4 Nov 2013
Long blog.. load of typos
As I’ve stated before, this blog has been a great way to make new friends and stay in touch with my 100s of friends and former employees around the world. When you are in a small company you tend to lose touch with what else is going on as you no longer have 1000s of folks feeding you market intelligence. Small companies live and die by the risks they take, and I’m primarily focused on reducing risk by sharing G2 and perspective.
Industry History (experts can skip this section)
I’m fortunate to have worked with some of the best teams in both Security and Fraud areas. Back in 1998 I ran Oracle’s Payment and Security National Practice where we did things like PKI, Single Sign On, as well as Oracle’s first Java application: iBill and Pay (built on Oracle’s first Application Server OAS which scaled to 40 users regardless of hardware). I switched from the tech side to the business side in 02, and can assure you that running online Banks keeps you in the security AND Fraud space. In 2008 I left Citibank to go to 41st Parameter (just acquired last month by Experian). 41st Parameter was founded by a visionary fraud prevention guy.. Ori Eisen, with a focus device ID.
From a Commercial/operational perspective there is always friction between the security teams and the Fraud/Operations teams. The security teams are always working to enhance security, the fraud and operations teams are always working to mop up the mess from any holes in security and create proactive processes by which they can stop it. As I said in my blog last week, if I let security guys have their way with authentication …. customer experience would be awful.. and no one would use online banking. Hence we have services like Risk Based Authentication, Honey Pots, Fraud Controls, …
This same Security vs. Fraud dynamic plays out in payments. From the 1970s to the 1990s banks had built their authorization infrastructure around tools like HNC’s Falcon to create rules based authorization, with daily tuning of rules based upon fraud. Today Banks continue to invest billions of dollars in fraud and risk infrastructure (see blog). The metaphor for competition here
If you are camping with your friends and a hungry bear comes to your campsite.. you don’t have to be faster than the bear.. you just have to be faster than at least one other camper.
Thus the rule of thumb: fraudsters always attack the easiest target. Big bank billion dollar fraud platforms thus drive fraud to smaller competitors. This enables the large banks with sophisticated controls to derive higher margins in payment products, which drives incremental investment. This is one reason why large US banks are so resistant to EMV (it levels the playing field). Fraud numbers in the US are not well reported, the best data is from my friend in the UK (see UK Card Association). Large US banks were not involved (or informed) of Visa/MA’s plans to mandate EMV. As one CEO told me personally “Tom .. to this DAY Visa has never come by my office to discuss EMV, I found out about it the same way you did.. in a PRESS RELEASE.. “ [Top 3 Issuer].
In the late 90s Banks were not prepared for Card Not Present (CNP) Transactions that came from eCommerce. Their fraud systems (ex HNC Falcon rules) were not tuned for this type of transaction. Actually, banks really didn’t care much here because 100% of fraud loss was borne by the merchant. The only Bank impact was helping the customer deal with fraud (and reissuing cards). Thus RETAILERs began investing in Fraud systems and 3rd Party specialists (GSI, CYBS, 41st P, Digital River, 2CO, PayPal, …) emerged to help manage fraud on behalf of retailers. LARGE retailers followed the same path as large banks, investing in custom fraud infrastructure (ie Amazon, Apple, Google, Airlines, …).
Banks thus ceded eCommerce risk management to 3rd parties until around 2003 where 3DSecure was developed (See Wiki. Implemented as VBV by Visa and MSC by Mastercard). Merchants were incented to adopt the scheme by a liability shift (to banks) and an interchange reduction of 5-10bps. Rollout of the scheme in Europe was a disaster (see UK Guardian). Banks now owned a mountain of new fraud losses (as 3DS technology was broken), with only ONE tool to address: Decline Transactions. See my 2010 blog and Schneier’s: Online Credit/Debit Card Security Failure
Banks are determined to avoid their prior mistakes, in eCommerce risk/roles, and take a leadership position in mobile (ie payments, risk, authentication, data, … ). I’ve detailed their efforts in:
Why is mobile so important to Banks?
#1 PRIMARY INTERACTIVE customer touchpoint. 10 years ago, how did you interact with your bank when you were away from home, work and a branch? The only interaction you had was a piece of plastic. Mobile enables a new class of Services.. but ALL mobile services must add value. The rest of these priorities pale in comparison to consumer touch… Banks are thus experimenting on what they COULD DO with mobile to remake banking.
#2 Authentication. Confirming identity of consumer.
#3 Risk Management. Both gaining additional consumer insight, and enabling new levels of risk control based on this data.
#4 Remaking of Retail Banking (reducing cost to serve)
#5 Mobile Payment.
#6 Partnerships. Sales, Distribution
I’ve touched on #1 many times, but before I go to Authentication/Authorization/Risk, let me provide a brief recap of my many blogs covering the “other services”. As I outlined in Card Linked Offers, Banks don’t realize is that just because you CAN interact with the consumer doesn’t mean that the consumer WILL. You must actually deliver VALUE if you want to capture consumer TIME. Having run 2 of the largest online banks I know what customers do. Retail Customers log in 3 times a week, check their balance, pay a bill or two and log off (180 seconds later). Bank CEOs.. I gave my recommendation on what you SHOULD be doing in my Bank NewCo blog.
Authentication – THE Lynch Pin
As I stated in Who do you Trust,
Google and Apple are working to secure their platforms, and assume the central trust role in authenticating the consumer. I’m much more interested in the Apple’s new developer APIs than I am in the fingerprint app. How will they begin to “lock down” applications, what new authentication features will they expose to developers? How will they allow consumers to provision sensitive data to other apps?NFC Change
Hardware is evolving to software (from NFC to the SIM). …[ If Google locks down Android with a new secure OS, they will be in a position to provision Google applications (Maps, mail, search, …), identities, and cloud based services (drive, Google Now, Commerce, …). The “freeware” model could still exist, but without the cutting edge Google services it becomes a COMMODITY HARDWARE game.
What we will see at Money 2020, is that there is an all-out war going on for the Trust role: Banks (see Tokenization), MA/V, MNOs, Samsung, retailers… everyone realizes this is the “key” to unlocking future value in the convergence of the virtual and physical world.
and in Authentication – A Core Battle for Monetizing Mobile
As Ross Anderson said “if you solve for authentication.. everything else is just accounting”. Think of how much bank infrastructure is dedicated to authentication of the consumer and risk/fraud management. This infrastructure was built over last 30 years because there was VERY poor ability to authenticate a consumer (ex. signature and possession of card) AND inconsistent CONNECTIVITY at each commercial “node” touching the transaction. Today we have complete connectivity, but the MODEL has not evolved from its archaic past.
Beyond Authentication, mobile also plays SUBSTANTIALLY on the risk side, as it enables Banks to interact OVERTLY and COVERTLY with the customer. For example a risk system could ask: is the customer’s cell phone within 20 yards of their transaction (at X merchant). Or even issue the customer a one-time PIN (or PIN request) to complete transaction.
Perfect Authentication – A threat to Banks?
This question is very similar to the story above on EMV. The engineer in me recoils at the thought that a sophisticated technology (which decreases risk), would not be welcomed within a market. To understand WHY, you must answer the question: WHO benefits from the risk reduction? If your business is risk management, and someone takes risk away, what is your business?
If we made an inventory of payment systems (technical investment) between merchant to consumer bank we would see today’s systems, processes and rules would be DESTROYED by a future state of connectivity and authentication. I’m sure this one line statement will be questioned “prove it”, but I don’t have time.. I’ll leave it to someone else. Take this statement for what it is: my opinion.
Authentication is 0-1, Risk and Fraud deal in shades of grey. For example, if there is a CHANCE that Joe Smith is a really a the end of the transaction, and he is my wealth customer, I’ll let him in the door, see what he wants to do and then risk it based on it. I certainly won’t LOCK HIM OUT. Another example, if I could authenticate a customer why do I need to make the transaction secure? This is the BEAUTY of the Square “pay with your name” scenario. Why do I need tokens? Someone just needs to map consumer ID to payment types.
The very concepts of payment “products” begins to dilute. No more credit, debit, pre-paid, Amex, ACH, check, … In a world of perfect Authentication “old line” products evolve toward dumb pipes as competition shifts to speed and cost (not risk).
From Cash Replacement
Networks are designed around a value proposition. For payments to flourish, a coordinated system of instructions which can be read by trusted participants is necessary. Providers of payment services must consider what network participants are providing in order to collaborate in risk management and settlement; the greater the number of consumers and businesses that participate, the greater the collaboration and interdependency. As more people adopt the payment system, its value increases, since it provides access to more people; this encourages larger networks. Not only do the benefits increase as the network expands, but the per unit cost of service falls. This behavior is the basis for what economists refer to as a “network effect”.
Once a payment system reaches a “critical mass”, economic value will be created at the ends of networks. At the core- the point most distant from users-generic, scale-intensive functions will consolidate. At the periphery-the end closest to users-highly customized connections with customers will be made. This trend pertains not only to technological networks but to networks of banks as well as small merchants and even to consumers who engage in shared tasks9. From a payment network perspective, this means that the “routing” of payments will provide much less revenue opportunity than managing the end points (e.g. the customer interaction or the products which are sold on the network).
…] Payment networks are inherently “sticky” with investments required by consumers, merchants, and banks for effective functioning. Payment networks also have substantial government involvement to support Commerce and Treasury functions that ensure stability, resilience and protection of parties. Innovation in payments is challenged by this network dynamic. As most small companies know, getting a bank to make a decision is tough… but nothing compared to getting 4-6 groups (issuers, acquirers, merchants, MNOs, Regulators, networks, ..) to collaborate in making coordinated change. A level of difficulty that is only superseded by the challenge new entrants face in competing directly against these existing networks.
A truely jaw dropping piece of research was completed last month by NYU’s Thomas Philippon ( http://www.voxeu.org/article/where-wal-mart-when-we-need-it).
The cost of intermediation grows from 2% to 6% from 1870 to 1930. It shrinks to less than 4% in 1950, grows slowly to 5% in 1980, and then increases rapidly to almost 9% in 2010
In other words Payments and Banking are one of the few network businesses in the HISTORY OF MAN to grow less efficient (rail, telecom, energy, …). This is BY DESIGN as the orchestrators of banking have successfully created constructs to squeeze COMMERCE. Further demonstrating that existing payment networks are incapable of leading ANY FORM creative destruction. As I stated in Commerce Battlefield
Mobile is a platform which enables a radically improved customer experience. With respect to payments it also offers a unique ability to authenticate a consumer (fingerprint, GPS, cell tower location, voice, camera, …). Yet, no banks are looking to leverage these “new” capabilities in a “new” payment system. After all, given a clean sheet of paper, no one in their right mind would design a payment system like we have in Visa/MA: present a credential to a merchant, who passes to a processor, who passes to network and routes to issuer to approve a customer transaction… giving the auth to everyone in the chain again.. and getting back another message. If everything is connected why not just ask the consumer to send the money from their bank (ex Sofort, Push Payments also read Banks will Win in Payment ).
Why? Well because Banks can’t make money in a Sofort model.. (would need to create all new merchant agreements). This is why Banks are going through contortions to stay within Visa/MA, yet attempting to alter it fundamentally (ie Tokens). … (Also see Push Payments)
Regulation… the KEY
Payments, telecom, commerce, customer data, … all are regulated (merchants … not so much). Banks are completely justified in seeking solutions to their current regulatory burden. After all they bear most of the AML, BSA, CPFB, FED, OCC, .. burdens here. What needs to happen is that regulators must allow non-bank entities to bear risk. This is where innovation occurs. See blog US Payment Innovation and Regulation