10 Jan 2016
V/MA are among my largest holdings, thus I’m constantly assessing. This also happens to be a consistent institutional investor and Bank question. So I thought I would share my views.
- 90% of Electronic Transactions are done in the top 10 Countries (see World Payments Report). Payments are like mobile phones in 1998… just getting started.
- V/MA have become the irreplaceable utility and standard on how cards should work (online and POS). They are further growing their control (tokens/auth) and services and perhaps most importantly are a VERY efficient network with low fees.
- Domestic debit networks (China Union Pay, Interac, Sepa DD, ELO, Russia, …) will succeed Visa/MA will benefit as connected consumers need a V/MA bug for eCommerce and Travel. Think of domestic debit as phone OEMs.. and V/MA as the MNO + GSMA.
- Bank margin is driven by risk. Identity and Authentication are key for non-credit risk (ie margins in payment), AND are even more critical for mobile platforms (ie Google/Apple) and retailers who are not likely to cede control over mobile or consumer experience
- Structural changes in identity, risk and consumer behavior are changing the economics of payments, enabling specialization and destroying traditional economies of scale
- Successful issuers will not fight to reshape the environment, but seek to partner, collaborate and deliver value
- Banks network plans are chasing a very dynamic V/MA, who are further advancing the mobile, tokenization, authentication, standards, partnerships …etc (enhancing their networks). Expect any new bank network to tackle debit first (6-10 yrs).
- While there are many more logical ways to design a payment network, but there is no design that results in improved issuer margins.
- Payments itself is quickly becoming a loss leader for other services. Look for companies that can efficiently deliver value within the larger “commerce bundle” for clear winners (example Google).
- Model for new network is Wirecard AG (WDI) in Europe (see Investor Pres). Investors should review the tremendous “partnership platform” that WDI has enabled. Look at what WDI has done for Alipay in Europe.
- The Issuer Inventory of Payment Decisions is IMMENSE. These decisions DO NOT include the changes going on within the core banking products and channels that payments support.
- Most likely alternatives to succeed are where the consumer is at the center of design and there are shared economics. Bitcoin in particular could disrupt everything, the challenge of bitcoin is in a shared economic model.
- The future of payment network profitability is in unlocking merchant value. Thus expect continued effort to “tilt” toward merchant by all traditional payment players (See profitability/growth of SFS/ADS and Prepaid)
- My investment hypothesis is to think of payments as the key service in the rewiring of commerce. Expect to see massive changes in the economies of scale in retail, issuing/lending and banking that are part of Internet 3.0. ALL OF MY BETS revolve around Payments PLUS _______ (fill in the blank). Payments is evolving to infrastructure (see Payments in OS)
- Expect 2016 to be a hot year for M&A in payments. Particularly around data and private label.
In the last 6 months we have had a flurry of new payment network developments
- Russian creating the “Mir” card as domestic alternative to V/MA (see WSJ)
- Federal Reserve – US Faster Payments
- VocaLink and The Clearing House (Big bank faster payments)
- Early Warning and ClearXchange (my blog)
- Apple P2P
- Google P2P (Mastercard providing service)
- Paypal Venmo over $2B TPV
- Wirecard / Alipay Europe
Debit continues to dominate payment growth, and debit processing makes up 19% of Visa’s revenue (2014). In 2014 I outlined the Post Durbin Debit dynamic in Debit Card Wars. Russia, China, Brazil, India, Canada, EU, Australia all have domestic debit networks. Most were led by the central regulator. Payments on your DDA account (debit) were one of the few ways US banks made money in retail banking with roughly 40% of mass market DDAs unprofitable. Durbin hit US retail bank profitability hard. (See Global Growth, Controlled Chaos). The reduction of debit fees for large cap banks (over $50B in assets) combined with mobile has driven a tremendous culling of branch infrastructure in the US. Globally I see debit as the initial “connection” where consumers gain access (broadly connecting to the global economy). Local debit network growth enables accelerated cross network growth (geometric N^2). Additionally, debit connections enable data and authentication, thus enabling credit issuance (further margin growth).
Too often investors in payments mistake volume in payments for success in payments. Payments are an indicator of commerce, consumer trust, value, and interaction. Barriers to entry and switching costs within payments are decreasing in a transformational way. Payments are becoming like a utility (ie electricity or internet service..) and ability to price is changing as well. Just as Paypal benefited from the innovation of eBay, payment “success” is an indicator of a shift in a commerce or banking value proposition. There are many start up opportunities in this network revolution.. as existing rigid assets try to adapt to the new found “open connections” from POS to the consumer’s bank account.
Networks NATURALLY form around a function and other entities are attracted to this network (affinity) because of the function of both the central orchestrator and the other participants. Open networks (internet/TCPIP, Visa, NASDAQ, … ) succeed where a common infrastructure benefits MANY NETWORKS. Visa and MasterCard have transitioned to become common network infrastructure, a position FAR MORE valuable than that of a closed credit delivery system. They are a network of networks.
Structural changes in identity, risk and consumer behavior are changing the economics of payments, IMPROVING the role of the network, enabling specialization and destroying traditional economies of scale. We see these structural changes manifest in the declining ANRs of top 5 issuers, the explosive growth of Private Label, and new lending models (ie Affirm, Prosper and Klarna). The global payments “utility” is being REWIRED at a time where the end point dynamics (commerce, unbanked, P2P, social, trust, authentication… ) are also changing rapidly.
Over the last 40 yrs, payments data and risk management were concentrated in the “Issuer Node”. Big banks built large data utilities to managed these risks, that smaller banks and retailers could not manage. Tokenization and authentication have greatly shifted the data advantages of the large banks. Economies of scale are dissolving as data advantages, consumer behavior and trust migrate away from Banks (see Perfect Authentication a Nightmare for Banks).
Historically large Banks dominated the rules, pricing and ability to manage data driven risk. Payments is not a technically complex industry.. it is politically complex. Banks exist to manage risk, thus banks want risk they can control (and manage). This is what makes most of card payments very very illogical (system is designed to allow risk).
Banks are faced with 100s of decisions in payments, including new networks (NACHA Faster payments, TCH/Vocalink, Early Warning/ClearX, …), new presentment tech (EMV, HCE, BLE, ), new platforms (SamsungPay, AndroidPay, …), new regulations (Durbin, Fed, SEPA, EU Privacy, ..), new competitors (Venmo, Bitcoin, Facebook Pay, MCX, …).
Consumers Migrate to Value, not to an app or a network. Within this chaotic environment, the number one Issuer question is WHERE DO WE SPEND OUR TIME? I can’t imagine time should be spent rebuilding what works in order to gain control. Issuers that take this rebuild approach are chasing the past and competing with a very dynamic V/MA, who are further advancing the mobile, tokenization, authentication, standards, partnerships …etc (enhancing their networks). While there are many more logical ways to design a payment network, or exert control, there is no designs that result in improved issuer margins. Visa and Mastercard have thus become irreplaceable.
Banks must pick areas where they lead, and where they support.. but MOST IMPORTANTLY: where they can deliver value. The future of payment network profitability is in unlocking merchant value. Thus expect continued effort to “tilt” toward merchant by all traditional payment players. One of my favorite payment reference models is Wirecard AG (WDI), a stock that has grown 300% in last 2.5 years. Wirecard has taken an “Amazon API” approach to banking, with 100s of partnerships. It is a platform for innovation.
Banks operate at a significant regulator disadvantage that penalizes them for collecting more data than they need, or using it in way that the consumer does not consent to. The card linked offer FAILURE has shown banks that they are in a very poor position to lead, thus they must seek a mechanism to collaborate in a way that they can control use of their data. This is the core of what CommerceSignals does.
Tokens = Control
Margin in payments is a function of risk. Tokens bind payment instrument to identity and thus are a cornerstone service for managing risk (ie monetizing payments). Banks should logically want to build a service here. However mobile platforms (Apple/Google) and MNOs (Verizon) have a better view of consumer identity and use. Platforms also control the OS where “tokens” are used/provisioned.
The payment networks are in the most logical place to run the Token Service Provider (TSP) utility. Visa has given its issuers use of VDEP TSP at no cost, where as Mastercard’s MDES is has a very complex price schedule. Banks are very concerned with the shift in risk management toward the network.. Thus the top 6 banks are working to build a V3 token utility around the excellent BellID platform, within The Clearing House (TCH)… fresh off $60M in bank funding. This is the 3rd or 4th effort by banks to create a new network after the previous 27 bank consortium led by Paul Gallant failed. JPM is the current champion of this TCH TSP effort as they see a TSP utility as key to creating a new V/MA.
Can a JPM led effort circumvent V/MA? Here is how one top 3 issuer put it “the more JPM pushes to get TCH to build a TSP.. the more we want to run the other way”. There are many more logical ways to build a payment network, but V/MA are a pair of a golden geese. We see this in the hilarious EGG ON FACE results from Chase’s efforts at Walmart (see Walmart Pay). In a best case scenario, I expect this TCH effort to result in bank ownership of debit tokens/networks only. Particularly given V/MA’s strong position on wrapping.
Another significant token development is the creation of a new Card Holder Present Rate Tier. This will have enormous implications for Paypal, and a significant reduction of CNP issuer revenue (see blog). Holder of Cards on File (ie Amazon, Google, Apple) will not tokenize without this new rate tier, they want risk based pricing which in my view is completely justified given they have proven consistent ability to manage online fraud below 3bps. Visa/MA have upside in increased use of TSP, growth of Visa Checkout/Masterpass and greatly expanded control over use of cards beyond EMV/NFC. As I’ve stated numerous times Apple would prefer BLE presentment and enable ApplePay in eCom.. but they must have better treatment of tokens + auth (vs today’s CNP rates/liability).
There are many battles here.. who owns the risk? the consumer? the rules? Authentication? the token resolution? How can non bank service providers monetize their services? These are the strategic business issues which prevent any new TSP from gaining traction. The leading US bank utility in authentication is Early Warning Services/Payfone … nothing else comes close.
What do Retailers want in Mobile? Control.. which is just as ridiculous as it is for banks. However they are in a very strong position to orchestrate value. A top 5 merchant told me 4 weeks after the 9/14 launch of Apple Pay “Retailers like Starbucks have proven that we are best placed to deliver value and influence consumer behavior. I don’t want to force my consumers to do anything, but similarly I want to networks that let me play on an even field. These next 5 years are going to be complete chaos for consumers. What do we want them to do? Swipe, dip, chip, pin, tap, QR…? We have been planning for EMV for 3 years… am I really supposed to jump to Apple in 4 weeks?”
Will MCX be a massive success? Per my Walmart Pay blog, top retailers have acceptance costs less than 50bps across all cards. There is NO MONEY to be made working with top 10 retailers… ever. These top retailers have now realized that creating a ubiquitous low cost payment network (MCX) just gives smaller retailers the same cost advantages that they already enjoy. Just think about this for a minute.. the big retailers are now RUNNING TO Visa and MA at a time where the BIG ISSUERS are frustrated and thinking of running away. With Walmart and Target going their own way in payments I see MCX as a doomed effort.
These “affinity” dynamics should take place in a normal network with functioning market mechanics (supply/demand). This is a shock to the previous payment network owners however.
Many Retailers now prefer working with V/MA than they do with Apple, Google, and other value providers. Why? They correctly fear the steering ability of technology companies with high consumer trust and high consumer touch. Traditional retailer business models are challenged, as consumer behavior changes, transparency improves and new value bundles/orchestrators emerge (see rewiring of commerce). Payments itself is quickly becoming a loss leader for other services. Look for companies that can efficiently deliver value within the larger “commerce bundle” for clear winners (example Google, Alliance Data, …etc).
As I mentioned private label and store loyalty growth dwarf that of 4 party networks. If payments are tilting toward merchants, private label are the “inside the tent” retail partners. Alliance Data has all of the assets to enable digital marketing, payments, and loyalty. ADS also has the advantage of working with the most profitable “long tail” SMB group.
Bitcoin/Blockchain is a transformative innovation that could change everything. A self authenticating currency with no need for a centralized network (a distributed ledger instead). It is the most beautiful, elegant and revolutionary payment mechanism ever devised. The issue with its progress is that it disrupts EVERYTHING. The 4 party V/MA model allows 1000s of companies to manage risk and invest billions of dollars. Whereas there are very few ways to monetize involvement in Bitcoin. It’s anonymity is also disruptive to government efforts to track payments (for various reasons). It is destabilizing and democratizing.. and will need a very very big supporter to move into mainstream. My choice would be Apple P2P.
Most likely alternatives to succeed are where the consumer is at the center of design and there are shared economics. Bitcoin in particular could disrupt everything, the challenge of bitcoin is in a shared economic model.
Features of a new network
Presence. Consumers migrate toward value, supporting commerce means going to where consumers ARE … NOT where you WANT THEM TO BE. This obvious statement is perhaps the best statement on why most “payment innovation” is broken. Tapping a phone is not innovation.
The next phase of value creation must involve collaboration (Internet 3.0, Sharing Economy, … etc) and value orchestration, as consumers trust their own self created communities, not specific brands or retailers. This is one reason why Facebook advertising is so effective, it messages people in the community they create (where they are).
Trust/Identity. The “KEY” [prerequisite] in value orchestration Identifying and Authenticating the Consumer (see Authentication –Core Battle for Monetizing Mobile). It is critical to consumer, mobile operator, handset OS, bank, … everyone wants to own it. My view on how it should work for Apple is in Brokering Identity – Part 1.
Consumer centered control. For example, Apple must deal with private label cards and store loyalty cards. In these models the retailers know everything about the consumer. Apple could just store these cards.. and act as a traditional container.. But that does not allow them to add value based upon the “trust authority” role they can now assume…. at least not in a primary capacity (appending a bio score/token assurance). In a trust broker role, Apple needs to think about allowing consumers decide whether to identify themselves and their data.. beyond just a token. My favorite commerce experience of all time is Square (sure they haven’t yet delivered.. but it is beautiful). Consumer doesn’t take the phone out of their pocket, but rather recognized at the POS and merchant greats them. Square Register checkout vision is just fantastic.. much better than a 8 year old “tap model”.. .
Brokering. Now think about this identity broker role in the context of beacons. I can deliver static content with beacons (where I don’t know the recipient/destination) and deliver CUSTOM content (where I do know the consumer). Let the consumer make this decision… and make the merchant create enough value to make the consumer WANT to give up their identity. This is the way a platform should work. In the context of the Cloud, it is about bringing together the consumers “cloud” in 1000 different ways with the environment (merchants, doctors, … ).
Data. The merchant has richer knowledge of what was bought, the consumer has richer knowledge of who bought it. Platforms should look to create this kind of open, flexible interaction (an approach that will make my bank friends have kittens).
My 2016 Picks
My investment hypothesis is to think of payments as the key service in the rewiring of commerce. Expect to see massive changes in the economies of scale in retail, issuing/lending and banking that are part of Internet 3.0. ALL OF MY BETS revolve around Payments PLUS _______ (fill in the blank). Payments is evolving to infrastructure (see Payments in OS)
Along these lines my invesment picks are below. Remember I’m not a financial analyst.. but an industry big picture guy.
- Commerce Signals (gratuitous advertising)
- Alliance Data (Possible M&A Target)
- Wirecard – WDI
- Fleetcor (FLT)
- POYNT (private)
- Affirm (private)