Payments – Wrapping, Rules, Acquiring and Tokens

if Google had challenges pulling off POS innovation (after ~$1B in investment), rest assured you will too. Banks are well positioned to throw sand in your gears … focus on delivering value within merchant –consumer relationship.

18 June 2013 (sorry for typos)

Thought it was time for blog this week. Primary objective is to inform the venture community of changes which may impact payment related start ups. Sorry that the title isn’t a little more polished (you can tell I’m rather left brained). The exec summary of this blog: don’t ever bet your business on someone else’s rules… particularly if they themselves don’t own them.

Background

All Networks are working on unique token schemes (as I outlined in: Payment Tokenization, “New” ACH System, Visa’s Token Plans and Business Impact of Tokenization). The business drivers here are: #1 Control, #2 Mobile Payments. The US Banks have gotten together in The Clearing House (TCH Tokens) and are in the midst of piloting with 2 providers. In this TCH token initiative, the banks have logically determined that if a customer doesn’t need to see their Primary Account Number (PAN), then they will provide a number which they can uniquely resolve. For example, in mobile payments Citi could put in a unique Citi 16 digit number that is not a MasterCard, not a Visa card, not an ACH account number.. its just a Citi “token”.  Citi can decide how to resolve this number adaptively.. based upon what the customer wants, or what products they have with them.  There are MANY benefits to this approach:

  • Banks control account
  • Banks control DATA (transactional and account information)
  • Banks own network rules
  • No fees to other networks
  • Set unique (NON DURBIN) pricing for a NEW payment product.
  • No restrictions on “Routing”
  • Enables banks to “switch” providers of any payment service or network clearing
  • more detail here…etc

This is a BRILLIANT move by banks. I believe that this central bank “facility” within The Clearing House will be their centerpiece for consolidating all of Debit, in addition to the mobile play.

TCH Tokens are not the only game. Visa, Mastercard and Amex (through Serve) are also in this token game, and others like Payfone (through phone number as token at VZ/ATT), Google (through TXVIA) are also on the periphery. My view is that the BEST tokens are ones you don’t have to issue (ie Square/Voice, Apple/Biometric, Google/Facial Geometry, Payfone/Phone #…).  I outlined dynamics of the strategies in my blog last year “Directory Battle Part 1 – Battle of the Cloud”.  Its amazing that this topic is not covered more broadly in the mainstream… of course most of these efforts above are not discussed at all, and sometimes denied.

Of all the token initiatives, I believe Visa is most likely to succeed. This is not a typo… I’ve been very negative on Visa in the past.. as they have alienated everyone. But Charlie has started to change the culture, he has pulled the JPM relationship out of the toilet and has made a tremendous hire with Ryan. Why do I like Visa’s token prospects? They failed in their first initiative (non 16 digit PAN required big changes by everyone), and learned their lessons. However, most importantly, they can change the rates through rules on CNP and risk “ownership” creating a “new” version of VBV, with the best payment brand.

Wrapping

Currently the networks are at war with anyone attempting to wrap their product and add incremental value. As I outlined in Don’t Wrap Me, and Battle of the Cloud Part 3

The threat to banks from “plastic aggregation” at POS from solutions like Amex/Serve, PayPal/Discover, Square/Visa, MCX, Google is real. Make no mistake, Banks have legitimate concerns surrounding ability support consumers and adjust their risk models. But the real business driver here is to “influence” mobile payment solutions that do not align to their business objectives. Key areas for bank concerns:

  • #1 CUSTOMER DATA
  • Top of wallet card (how does card become default payment instrument)
  • Credit card ability to deliver other services (like offers, alerts, …)
  • Ability for issuer to strike unique pricing agreements w/ key merchants
  • Brand
  •  …etc

Visa, MA, Amex, DFS are in a great position to “stop” wrapping. What does this mean? They have initiated new rules, fees, cease and desists, threats of litigation …etc. Banks are thus looking to circumvent these restrictions by placing their “token” with the customer. This token is thus a new quasi acceptance “brand”.

Acceptance is therefore the new battle arena (who can convince merchants to accept their tokens, rules, rates, …). eCommerce may have slipped away from the banks and networks (PayPal), but they are determined not to let this happen in mCommerce, or at the POS.  JPM has structured its new agreement with Visa  to give them the flexibility on rules in acquiring and network routing for a new acceptance brand (Chase Merchant Services – CMS).

Retailers

Retailers are not the dumb mutts that banks assume. The MCX consortium realizes that greater bank control does NOT benefit them unless the Visa ratesservice is ubiquitous and standard so that banks can compete against each other, with no switching costs. Analogy here is internet traffic routing…They just want the payment cleared, with transparency/control in price, speed, risk.  Retailers also want the death of bank card rewards schemes, and if they can’t kill them instantly, want the ability to deny “preferred” cards. I told a major retailer yesterday that they should offer an “X Prize” to anyone that can make sense of Visa’s rate structure in a youtube video.

Many Retailer’s also have a “token” in form of a loyalty card.. with Target’s Redcard, and Starbucks demonstrating the model in which a retailer led payment scheme could work. For retailers, their loyalty program is fundamentally about selling data, and trade spend.

As a side note, the “big” secret in acquisition is that most (~60%) of profits come from the bottom third of retailers.. specifically the small independents that don’t know enough to negotiate (hence the ISO business). Companies like Walmart negotiate heavily with the top issuers to reduce rates from “standard”.. and still end up paying over $1B a year.Square fees

I see a substantial opportunity for acquirers to participate in what I would discussed within Payment Enabled CRM. This would change their profitability from one driven by small merchants to data/analytics. This is undoubtedly what JPM sees within CMS. Retailers know that they can’t further empower the big bank with their data, but rather need an independent party to run the CRM platform for them.

Summary

I’ve already spent a little more time than I was anticipating here. For start ups my message is quite simple, if Google had challenges pulling off POS innovation (after ~$1B in investment), rest assured you will too. Banks are well positioned to throw sand in your gears … focus on delivering value within merchant –consumer relationship. The Mobile-retail interaction is greenfield, and there are 1000s of different flavors.. no one company will be the centerpiece here. Avoid POS payments.. or be the “arms provider” to the big institutions as they duke it out. My view is that the key for MNOs, Apple, Amazon, Google and Samsung’s future value is

#1 Authentication (Linking the Physical and Virtual World)

#2 Orchestration (Coordinating Virtual and Physical World Processes, Data and Value Chain)

Retailers Discourage Credit Cards

I maintain that Banks have the facilities to win in payments (see blog).. but winning is more than leveraging your user base and ubiquity to extract tolls from merchants.. and more about delivering value.

9 July 2012

WSJ Article Today: Price of Plastic Going Up?

Merchants may soon begin to impose a surcharge each time a customer pays with credit card, a practice Visa Inc. and MasterCard Inc. currently prohibit…. [But provision will likely go away as part of impending settlement].

The “accept all cards” rule is likely to undergo a huge change, with implications for Visa/MA earnings, new retailer led payment networks, mobile wallets, issuer loyalty programs, EMV reissue, and “new products” (ex. Instant credit, pre-paid, decoupled debit, …).

Take a look at this excellent GAO Report to gain detailed insight into the battle being fought.

 Several of the large merchants that we interviewed attributed their rising card acceptance costs to customers’ increased use of rewards cards. Staff from these merchants all expressed concerns that the increasing use of rewards cards was increasing merchants’ costs without providing commensurate benefits. For example, one large merchant provided us with data on its overall sales and its card acceptance costs. Our analysis of these data indicated that from 2005 to June 2009, this merchant’s sales had increased 23 percent, but its card acceptance costs rose 31 percent. Rewards cards were presented as payment for less than 1 percent of its total sales volume in 2005 but accounted for almost 28 percent of its sales volume by June 2009.

This will have an impact on Visa’s volumes if card issuers don’t start immediately renegotiating the rates with the top retailers. This taken together with Durbin (see previous blog), retailer driven payment networks (ex See Target RedCard), Retailers acting as banks (see GDot/WMT), Google/PayPal at POS (as MSBs), Pre-paid cards, …etc. We have a VERY exciting time in payments that the banks will be challenged in responding to.

Why will this impact Visa’s US volumes? Well if signature debit it dead, consumers will use PIN debit (just like Canada and Australia). In the Post Durbin world, Retailers don’t have to route PIN debit transactions through Visa at all. If retailers aggressively reprice credit card transactions (adding fee of 1-2%) we will have consumers shift spend back to debit.. a PIN debit… This also is happening at a time when consumers aren’t exactly fond of banks and fees. If the top 20 US retailers add fee to credit card use, this could impact Visa’s growth buy 2-6% in 2 years. The main dependencies here are Issuer’s ability to lower interchange for these retailers and survival of Signature debit (over bank controlled PIN Debit).

Certain merchants obviously benefit from access to ubiquitous consumer credit facilities, and these merchants are unlikely to add on any fee. But retailers in non-discretionary and low margin segments will likely move aggressively to stem the growth of loyalty driven credit card use. I would also expect retailers to add lower cost payment options, instant credit (ex paypal’s BillMeLater) and new products which may replace some of the “lost” loyalty benefits (ex Target RedCard).

I maintain that Banks have the facilities to win in payments (see blog).. but winning is more than leveraging your user base and ubiquity to extract tolls from merchants.. and more about delivering value. Unfortunately Banks are working to restrict growth of new payment mechanisms by enhancing control points (ie ACH) .. they have seen this coming and are looking to lock any door they can. If you lock the door.. someone will just jump through the window.

BIG winners if there is a settlement on passing credit card costs:

  1. Payment service providers not dependent on credit, or offering alternative PayPal, Google, Square,
  2. Instant Credit
  3. Retailer Led payment networks
  4.  Pre-paid,
  5. PIN Debit

Loosers:

  1. Anyone dependent on a credit card (NFC, issuers, loyalty, …).

For my mobile friends.. this may give you additional context on why many merchants don’t accept NFC?