Before getting into a discussion of the online payments segment, it would be a good idea to see the basic structure within which all the disruption is going on. The following flow chart is illustrative:
The primary players in the payments space are banks, deriving two kinds of revenue: the first being through fees charged for maintaining certain type of accounts and the second through commissions on payments processed by them. So all the innovation is basically on the transaction side.
This is also the side where smaller, third-party players can create niche competencies and larger technology companies like Apple (AAPL - Free Report) , Alphabet (GOOGL - Free Report) , Facebook (FB - Free Report) , Alibaba (BABA - Free Report) , Tencent and Samsung with their loyal customer base and deep pockets can make a difference. The increased number of players is the primary reason for the margin pressure.
The higher volumes are related to expanding payments infrastructure in emerging markets, digital commerce (both business-to-business and business-to-consumer) and new payment processing categories like peer-to-peer to name a few. The cross-border payments landscape is also a big contributor to volumes and an area for disruption given existing system inefficiencies and high cost.
Who Are the Stakeholders?
Of course the biggest stakeholders and revenue earners are still banks, despite the fact that they are seeing increasing pressure on the retail side, pushing them to invest in technology to bring the kind of convenience millenials expect. The corporate side is more stable because of the increased security and convenience of transacting through banks.
Payments networkslike Mastercard (MA - Free Report) and Visa (V - Free Report) help authenticate payments made through credit cards issued by banks, collecting a fee for the service. Visa Checkout and Masterpass (the authentication systems for online payments) have been gaining traction.
Just last month, Google entered into agreements with the two networks to integrate their services into Android Pay, which allows identity verification through fingerprints instead of a password. The rollout is expected to be completed early next year thus extending Android Pay’s reach and expanding volumes for the networks.
PayPal also ended years of haggling with the networks, signing deals with Visa in July and MasterCard in September. These relationships are expected to help PayPal speed up money transfer times in B2B, B2C and P2P transactions. The immediate availability of cash and more choice will make the platform more appealing to PayPal customers.
Apple Pay started off with relationships with the two networks, while Android Pay signed an agreement in October that will extend its reach to all merchants linked with the systems. The merchant side integration will be automatic and will roll out early next year.
Facebook Messenger rolled out version 1.2 beta in September, which allows the platform to process payments directly in the 30K bots built so far. The number of developers continues to grow and the company is in conversation with Stripe, PayPal, Braintree, Visa, MasterCard and American Express to facilitate the process.
The need for security in online payments has driven all these online players to get the recognized authentication brands on board. So the technology players (app makers and some of the service providers/fintech companies) entering the space have been good for them so far.
Another flow chart will explain how the various stakeholders earn from typical mobile transactions:
Technology the Disruptor/Opportunity
The purpose of applying technology in any given space is to bring efficiency, whether with respect to process or cost of operations or time spent. The payments segment is no different in this respect.
Since customers these days carry an electronic device (usually smartphone), this device has become a gateway for making payments, allowing companies like Apple and Google to cut into bank profits. At the same time, these devices have extended banking services to areas without or with limited banking infrastructure, especially in emerging markets, thereby broadening the market for banks.
Banks dealing with fintech companies: Payments processing is just one side of the challenge for banks. The truth is, most customers are looking for the convenience of always-on banking services, which is difficult without leveraging the cloud, big data, analytics, the Internet and suitable software. Banks are saddled with high cost of operations and significant regulatory control, which affect their competitiveness with the fintech companies.
But it’s not all black for them either. While venture funding has been pouring into startups (KPMG estimates total funding for the year is on track to reach $14.8 billion across 820 deals), very few such companies have survived in the past. True that this time it’s different because of the advantages of cloud computing and involvement of leading tech companies, but banks aren’t sitting on the fence either.
Blockchain to the rescue: Initially viewed as a disruptive competitor to centralized banking processes, the distributed ledger system called blockchain is now largely considered a big ally. Blockchain potentially enables simultaneous processing of millions of transactions involving identity verification, authentication and transfer of assets almost instantly, across the world, and without displaying personal information to transacting parties.
The resultant elimination of complicated banking processes can streamline bank operations, speed up record-keeping and reduce costs for banks. There is another significant advantage in data storage cost savings because of equally accessible location of data and shared resources between banks.
As evident from the above, this involves a sea change in the way banks operate today, not just in their centralized approach, but also in the way they handle customer data and security. This isn’t a problem that will be resolved overnight given that the entire banking system must be overhauled and reinstituted. But it hasn’t stopped banks from investing and exploring the opportunity given the continued competitive pressures.
Most of the big banks are tied up with either IBM or Microsoft to test and develop the technology and a full-fledged rollout may not happen for another five or even ten years.
For now, the focus is on testing the technology in some segments. In September for instance, Bank of America Merrill Lynch entered into a collaborative agreement with Microsoft to develop a distributed ledger on Azure for trade finance transactions for sale to other parties. Trade transactions are by nature highly manual, time consuming and involve a complicated process vulnerable to document fraud. Blockchain should solve these problems while also significantly lowering the processing time of seven to ten days.
Cross-border payments typically take time and involve cost. At the same time, Accenture estimates (as reported by WSJ) that the total value of cross-border transactions through banks is around $25-30 trillion a year. Therefore, this is a very attractive segment for disruption.
So in October, Visa announced the Visa B2B Connect, a blockchain network developed in collaboration with payments technology startup Chain. Visa, which is also an investor in Chain, is looking for a share of this business and its solution is compelling: by using Chain’s Core technology, the companies claim that they can process cross-border payments in real time, much like when a Visa credit card is used. Visa has reportedly run a prototype of B2B Connect with 30 banks across 10 countries. But it isn’t alone: Startups R3 and Ripple, and the banks themselves are working on similar solutions.
R3, in fact, has already announced the successful testing of its Intel (INTC)-based blockchain solution for bond investing in partnership with CIBC, ING Bank, HSBC, Scotiabank, Societe Generale, State Street, UBS and UniCredit. R3 also leads a consortium of more than 60 of the world's largest financial institutions created to develop commercial applications using blockchain technology for the financial services market.
The online payments landscape will continue to evolve over the next few years as banks, financial services companies and technology companies look for their share of revenue. For banks and financial service companies, it’s a question of protecting their turf, while for technology players, it’s a question of expanding their revenue base.
There is unlikely to be any clear winner that will take all the spoils. The government will continue to play a big role in the new paradigm. This is particularly true in case of emerging markets where digitization can take services to more people who are anyway more inclined to use their mobile devices.