Paying the Price — Disruption in the Cards and Payments Industry
Tech giants from Apple to Alibaba have upended the financial world by defining the digital payments experience. Seeing such lucrative opportunities, even governments have jumped into the fray, with India and China creating new forms of payments.
The industry dynamics, now threatening incumbents, extend far beyond the traditional ecosystem of banks, payments networks, standards bodies and merchants. Today, fintechs, technology firms, startups and regulators play increasingly important roles in the payments ecosystem.
Traditionally, banks make up nearly one-third of payments revenue and enjoy a healthy growth rate. Payments revenue principally comes from three avenues, namely:
- Card products, including credit, debit and prepaid cards.
- Transaction charges, both domestic and cross-border.
- Other fees such as overdraft and account-related charges.
Each revenue stream is under pressure from outside forces. This disruption is region-specific based on regulations and historical context. In China, Alibaba (often called China’s Amazon) and WeChat (China’s Facebook) upended the payments system in their own unique ways as each created a platform of nearly one billion users.
In 2014, WeChat Pay started a person-to-person digital gift card service that took off and evolved into a wallet provider.1 Besides using QR code payments, the company made it easier for merchants to accept and process payments with phones instead of dedicated point-of-sale equipment.
Alibaba pioneered easy internet-based payments for e-commerce consumers and merchants. Alipay linked bank accounts to its wallet and incentivized merchants by eliminating transaction fees. Fees are levied only when merchants move money back into their bank accounts. With an ever-expanding ecosystem, merchants can buy from their suppliers on this ecosystem without paying transaction fees. Through cheaper rates, higher acceptance and ease of use, these companies have essentially removed financial institutions from the payments flow.
The competition within the credit card industry has been heating up too, with Apple’s venture into cards one significant example. Incumbent financial institutions are upping the ante with better rewards, more attractive physical cards and a better digital experience for consumers. All big issuers, including American Express, JPMorgan Chase and Capital One, have launched or refreshed their credit card products. There is also intense activity in the cobranded cards space as Walmart, Costco, Hilton, Marriott and others have updated their offerings. As a result, acquiring new business is getting costly or even uneconomical if not structured correctly. This segment, at least in North America, is still dominated by incumbents even though competition is increasing.
There has been a flurry of activity on the payments acceptance side with megamergers such as Fiserv and First Data, FIS and Worldpay, and Global Payment and TSYS. Meanwhile, Square has steadily grown into a top 10 processor by focusing on small merchants while also signing a few large corporate deals.
And Stripe has attracted developers with the company’s payments application programming interfaces (APIs). Will Gaybrick, chief product officer and head of payments for Stripe, said his company envisions working with banks rather than trying to supplant them.
“The way we think about it is sort of like disruption via partnership,” he said at October’s Money 20/20 USA conference in Las Vegas. “It’s not disruption of the partners — it’s disruption of the status quo, of a world in which it is hard to get a loan, of a world in which it is really difficult to just pay money out to a bank account in Sri Lanka.”
Also, companies like Klarna and Affirm are changing the dynamics with point-of-sale lending. This reduces the burden on merchants and helps consumers avail themselves of lower fees — at least lower than expensive credit card interest rates. Overall, we are seeing each financial function getting unbundled and facing a new type of challenge from strong technology platforms.
Meanwhile, governments and regulators are eager to intervene and determine how payments systems can become more inclusive. Credit cards work only for consumers with credit history. Debit cards require bank accounts. In many parts of the world, these simple conditions are serious hurdles.
The Indian government, for example, has brought millions of citizens into the financial system by incentivizing them to open direct deposit accounts linked to life insurance coverage. Further building on the progress already achieved through its unique identity Aadhar project, the government has rolled out its Unified Payments Interface (UPI), which enables cheaper and faster payments with simple APIs for service providers to move money. This also facilitates interbank transactions through mobile platforms with a secure two-factor authentication protocol.2 At this point, providers like Google Pay, PhonePe and Paytm have amassed 93% of the UPI market.3 Users benefit from a single application to conduct various transactions such as money transfers, bill payments, mobile recharges, and retail and other everyday purchases.
Even in the wealthiest nations, the number of people classified as “unbanked” measures in the millions. An estimated 14.1 million U.S. adults did not have bank accounts in 2017, according to a survey from the Federal Deposit Insurance Corporation.4 And a 2015 federal study found that about 45 million U.S. adults had no credit history or a credit history so limited that it was unscorable.5
Governments are also passing stricter laws — such as Europe’s General Data Protection Regulation — to recognize citizens’ rights and provide greater transparency and control to consumers. Data residency restrictions will further affect how payments information is handled. As transactions become channel-agnostic, companies are under increasing pressure from regulators to ensure data security across all modes of transaction. Moreover, the explosive growth of payments channels increases vulnerability to payments fraud. Thus, providers must find smarter ways to stay vigilant against cyberthreats. The emergence of cryptocurrencies also promises to bring in a new wave of change that’s difficult to predict.
To survive these challenges — let alone prosper — organizations must quickly find their own paths through this new environment. Businesses need to:
- Develop their own API road map.
- Collaborate with other businesses (successful payments efforts are fueled by partnerships).
- Focus on creating frictionless transactions, one of the most important elements in the growth of the new payments ecosystem.
- Tailor strategies around their geographic base, since payments systems vary wildly among regions.
- Identify innovative or disruptive services that can be monetized, particularly through recurring revenue.
These are times of great change. In the coming years, we can expect a confluence of consumers’ digital experience expectations, regulatory interventions, rapid innovation and a changing security landscape to spark even greater transformation within this industry.