7 Trends Impacting Retail Payments
The payments industry has all three attributes of a highly attractive market: it’s large, it’s growing, and it’s profitable. But that does not mean everything is rosy. In this ABA Banking Journal article, Strategy& explores 7 trends impacting the complex and competitive environment of North America’s $180 billion payments market.
7 trends impacting retail payments
Sorting out a complex and competitive environment
By Mark Flamme and Kevin Grieve
he payments industry has all three attributes of a highly attractive market: It’s large, it’s growing, and it’s profitable. The global payments market is expected to double in the next decade. And because of the structural nature of the business, which includes relatively stable and predictable transaction volumes combined with low capital intensity, the industry is very
profitable. But that does not mean everything is rosy. North America’s $180 billion payments market is mature, consolidated, competitive, and under attack. Since the global recession, tepid economic growth has caused financial institutions to shift focus to risk-adjusted capital returns and has prompted consumers to de-leverage, creating a set of underserved
segments. Increased regulation combined with the zero cost of money has decreased interest rate spread and lowered margins, elevating the importance of fee-based and account-based income and forcing players to look for new revenue streams. Multiple monoline payments players have been absorbed into larger financial institutions or have expanded their service offering into
a broader set of financial services. Merchants continue to consolidate market share, simultaneously increasing the competition for cobranded cards and programs and increasing the adversarial relationship between merchants and financial institutions. Leading payments players are now refocusing on topline revenue growth and reexamining their value proposition. What does the future hold in this incredibly complex environment? Our research indicates seven key trends will significantly reshape the payments industry in the next three to five years. 1. Increased card “stickiness.” Platforms that enable purchases with stored card credentials, such as Amazon, Uber, and iTunes, will establish card switching costs, co-opt card brands, and relegate payments to a utility function. Consumers rarely remember which credit card they registered in their accounts, and rarely see the card brand during online checkout. And just as billpay makes checking accounts sticky, cards linked to multiple platforms will have a stickiness that increases switching costs for consumers considering a new card. Issuers would be wise to create incentives to put their cards at the top of the platform wallet. The recent partnership between American Express and Uber is one of many examples of this trend. 2. Interchange fee deflation will continue, and “value-add” and “utility” rates will emerge. Merchant credit card fees as a percentage of gross dollar volume of transactions have declined, on average, 2% per year since 2006 as merchants have pursued a lowest-cost-of-payments strategy. Going forward, pressure from the Merchant Customer Exchange, litigation, and other efforts will drive rates down further. Additionally, platforms like PayPal can bundle value-added services, such as in-store marketing, through Bluetooth beacons, tablet
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checkout, and advertising platforms into transparent rates. Recognizing that future interchange will be driven by merchant value-add, large payment players are taking action to enhance their current value proposition against current interchange rates. For example, Chase’s lease of VisaNet creates an end-to-end network in which Chase can create new merchant value propositions and control pricing. Acquirers and issuers that are unable to provide additional merchant value will be relegated to lower utility rates. 3. Moving to real time. PIN and signature debit, automated clearing house, and wire transactions will converge through real-time infrastructure with pricing based on timing of funds availability, real-time funds guarantees, and associated information flow. Fiserv and Fidelity Information Services are utilizing their respective
electronic funds transfer networks to create real-time good funds functionality in areas like billpay and personto-person payments. Additionally, PIN networks are offering to process signature debit transactions, effectively converging the two transactions. Real-time transactions will force banks to rethink their value propositions and fee structures. 4. Underwriting innovation will enable extension of credit to a broader set of consumers. Traditional credit scoring is an imperfect measure of borrower risk, which leaves many consumers out of the marketplace. The average medical student, for example, graduating with $180,000 of student loan debt, a thin credit file, and a high debt-to-income ratio might still be a worthwhile risk for a creditor. Companies like LendUp, Kreditech, and ZestCash are working on models to assess creditworthiness using new criteria, including rental records, cell phone payments, and social behavior. Significant opportunity awaits the entity that opens up the underserved market. 5. Monetization of payments data through transaction history-based deals and offers, licensing of merchant name and address, real-time consumer location, and chargeback databases will continue to grow. Multiple players have made strategic moves into the merchant-funded rewards space; new developments include Bank of America’s partnership with Cardlytics, Chase’s purchase of Bloomspot, and Discover’s offer platform. We see the next generation of merchant-funded rewards evolving along three dimensions: first, a broader assortment of national and local offers across multiple channels; second, offer delivery embedded in the consumer path-to-purchase based on consumer context of location, time, and recent purchase history; third, more pay for performance as advanced campaign analytics tracking
Consumers rarely remember which credit card they registered in online accounts, so cards linked to multiple platforms will have “stickiness”
follows the offer from impression through purchase (thus allowing merchants to determine marketing ROI). Payments players that can’t take a more active role in the broader commerce experience through data will be left behind. 6. Mobile payments will be dominated by open cloud and host card emulation. These platforms enable multiple parties to build consumer value-add applications. Key to consumer adoption will be a compelling commerce experience. No single entity has the data required to create a dominant model. Despite the existence of numerous mobile wallets offered by merchants, banks, and telecom providers, we expect to see more collaboration around data assets to break the competitive logjam. New players will continue to reshape the payments marketplace. With Apple’s
announcement of Apple Pay, we see further validation of the cloud-based e-wallet platform. While consumer adoption is still unclear, we think this is one of the many evolutionary paths toward mobile payments at physical points of sale. As the market evolves, the various e-wallet players will need to offer a compelling consumer and merchant value proposition while addressing data ownership, privacy, and security concerns. 7. Regulators will continue to play an active role, limiting prepaid card fees, reconsidering debit card interchange rates, standardizing state money transmitter laws, and, ultimately, setting guidelines to protect consumer data. Industry reference data utilities may evolve to share the compliance burden of anti-money laundering and know-your-customer regulations.
The payments landscape is being shaped by several powerful market factors that are collectively changing the game for all participants. Our overall prediction is that long-term profit pools in credit cards will stagnate, debit card and prepaid profit will be driven down, and profit growth will shift and expand in areas beyond the commoditized market of payments facilitation. These new growth areas and new value-add services will be fueled by big data and delivered in real time within the context of consumer preferences.
Mark Flamme and Kevin Grieve are financial services partners in the Chicago office of consulting firm Strategy&, where Grieve leads the firm’s payments business. They specialize in work with major banks, payments networks, and financial technology providers.
Published in ABA Journal, October 2014. Copyright 2014. All rights reserved. This file is for web posting and e-mail distribution only; may not be used for commercial reprints. Provided by The Reprint Outsource, 717-394-7350