King of Card Data Links Seeks New Worlds to Conquer

John J. McDonnell Jr. flashes a two-thumbs-up sign by way of greeting.

This is not surprising, given his successes in the data communications industry. In five years, Mr. McDonnell, 58, has turned his Transaction Network Services Inc. into the country's premiere transaction data communications network. The key to its success has been speeding up credit card transactions.

The Reston, Va.-based company competes head-on with the telecommunications industry's major players - AT&T, Sprint, and MCI.

"We've pretty much beat up on MCI and Sprint, to the point where they are not nearly the factor in this industry that AT&T continues to be," said Mr. McDonnell, who is president and chief executive. "But we are now the biggest."

"It's a David and Goliath story," said Steven S. Birer, senior analyst for Hambrecht & Quist, San Francisco, the company that took Transaction Network Services public in 1994. "Jack saw a market need and built a product that would meet that need, and sure enough he was right. The company has become the de facto standard for data communications in the credit card industry."

Taking time out from a securities industry conference in New York, Mr. McDonnell spoke enthusiastically about where he wants to take his company, swiveling in his chair and tapping on the arm rest.

Like his tie - a child's drawing of a space ship zooming toward a distant star - he was bursting with ideas and dreams.

Born in New York City's borough of Queens, he received a bachelor's degree in electrical engineering from Manhattan College in in 1959 and a master's in the subject, from Renssalaer Polytechnic Institute in Troy, N.Y.

He then joined the Air Force, where he trained as a pilot and worked as an engineer for the National Security Agency in Fort Mead, designing satellite systems. "Everything I have done since then has een pretty much triggered by that two-year tour of duty," he said.

After leaving the Air Force, Mr. McDonnell worked for an electronics company, then founded one of his own. He then started an executive airline service.

The turning point in his career came in 1976, when he was appointed director of technology and telecommunications for the National Commission on Electronic Funds Transfer. The now-defunct federal body was set up to inform Congress on developments in the industry.

The job is what got him involved in the banking side of data communications, Mr. McDonnell said. And there he embraced a newly introduced technology that he decided was the "wave of the future for banking."

It was the packet data network, which transmits data in short bursts instead of continuously. Transaction Network Services uses it today to route point of sale information.

In 1978, when he left the funds transfer commission, Mr. McDonnell went to work for BT Tymnet Inc., a public data network based in San Jose, Calif., as vice president in charge of international operations and sales.

Mr. McDonnel says he put BT Tymnet in the financial services industry. In seven years there he designed an international automated teller network for Hong Kong Shanghai Bank and set up the network for Wells Fargo Bank's magnetic stripe terminals.

In 1985 he switched gears, joining the Electronic Industries Association as head of its telecommunications group. The job made him chief lobbyist for the telecommunications industry.

Three years later, Citicorp recruited him to be president of its short- lived Digital Radio Network.

Mr. McDonnel says he had every confidence that radio transmission was the wave of the future for packet data networks. But though a technological success, it was "a marketing disaster," he says. "The banks just weren't ready to embrace radio." The project moved along too slowly, and cash flow became a problem.

Meanwhile he had learned a crucial bit of information which would shape the direction of his future company. He learned that local phone companies had installed a "fast-connect" system to link calling card customers to long-distance interexchange companies like Sprint, MCI, and AT&T.

The fast-connect system uses "800" or "950" numbers, which bill the recipient of a call, not the caller.

Mr. McDonnell was excited. "We can go into this fast wire transmission - a quick connect to the local telephone company," he thought. The attraction for the merchant: no charge for the call. That would bring in transactions for Digital Radio's packet data network, he reasoned, and establish some cash flow.

But Digital Radio's board would not consider the idea, for fear it would divert focus from radio. Mr. McDonnell decided to go his own way; Digital Radio Network ceased operations in 1991.

Mr. McDonnell discussed his idea with data communications consultants, who agreed about its potential - that there "was no reason ... why we couldn't use it for the banking industry just the way it was being offered to the telephone industry.

"And this was the business plan," he says - "to build a network based on this quick connect and offer it to the credit card industry."

Today when a card whose third-party processor uses Transaction Network Services is swiped through a point of sale terminal, the network's "950" number is dialed.

The network receives the transaction data and within 200 milliseconds feeds it to the third-party processor. The processor in turn relays the information to MasterCard, Visa, or others and returns an answer through the system.

Mr. McDonnell ran around with his business plan, looking for ways to raise the seed money. He quickly got the ear of William Melton, president of Cybercash Inc. and the founder of Verifone Inc., now the world's largest provider of point of sale terminals.

The two had met in Hawaii in the early 1980s. Mr. McDonnell was working in the international division for BT Tymnet, and Verifone was just a three- person office in Honolulu.

In 1990 Mr. McDonnell and Mr. Melton met in Nashville with Fred C. Goad, chairman of Envoy, the merchant processor based there.

"My business plan said that we would break even at five million transactions a month," Mr. McDonnell said.

"Bill said to Fred, 'If you guarantee Jack five million transactions a month (half of Envoy's volume, then split between Tymnet and Telenet) I'll write the check so he can build the network.'

"So we drew up a letter of intent, signed it on the spot, and we got back to Washington and he wrote me a check for $1.25 million."

The economic downturn at the start of the 1990s also helped the fledgling company.

If banks and third-party processors "were all sitting there fat, dumb, and happy," his company might have been less successful, he said. "Here comes a brand new network operator; If your current vendor operator is AT&T and Sprint, who needs a new kid that's out there building a network?"

But "everyone was looking to cut costs."

He said he had already developed credibility from having built the Digital Radio Network.

The processors "wanted a cheaper transaction, because they were feeling the price pressure from the banks to lower the transaction fees," Mr. McDonnell said. "So it ended up that the bad economic situation actually helped us. People were willing to listen because we were promising them better performance at lower prices. That was our ticket in."

At the time, Mr. McDonnell said, 60% of electronic transactions were done over the old "800" numbers, which were expensive and slow. They took 30 to 45 seconds to complete a transaction, and cost as much as 20 cents a minute - including 5 cents just for the communications part.

From his days at Tymnet, Mr. McDonnell knew that the public data networks were priced at about 3 cents to 3.5 cents per transaction and were faster. But there were local access charges, so merchants preferred the slower "800" numbers.

He knew he had to beat them both, for price and speed. Using the "950" number and his private network, he came in at under 10 seconds.

"We came in at 3 cents a transaction and just sold the speed and the fact that it was reverse billing, and it caught on," he said. "The market was ready for an innovation."

His first 43 transactions through Envoy came from Sizzler Steak House, which, Mr. McDonnell noted with a dull irony, has just filed for bankruptcy.

From those first transactions, Mr. McDonnell built his small kingdom. Last month his company averaged 5.6 million transactions a day, with an average price of $100.

"So we are moving $560 million a day," he said.

Revenues in 1995 were $41.4 million, 56% more than the year before. Net income increased 63%, to $5.2 million.

Mr. McDonnell attributed the revenue jump to the 1994 acquisition of Fortune Telecommunications Inc. for $9 million in stock and cash. He said Fortune's CardTel service, a telephone verification network to guard against card fraud, generated $14 million in revenue last year 1995.

Analysts are breathless when they describe the successes and strengths of Transaction Network Services.

"The company is well positioned to meet the future," said Hambrecht & Quist's Mr. Birer. "There is nice, strong growth from the existing customer base" and long-term contracts.

The big event this year was the February signing of a five-year, $55 million contract with First Data Corp., said Craig Ellis, managing director at Wheat First Butcher Singer in Richmond, Va. The deal will add 400 million transactions to Transaction Network's base of 1.2 billion last year, Mr. Ellis said. He predicted 2.1 billion transactions in 1996, for a 71% increase.

"Jack brought real competition to the pricing for communications services for the processors," Mr. Ellis said.

The company's other customers include Business Services Inc. (formerly JC Penney BSI), Deluxe Data Systems, EFS Inc., MasterCard International, Gensar Technologies Inc., and First USA Inc.

Kurt Helwig, executive director of the Electronic Funds Transfer Association in Herndon, Va., said Mr. McDonnell "is driven."

He's "the consummate businessman," Mr. Helwig said.

Because the company is small, it can "respond more quickly to the dynamics of the industry or a particular customer's need," he said. Mr. McDonnell 'keeps customers coming back."

One thing that keeps Mr. McDonnell up at night is the possibility of a system failure such as happened to Sprint several weeks ago.

But Mr. McDonnell said it's not likely to happen. The Transaction Network Services system is set up like the Internet, with many lines flowing into many others in a "bulletproof" network.

"We don't put a switch anyplace where we can't get three separate fibers coming out of that city to go to three other cities," he said. "It's a totally enmeshed network."

Transaction Network Services has 102 employees. Most work in the 24- hour-a-day operations center in Reston. There's also a primary office in Fort Lauderdale, Fla.

Mr. McDonnell said he plans to expand his packet data network to new industries at home and abroad.

He is currently working with brokerages on a data communications network between mutual funds managers and the trading brokers.

The company is also moving into electronic benefits transfer. It has government contracts in Maryland, Minnesota, New Jersey, Texas, and Utah and is the only company approved by the federal government for these transactions. It also processes Medicaid eligibility and verification transactions.

On the international level, Mr. McDonnell is setting up a packet data network in Europe, using Ireland and England as his jumping-off points.

And in May the company entered into an agreement with Canada's Transact Data Services, which will use Transaction Network Services' technology. For every transaction that goes through that network, Transaction Network Services will receive a royalty.

Its successes have made the company a target for competitors, but Mr. McDonnell seems unfazed. Leaving the interview, he flashed the two-thumbs- up sign again and said:

"We have gone from being the hunter to the hunted. We were the guys who were out there trying to take business away from everyone else; now we have become the dominant carrier, and everybody's out there shooting at us.

"I'm not sure that is a comfortable place to be, but that is certainly what has evolved."

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