Building Networks and “Openness”

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8 Dec 2011

I’ve been reading some off beat stuff lately. One book “Weak Links: Stabilizers of Complex Systems from Proteins to Social Networks” was very thought provoking. As Mark Stefik (PARC Fellow) said ‘Something magical happens when you bring together a group of people from different disciplines with a common purpose.’ The combination of people, experience and approaches often leads to unexpected consequences.

As an engineer I like to solve problems.. I usually learn more from mistakes than I do from successes… but it is the learning that is fun. As an investor and entrepreneur I don’t like making mistakes… my preference in the start up environment is to have the learning cycle counted in minutes and days (vs customers and capital). I was speaking with a US Central Banker last month and the concept of “openness” was discussed. A hypothesis was laid out by the Fed “Mobile payments are not taking off because of a lack of common standards”.  The Fed team is very good, the best way to encourage a good dialog is to lay out something radical; as for this hypothesis I disagreed completely. As stated in my numerous blogs: history has clearly showed that closed systems must form before open ones.  I also told the Fed that the problem in US mobile payment IS NOT lack of standards but lack of a value proposition to consumers and retailers. In other words existing payment instruments solve all of my problems.. mobile payment simply does not add additional value (in isolation) compared with existing products (See Mobile Advertising Battle). In order to stimulate a change in behavior (merchant and consumer) there must be a strong value proposition. Two years ago I discussed the implications for broad payment standards in SEPA: Chicken or the Egg and in March of this year I outlined how SEPA has depressed payment innovation in the EU.

Given all of the chaos in NFC at the moment, I woke up this morning asking myself what is the “right amount” of openness and standards? How do successful networks form and mature? What are successful “open” networks? What is the first “open” standard you think of ? TCP/IP? Linux? Java? RosettaNet? EDI? Open Network? Internet? GSM? US Interstate system? SEPA? The Weak Links book opened my eyes to many new concepts, one was on how affinity influences network creation, and another on how few open networks exist in Nature. Networks form around a function and open networks are not necessarily the most efficient.

Scale-free distribution (completely open networks) is not always the optimal solution to the requirement of cost efficiency. .. in small world networks, building and maintaining links between network elements requires energy…. [in a world with limited resources] a transition will occur toward a star network [pg 75] where one of a very few mega hubs will dominate the whole system. The star network resembles dictatorships in social networks.

The network forms 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. Of course we all know this as the definition of Network Effects. Obviously every network must deliver value to at least 2 participants. Networks resist change because of this value exchange within the current network structure, in proportion to their size and activity. Within the EU, SEPA undertook a rewrite of network rules and hoped that existing networks would go away or that a new (stronger) SEPA network would form around its core focus areas (SCT, SDD, SCF, ..). It was a “hope” because the ECB has no enforcement arm. In other words there was a political challenge associated with ECB’s (and EPC specifically) ability to force an EU level change on domestically regulated banking industry.. given that SEPA rules destroyed much value in existing bank networks, the political task was no small effort. We have seen similar attempts (and results) when governments attempt to institute major change in networks (Internet NetNeutrality v. Priority Routing, US Debit Card Interchange, …)

Mobile Payments Standard?

If we take a look at today’s payment networks what are the biggest problems to be solved? I have a perspective, but its certainly biased. How about payment routing and speed? These seem to be common merchant and consumer concerns. Keeping with an internet analogy, can you imagine if there were no DNS servers to route IP traffic? Every router would have to keep the directory for the entire internet not only of the final destination, but also the most effective route to forward traffic. What if the internet were not indexed? No ability to find information (thanks Google for fixing this).  In the payments environment, the central assets of Visa and MA is 1) A Directory and 2) the rule that EVERY participant must route traffic through them (with a new PIN debit exception in US).

Outside of card transaction’s banks maintain their own directory for routing retail and commercial payments; this is called “least cost routing”.  A key bank service I would propose (note: I’m not the originator of this idea) is a universal directory service mapping e-mail, phone and account numbers.  In Australia, the banks have this today run by my friends at Cardlink and completed under project Mambo. In the US, The Clearing House (TCH) has had the UPick service completed for a number of years.. without much interest.

My thought here, is that rather than facilitate a EU mistake in mandating a change in all rules.. decrease the switching costs between networks so that market forces can take hold. I’m not proposing to take the directory public.. but at least give regulated entities equal access. In Australia the driver was to decrease bank switching costs, also note that Australia has no Signature debit.. just as in Canada.  A common directory could also follow rule that non-regulated institutions could not hold account data (or card number).. Just as I don’t have to know my Bank’s IP address.. I could use another identifier (email, mobile, …) for online transactions. The danger for banks is that this would certainly open up the world of least cost routing to non-banks. Payments would become “dumb pipes”.. which is perhaps what it should be.

Mobile payments is certainly not critical government infrastructure. So what is Government’s proper role? Consumer data protection, transparency, regulatory requirements, equal participation/access..  ? I don’t know the answer. I like the idea of the Government creating a model service for R&D purposes.. perhaps based on Fedwire and letting non-banks have access to it… I also like the idea of a common directory.

ISIS

For 2.5 years I’ve been writing about ISIS.. I’ve always have been a huge advocate.. until lately. What has changed? My position, and that of retailers, is that today’s payment networks are heavily tilted in favor of the banks. The opportunity I originally saw for ISIS was constructing a new merchant friendly network that was an “extension” of the current mobile network which the carriers run (The original business case for ISIS is outlined in ISIS: Moving Payments from Rail to Air).

Keeping with my theme of openness and standards how is ISIS creating a platform for other to invest in? What value is an ISIS mobile payment to a retailer? Yesterday’s blog talked about the complex supply chain necessary to deliver on NFC. Don’t get me wrong, there is nothing wrong about NFC technology.. it is a very well defined specification. But it is complex.. if it was a NEW WAY of doing payments (or better yet commerce) perhaps it should have started a little less ambitiously. The team seems as if it prudently sought to reduce risk, but it also gave up on a central element to its value proposition. My analogy for today is that ISIS project is like Vanderbilt’s skipping steam and going straight for high speed mag lev in 1880…. While the entire country was growing at a 10x pace and he had no right of way..

Big projects are tough in normal times.. but mobile is changing at an unbelievably fast pace. Small focused projects are certainly lower risk when innovating at the cutting edge. Everything is changing.. how could anyone architect an open system in such a fast changing environment? It would seem that technical standards like TCP/IP or GSM were successful because of their ubiquity and distributed control. They could be used by all to create different networks with different value propositions.. which incented millions of companies and consumers to invest.  I just don’t see how MNOs can create a business platform based on NFC. Their best shot may be to work with someone like Sequent Software to create an architecture for 1000s of applications to access secure element data.. instead of the one single CSAM wallet coming out in Pilot Dec 2012.

Your thoughts are appreciated

Previous Blogs (Nokia NFC Ecosystem, ISIS Ecosystem or Desert, Banks will win in Payments.. but WHICH ones?)

Nexus S – Verizon’s Plan B

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6 December 2011

Today’s WSJ article that Verizon plans to block Google’s wallet on its new Samsung Galaxy Nexus .  While the mainstream press sees this as a slam on Google… I see this as Verizon constructing a fallback strategy. Why on Earth would Verizon want to allow the Nexus S on its network at all? It is a 2 year old Google designed phone which embeds a “non-standard” NFC architecture (embedded SE) which is controlled by Google (and cannot be controlled in a UICC based architecture).

As I stated yesterday, the ISIS is experiencing delays in its “go to” architecture. The rumor is that the current ISIS timeline is pilot in December of 2012 and production in mid 2013. I see this move by Verizon as accomplishing 3 things..

1)      The Google Nexus S is the only production NFC phone in the market (actively using NFC.. 50M blackberry’s have it.. but element is cold and lonely). It could allow Verizon and the ISIS team to reconfigure their CSAM wallet platform to this “non standard” architecture to accelerate time to market for a test.  The desired ISIS architecture is SWP/UICC based…  Note that if this is indeed Verizon’s plan, they will need Google participation as Google owns the SE keys in the Nexus S AND they have not published the APIs for the NXP element access

2)      Gives Verizon a phone in the market to pilot with Google. In other words they can play in the Google camp without a formal commitment. Verizon can play ISIS and Google off of one another to see which horse will win. This is very smart.

3) Gives Verizon access to NFC/Android much beyond payment. As Google has clearly articulated in Android Beam, NFC will be the tool for machine-machine communication. How you share pictures, videos, music and apps with another phone. VZ’s current NFC plans revolve all around ISIS and payment (and very closed), Google sees NFC as another radio to do many, many different things. As this week’s Comscore report shows.. Android’s 46%+  market share is a key driver of VZ’s success. VZ needs this handset not just for wallet.. but for access to all the other cool new Google toys that will come out supporting NFC. The question the analysts should be asking VZ is how their SWP/UICC architecture plays in the Google model. How will VZ allow many apps to access the NFC radio AND the secure data? There is only one software company that can help here and that is Sequent.. The other option is a multi SE architecture (see my previous blog, note blog was wrong on Apple), which RIM will likely support. In either of these scenarios, complexity reigns.. the only real option is to let Google drive the definition and the apps. Perhaps this is why VZ has thrown in the towl to Google’s Nexus architecture (hardware).. but not yet on software (wallet)

Don’t believe everything you read.  Verizon’s decision to commit to selling the Galaxy Nexus  is an indication of major strategic planning.

Related article on the ISIS Platform: Ecosystem or Desert?

ISIS Delay..

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ISIS Delay

My last blog on this subject was only 2 months ago.. Headline was “ISIS has 12 months”.  Rumor this week is that ISIS has 12 months to go TO PILOT (Dec 2012). The driver seems to be the UICC chip that supports the SWP SE (Gemalto’s fault??).  Note that my previous nine party chart did not even consider the UICC.. so here is a revision.. (added UICC, MNO, and POS register)…

How would you like to run an industry consortium that had to coordinate a release and a new technology across 12 different companies!?? Oh.. a few other minor considerations as well:  no compelling customer value proposition and against Google? My favorite question to ask anyone from ISIS is what will the application do for me that my Citi sticker won’t do now?

  • Provision over the air? (Who cares)
  • Turn on/off the card/element? (Who cares I don’t pay for fraudulent charges)
  • Offers? (Who cares.. Citi can tie merchant offers directly to card use.. Clovr Media/Linkable)

There are MANY future functions like eReciepts and Item level coupons.. but these are VERY far off because they require retailer participation.

ISIS is proving that the NFC supply chain is not workable… at least not without a very substantial customer value proposition. A December 2012 delay to a PILOT may well be the death knell for ISIS… how can carriers invest $200M in a team that won’t see production until mid-late 2013?   There is no shortage of parties complaining about Google’s approach.. but by taking control of the spec, the architecture, the handset and “TSM” they have eliminated the complexity and have been able to get something to market… and are improving from there based upon REAL customer feedback. So while ISIS will struggle to get a pilot running by late next year, Google is signing up new retailers every week, improving its applications and gaining market experience.

As I outlined previously, carriers started from a basis of control with the NFC Forum’s technical specification. Obviously, the handset has proven to be a platform of digital/physical convergence.   We all see enormous opportunities to re-wire physical commerce with the handset at the core. But today the handset’s “commerce” success is driven by its open nature (apps and connectivity). It is a platform where anyone can build anything within a given set of loose rules (tighter in Apple’s case). In order to attract retailers, advertisers, issuers.. the MNOs had to continue this “open” approach.. but instead have taken one of control. This control approach may have been unintentional as not many organizations have successfully built business platforms (favorite book on topic is Platform Leadership). MNO’s control approach could have also been driven by the desire to securely maintain customer information. Whatever the reason, companies will likely develop approaches (See Square Card Case) that keep information out of the secure element and place it in the cloud. As I related in the Square article.. the success of NFC is far from given.. All that is really needed at the POS is a “key” that key could be a single number/identifier delivered by NFC, your voice or your IRIS.  Keeping all customer information on the phone is rather stupid. One MNO told me this week.. its on the phone in case it doesn’t have connectivity. Well guess what.. stores have the connectivity.. that’s how Visa’s system works.. Stores are not dependent upon the Phone’s connectivity.. but rather their own.

It’s never easy for a Fortune 100 organization to admit that they made the wrong bet.  Globally, there is also a very strong inter-carrier commitment to “carrier controlled NFC” work. All it will take is one major carrier to change course and join Google’s camp to bring down a global house of cards that is NFC.  My guess is that carrier controlled NFC find long term traction in public transit and ticketing perhaps even in government identification. .. but this is 3+ years out before any substantial (>20%) adoption.

Customers.. you want ISIS mobile payments functionality? Go get a sticker.

MNOs.. do you want ANY part of mCommerce? You better move quickly to partner with someone that can get all of this done. Their dance card may fill up quickly. If you don’t move beyond the “control” approach.. you will be relegated to dump pipes.. as thousands of businesses work to get around your controls..   Given the Carrier IQ blow up this week, you have no ground for claiming you would manage privacy better than Facebook or Google.

Structuring a Bank Groupon – 101

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30 Nov 2011 (as always pardon the typos)

My post yesterday resulted in some good feedback. Theme was “are you bank friendly…? Stop telling me about what does not work.. how about recommending what does!”  My previous blogs covered a number of lessons learned.. so today I’ll give my view on What Does Work as Banks attempt to extend their existing business models. Your feedback is certainly appreciated..

As background.. here are my previous related blogs

What Works?

Well perhaps the first step is to frame the objective.. what does the Bank want to accomplish? For simplicity let’s reuse yesterday’s example: a Bank Groupon.  What is the Bank’s objective? Maximize revenue? Of the Groupon Unit? Of the Corporation?   Given the recruiters response..  it would seem that maximizing the revenue of the Corporation is the focus and their method is control. The Bank emphasizes control because it has significant uncertainty on entity and outcome.

Example BankGroupon Conversation “we have no idea how this thing will play out.. we have a number of the assets necessary to make BankGroupon a success and should be able to put something together.. so hey lets give it a try.. get some leader in here that has some experience in a big bank.. and some with start ups.. lets see what he proposes”.

Banks are the best institutions in the world at managing investment and risk.  When a bank contemplates an investment in another company, it is certainly appropriate for them to assess the business model, the team, the environment and price the risk.  This ability to make and manage investments is much different than an ability to run a NON CORE business and react to market forces (Elephants don’t dance).  While banks may have individuals in their company with these skills.. these employees did NOT develop the skills within the bank.

There is an obvious need to decouple the Bank Asset (customer data), Capital, and Entity that executes the plan. Commercial and Investment banks have tremendous experience in structuring entities that separate a bank asset and capital. Bonds, SPVs, CDSs, CDOs, … these vehicles not only allow banks to move assets off balance sheet, but they also allow investors to take different tranches of risk and even insure/hedge against loss.  The first stage of these commercial bank activities is defining the underlying asset (with appropriate continuity and underwriting in portfolio).

“Asset Definition” is the critical piece I believe is missing in structuring most bank owned NewCos. If the business is core.. keep the asset in house. If it is non-core.. define it and let someone else go maximize it within covenants.

CEO Prospect – Approach

In the BankGroupon example, if I were a prospect CEO here is how I would approach the task.

1) Define the bank asset (non monetary).

What is the bank contributing? BankGroupon is a separate company. What is the operating agreement between the 2 entities. Optimally this asset would be a 10 yr exclusive agreement to sell pre-paid offers leveraging bank data. Just as with Bonds, SPVs, the agreement would have covenants to protect the bank in certain events, as well as MUTUAL performance guarantees. This operating agreement would be the central asset around which the business would be formed. The focus of a NewCo CEO would be to ensure that this operating agreement is sustainable and fine tune the covenants.  Can I build a sustainable business off of this asset?

Operating agreements are NOT easy to create, they require much thought and planning. However, these agreements HAVE BEEN the core asset of many successful bank driven entities (Visa, MA, Early Warning, Clearing House, …). Quite simply, it defines the asset, how it can be used and also governs the roles of other entities in participation.  If you happen to meet one of the bankers/lawyers that were involved in the creation of any of the operating models above.. they would probably say it was like 2 years in North Korea.  By not creating these agreements, the Bank has shifted the burden of defining the asset AND building the business to NewCo.  Ask any recent bank spin off CEO and they will tell you their lives were like 2 years in a place much hotter than North Korea.  Spin offs have very little leverage to influence asset definition AFTER they have taken the capital.

This is my central point.. and should probably stop here.. but let me finish up a few other thoughts. I see the prospect bank CEO and the bank investment lead (future BOD member) working on this for a year or so. During this time.. the CEO comp is heavy on cash with an incentive if bank cancels or funding is successful.  Just as with Capital markets folks.. lining up investors for a $200M offering.

2) Capital to start the business.

My next job after obtaining the right operating agreement is to get Capital. What is the path toward revenue and what will it cost me to get there? Most Banks have taken approach of supplying all of the capital.. or perhaps partnering with one other big organization. Since the source of capital drives the direction of the business it is very important to have CEO drive source and mix. For example, BankGroupon needs to attract retailers.. Retailers don’t like banks.. and Banks don’t understand Retailers. Having an entity that is 100% controlled by a bank is not a great sales asset. I would want a clear path to reducing Banks control to under 50%…  and gaining investors who are retailer friendly. I would do this by either converting Bank stock to non-voting, non bank investors, or other commitments.

Wrap up for now

I could probably write a book on this.. but won’t bore you with the diatribe.  There is no shortage of talent interested in running a bank owned Groupon. But most of these CEO prospects haven’t had to survive in a bank owned company/consortium before.  The high failure rate of bank driven start ups is because banks have not taken the time to define the asset and separate it from the capital.  If a BankGroupon is core to the business.. it should remain in the business. If it is not core, and you have assets to leverage.. define the asset and let someone else grow it.

Your feedback is appreciated..  I’m sure there are several of you that think this viewpoint is insane.. but hey.. sometimes great ideas are generated from dissecting insane ones.

Best

Card Linked Offers

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28 November 2011

pdf version here (sorry for previous Typos.. I need an editor.. so pardon the mess)

I’m fat and happy from all the Turkey.. and was thinking of what to blog about.  I’ve decided to link a funny story… with a complex market. Earlier this month I was called by a recruiter to lead a new company. Here is the abbreviated dialog

  • What is it? “a bank Groupon”..
  • How is it structured? A separate company? A Bank Division? “Both, it is a separate company 100% owned by bank”
  • Are they looking to spin it out? Will there be other investors? “no”
  • So CEO (with no equity upside) building a business from Scratch within a complex bank? “yes”
  • Where will it be based? “right here in NYC next to the Bank”
  • Did you know the COO of Groupon was given about $xxM in options… how are you going to compete with that? “we are not looking to compete on compensation.. but we do want to compete with Groupon”
  • Good luck with that!  (See my previous blog for lessons learned on bank spin offs)

Message here is that top banks and payment networks are getting into the “offers” space. I haven’t seen an industry analysis of CARD LINKED OFFERS…. So I thought I would create one. Today I was reading 2 month old post in All Things Digital: Will the next Groupon Killer be your Bank.. ? One of my first Blog posts (2.5 yrs ago) covered this subject as I saw in back in 2008/09 “Googlization of Financial Services”.  Here are a list of current leaders in Card Linked offers

Not all of the companies above are the same. Here are a few basic strategies behind these start ups

Strategy #1 – Improve Existing Loyalty Effectiveness. Colloquy.com is the industry leader in research on loyalty programs. Two recently published white papers by Colloquy.com display a macroeconomic view of the size and value of loyalty programs for U.S. consumers. Colloquy estimates the total value of loyalty currency issued to U.S. consumers in 2010 is a $48 billion dollar industry across financial, travel and hospitality, and retail sectors of U.S.

economy in 2 billion U.S. household loyalty program memberships. Edgar Dunn provide a great graphical view on the purpose of loyalty programs

Why do banks want to improve Loyalty?

A) Credit cards carry a much improved interchange (250-350bps vs $0.21 flat of Debit)

B) Loyalty Programs are highly effective card use AND retention tool. From Edgar Dunn

Strategy #2 – Redemption Network. Improve the way redemption works. Enable redemption of specific items. Catera and Cardlytics are leaders here. Great Article on Clovr (now Linkable Networks).

Banks used to see card offers as part of a large revenue stream.  Now banks need to find unique technologies in order to capture the customers’ attention again.  Some of that technology comes from mergers such as Cartera and Vesidia to form a new more innovative merchant network platform.  Other pieces of the card-linked offer space is coming from companies that are focused on card-linked offers, such as Boston-based Clovr Media.

… The card-linked offer company wants to make sure that promotions they are powering are meaningful.  They do that by getting down to the SKU level (the long number on products that identifies a unique product within a store. Tom said, “we can go right down into a particular product within a store, get right down into the SKU level.  Instead of 10 dollars off at Staples, it’s 10 dollars off a cannon printer at Staples.  We see that as a very powerful concept.

CONCEPT is the key word here as “networks” are minimal beyond eCommerce store fronts capable of redeeming offers for specific products. In the physical world, none of the participants above have cracked the code on the scenario above. POS integration is too hard AND retailers will not give up their data.  Entities like Catera are using other parties (ex SavingStar in Grocery) to give item level credit hours, days or weeks  after the sale.

Strategy #3 –  Advertising.  The first 2 strategies above are about leveraging the $48B in loyalty “value” to incent merchant participation. A third strategy is geared to attract retailer participation in an advertising network. The primary value proposition: target card customers with specific offers.  This strategy usually driven by card NETWORKS and Issuers looking to expand “value delivery” on existing networks (the  googlization article above provides an example). Although Banks certainly have the data to make this work, this is NOT a merchant friendly platform. Can you imagine using your Amex card at Macy’s then getting an incentive at Neimen Marcus? This is one reason why retailers are loathe to share any item detail information.. it would only help banks/networks more accurately target their customers.

Apparel, QSR, Furniture and a few other niches could be served in this model (few other retail categories have significant ad budget), but the price is credit card interchange.

Summary

Retailers will respond to Banks’ loyalty spend initiatives ($48B), but “redemption” will largely be online (restricted merchandise lists) because retailers do not share data at the point of sale.  Banks and the Networks are attempting to expand Card Linked Offers into the advertising space, but this means someone will have to sell retailers and construct campaigns.  Given that neither Banks nor Networks are adept at selling retailers anything, there will be a need for 3rd party ad exchange (ex freemonee) where advertisers can bid to place across multiple issuers (ie each issuer controls their respective cards).  These Ad Exchanges will be slow to mature because there is no proven CPA for card linked offers (and associated merchant sales lift/profitability). In other words the Merchant cost of accepting a credit card, paying for an offer, and tracking profitability is not a home run today. We need only to look at Visa Offers to see the confusing and bleak future. Consumers are overloaded with e-mail and messages.. behavior will not change until there is compelling value. Value cannot be delivered until there is a critical mass of ads which can be targeted. Targeting can not be done effectively because issuers only have merchant level preferences (not item level/brand). … Only certain categories of retailers have substantial marketing budgets… the majority of marketing is spent by manufactures.  Manufactures don’t know their customers.. (hence is why Shopper Marketing is red hot). … and so on

A logical extension of card linked offers is card linked pre-paid offers. This goes back to “Bank Groupon” listed above. Banks want to run a pre-paid program for retailers.. a “pay before” you eat… at a discount. Keeping it on the card so consumers don’t loose the offer and redemption is a seamless process within the existing card settlement flow. Hey this is a great idea for consumers and merchants. Problem is business model for banks. If this pre-paid was sold by a regulated bank entity I doubt if they would be able to take advantage of the breakage which drives Groupon’s profitability. Banks will also be responsible for things like escheatment..  this is where state regulators come looking for unclaimed funds.

Your thoughts and feedback are appreciated.

A related blog on Visa’s activities is listed below.

http://tomnoyes.wordpress.com/2011/05/20/visas-mobile-strategy-portfolio-manager/

PayPal at POS?

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18 Nov 2011

The most frequent question I get from eBay’s institutional investors and start ups is about PayPal’s opportunity to win at the POS. I met with 3 top Retailers who  have been pitched PayPal’s new service. Quite frankly they were laughing.. it goes something like this

“we [Retailers] just won Durbin and are in the midst of planning how we incent customers to use their debit card … and we get presentation from PayPal with a rate of 150-200 bps..  am I going to loose any customers because I don’t have paypal payment? Will Paypal bring me new customers that would not have shopped here in the first place? Is there going to be a 100% conversion of credit card customers to paypal? Why on earth would I want to do this?”

PayPal of course is also pitching a gaggle of new mobile tools that let people scan in aisle and shop online to pick up in store.. but does a retailer really want to outsource this?  PayPal’s core value was built around commerce, specifically the new form of commerce that eBay marketplaces brought. Buyers and sellers flocked to a tool that met their needs. No one came to eBay because of PayPal.  Payments are just the last phase of a successful commerce interaction. PayPal still has tremendous global opportunity, but their opportunity is an evolutionary one driven from their COMMERCE core. Their business model (and cost of funds) does not adapt well to the physical world.

PayPal has no tools in its shed to deliver incremental value within a PHYSICAL commerce orchestration role. They simply do not touch consumers or influence them prior to purchase. Facebook, Apple, Google, MSFT all have a much better chance of orchestrating commerce..  This is why Google’s Wallet will win against ISIS… the business opportunity is commerce orchestration…NOT about mobile payments. Never before has a customer had the ability to interact real time in store with products and offers.  Who will win? Which company above has a sales force of over 2000 globally selling to retailers today? Driving business growth? There will be no contest here.

How can PayPal use its tremendous consumer network to deliver value off of eBay?  The answer revolves around what they “could” orchestrate.. perhaps in a junior capacity.  What problems can they solve? If PayPal’s biggest asset is Consumers.. and objective is physical commerce… why not create a “reverse auction” for goods? Let consumers describe what they are in the market for and have sellers bid for the privilege to sell (and service) it. Give consumers option to buy it now in store down the street. This would relegate physical retailers to competing on price alone.. and certainly would not make them many new merchant friends…but they could start off doing this for excess inventory or mark downs.  This could be a very stupid idea.. but PayPal’s efforts to go head to head with Visa and MA in an area where they add no value at a high cost is not much better.

One corollary here is that Payments will become dumb pipes. Banks had a traditional role as the intermediary in commerce. They have fouled the well.. and continue to cry against the harm done to them by Durbin instead of engaging in an honest assessment of the future of their business.  Banks believe they have a lock on payments.. and similarly to ISIS engage in a strategy of control instead of value delivery. This dynamic will push “Commerce orchestrators” to find the path of least resistance (least cost routing) for payment. Not all payments are the same, for example Credit card payments are much different.. because they extend financing to benefit merchant consumer and bank. However there is no reason to force everything through this CREDIT card channel, which is precisely what the banks are trying to do with NFC (for example there is no debit NFC product.. it is not a technical issue but a business one).

Even if payments are dumb pipes they must have a reservoir to pull from, either in a DDA, stored value account or credit line. During my meeting with the Kansas City Fed last week, I discussed the McKinsey report describing how the bottom 4 deciles of retail banking customers are unprofitable. In other words the big 5 banks are trying to find a way to sponsor “switch your bank day” for 40% of their customers.  Many will leave the banking system all together, and this reservoir of funds will translate to cash, pre-paid or some other non-bank product. Banks loss of control over DDA is a slippery slope. If every American has a PayPal account, an iTunes account, an Amazon account, a Google Wallet and a pre-paid card they could find their control strategies are no longer effective.

I apologize in advance for the brevity of this note, and I certainly appreciate comments.. but this is how I see it.

Customer Centered Design … Why is it SO Hard?

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7 Nov 2011

I woke up this AM thinking about consumer value. Why is it that so few existing companies can deliver disruptive consumer value propositions? Execute innovation? It seems as if big companies are more interested in imitating what their competitors are doing … as opposed to focusing on customer (to deliver value). Steve Jobs was one of the few big business CEOs that focused on Customer. He knew that creating a fantastic customer experience was essential in anything to be “sold” to consumers, whether that was Apple or Pixar . Everything flowed from a consumer DESIGN and experience which then evolved to product and subsequently to engineering. Apple was fanatical about customer experience and customer centered design, obviously quality (hardware and software) and connected services were also essential in driving the experience to establish behavior.  How many products in the market start with customer centered design? How many of your product heads know their customers and how they differ by segment?  My time at Gartner and Oracle led me to a few hypotheses on software products:

  • Every Software product usually starts with a customer in mind… but customer focus typically fades fast as other objectives (financial, competitive, alliances, big “special” customers, timeline: execution on “something”…) move the product off of the initial customer centered goal.
  • Delivering any consumer value proposition requires either a killer value proposition or a killer distribution channel.  Consumer adoption is “unpredictable” at best…  be highly skeptical of any initial success (acquiring early adopters of a product) never resembles the broader launch when the product goes mainstream.
  • Small companies (leading delivery of a visionary consumer service) require alliance partners… Alliance partners require financial incentives that quickly erode the original value proposition. “when you dance with an 800lb Gorilla, you can expect to have your toes stepped on”. Give equity and it biases your board (focus on their problems/customers), give cash and it kills the consumer or the distribution channel. Equity is better.. but structure in a way you can take them out.
  • New Software products within large companies (ie MSFT, SAP, Oracle) are either poorly integrated into the core, or not integrated at all.  Product teams can spend over 50% of resources focusing only on internal integration… which further distracts from original  customer centered design. There is usually a case for 2 product teams here.. one focused externally on customer and market, they other focused internally on integration requirements.
  • Customer testing and trial is a 9 month+ process… no exceptions. Few companies go out of their way to solicit negative customer feedback on a new product. They are much more concerned about “secrecy”…  Companies may have justification for short-circuiting (Example: “what are we supposed to do with the engineering team while we wait for feedback”) usually come back to haunt as products in market are much more difficult to change AND effect consumer perception/adoption.  Cloud based services are no exception , “lets throw our product out there and see what happens, we will fix bugs later” is not a great business plan. This model makes your early adopters unpaid quality assurance participants..
  • Few companies can survive by tackling a niche in the consumer market. There are only 3 markets (US, EU, China) where a 10% market share equates to a sustainable business
  • Large companies may not be able to “win” in delivering a new value proposition, but they can muck it up for everyone else. Their game plan is one of “control” over value. They leverage their existing network, infrastructure, products, communication and market power to influence potential customers.
  • Consumer visionaries and innovators play a distant second to executives driving financial performance. There are exceptions. For example, Google is also a fantastic innovator, a result of having the best minds working round the clock with pressure to do something great.. not to drive a revenue target.

Story.. my lessons

My lessons learned on customer centered design are many… After Oracle I went back to my old team at Wachovia (which had just bought First Union) our team had launched the world’s first major online bank in 1995 (Cyberbanking).. I was fortunate to return to oversee the complete remaking of our online and payment services infrastructure… a $200M project (2002). As an engineer.. I have many faults..  among them thinking that I know what the customer wants without ever talking to them… We had 2 excellent execs at Wachovia that completely changed the way I thought about customer centered design.  We brought customers into the product design process at every stage.. hand drawn screen mock ups.. asking them obvious questions… Why do you do this? what are you looking for? When do you typically do this? What does this mean to you? Jason Ward’s amazing team took this customer feedback and analyzed it to prioritize product design changes.  When I started at Wachovia…. we had no facilities or process for including customer feedback, it was the call center’s problem to deal with. After development was complete, we did extended “dog fooding” with employees and customers.. then brought that feedback into refine final release. We also communicated with ALL customers.. why are we upgrading? what will be changing? We explained what things will look like. 3 months before it happened (believe it or not customers don’t like surprises in their bank).

What happened next was something that still amazes me.. During upgrade customer call volume went DOWN.. we transitioned customers from one system to another… completely changed screen flows … and they did not call to ask questions, they did not call to complain..  We had budgeted for extra call center staff.. and we didn’t have anything for them to do..  What was more amazing is that our customer satisfaction went up… DURING the transition to the new system. This is unheard of..

I have now learned that I don’t know what the customer wants or needs.. and the direct customer interaction is VERY beneficial to all involved.. from product to engineering to the call center. Communicating to the customer (if done correctly) is a great thing.. great customers love you and they want to know what you are working on.. find ways to share it with them. If customers perceive they are getting value they want to HELP you. It is imperative to build facilities to get this feedback.  In Wachovia there was only 2 regular standing meetings that the CEO would attend… financial and customer listening.  Although Wachovia failed on many other grounds.. it taught me the importance of keeping eyes on the customer and ensuring I received the RAW customer data. My priorities became my teams priorities.

Sorry to ramble… I have quite a few peers and former employees read this. Wells Fargo just completed the last migration off of our $200M Wachovia platform. The migration was very well done.. but quite frankly I miss what we had. WFC’s online banking is too clumsy.. too much information.. The difference between using an iPhone and flying the space shuttle (photo below). … although I miss that too.

Apple’s Commerce Future = Square?

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25 October 2011

My top question for October has been “What is Apple up to” in payments/commerce? It matters to me because investments and strategies have to line up. Is there new risk? Should I be running from NFC? Where do I place my bets?

Data Points (From previous blogs)

  • Apple/iPhone is staying away from NFC…Apple has something brewing that revolves around its iTunes account base.
  • Chase is working with both Apple and Square
  • Square just secured a billion dollar valuation on $3-6M in Rev from one of the best VCs (IMHO) KPCB.. SO they must have some big idea…
  • WSJ Article reports Jamie Dimon is talking to Dorsey on Payment.. what possibly could Jamie be so enthused about?
  • Keith Rabois said he would never have gotten involved in Square if it was just about a doggle and payments..
  • Visa is on board.. so they must have a plan to drive card volume. Visa invested at a time when new mobile  PCI standards were “in flight”
  • The Square doggle is mag stripe only.. (doesn’t work outside US)
  • They are pushing the doggle like mad, expanding distribution to WMT stores this week.
  • My previous blog outlines how Square has shifted into V3 of a business strategy that is about commerce (not payment). V1 was “Payments for Craigslist community”, V2 Small Merchants alienated by terms of today’s Acquirers, V3 Commerce
  • Square card case shows TODAY’s product for working in physical retail. To make this work efficiently (and at scale..) many people have to be “registered” with Square as Payers (to open a Tab). Visa Wallet, and Apple iTunes would seem to be logical extensions to expand this registration rapidly. See Card Case demo Square’s site http://www.youtube.com/watch?v=la0zz-pPEl4
  • As I stated previously, there is no need for NFC… anything that NFC can accomplish can also be accomplished with a single key exchange.. whether that key is biometrics, a loyalty card or your GPS location
  • In this blog 2 years ago (wow I’ve been writing about Square for that long!?), outlines how a commerce process of the future may look like the local country store of the past. I know who you are when you walk in.. ask “would pay like you did last time or put it on your account?”.

Apple/Square – the Anti NFC?

All indications are that Apple has a new “location registration” type of service.. Allowing users to determine “Who” they want to make aware of their presence. I’m sure most of you familiar with Square’s card case can see the immediate link: if you walk into a “registered” store you have given “permission” to be aware of your presence the store will be able to market to you during your shopping experience AND when you go to register it will know who you are based on Voice (Square example), picture, GPS, or some other proximity indicator. Assuming your payment is on file (iTunes/Square) and the retailer is “connected” (to same cloud as consumer): the entire marketing, shopping and checkout process is done without ANY select, scan, tap, swipe or anything … throughout your entire shopping experience. For example, you could be watching targeted iPhone ad videos while shopping with discounts automatically applied at checkout.

Hey I could be wrong … and should have just kept my mouth shut while I go patent this.. but I think this is already in flight.. so my goal is to inform investment decisions. My confidence level?

Square is building this? 60-70%

Apple is participating? 30-40%

This would make Square’s Wal-Mart distribution efforts look brilliant. Give away millions of free doggles to get consumers to sign up.. then leverage this network as the basis for future in store payment network.

Is this really a Killer App?

My response centers around this question: How would retailers (and existing value chain) react?

  • Where is the value to the retailer? In store marketing is not valuable without knowing intent to shop or buy.. or brand preferences..
  • What do Square, Visa, Apple know about physical advertising and retail?
  • What incremental sales with this drive? New customers? Basket Size?
  • Will I lose business if I don’t do this?
  • This use case solves a “payment” problem and an “instore awareness” problem.. What is the benefit to the merchant? Speed? Reduced Interchange?
  • If Chase and Visa are driving this.. retailers will not be jumping over themselves to be first on board
  • IBM has an 80% share registers in top 20 retailers.. Are they going to give up the POS to Square?

On the positive side.. this is certainly MUCH cheaper than NFC.. Merchants: Why should you buy NFC terminals at all? This highlights again why the MNOs insistence in following a “control” model for delivering value through NFC will be such a failure (see related blog). Data should not live on the phone.. but the cloud.

Investment Implications?

  • Be cautious in over estimating the uptake of NFC. It is not a panacea for payment. It is a great tool for machine/tag to machine communication (ticketing, door opening security, RFID reader, music sharing, …).
  • Verifone’s vision of new terminals everywhere should be balanced with a view of no more payment terminals at all.
  • There are some very big bets going on here.. Apple, Kleiner, Visa, Chase.  If you are not aligned to one of the big players you could get stepped on quickly
  • Many opportunities to add value within this “future” scenario.. SAP, Oracle, and other retail experts are well positioned to help retailers
  • Visa and Chase’s involvement make retailers participation less certain… therefore increasing retailer interest in other “retailer friendly” value propositions.
  • My favorite one.. in store bandwidth. Stores are sink holes for radio signals..  Verizon and AT&T could gain control over this entire value chain by selling connectivity solutions (ie microcells) into stores. They can control the content in the phones to a much higher degree.. for example blocking any non-retail friendly site while a customer shops.
  • Government Regs.. We need to start managing who has access to location information in a much more “regulated” fashion.  I’m more concerned about my location information than I am about my payment info. Why? I know I won’t be held liable for my fraudulent card data.. while a bunch of physical thieves could rob me blind if they know where I shop and when I’m gone from my house.  There is an assumption that customers will let this happen. My recommendation is for Square and Apple to spend a little time in Germany..
  • Visa Offers could have a new outlet in store.. unfortunately.. they don’t know how to “sell” offers to retailers..

Make no mistake.. I like this model and think it is brilliant. But others are much better positioned to execute on it.  Starting a network business is hard.. cracking the nut on a retailer value proposition.. harder.

If this is true.. I could be flipping to a fan of Square.. errr… Apple?? I finally see Kleiner’s investment approach at work. As one of their partners said to me “Tom, if we get a great team in place.. they will figure it out… Google had no idea of how it would make money when it started.. they turned out OK “

CEO of Tempo Interview

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Great Interview w/ CEO of Tempo on how Durbin killed margins in Debit.. and killed Tempo

http://pymnts.com/Tempo-CEO-Opens-Up-about-Decision-to-Shut-Down-after-Durbin/

Just as I wrote in March (Sepa and EU payment innovation), when governments intervene to set prices.. “innovation” can be impacted.  John says Tempo is the “poster child” of government regs gone awry.  On the flip side.. third party payor processes are also disconnected from market forces (payments, health care, education, pension, …).  Bank of America’s response ($5 debit card fee) is the right response for america’s banks to take toward Durbin, customers that directly incur the costs for services they use can make more informed decisions (and change behavior) to optimize their own value equation.

In the US, bank debit cards will be evolving to what we see in Canada and Australia. It remains to be seen if we will see fall off in Debit transaction growth in favor of “free” credit card transactions.

Banks and Visa/MA certainly see things like mobile payments driving convenience of using credit.. while the “pain” of using debit increases…