built on two powerful pillars:

• Intangible Assets: The American Express brand is globally recognized as a symbol of financial trust, security, and prestige. This powerful brand perception, built over more than a century, allows it to attract high-value customers and command premium pricing.
• Network Effects: The business model creates a virtuous cycle. The more high-spending cardmembers Amex attracts, the more essential it becomes for merchants to accept the card. The more merchants that accept the card, the more valuable it becomes for cardmembers. This self-reinforcing loop creates a formidable barrier to entry for potential competitors.

No investment is without risk. For Amex, investors should keep an eye on:

• Competition: The payments landscape is fiercely competitive, with challenges not only from traditional rivals but also from innovative fintech companies like PayPal and Block.
• Economic Sensitivity: As a lender, Amex's fortunes are tied to the health of the economy. During a recession, consumer and business spending may fall, and credit risk increases as more customers may struggle to pay their bills, leading to higher loan write-offs.
• Regulatory Scrutiny: As a major financial institution, Amex operates under the watchful eye of regulators. Changes in laws regarding card fees or lending practices could impact its profitability.

American Express is one of Berkshire Hathaway's oldest and most significant investments. Warren Buffett was famously attracted to the business in the 1960s after the “Salad Oil Scandal,” a crisis where a client of Amex's warehousing division defaulted on huge loans secured by nonexistent salad oil. Amex's stock plummeted as investors feared the company would go bankrupt. Buffett, however, did his own scuttlebutt research. He visited restaurants and talked to merchants, observing that customers and businesses hadn't lost faith in the core payments business. They were still proudly using their cards and checks. He realized the scandal had not damaged the company's most valuable asset: its brand and the trust it commanded. He invested heavily and made a fortune. For Buffett, Amex has always been the quintessential “toll bridge” business—a company that earns a small fee on a massive and growing volume of transactions within a protected ecosystem.