Payment services have historically been a relatively stable sector of the financial services industry; at best, they are an after thought. Significant developments and progressive changes in the background and in back-office systems have been implemented in recent years; yet, there have been few really great leaps forward with a major impact on the consumer experience since payment cards (charge cards, credit cards, payment cards) began to supplant checks and become an alternative to cash 50 years ago. However, all that looks set to change.
The last 2 years have seen a growing number of initiatives in the payments sector, especially in mobile payments technology. The range and variety of current developments is extensive and potentially quite confusing. What is less certain is which, if any, of this multitude of initiatives will have the potential to penetrate mass markets and truly transform consumer behavior.
There are drivers of change from many directions:
- Consumers have been progressively moving away from the use of cash for decades. In advanced consumer societies in North America, Western Europe/Scandinavia and Asia, the use of checks has dwindled in favour of payment cards of various types. Payment by cash is now largely restricted to small value retail purchases. Even here, the indications are that consumers would embrace simple-to-use, reliable, cash-free payments methods with alacrity.
- Merchants who use point-of-sale card terminals typically pay fees of 2-5 percent of gross sales value to credit card companies and acquirers for credit card use and a lower rate for debit card acceptance. Their judgment is that this is, at present, a necessary cost to bear in order to allow customers to pay them without incurring the additional inconvenience of cash. From the merchant’s point of view, card acceptance has some advantages in reducing cash needs and the risks of crime, but 2-5 percent is a high cost to bear. The pressure exerted by Congress via the Dodd-Frank Act and the remit of the Commodity Futures Trading Commission to oversee a reduction in interchange and the cost of ‘loyalty cards’ has triggered a shift in this market. There is no doubt that cheaper payment alternatives would find a widespread market.
- Small traders and craftsmen, for example in the building trades, domestic services and those operating without a fixed home base, have historically had few options for efficiently and cost effectively receiving payment beyond cash or checks, each of which has significant drawbacks. There is massive pent-up demand here for more efficient, streamlined and low-cost systems that provide reconciliation data that can be integrated into their accounting software back to small businesses around the collection of funds. Tax authorities would also probably favour more traceable payment mechanisms from the perspective of reducing tax evasion.
- Recognizing these pull factors and faced with the threat of disintermediation by new technology-based start-ups that ignore the wider banking relationship, banks and other financial services companies see both major opportunity in introducing innovative payment systems to satisfy the latent demand and a clear threat if they don’t innovate to serve a sizeable and lucrative small and medium enterprises market.
- Card companies, perhaps the market participants most threatened by transformational payments technologies, have stronger interests than many in controlling the direction of innovation. Payment networks, card-issuing companies payment processing companies and banks all face differing challenges and some may be more exposed than others.
- Given the potential for substantial market disruption, there are obvious attractions to many classes of new entrants who might be able to develop a winning proposition.
One of the major enablers is technology. Two areas have proved especially significant. The first is near field communication (NFC). Earlier radio frequency identification (RFID) allowed enabled devices to operate as contactless payment methods.
Contactless smart cards have been in use in many parts of the world for over a decade. However, in some markets, adoption was initially limited by unreliability and by the need for significant capital investment by retailers. NFC extends the technology by allowing higher capacity two-way communication between devices. These can function as contactless payment systems as before, but can also form the basis for more advanced and reliable systems.
The second key enabler is the platform of advanced technologies now available in smartphones, tablets, other portable devices and mobile communications. Apart from enabling remote communication with banks, card companies, supplier bases, etc. global positioning (GPS) technologies can locate consumers accurately and push much more relevant data and information to them. Together, NFC and mobile technologies provide the foundation for significant further advances in payments systems, which are attracting attention and investment from many directions. Hardly a month passes without a new product or platform announcement, a new industry partnership or a new entrant promising a radically new approach.
Some key recent developments include.
- Barclays Pingit allows holders of any current account in the UK to transfer and receive money using any Android or iOS device. Small business operators and traders can use Pingit to get paid instantly by customers. Consumers can transfer cash between friends and family members, split bills in restaurants and so on. Pingit uses the UK’s Faster Payments Service, introduced to radically reduce transfer and clearing delays, so payments are effectively instantaneous as well as free. Barclays also hopes to attract new customers for its wider banking services.
- New entrants such as Moven (from Movencorp Inc. in the US) and Ontrees are also competing directly with the banks by offering a combination of mobile banking and payments services via smartphone. Ontrees integrates data from customer bank accounts and purchase transactions, allowing a variety of analyses, services and presentations of financial information. Moven offers comparable benefits, combined with a payment infrastructure based on both debit card and RFID.
- Point-of-sale is traditionally the world of credit and debit card companies and acquirers. A number of retailers are introducing or have introduced new payment options based on mobile phone apps and NFC, including Starbucks in the US and Canada. In the UK, MasterCard recently announced a partnership with Weve (owned by Vodafone, Everything Everywhere (EE) and Telefónica UK (O2)) to develop a comprehensive contactless mobile payments system. However, the introduction of contactless NFC terminals has not been problem-free and there have been complaints over reliability and security.
- Zapp: Also in the UK, VocaLink, which already operates Link, one of the largest ATM networks and provides the infrastructure for clearing services for credit transfers and Direct Debit is launching Zapp, which will allow retail customers to pay for purchases via a mobile application loaded on their smartphones.
- Systems targeted at small businesses and sole entrepreneurs include Square Register from Square, Inc1 in North America and iZettle, a Swedish company currently operating in a number of European and Latin American territories. Both solutions involve extending the range of existing payment card technology with the use of a card reader; this plugs into the audio jack of a smartphone and allows it to read either the magnetic stripe or the chip on the payment card and communicate with a payment provider. In 2013, iZettle formed a partnership with Santander. Intuit, who market the QuickBooks accounts software for small businesses in the UK and PayPal, eBay’s global payments services provider, have both introduced similar services.
- eBay acquisition of Braintree: In September 2013, eBay acquired the payments provider Braintree, whose Venmo app supports payments by tablet and smartphone for US$800 million. Braintree will operate within eBay’s PayPal business, strengthening its capability in mobile systems. At the same time, the acquisition eliminates a rapidly growing competitor. As PayPal continues to explore NFC, the company is developing a virtual wallet and the ability to support peer-to-peer transactions.
- Klarna acquisition of SOFORT: Also in 2013, the Swedish online payment services company Klarna acquired a German rival, SOFORT, for more than EUR150 million.
However, the very range of current developments testifies to an immature and uncertain market. It is clear that only a very small number of these innovations will prove to have the winning combination of customer benefits, ease of use and economic advantages to survive. Markets simply cannot support a large number of inconsistent and conflicting payments systems. Regulators, too, should increasingly drive consistency and standards to protect consumers, such as under the Payments Services Directive in the European Union.
Advanced payments systems are having to break into a market which is inherently low margin. The transaction fees which can be earned directly from providing payment services are, however, not the primary attraction.
The potential value lies in control of the consumer interface and the access it provides: to customer and market data and the ability to target added value services, advertising and promotions directly to the customer at the right time in the right place. In effect, payment data is more valuable than payment fees: payment transaction data can generate value for all of the participants in the payments value chain. This potential is why the payments battlefield is particularly fiercely contested at the moment. As we have seen, banks, card companies, new entrants, mobile telecommunications companies, hardware suppliers are all in effect fighting to take control of consumers’ day-to-day spending and payment operations and exploit that control as the basis of higher value, higher profitability services.
Technology and applications that can exploit payments data, for example, in delivering assessments of payment information quality or customer and marketing analytics, can help develop marketing strategies and inform audience segmentation. Many of the competing technologies have different, very powerful backers, that are all jockeying for position. But they will not necessarily be able to impose a solution on the public. It may be that telecom carriers, hardware providers or card networks will determine the future of payments technology rather than banks themselves. However, for new payment technologies to be seen as more than a gimmick and for consumers willingly to adopt them, more needs to be done to identify systems that will add value for the user as well as for the provider.
To attract consumer take-up, alternative systems will have to compete effectively with the simple or virtually costless alternatives of using plastic or carrying cash. While each of these carries some theoretical risk (loss, robbery, fraud), in practice the risk is small. And, by definition, the acceptable economic cost of a payments system is limited to a small proportion of the value of the underlying transaction. Will consumers switch in droves to new technologies? Despite the hype and the major investments now being made, new systems may face an uphill challenge.