LONGREAD: tools of commerce

Payments are a high-volume, low-margin business. Even the smallest changes in revenues or margins deliver significant changes in actual dollars because of sheer volume.  

"The payments world is fundamentally divided," - Grant Halverson, former CEO, McLean Roche Consulting

The European Union says payment systems are the "second- or third-most important network in any country outside national security and military issues”.

Payments impact every government, business and household - as well as every import and export transaction, every consumer and business payment transaction and more.

Payments are truly ubiquitous. Yet the payments world is fundamentally divided.

Broad trends in developed economies and emerging markets are fundamentally different with very little cross over.

Cash, cheque or card?

There are two main themes in developed markets.

There a number of strong credit card markets with high cash and cheque use with 72 per cent of global credit card receivables available in only five countries - America, Canada, Japan, Korea and England.

Mainland Europe serves close to 510 million consumers. It is the largest developed consumer market with a preference for debit card/EDI (electronic data interchange) with little cash or credit card use and virtually no cheques.

A number of EU countries have all but eliminated cheques over the last 15 years replacing them with EDIs, well before 'digital' became fashionable.

Emerging markets make up 78 per cent of the world population and are still dominated by cash.

In these markets, there is an estimated unbanked population of two billion people - or 45 per cent of working adults and mobile payments have limited impact.

However a number of pioneers have developed efficient and widely used mobile payments.

New payment infrastructures were created where none existed in the Philippines, South Africa and Kenya from 2000 to 2007.

Other emerging markets such as Bangladesh, Brazil, China, India, Nigeria, Mexico and Pakistan are also developing mobile payments systems.

Driving success

International remittance flows in the Philippines, the drive for social cohesion in South Africa and Kenya or eCommerce in China are all key drivers of success in these markets.

China now has the world’s largest mobile market with AliPay and WeChat dominating the market and India launched its own debit card scheme, RuPay, to reduce payment costs and avoid being dependent Visa or MasterCard.

However, the cost of payment systems is a major impost on all economies.

Payment systems cost an average 1.2 per cent of gross domestic product (GDP), however the EU estimates their cost of payment systems ranges from 0.6 per cent to 1.6 per cent of GDP.

These costs blow out even further when emerging economies are considered.

India recently changed its banknote policy to try to reduce cash use and South Korea has tenaciously developed credit cards in an attempt to eliminate the 'black' cash economy.

The Irish National Payment Plan 2013 reflects the EU view - they estimate their payment system is 1.4 per cent of GDP and have set clear goals and actions to reduce costs.

Given the strategic importance of payments the critical question is: does every country have a comprehensive payments plan, and if there is a plan why isn't it public?

Unfortunately, the vast majority of countries do not have comprehensive, public plans and therefore savings and efficiencies are not being pursued and maximised.

The EU has a long track record of seeking and achieving reductions in payment 'costs' especially across the credit/debit card industry.

Australia was the first to introduce laws to force changes in wholesale 'interchange' rates and the EU was quick to follow, exerting maximum pressure on Visa, Eurocard (now MasterCard) and other closed loop payment networks such as American Express, Diners Club, JCB, China Union Pay to reduce interchange and/or merchant service fees.

Since 2002 payment regulators in developed countries have targeted 'same day' transactions as the next key development – which has led to expensive executions using current systems and legacy providers.

Local players

The cost of debit and credit-card networks continues to be a major issue for regulators regardless of attempts to rein costs in.

Reduced interchange costs have been offset by more ad-hoc fees and charges as well increases in annual fees - for example all international charges now have a 3 per cent fee on top of foreign exchange rates, having been fee free prior to 2000.

The global players all have strengths and weakness - Visa and MasterCard are the largest but are far from dominant. Visa is weak in mainland Europe, neither MasterCard nor Visa have made progress in China and progress in India has been limited.

Other global payment players include American Express, Diners Club/Discover JCB, Cetelem and China Union Pay.

There is also a layer of local players who, in many markets, control 30 per cent to 45 per cent of a market.

These players include retail store cards, conglomerate consumer cards, single purpose consumer credit offers, airline cards, consumer finance offers, buy now pay later, instalment loans as well as payday lenders, pawn brokers and traditional lending practises e.g. family loans which vary in many markets. This list could go on.

Payments & profits

Banks and independent card issuers are the prime drivers of consumer and business payments however major payment networks also exist within governments and business environments.

The ability of banks to service these three sectors efficiently and effectively is critical as payments are a key part of most banks operations and profits.

According to McKinsey the global payments industry accounted for 34 per cent of overall banking revenues in 2016. This is up from 27 per cent just five years earlier. They predict annual growth will average 7 per cent for the next five years, making payments a $A2 trillion industry by 2020.

A similar situation applies to technology providers. First Data, FIS and TNS are multi country providers who have built businesses in many regions. However the share of payments from multinationals is small and will remain so as local and regional technology providers dominate.

The payments industry has long been an early adopter of technology.

Early in the 1980s, the industry adopted electronic switching, which quickly developed into electronic charge submission to eliminate manual authorisation phone calls and expensive paper charges. Today, this technology underpins all consumer payment systems globally.

Technology is part of the back bone of payments and is implicit in its efficiency however not all technology is well used and adoption rates can be low.

In the US, the implementation of credit and debit card chips has been a disaster with only 60 per cent of merchants fully compliant two years after deadline.

The current market developments revolve around fast payments, wider adoption of social-media payments, peer-to-peer payments, multi-currency payments with netting and better use of internet/eCommerce payments.

Mobile payments in developed markets have been totally unsuccessful in building critical mass quickly.

Attempts made by banks, card issuers and technology companies like Apple all have been resounding failures in attracting mass consumer use in the US.

Contactless payments have quickly become the default point of sale payment in most developed markets, despite being ‘legacy’ technology, reaching 60 per cent to 90 per cent consumer usage in three to five years.

Tap and go

Apple Pay is a good example of regional and implementation challenges for a second generation mobile product.

Apple Pay launched three years ago in the US while the entire payments market was distracted with card chip implementation.

The fact that two thirds of Apple users couldn’t initially use Apple Pay because their phone didn’t have near-field communications (NFC) chips also created dissatisfaction with many Apple consumers in the US. 

PayPal, Square Cash and Dwolla are all third generation peer-to-peer transfer apps in the US on smart phones primarily aimed at 15 to 35-year olds.

These apps have zero cost for consumers and are a quarter of the cost to operate when compared to debit and credit cards. They present a major threat to card schemes for smaller transactions and social media interaction.

One offering, Zelle, took on 30 US banks in 2017 with transaction volumes of $US54 billion.

China's mobile payment market is the world’s largest, reaching $US3 trillion in 2017, up from $US81 billion in 2012.

AliPay has 520 million active users and TenPay, in partnership with WeChat, has 960 million active users with 40 per cent using the payments technology.

These two platforms share 85 per cent of the mobile market and now threaten the government owned payment card China Union Pay.

Key to the rapid development and growth in China is November 11 or ‘Singles Day’. Sales on Singles Day in 2017 totalled $US29.6 billion.

China-based mobile technologies have also expanded overseas to support the 100 million travelling Chinese tourists –with AliPay used in 28 countries and WeChat in 17.

The main difference in Chinese mobile payments is the use of QR codes which is currently not a standard point of sale globally. This is mainly because there are some concerns about the security of QR codes.

Crypto boom

Then there are cryptocurrencies like bitcoin and other non-traditional currencies based on distributed ledger technologies such as blockchain.

For all the headlines surrounding these technologies, you mightn’t think they are now a decade old and are far from mainstream.

Shortly after launching in 2007, a number of experienced payments experts reviewed the capabilities of bitcoin and blockchain. The review quickly concluded bitcoin and/or blockchain had no possible role in mass consumer or business payments.

They argued the concept of a global peer to peer network was simply not feasible given the current and future volumes.

Although bitcoin processes seven transactions a second with an average transaction time of 12 minutes, there can be a peak delay of up to three days.

Comparably, Visa and MasterCard process 16,000 transactions per second with a peak of 24,000. No amount of ‘tweaking’ will take bitcoin to this level.

Bitcoin has also had two systems outages in the past 10 years requiring the total network to backup transactions for two days. If this occurred in the global payments market the result would be catastrophic.

The ability of blockchain to work in other high volume segments such as correspondent banking or foreign remittances is also unlikely given the volumes and global reach needed.

Fintech - the latest buzz word (actually invented in 2008) - was to herald the ‘total destruction’ of banking, payments and insurance.

However a decade on, fintech has yet to reach this goal with investment levels insufficient to build any true competitor to banks.

Today, fintechs companies are busy seeking partnerships with banks in the hope of being acquired - hardly an enthralling prospect for many of these young entrepreneurs.

The longer term future of payments revolves around the development of fully portable 'digital' consumer and business IDs which are supported in cyberspace and do not require a card or phone.

In this future a consumer might 'call up' the ID at any point of sale and confirm the sale using biometrics and security features which work in person or remotely for eCommerce transactions.

The payments system is and will remain crucial to any economy – developed or emerging.

It is, by its very nature, vastly diverse, eclectic and fragmented and it is fundamentally technology reliant.

But just how it will change as technology evolves remains anyone’s guess.

Grant Halverson is former chief executive of McLean Roche Consulting and payments expert. He is a former managing director of Diners Club Australia and senior Citibank executive.