US Regulations – Online Payment/Transfer

Posted on by
6

Lessons from PayPal

January 25, 2010

I was on the phone today with Jeff McConnell, a tremendous exec with a long history of leading innovation in money transfer (WU, Moneygram, iKobo, …). In some respects it’s hard for me to believe that 2002 is 8 years ago, and I was reminded of how challenged PayPal was in obtaining the proper licenses “after the fact” in its early business.

In his 2006 book The PayPal Wars, Eric Jackson did an excellent job laying out the challenges paypal faced in its early years.  In the early days after its inception in 1999, PayPal was moving toward becoming a bank, but the Internet startup decided that banking regulations were too cumbersome. “We just wanted to be able to facilitate a quick payment,” he said. “The question of how to classify PayPal lingered for some time….It’s a sort of modern-era Western Union.. really, all PayPal is doing is shifting money around on your behalf.” 

To see the “change” in PayPal’s regulatory approach, take a look at PayPal’s 2002 prospectus.

We believe the licensing requirements of the Office of the Comptroller of the Currency, the Federal Reserve Board or other federal or state agencies that regulate or monitor banks or other types of providers of electronic commerce services do not apply to us. One or more states may conclude that, under its or their statutes, we are engaged in an unauthorized banking business. In that event, we might be subject to monetary penalties and adverse publicity and might be required to cease doing business with residents of those states. A number of states have enacted legislation regulating check sellers, money transmitters or service providers to banks, and we have applied for, or are in the process of applying for, licenses under this legislation in particular jurisdictions. To date, we have obtained licenses in two states.

This 2002 regulatory view, by the Paypal exec team, was based on a position that PayPal was acting as a Third party payments aggregator (TPPA), not in need of a money transfer license. TPPA is a description used for merchants that are charging a credit card for a product or service that they do not own. TPPAs simply facilitate the exchange of money between two parties sometimes using a credit card as a funding source. Several fraud and AML incidents arose which got the attention of both federal and state organizations. It became clear that PayPal was being used for much more then payment for goods within the eBay marketplace.

In Feb of 2002, the Federal Deposit Insurance Corporation (FDIC) ruled that PayPal is not a bank, which accelerated efforts by states to pursue PayPal for violating money transfer laws (New York and Louisiana are most notable).  This could have been the death knell for PayPal, as they were operating without the proper licenses. PayPal’s “post facto” licensing efforts were greatly aided by the local political support from thousands of eBay’s buyers and sellers. Today, according to spokesperson Michael Oldenburg,  PayPal is licensed as a money transmitter in 43 states (not all states require a license), demonstrating that regulatory risk was far greater than what they articulated in the 2002 prospectus. For those interested in the legal/regulatory conundrum faced by regulators, I highly recommend:  Regulating Internet Payment Intermediaries, by Ronald J. Mann, University of Texas School of Law

For today’s “emerging” payment companies, there are 4 primary choices for operating in the US:

  1. Obtain the licenses
  2. Operate as an agent of an entity with the proper licenses
  3. Sell your software to a licensed entity
  4. Exchange non-monetary forms of value (minutes, eGold, credits, …).

Obtain the licenses

For those of you that read my Blog, you’re probably aware that I’m fairly negative on Obopay, however they do excel in obtaining US MTO licensing (https://www.obopay.com/corporate/stateLicenses.shtml) . Unfortunately, all of these US licensing effort seems for naught as they are pulling out of the US and focusing in emerging markets as the “sender pays” model does not work in developed countries (morphing from a failed US P2P effort to Remittance). Today, PayPal, Western Union, Travelex, Moneygram, MoneyBookers (soon to be NY licensed) also operate as licensed Money Transfer Organizations (MTOs).

Becoming an MTO is not for the faint of heart, as regulatory capital requirements in excess of settlement obligations (fiduciary assets) are a complex (state by state) maze. This creates a challenging dynamic where capital reserve requirements grow as payment volumes grow. As a start up this means you not only need to raise capital to start the business, but also the regulatory capital BEFORE you get the state licenses.

MoneyGram’s 2007  “investment issues” offer many insights into MTO challenges. MGI suffered an $860M+ plus loss as it shifted out of high yield asset backed securities (which lost their investment grade rating). To preserve liquidity it sold $630MM in preferred and received debt financing of approximately $500M, a situation which today leaves MGI common shareholders in a $870MM equity deficit.

Operating as an MNO is not your only choice. I’m amazed at how few companies there are attempting to develop a bank based model. Trolling the dust bin of failed financial institutions may provide a unique opportunity for a start up to acquire the “shell” of a licensed bank to develop a “payment” focused value proposition. The strategy behind Revolution Money’s acquisition by Amex gives Revolution the “best of both worlds”: an acquirer and a bank. If it were not for Amex’s bank charter (and associated regulatory capital), Revolution’s PIN based debit would be highly susceptible to NACHA aggregation restrictions if they are operating as a non-bank, operating as a type of decouple debit.

I know from my own personal experience that operating as a “payment bank” is not without challenges, not just Citi C2it.. (which stopped 2.5 yrs prior to my role), but Citi GTS which today provides many of the banking licenses for payment providers like WU, Vodafone, ZAIN, …  In addition to Citi GTS, one of Citi’s most profitable “global” retail bank businesses is NRI (Non Resident Indian) which serves affluent Indians (within the US, UK, …) with comprehensive services that cater to the needs of affluent clients. Citi also effectively up sells NRI clients services within its investment and commercial bank.

Operate as an agent

Pre-paid cards offer a “fast track” to operating a new payment service (Revolution money, Squareup, payoneer, iKobo, …). In this model the service relies on the licenses of the underlying bank (example Metabank). The legal precedent here is rather new as witnessed by May 30, 2007 finding by the First Circuit , which affirmed that the National Bank Act preempted New Hampshire regulation of the pre-paid product. In the “agent” model, it is therefore paramount that start ups seek a federally chartered partner. 

There is still substantial “risk” in this pre-paid agent model, as traditional banks and networks control the “rails” for this payment type. For example, Consumer accounts must be “funded” from either a card or DDA account. NACHA has developed new rules which significantly curtail the ability of a “payment aggregator” operating off of a current account (see NACHA Tightens Risk Management and aggregation rules) . Additionally, card networks and acquirers are much more attuned to the risks that these new payment intermediaries present.

My top vendor in the bank model is CashEdge (having been the banker who signed the agreement at Wachovia). CE is the “3rd party sender” for Citi, BAC, Wachovia, PNC and other top banks representing approximately 50% of US DDA accounts. You don’t hear about them much because they are a white label “bank friendly” service. They excel in risk management, with a team second only to paypal. Most of you in the US reading this already use their software.. but just don’t know it.  In the mobile space, I love the innovation at BlingNation.

Sell your software

This is rather straightforward. Within the mobile money space, companies such as Monitise, HyperWALLET, Fundamo, Paybox (now Sybase 365) all provide good platforms from which to build an offering. Issue for small companies is that the entities which have the necessary license have largely made significant bets here already. Of course some of the bets by big banks (some alliteration here) have been terrible, most notably Firethorne which has lost the accounts at Chase, Citi and Wachovia all in the last 8 months.

Exchange non-monetary forms of value

Beyond the scope for my discussion here. My advice is that this is a slippery slope and you will have trouble (as a payment company) attracting “A Class” capital. Look no further than the history of e-Gold for education on the issues.

U.S. GOVERNMENT SEIZES E-GOLD ACCOUNTS, OWNERS INDICTED

Summary

In writing this I cannot help but be struck by many similarities in the “unregulated growth” of PayPal and Vodafone’s MPesa. The growth of both companies was driven by an existing customer base and a value proposition which addressed clear gaps within the payment systems of their respective markets. In both cases, there was no clear regulatory authority to restrict them and once they were firmly established (through contagious adoption) it was too late to stop.

Within the EU, the ECB has developed ELMI regulations that are supported by other initiatives such as SEPA (See http://www.paysys.de/download/Krueger%20e-money%20regul.pdf).

Related posts

http://tomnoyes.wordpress.com/2009/12/16/cash-replacement-part-2/

http://www.banking.state.ny.us/legal/lo020603.htm

http://www.ecommercetimes.com/story/18211.html?wlc=1264432425

SEPA: Chicken or the Egg?

Posted on by
4

4 January 2010

I was reading an update on SEPA : New Alliances Required to Tip the Market. The report gave me new perspective on how challenging it is to change a networked business. This challenge is exacerbated by the ‘well intended’ EU political compromises in SEPA (specifically) and EU regulation of retail finance (more broadly). Clearly “payment networks” can benefit from innovation, but as Juergen correctly states “In a network industry, cost reductions and/or additional revenues that can be realized by applying the new standards have to exceed the network effects currently realized with the old standard”.

SEPA is struggling to resolve issues in cost/benefit allocation given the slow growth and adoption for SDD and SCT. The greater growth in SEPA Cards Framework can be attributed to the “control” and investment from Visa/MA as they manage compliance (and marketing) or the new SCF brand. An excerpt from the report above:

Key strategic decisions have to be made almost simultaneously in organisations that are in competition with each other, follow different strategies and have different abilities to innovate or prepare for an industry change. Only if consensus on a new business model can be reached – among stakeholders who represent significant market shares and hold key positions in the industry– will it be possible to generate the synergies promised by SEPA. As already described, the cross-border business within SEPA represents only a small share of the payments market. The dominant national standards, which all would have to be replaced by the new SEPA standards, are built around national market requirements.

International banks (for example, Deutsche Bank) have separate organisational units in several European countries that run their own national payments engines. They maintain different payment infrastructures in Europe. Modifications in response to new compliance requirements (for example, money laundering or new requirements of the PSD) create several similar projects [for this single bank]..

The costs for SEPA (estimated at €10B) fall heavily on the banks, and the benefits (ex. e-invoicing, cross border competition in payment products, …etc) are expected to be realized by the consumers of bank payment services (with and estimate €7B revenue hit to banks). Fortunately for the Banks, in 2002 the approach decided on by the EPC was to create SEPA in a market-driven and self regulated process.

The over arching goal of SEPA is to make the EU a single market on “payment” par with the U.S. Perhaps the best way to start is not by incenting changes to “payments”, but to open the EU retail banking market. (Think of the US banks operating under a Fed charter).  “All banking is local” can be the mantra ascribed to the EU today, with each country maintaining tight regulatory control over domestic financial institutions (i.e. M&A and Liquidity). Significant market forces could be unleashed when local banks can operate throughout the EU, and a German consumer can seek the best rate and apply for an account at a “Spanish” bank.  Today the regulatory hurdles for this retail competition are significant.

The EU, ECB and the EPC started with payment standards and “infrastructure” as it did not alienate any of the existing participants (market driven.. .not mandatory). What we have is the fruit of this compromise, standards for payments across the EU without the ability for companies to compete for business across the EU domain. The unrealized value of the “SEPA Innovations” are thereby constrained by the market in which banking operates. Perhaps integrating EU retail financial markets would be a better first step. This “openness” would certainly provide an attractive carrot for bank led investment in common payments. Which comes first? The Chicken or the Egg?

See data here

CapCo Analysis

NFC Break Out – VISA/FirstData/AT&T

Posted on by
7

23 December 2009

Previous post http://tomnoyes.wordpress.com/2009/11/25/visamobpay/

Get set for a major announcement in next 4 weeks from Visa, AT&T and FirstData that will combine an AT&T pre-paid card account, managed by FirstData, and with services from several Visa led start up companies  (both mobile advertising,  couponing and NFC). Consumers will be issued NFC stickers for existing phones and can fund the account with existing card and deposit accounts. AT&T will also have an integrated reward system to reward payment activity with coupons, airtime and special offers with participating merchants. In addition to the NFC sticker, Visa will also be trialing other “other form factors” including: plastic, handset integrated NFC (new phones) and 3rd party hardware for OTA provisioning. FirstData will begin a new role as both the processor and Trusted Service Manager (TSM).

As stated previously, the US market is ripe for a break from the 6 party political “fur ball” that is hampering mobile innovation (Card Issuers, Acquirers, Network, Merchant, MNOs, Handset Mfg). Mobile Network Operators (MNOs) are better positioned to execute in mobile payment in all markets. AT&T is no stranger to credit cards, even today the ATT Universal card is the largest affinity card within Citi’s portfolio.  The implications for card issuers are unclear, given the uncertainty of “mobile payment” consumers behavior and payment patterns. There is a storng possibility that this initiative will be a “tipping point” in both mobile commerce, unleashing a new wave of innovation for all consumers (not just iPhone any longer). It will be very interesting to see if Apple is a part of this initiative. 

More to come..  

From Previous Post

For those outside the US, US MNOs have substantial control over handset features and applications, they have been leveraging this “node control” to “influence” direction of payments. The central US MNO argument being “it is our customer, our handset, our network we should get a cut of the transaction rev”. Unfortunately existing inter-bank mobile transfers/ payments are settled through existing payment networks that provide limited flexibility in accommodating another party (beyond issuer/acquirer), with much room for improvement in authorization, authentication and consumer “control”. 

Outside the US, the situation is much different, as consumers have great flexibility in switching MNOs, have ownership of their handsets, and are largely on pre-paid plans. The MNO challenge for payments in this environment is largely regulatory.  Many countries (EU, HK, Korea, Japan, SG) have open well defined rules for MNOs role in payments (example: ECB ELMI framework within the EU), while other countries are highly restrictive and are in the midst of developing their legal and regulatory framework.  Even in the countries where MNOs participation is defined, they have largely benefited from the complimentary role that the service plays with pre-paid plans (not in interchange at POS).

Globally, MNOs are looking for a payment platform where they can benefit from interaction between consumer and merchant, with flexibility to deal with a heterogeneous regulatory environment. The competitive pressures on Visa/MC are much different then they were 5 years ago (when both were bank owned). The network fee structures and rules were written with banks and mature markets in mind. Emerging markets present a much different set of opportunities, as MNOs lead banks in brand and consumer penetration within every geography.

All of this leads to the case for a new “Mobile Payments Settlement” network, a network which will alienate many banks.  I expect to see Visa roll out the initial stages of this network in the next 2 months with an emphasis on NFC. Quite possibly the best kept secret I have ever seen from a public company. I’m sure many Silicon Valley CEOs are crossing their fingers (with me) on this, as a “new wave” of innovation is certainly close at hand that will drive growth (and valuations).

For those not keeping up with the 50 or so product announcements a day on NFC, handset manufacturers committed to have NFC enabled phones to consumers in mid 2009 in the GSMA 2008 congress. NFC capabilities are numerous (Vodafone YouTube Overview), and may represent a true disruptive innovation surrounding payments. There have been many very recent product announcements that will enable existing phones to use NFC, and P2P Capability. All of which will blossom in a more “fertile” mobile settlement environment.

Side note: This is not all bad news for Banks, as the structure will certainly provide for existing cards (debit/credit) and may deliver substantial revenue through cash replacement (small < $50) transactions.  More details on structure of MNO in settlement 2 weeks….

Select Product/Alliances Below:

Cash Replacement – Part 2

Posted on by
8

December 15, 2009 (PDF VERSION HERE)

Part 2 – Cash Replacement (V1)

In my previous Blog (see Investors Guide to Mobile Money) I outlined a simplified categorization of payment schemes for “first world” economies. The common win-win for both mature economies and underdeveloped appears to be Cash Replacement. Cash Replacement has been the subject of thousands of reports originating from: economists, bankers, academics, non-governmental organizations and consulting groups (a few of which are listed in references below). The objective of this blog is to provide a market basis for investors and small companies attempting to “quantify” the opportunity in cash replacement, specifically e-Money and non-card based schemes.

Global debit and pre-paid card growth have been the key instruments leading in cash replacement use within top global economies. The card infrastructure (ie “card rails”) that provided for this success was “built” on the credit card value chain over the last 35+ years Cap Gemini’s 2009 World Payment Report provides an excellent overview of key trends. Key excerpts below:

  • The worldwide volume of payments made using non-cash instruments (direct debits, credit transfers, cards and cheques) grew 8.6% to 250 billion transactions in 2007. The use of cards continues to be the single strongest driver of volume growth. Global card transactions (credit and debit) grew 14.5% in 2007.
  • The ten largest markets accounted for 92% of all non-cash payments transactions in 2007 (when they represented 84% of global GDP).
  • Unlike in the US, where cash in circulation has decreased by 7.4% in 2007, cash is still increasing in Europe, albeit at a slower rate of 7.8%.

Background

A historical review of products attempting to gain traction in cash replacement reveals a battlefield littered with the “corpses” of plastic and digital products.  (Ref 1)

  • Mondex, now owned 51% by MasterCard and national franchises owned by big banks, is after years of testing still confined to trials, often internal to banks.
  • VisaCash. See history here http://www.mondex.org/main_page.html.
  • DigiCash eCash, licensed by several big banks worldwide
  • CyberCash never rolled out a stored value system at all; after announcing a trial in September 1996 the CyberCoin system was never rolled out except on a limited scale at Barclays in the UK.
  • eGold. http://lawvibe.com/e-gold-founder-admits-e-gold-used-for-money-laundering/
  • Geldkarte in Germany
  • Paybytouch
  • Obopay

These “failures” were less to do with technology, and more to with competing against an existing payment network(s). 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.

Why read further? Although I’ve painted a very negative picture of past payment failures and the challenges of competing against the traditional networks, the payments business is undergoing tumultuous change and where there is change, there is opportunity. To understand the forces and competitive dynamics of cash replacement, it is important to understand both the local and global forces driving this change (see pdf above).

Emerging Market Regulation

As this blog is largely focused on emerging markets, it is worth noting several “unique” regulatory challenges within emerging markets as regulations surrounding MFIs and Money Transfer Services have been evolving at an astounding rate.  This regulation evolution is not taking place in a vacuum, as regulators always work with the entities they regulate.  Teams capable of local engagement and partnerships are therefore much better suited to operate in this dynamic regulatory environment. As an example, Vodafone has developed enormous competency in the payments space, extending not only its “product” success in MPESA, but developing talent which can be leveraged to seed other local teams (in the 40+ markets it serves).

As a generalization, there are 4 bodies of legislation that impact mobile money:

  1. Bank Regulation (particularly role of non bank agents, and payment networks)
  2. Micro Finance Institution
  3. Electronic Transaction Legislation (Consumer protection, admissibility of electronic records, prosecution of electronic crimes, …)
  4. Telecommunication Regulation

MNOs success to date has not been in isolation, given that in every instance (above) the MNO partnered with either an MFI or Bank.  2009 Mobile Money Summit in Barcelona provided several excellent presentations covering the global regulatory environment, an environment that is both complex and evolving. It is imperative that your team understand the local regulatory environment. Regulatory changes have significantly impacted many investments made to date, with the key example of Reserve Bank of India’s Aug 2009 regulation preventing non-banks from domestic money transfer (destroying Obopay’s P2P plans).

Network Effects – Stating the Obvious

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).

Transportation has proven to  key opportunity for electronic money: Oyster in the UK, Octopus in HK, CashCard in SG, …etc. Success in these transportation initiatives has been “relative” because they have been challenged to generated consumer adoption beyond transportation “core”, and they have note generated an attractive margin to the network (for the economic reasons that Georgios lays out above).

The European Central Bank (ECB) has provided a new regulatory framework for electronic payments (see ECB ELMI overview by M. Krueger, and World Bank). The ELMI framework, as well as Singapore’s Electronic Legal Tender (SELT) concept, demonstrate a tremendous collaborative multi year effort between central banks, governments, financial institutions and business to provide rules, law, consumer protections and an environment which would support alternatives to cash. However, it also highlights the scale of effort needed to move a consumer behavior that has existed for millennia.

Financial Case

In general, economists and bankers agree that there is a strong macro economic case for cash replacement when accounting for the “shoe leather” costs (Ref 5). However, it remains to be seen “who” will pay for this convenience. Ref 1. Electronic Money and the Possibility of a Cashless Society by Georgios Papadopoulos provides and excellent analysis:

“…the high social cost of cash is all too general. The costs and the benefits for cash as well as for electronic money are not distributed evenly. The cost of issuing cash is paid by the state and financed by taxation. Most of the infrastructure for e-money is paid by the issuer, which in turn is charging the user for this payment instrument, even though the distribution of the costs between the consumers and the merchants is uneven. Consumers may pay a fee for the card (either directly or as a part of their checking account), while merchants have to pay a fee to the issuing bank(s) either pro transaction or as a percentage of the total value of the transactions and in addition carry the cost for the infrastructure“… from Georgios Papadopoulos

This “free nature” of cash, combined with its unique qualities (i.e. anonymity, history, physicality …etc.) further challenge new payment models and the barriers they face from existing card and bank networks. Payment networks are resilient, this is both a strength and a weakness. In 2000, the average transaction cost for credit card transactions was around US$0.70 (ref 1) and thus did not serve as a viable option for cash replacement. At the time, VISA cost studies showed that card transactions of amounts of less than about US$10 are in fact unprofitable for the Issuer bank and amounts of less than US$38 are unprofitable for the Acquirer bank. Any product attempting to take the place of cash must make low value transactions efficient and profitable to the parties providing the service.

The “debit revolution” for the card networks began with pricing and risk. For the non-bankers reading, issuing debit cards was (and still is) a highly contentious fight within banks. Large issuers did not want to forsake the high margins of credit cards (350bps + interest on ANR) for the paltry returns of linking a current account to a card (150-250 bps and no interest income). This fight was exacerbated by the fact that banks typically run the “card business” separate from the deposit “retail” business. Banks began supporting debit when they realized that Debit DID NOT displace credit cards, but rather supplemented it, providing net incremental (non-interest) revenue to the bank. After this realization, banks then began to take issue with PIN Debit vs Signature (another story).

The story of interchange rates, and how they are negotiated is complex and full of intrigue. For those of you interested, read the US Federal Reserve’s “History of Interchange”. As you can see from the table above the trend (across all products) seems to point “north east”, a trend not lost on merchants and consumers. It is important not to assume that these rates will remain static. Banks (issuers and acquirers) can respond to competition, a state which does not seem to be of an immediate threat.

The debit success led the way for pre-paid cards. Pre-paid may present the best “global” opportunity to reach unbanked customers and further impact cash (See US Federal Reserve Study on Prepaid). Pre-paid is a category with both open and closed loop models. Open loop prepaid has benefited from Visa and MasterCard’s recent independence from their bank ownership model (in 2008 and 2006 respectively). In the US Pre-paid has seen substantial participation from non-banks such as Wal*Mart (11/2009 American Banker) whose business strategy aligns well with reaching the unbanked and delivering disruptive value in bank like services.

US Federal Reserve – Interchange Fees (Cross border excluded)

In the US, Gross dollar volume (GDV) for all prepaid cards is expected to grow at a compound annual growth rate (CAGR) of 21%, approaching $250 billion by 2012. Open loop prepaid cards are likely to produce a 36% GDV CAGR and closed loop gift cards a 5% GDV CAGR between 2008 and 2012 (First Annapolis). The EU provides a much larger opportunity in pre-paid market. Research indicates that the EU prepaid market is likely to generate a turnover of €132 billion across the predicted 418 million cardholder base, with transaction volumes of 4.4 billion by 2015. Within Asia and Africa, it remains to be seen whether prepaid cards will gain traction outside of Japan, Korea, SG, HK, and AU. New payment innovations present opportunities for non banks to create local (non card) networks (ex: MPesa, ZAP, GCash, …etc. )

The network motivation for pre-paid is quite simple, just as it is with credit and debit, there is very little incremental costs to adding transactions to the network. For merchants the incentive is to decrease costs. Unfortunately merchants are limited, within their existing card agreements,  in their ability to pass on these costs directly to consumers ( surcharge on payment type). This limits merchant ability to incent consumer behavior toward the lowest cost payment channel. An excellent paper covering network effects economics and interchange is covered in Ref 7 (highly recommend).

Global Network Volume – 2009

Card products (particularly debit) are filling most of the convenience gap, as PIN Debit competes quite well with Cash at most merchants (see The Move Toward a Cashless Society: Calculating the Costs and Benefits) Debit card volume growth has exploded globally, many would argue that it is the closest competitor to cash. Consumers have shown a tremendous reluctance to bear the “direct” cost payment. In other words: would I like to wave my phone at Starbucks to pay for my next cup of joe? yep… would I pay $0.10 for it? nope… I will use cash.

The payment heads at the major banks echo this view, as consumer data and spending patterns don’t reveal significant gaps where consumers report that they are not served by current payment products. Within Europe, cash replacement in areas such as ticketing and public parking shows significant price sensitivity on part of consumer (assumption of convenience cost). SMS payment providers are heavily subsidized and largely unprofitable.

Payment Costs

The benefits of electronic payments are not without costs. Most analysis estimate the cost of payments to be 1.10% – 1.60% of GDP (EU Reference, US Federal Reserve, Journal of Network Economics, Africa, ). Most analysis point to a significant “social” savings potential in moving from cash to electronic payments. However, this data is highly skewed toward developed countries (as significant differences in infrastructure are not accounted for).

Many emerging economies which did not “ride the wave” of consumer credit access have limited consumer and merchant payment infrastructure (ie. POS terminals, credit bureaus, consumer laws, …etc). In addition to infrastructure issues “Cash is King” in many of these emerging markets because no financial company has developed business model to profitably serve the rural poor.

Banks typically have challenges pricing “down market” as concern over cannibalization prohibit price led competition of channel focused products which compete with an existing product. CGAP research (also see IAMTN) shows that MNO pricing of money transfer services is substantially lower than services available from either money transfer services or banks.

Most interviewees in Kibera say they chose M-PESA because of cost. For example, sending 1,000 Ksh (US$13.06) through M-PESA cost US$0.39, which is 27 percent cheaper than the post office’s PostaPay (US$0.52), and 68 percent cheaper than sending it via a bus company (US$1.16).

Within emerging markets, the primary distribution channel is local agents (An excellent cost analysis for agents has been done by CGAP.) Agent incentives are a very important aspect to any emerging market business case.

Just as banks have used payments as a “loss leader” to generate revenue from other products (current accounts, cards, …) MNOs and their agents have created a model where payments enhance the value proposition of their core product (communication).

e-Money

The ECB definition of e-Money is

… any amount of monetary value represented by a claim issued on a prepaid basis, stored in an electronic medium (for example, a card or computer) and accepted as a means of payment by undertakings other than the issuer, predominantly for small-value transactions (for example, the settlement of modest transactions over the Internet and of parking or telephone charges and payment for public transport services)9. In common with banknotes and coins, e-money is ‘fiduciary money’, deriving its value not from its intrinsic worth but, instead, from the bearer’s expectation that it can be exchanged for its underlying value.

Successful eMoney initiatives, in both developed and emerging markets, have typically been tied to an existing value chain. A few examples: Paypal-eBay, Oyster – UK Transit, Octopus – HK Transit, Payforit – UK MNOs, MPesa – Vodafone Kenya, GCash – Global/BPI.  In almost every case, these initiatives began as a closed system and evolved to connect to other payment networks. Once value is stored in a network, every business will seek to connect, at an investment rate proportional to the network’s size, value stored and alignment to current customer demographic.

Paypal and Vodafone have shown that there are significant revenue opportunities in e-money. As the major card networks seek payment volume, they will likely develop new rate structures to incent MNO led payment initiatives to “ride on their rails” (ex. Pre paid card).

Network Profitability – 2008 US Volume

Mobile Money – Emerging Markets

The emerging market environment is a fantastic crucible for innovation as the network effects associated with the convergence of: finance, telecommunications, consumer access and business fuel economies within emerging markets. For those outside of the mobile payments industry, there are 3 principle emerging market success stories in mobile payments: M Pesa (Vodafone/Safaricom), ZAP (Zain Group), and GCash (Globe/BPI). Understand that my list is contentious given that all three are MNO led (I’m open to feedback, but it must be quantified by data). A more detailed list can be found here

M-Pesa certainly seems to win the “award” based upon Consumer Metrics and most talked about. Prior to getting started here, I encourage readers to review 2 fantastic briefs M-Pesa: M Pesa by Tonny Omwansa , CGAP brief. My stated bias toward MNOs in emerging markets (See MNOs Will Rule) is driven by the following facts:

  • There are 3 success stories as proof points
  • MNOs have developed a business model to profitably sell and service unbanked customers SEPARATE from banking (phone)
  • Payments enhance the MNO business model in emerging markets
  • MNOs have the resources to invest

The research on mobile money for the unbanked is tremendous and I can do no justice by trying to summarize. Imagine that you run a local shop in Kenya which sells dry goods and mobile phones, you must come up with 5 reasons why one of your unbanked customers would want to give up cash and pay a fee to load her money on cell phone. A few questions come to mind:

  • Value Proposition? Cost? Convenience? Will it make my life easier?
  • Use. What can I do with it? (something I can’t do with cash today)
  • Trust. Who has my money? Do my friends use it? Brand? Government?
  • Risk. Is it safe? (consumer protections, contract, access to legal system)
  • Support. Who can I see if there is a problem?

Previously I have stated a radical hypothesis: the successes above were driven by the mobile proposition (communication), and payment supported the existing MNO value proposition. The path of evolution for MPesa and its competitors are unclear and will be heavily influence by regulation. Today, MPesa operates out of a single commercial account with the central bank. That account has a balance of almost 10% of the GDP, a fact that highlights the potential to serve the needs of the unbanked.

The emerging market evolution is not so unlike that experienced with credit cards, although the “value chain” which drove the adoption is different. US, Japan, and EU access to consumer credit drove the development of the card networks; Consumer’s did not want a “card” as much as they wanted convenient access to a revolving credit line. In emerging markets it is the demand for communication that is driving the development of the network.

Investment (Greater detail in my previous post – Investor’s guide to mobile money)

As we look a cash replacement we will find that initiatives are frequent and success is not. It remains to be seen HOW the highly regulated world will evolve.  In the long term, Capital is attracted to success and growth. What we see today is a period of enormous flux and experimentation with established players making multiple “bets” (in the form of investment capital and revenue guarantees). Investments from established companies are in the form both in-house and partner led initiatives (examples: Citi Obopay, Obopay India, Nokia Obopay).

The Silicon Valley model, where a bet is made and a (US) team is built to “figure it out”, faces many hurdles; it is particularly challenged for creating products and services targeted to emerging markets (where paradigms are different and local knowledge is key).  Valuations today are driven by either: revenue, customers or board members. MNOs will lead investment in emerging markets, small companies must find a way to either collaborate with them (or their agents). ISVs should look 2 years down the evolutionary path where value begins to exit the “closed network”. Outside of the top 10 card payment countries listed above, 80% of the world’s population lives… a population that only shops locally with cash. You will have a hard time tackling this opportunity in Silicon Valley.

http://technology.cgap.org/2009/11/11/new-business-models-in-mobile-banking/

http://technology.cgap.org/2009/11/11/new-business-models-in-mobile-banking/

References

1 Why do stored value systems fail? Andreas Furche and Graham Wrightson NETNOMICS. Volume 2, Number 1 / January, 2000

2 Electronic money institutions – current trends, regulatory issues and future prospects, by Phoebus Athanassiou and Natalia Mas-Guix, July 2008. http://www.ecb.int/pub/pdf/scplps/ecblwp7.pdf

3 ECB 2008 Annual Report http://www.ecb.int/pub/pdf/annrep/ar2008en.pdf

4 Survey of developments in electronic money and internet and mobile payments, Sept 2004. Committee on Payment and Settlement Systems. http://www.bis.org/publ/cpss62.htm

5 The Move Toward a Cashless Society: Calculating the Costs and Benefits/. DANIEL D. GARCIA-SWARTZ, ROBERT W. HAHN *, ANNE LAYNE-FARRAR. American Enterprise Institute-Brookings Joint Center for Regulatory Studies

http://ideas.repec.org/a/rne/rneart/v5y2006i2p199-228.html

6 Optimal pricing of payment services when cash is an alternative/. Cyril Monnet, William Roberds. US Federal Reserve. Oct 2007. http://www.philadelphiafed.org/research-and-data/publications/working-papers//2007/wp07-26.pdf

7 Interchange Fees and Payment Card Networks: Economics, Industry Developments, and Policy Issues. Robin A. Prager, Mark D. Manuszak, Elizabeth K. Kiser, and Ron Borzekowski. 2009.  Finance and Economics Discussion Series Divisions of Research & Statistics and Monetary Affairs Federal Reserve Board, Washington, D.C. http://www.federalreserve.gov/Pubs/feds/2009/200923/200923pap.pdf

8 Electronic money and the possibility of a cashless society 18.02.2007. Georgios Papadopoulos http://papers.ssrn.com/sol3/papers.cfm?abstract_id=982781

9 ECB’s note on regulatory framework surrounding ELMI http://www.ecb.int/pub/pdf/scplps/ecblwp7.pdf

10 Where Value Lives in a Networked World, Harvard Business Review, Jan 2001, Mohanbir Sawhney and Deval Parikh).

11 NTT DoCoMo’s Osaifu-Keitai (http://en.wikipedia.org/wiki/Osaifu-Keitai),

12    “E-Money And Payment System Risks,” JAMES J. McANDREWS, 1999.Contemporary Economic Policy, Western Economic Association International, vol. 17(3), pages 348-357, 07.

13    The Economics of Interchange Fees and Their Regulation: An Overview David S. Evans and Richard Schmalensee

14    Why do stored value systems fail? Andreas Furche1  and Graham Wrightson.

15    Prepaid Card Markets & Regulation* Mark Furletti. US Federal Reserve. February 2004. http://www.phil.frb.org/payment-cards-center/publications/discussion-papers/2004/Prepaid_022004.pdf

Visa – New Mobile Payment “Rails”?

Posted on by
8

25 November 2009

Word on the street is that Visa is set for a major mobile payments announcement in next 6-8 weeks. Separately, US MNOs are also rumored to be collaborating on Near Field Communications (NFC) payments with acquirers. Could it be that the log jam on NFC is about to be broken? Is Visa developing new rails to support mobile payments? Let me say up front that this blog represents “connecting the dots” more than a definitive market projection.

The US market is ripe for a break from the 6 party political “fur ball” that is hampering delivery of mobile payment (Card Issuers, Acquirers, Network, Merchant, MNOs, Handset Mfg). For those outside the US, MNOs have substantial control over handset features and applications, and have been leveraging this “node control” to “influence” direction of payments. The central US MNO argument being: “it is our customer, our handset, our network we should get a cut of the transaction rev”. Unfortunately existing inter-bank mobile transfers/ payments are settled through existing payment networks that provide limited flexibility in accommodating a “new” MNO role and the network rules leave much room for improvment in: authorization, authentication and consumer “control”. 

Outside the US, the situation is much different, as consumers have great flexibility in switching MNOs, have ownership of their handsets, and are largely on pre-paid plans. The MNO challenge for payments in this environment is largely regulatory. Many countries (EU, HK, Korea, Japan, SG) have open well defined rules for MNOs role in payments (example: ECB ELMI framework within the EU), while other countries are highly restrictive and are in the midst of developing their legal and regulatory framework. Even in the countries where MNOs participation is defined, they have largely benefited from the complimentary role that the service plays with pre-paid plans (not in interchange at POS).

Globally, MNOs are looking for a payment platform where they can benefit from interaction between consumer and merchant, with flexibility to deal with a heterogeneous regulatory environment. The competitive pressures on Visa/MC are much different then they were 5 years ago (when both were bank owned). The network fee structures and rules were written with banks and mature markets in mind. Emerging markets present a much different set of opportunities, as MNOs lead banks in brand and consumer penetration within every geography.

All of this leads to the case for a new “Mobile Payments Settlement” network, a network which will alienate many banks. I expect to see Visa roll out the initial stages of this network in the next 2 months with an emphasis on NFC. Quite possibly the best kept secret I have ever seen from a public company. I’m sure many Silicon Valley CEOs are crossing their fingers (with me) on this, as a “new wave” of innovation is certainly close at hand that will drive growth (and valuations).

For those not keeping up with the 50 or so product announcements a day on NFC, handset manufacturers committed to have NFC enabled phones to consumers in mid 2009 in the GSMA 2008 congress. NFC capabilities are numerous (Vodafone YouTube Overview), and may represent a true disruptive innovation surrounding payments. There have been many very recent product announcements that will enable existing phones to use NFC, and P2P Capability. All of which will blossom in a more “fertile” mobile settlement environment. See one example “future” Visa mobile service here: http://tomnoyes.wordpress.com/2009/09/24/googleoff/

Side note: This is not all bad news for Banks, as the structure will certainly provide for existing cards (debit/credit) and may deliver substantial revenue through cash replacement (small < $50) transactions. More details on structure of MNO in settlement 2 weeks….

Select Product/Alliances Below:

[youtube=http://www.youtube.com/watch?v=2AmeM33r7wM]

Obopay India – Another Failure?

Posted on by
15

November 12, 2009

http://online.wsj.com/article/SB125774328035737917.html

I read this Journal article today and was very disappointed that marketing spin can now make its way into both academia and the WSJ. Serving the worlds poor and unbanked is something to take very seriously. One of the few areas where I personally make an impact is: directing investment to opportunities.. My attempt here is to cut through the obfuscation and provide , to those that are investing,  an accurate view of Obopay’s current state, and the challenges that lay ahead for those investing in this space.

It is a slippery slope for Academics (like WSJ Author) to start acting like marketing agents. This article is beyond obfuscation.. “Thanks to Obopay, millions of unbanked people in places like Africa and India are having access to financial services for the first time in their life.” I question whether there are more the 100k active Obopay customers globally. Obopay has no customers without a bank account today (credit/debit/ACH), therefore Obopay did nothing to provide this “access”. For example Obopay’s service requires you to enroll online.. nothing quite suited for the “unbanked”.

India is a fantastic emerging market, but Obopay’s success in this market (or any other) is highly questionable. Here are some factors influencing my view of Obopay.

  • Go on Obopay’s website and take a look at the backgrounds of their 8 top execs.. Very “limited” experience in banking, profile seems to be Bay Area software development, or having worked at a card network.  A Payments company should be attracting talent with that has run a payments business.  I doubt you will see this same exec team next year as the BOD makes some tough decisions based upon the progress of the company. (note that since this post they have updated.. thanks for listening.. )
  • Obopay Press releases.. many alliances and awards.. NO CUSTOMERS.
  • Obopay’s US experience. See http://tomnoyes.wordpress.com/2009/10/30/citi-is-out-of-obopay/
  • Obopay’s invested capital http://tomnoyes.wordpress.com/2009/10/13/nokia-moneyobopay/
  • India has some of the toughest regulators on the planet. Its most recent regulation (HERE) in August of this year prohibits non banks from participating in mobile P2P.
  • In India, similar to the US, Obopay is swimming upstream, where regulations require it to tie its products to a debit/credit card and each bank must authorize. For example, Citi only authorizes “send” not recieve.
  • Go to Obopay’s Indian website http://www.obopay.co.in/why_obopay.html.. you will see  “future” services like top-up and bill pay because they are having to morph their strategy due to reg constraints (above).
  • Try to find “fees” for Obopay in India. You won’t find them separate from Yes bank (which goes to scale of use in India.. few customers, and Obopay can’t sell the service separate from a bank/MTO).
  • Unbanked. Grameen Solutions is a fantastic team serving the worlds poor, but their choice of partner in Obopay is not working out. Some of this “blame” could be shifted to the regulations (mentioned above), but the ecnomics of Obopay are just not working for this team. Take a look at http://www.grameensolutions.com/News-Events/. Perhaps Obopay should morph into an NGO ?

Currently MNOs have the best chance of success serving the unbanked (MNOs will rule in emerging markets). Obopay is currently serving banked customers in India and there are many services that the banks currently offer that compete directly with Obopay. For example, in Citi India Citigold/NRI customers could instantly transfer funds to any Citi customer globally (at no charge).

India’s domestic banks also have similar services. Put yourself in the shoes of an Indian bank customer, why would you want to pay 1.5% + 100RS (estimate) for sending money when you could use cash or wait until you gain access to your computer?

Obopay started out as a “cash replacement play” where the sender pays, a model that has not worked well for them. They are continuing to morph their strategy to find a fit…. Banks and MNOs have several strategic advantages here, and will likely compete aggressively in any area in which Obopay attempts to “Brand” payments (to the detriment of existing products and services).  Cash replacement is a win-win area.. stepping beyond that will be challenging for a company whose top execs have no banking background.

For the unbanked, MNOs will be the industry group most likely to succeed as they are the only business that has developed a business model to sell and support unbanked (MNO/Bank partnerships and new regs).  See MNOs Rule in Emerging Markets

Other great Blogs

http://paymentsviews.com/2009/08/06/a-look-at-obopay/

MNOs as Depository Institutions?

Posted on by
2

Updated November 10, 2009

Excellent Background Articles:

Success and value breed trust and loyalty. MPESA customer surveys by CGAP point to desire for MPESA to offer interest on balances. The genesis of MPESA’s success is not something that Banks have seen before (in emerging markets):

  • Cash replacement (without their control)
  • Technology
  • Customer segment – Growth from the LOW end of customers that banks normally serves

Deposit taking, and payments are typically a regulated businesses which banks have excelled. However their past success was serving a customer segment that was far different then what MPESA serves today. Can Banks adapt to the new opportunities service the unbanked in emerging markets? Will new Micro Finance Institutions (MFI) emerge as the principle banking entity? Will MNOs seek approval to offer financial services separate from Banks or MFIs?

In Kenya, the explosive growth of MPESA has put both regulators and banks in a very awkward position. It was originally launched as a money transfer business, and has emerged as an effective cash replacement with an annual transaction volume of over 10% of Kenya’s GDP. Consumers have unexpectedly embraced MPESA, and regulations have had a challenging time adapting (or anticipating) the vector in which it has grown. The regulatory challenge now is “connecting” the MPESA network to the “banking” network and evolving the:  regulatory authority, regulations and controls around it.

In 2005, Kenya drafted the Deposit Taking Micro Finance Bill which was past at the end of 2006.

http://www.microfinanceregulationcenter.org/files/25464_file_Kenya.pdf

http://www.microfinanceregulationcenter.org/files/39171_file_Microfinance_Act_2006.pdf

In addition to supporting traditional MFIs, the Act made it possible for non-banks to participate in deposit taking as an MFI (in the future), and now the first “non-bank” MFI has been accepted (just 3 months ago in June 09).

http://www.microfinanceregulationcenter.org/resource_centers/reg_sup/article/57056/

It remains to be seen whether an MFI license will be granted to MPESA, to extend its money transfer license. A more likely route will be for (multiple) MFIs to be approved to source funds from MPESA (MPESA as payment network)

The Philippines may provide the best example for MNO/Bank collaboration in mobile money. GCASH in the Philippines is the mobile money solution from MNO Global in conjunction with Bank of the Phillipines (BPI).

http://www.bpiexpressonline.com/index/find_page.aspx

Last year Global and BPI partnered in the creation of a new microfinance provider:   Pilipinas Savings Bank

http://www.syminvest.com/market/news/microfinance/philippines-ayala-corp-bpi-globe-set-up-rp%E2%80%99s-first-microfinance-bank-to-help-small-business-/2008/10/31/1322

The Philippines was one of the first countries to develop a comprehensive law in support of MFIs. In 2000, Philippine regulators acted in response to the updated General Banking Law which mandated recognition of microfinance as a legitimate banking activity. Regulators developed a unique set of rules and regulations MFIs as the updated Law declared microfinance as a flagship program for poverty alleviation.

http://www.microfinanceregulationcenter.org/resource_centers/reg_sup

Bank as Depository Institution

Before tackling the issue of Deposit taking in Kenya, let’s discuss the issues surrounding existing (non MFI) banks servicing MPESA customers. Having spoken to several of the key parties in Kenya, the business issues surround: who “owns the customer”,  who is assuming the risk (“money transfer” v. bank ) burden for this connection. For purposes of example, let’s take the KYC requirement in Kenya (as in most countries) a customer sighting (by a bank employee) with valid ID. Kenya has had problems with counterfeit IDs

http://www.standardmedia.co.ke/InsidePage.php?id=1144013210&cid=472&

How should regulators proceed? Bank infrastructure in many parts of the country is immature. There are over a million people that would need to go through the KYC process, most of which do not have an identity card (separate from issues in article above). Should regulators relax the KYC burden? Should money transfer agents be allowed to operate under MFI regulation? In my post below, I’ve outlined a few of the regulatory approaches

http://tomnoyes.wordpress.com/2009/11/01/mnosrule/

I would certainly like additional feedback, but my understanding is that regulators are taking a concurrent track: Updating the MFI regulations (originally designed in 2005), updating the “Money Transfer” regulations as covered within the General Banking Act, approving MFIs to source funds from MPESA (services on the MPesa Network) and defining a new regulatory scheme for mobile money which would touch both banking and telecommunications regulations. Vodafone’s regulatory experience here will likely prove to be a tremendous differentiator in future markets, as their ability to field a team capable of partnering with regulators further enhances their creditability.

(A very broad summary of the issues, apologize in advance for the gaps.) From a Bank perspective, concern is justified over MNOs ability to create a liabilities business. Banks should have the right to compete for these deposits, with a level regulatory playing field. From a MNO perspective, banks have not served these customers in the past. For MPESA, the Banks interest in this segment arose after the MNO developed it. The banks should pay for this “customer acquisition” and servicing, and the MNO should be able to offer products and services that support customers.

MNO Deposit taking

There are currently 3 separately regulated parties that are positioning to provide interest bearing accounts: Money Transfer Services, MFIs, and Banks.  Emerging markets have invested significant resources in defining MFI regulations, however these were drafted prior to the success of services like GCASH and MPESA. The CGAP data in Kenya clearly shows customer “interest” (pardon the play) in using MNO services beyond that which a “money transfer agent” is licensed to perform. However accelerating the attractiveness of these money transfer services, by providing interest bearing accounts, may further exacerbate an already challenging regulatory situation. I would expect to see regulators requesting that MNOs open up/partner with traditional banks (as the depository institution) prior to approving MNOs as an MFI, or enabling traditional MFIs to compete. Interoperability between these licensed entities must be addressed. This view flows out of MNO incentives (e.g customer ownership, high fees for cash out) and current agreements with bank(s) with regard to settlement of funds. With that said, I would expect very little success for traditional banks attempting to provide this service, as it does not align to their business model. A model which will likely succeed is MFIs access to “non-traditional” payment services, as both MNOs and MFIs are nimbal and able to adapt quickly here and support their existing business model. See Western Union example below (in India)

http://www.dnaindia.com/money/report_western-union-takes-mfi-route-for-rural-spread_1299994

The challenges that MPESA faces, while challenging, are extremely exciting as it represents the “Phase 2” success of mobile money in emerging markets. Just look at the rate of change in issues facing service in Kenya today, compared with 18 months ago

http://technology.cgap.org/2008/05/28/can-m-pesa-work-for-microfinance-clients/

Mobile Money: MNOs will Rule in Emerging Markets

Posted on by
19

Updated Dec 15, 2009

Regulators in Africa and India are working actively to ensure consumers (and the global banking system) are protected in the exciting confluence of mobile and finance. Their involvement is completely appropriate given the opportunity to improve the lives of millions of unbanked people around the world. Defining responsibility and the commensurate controls associated with connecting non-traditional (unregulated) networks to highly regulated banks is a herculean effort which may lead emerging markets to remake a “payment system” that is more efficient than that which exists in today’s developed countries. This opportunity for “leap frog” improvements will be driven by the unique path emerging markets are evolving. Key stakeholders will be able to leverage learnings of developed countries, and trials in emerging markets, as they develop infrastructure necessary to support a network that enables both financial services and telecommunications.

Today’s regulatory approach, within these emerging markets, may be best summarized as an “experimental period” with simplified controls. Very early regulations have focused on simplicity by ensuring that the “value” stays within the MNO network, and limiting: balances, ticket size and beneficiaries. By constraining transfer of “value” to well defined  MNO services (ex top-ups) regulators have certainly addressed many risk, AML and audit issues. These early controls have provided time for regulators to review progress and fashion new regulations in which existing regulated entities can comment. This order, with which emerging economies are proceeding, may come as a shock to some in the developed world.

Many believe that this more cautious orderly approach in mobile payment was driven by the unstructured success of MPESA (links below). An estimated 10% of Kenya’s GDP currently passes through this channel.  Governments, banks and MNOs leveraged the learnings of the Kenyan market, first among them is: once a new payment system takes hold, it is hard to change. The alacrity with which MPESA was adopted by Kenyans has caused “a new awareness” among governments and business for both the opportunity to provide access, and the challenges faced in managing it. For regulators, there is a renewed sense urgency for defining the “rules” by which to protect consumers and hold participants accountable. Ex in India below

Vodaphone MPesa in India

Regulatory changes have significantly impacted many investments made to date, with the key example of Reserve Bank of India’s Aug 2009 regulation preventing non-banks from domestic money transfer (destroying Obopay’s P2P plans). Banks have created much friction for the expansion of “pilots” and their capabilities. The banks’ position is that once value is exchanged between network participants, or to another network, that these services compete directly with a regulated “payment system”. So we have a “dance” of 4 parties: Regulators, MNOs, Banks and Consumers. In my discussions, the regulatory approach may be generalized by the following:

A)    Experiment.  Set interim guidelines with expectations that they could be revoked/changed. Communications regulators are driving this approach as they try to assist their stakeholders. MPESA began because of Communication regulatory authorization… not KCB

B)    Review. Require submittal of plans to both communication and banking regulators.

C)    Establish. Legal/Regulatory accountability. Define responsibility and audit guidelines for responsible regulators. For example in Kenya their was very little consumer protections for electronic transactions, the Kenya’s electronic transactions act was just established this year and serves as a model for Africa.

D)    Define Audit responsibility for MNO. May force partnership with regulated bank for clearing and settlement. Set auditing guidelines for MNOs under communications regulations (Monitor/audit payments and transfers).

E)     Constrain. Set limits on MNO services and “value” allowed to accumulate in MNO “wallet”, …etc. Example RS 5000 in India, Prohibit/restrict any bank functions in MNO. ex, No interest bearing accounts.

F)     Isolate. Restrict payments connections external networks. Ex in Africa.. Commercial “beneficiaries/payees” must be approved over a certain volume threshold. (regulatory Instrumentalism). Note: MNOs have addressed this by shifting value to a “regulated” payment (ex. Pre-paid card) and partnerships.

G)    Enforce KYC responsibility for MNOs engaging in payments at Cash in/out points. Example retail partner is responsible for validating identity.

Business Model

It is difficult for established businesses to create effective business models “down market” from their current customer base (see Clayton Christensen – Innovators Dilemma). MNOs may be best positioned to execute, on the mobile money value proposition, given that the “unbanked market” is market that they serve much more effectively today (reputation/brand/service/efficiency), and the fact that “mobile money” is a key to sustaining their growth.  I cannot underestimate this point. For banks serving the unbanked represents a low margin (if not money loosing) value proposition for all of their current products. Similarly, payments are a profit neutral business for banks separate from the lending or commercial services which surround them. Bank product lines are typically not focused on accounts with balances of less the RS 5,000 ($100). In addition, existing Bank systems typically do manage millions of small ticket real time money transfers (think SEPA or Wire) with associated risk, authorization, and AML controls. This “gap” in serving emerging markets is prompting indigenous efforts (ex RBIs: RTGS, National Infrastructure for Mobile Payments, and India Card).

For MNOs in emerging markets, mobile money is aligned to their current business and in fact essential for growth. Allowing “cash in” and “transfer” enables customer usage  through pre-paid plans. For MNO consumers, access to money services provides ADDITIONAL value to their EXISTING MNO relationship (more on this later). MNO success in “mobile money” is assured because the service further enhances the EXISTING MNO business model, a model which the team and infrastructure to: market, sell and service the unbanked is established (and profitable).

The consumer value in mobile money stems from the macro economic transformation that exchange of value provides in moving from “informal” communication to money centered “business” communication. Payments and value may well evolve differently in emerging markets over the next 5 years as payments, telecommunication, regulation and new services establish a unique ecosystem that serves 1 Billion consumers never “connected” to the world’s economy. It is the combination of “network access” and “value access” that provides transformational opportunities to the world’s consumers. This market dynamic leads to transformational “leap frog” opportunities within emerging markets.

MNO Fragmentation

The principle challenge for MNOs to address is in emerging markets is: fragmentation. A large reason Vodafone was successful in Kenya was that they had 80% of share. Fragmentation of consumers in highly competitive mobile markets, combined with conflicting standards, technology and retail partnerships may cause consumer confusion. This chaos is anathema to the “trust” necessary to establish consumer confidence in payments and value storage. For example, in Nigeria can you pay your utility bill on any cell plan? Dominant MNOs will likely race to establish payment networks and partnerships, even in the constrained regulatory environment. Less dominant MNOs will likely look to regulators, standards, interoperability and other mechanisms to level the playing field. It is essential that MNOs get this right the first time, as “trust” is something earned over many years and quickly destroyed.

In emerging markets, MNOs may be best served by attacking “breadth” opportunities first. Very simple services that can have very broad impact, with very little assistance from external vendors may provide better support for immediate growth:

  • Nature of network effects are that you must deliver value to everyone on the network (whether a bank or an MNO). Successful networks must have established physical distribution points.
  • Objective in payments is to establish use and acceptance. Example, receive your pension… now establish a savings account, or send money to your grandson.
  • Trust.. Serviceability, manageability, and risk management in “simple services”.

For Bankers

As a banker myself, I never admit defeat in attacking a profitable market segment. Given that payments are not particularly attractive for banks (separate from the products and balances that support them), there are several strategic options (Beyond the scope of this post.. but which I would love to discuss). In general banks should maintain engagement with regulators and MNOs, and focus on providing services that protect their network and enable access to consumers. Examples:

  • Switching. Extending payment capabilities in existing accounts and networks. Switching between multiple MNO value stores
  • “Participating” on the mobile network. Micro lending through “supporting role”.
  • Risk Management.
  • Partner w/ large existing customers in their participation. Example, Pension/Payroll to mobile plans, or connecting to MNOs to business (retail lockbox on mobile)
  • Managing compliance. Example: Cash out

For Software Vendors (ISVs)

In emerging markets, I would expect to see rapid evolution constrained only by regulation. Expect to see very simple services that can have very broad impact, and support MNOs existing value. A key distribution point for these services are local agents. For those of you in the US, think of these agents as the local “country store” of 80 years ago, trusted members of the community that frequently extend informal credit. Banks in Kenya are just gained access to agents in distribution of their services in order to compete with Vodafone and ZAP.

Many of the “consumer facing” services will require very little assistance from external vendors until the networks mature and value is transfered beyond the MNO network. Example issues for vendors today:

  • MNOs have very solid SMS development skills. Look at MPESA, ZAP, GCASH.. who developed the software behind them? The MNO.
  • Simplicity lends itself to better risk management, a key for reinforcing the “integrity” of a new payment system. Solid risk management is even more pronounced in the face of new regulations.
  • CEO visibility with MNOs, Banks and Retailers. Paying a “US Vendor” for anything relating to a payment function is not likely. Citi mobile teams have built tremendous SMS applications in weeks (sorry Silicon Valley).
  • Government Visibility. In addition to CEOs, governments and regulators are highly involved in addressing the needs of their citizens, whether “unbanked” or “unphoned”. Regulators globally are looking to share learnings from Kenya, Philippines, India, … Banks expect between 600M-800M people will gain first time access to financial services over the next 8 years. A tremendous market, that will be served much differently then banks (and retailers/MNOs) have operated in the past.

This is not to say that ISVs have no role, but rather their role will be supportive of facilitating exchange of value… NOT leading with a brand (ex Obopay). Examples:

  • Government  pension distribution across multiple MNOs
  • Business connection to multiple MNOs payments
  • Businesses clearing settlement, AR integration and reporting
  • CRM solutions for customers, automated response
  • Assist MNOs, Banks and Businesses in compliance and reporting.
  • Bank connection to MNO networks. Ex: micro lending… receive your pension… now establish a savings account, or send money to your grandson.
  • ISVs should look at supporting services in connecting business to this new network.

Related articles


Citi is out of Obopay

Posted on by
4

Nov 2, 2009

See previous post http://tomnoyes.wordpress.com/2009/10/13/nokia-moneyobopay/

Also See post on 11/12 Obopay India – Another Failure?

Just recieved notice today that the Citi/Obopay “pilot” is over… am I suprised? No, at least not with the service termination.  From a Citi perspective, this was a 3+ year pilot without a business owner or business case and only 2,000 cusotmers (this is not a typo.. I’m not missing any 0’s). The original plan was to gain customer insight.  Once Citi invested…. the pilot dragged.. as Citi’s participation provided “value” to Obopay. Key learnings for banks:

  • do this “payments stuff” in your own environment, or manage pilots with a very well defined end date (less then 6 months).
  • Once capital investment is made, heavily involve the supporting Line of business  (note to innovation teams)
  • Set clear metrics for success, and don’t be afraid to pull the plug
  • Ensure customers are aware that service is a  “pilot”. Take a look at this notice below.. move your money out of here in next 2 months. 4 years… not much customer communication on this one.
  • Re: Payments. Banks should think long and hard before they enable the next Visa/MC. Do you really want to outsource payments? (Next week’s paypal conference will lead to some very disruptive stuff.)
  • Fat clients on mobile phones have been a global bust over last 6 years. Sorry Apple (See Apple’s Payment Patent Here).  This fat client failure has extended from mobile payment (Obopay) to mobile banking (see Firethorn is dead). iPhone is potential as a game changer, but Apple (the manufacturer) is trying to create a closed system without banks (Perhaps their brand is strong enough to make everyone ditch their exsting relationships… naa). The best hope for rich applications (FAT CLIENTS) may be NFC, but the MNOs and handset manufacturers are strategically delaying (subject of a future post).

So while the Citi-Obopay service termination is not a suprise, the ability for Obopay to attract new capital (without customers or much due dilligence) is amazing. Carol must be capable of selling sand in the desert. Given my interaction with “some very large” MNO/FSI mbanking heads in US, India, Asia, EMEA, … Obopay’s focus and “success” is much of a mystery (and not much concern). On the positive side they have an excellent marketing/alliance team.

Citi Obopay Service Terminiation

Citi Obopay Fee Schedule

Unbanked: Cash is King

Posted on by
1

Tackling regulatory and consumer issues in emerging markets

While I was consulting w/ regulators and banks in Malaysia, I asked about the penetration of cards. The response from a lead banker was “Cash is King”. This response is a great summary for the key issues facing MNOs, FSIs and Regulators attempting to improve electronic payment penetration in emerging markets. Adoption of new payment mechanisms in developed countries has historically taken 20-30yrs. Emerging markets will surely proceed at a faster pace, but the work to be done is greater given the absence of: regulations, consumer protections, and electronic/physical infrastructure (among both banks and MNOs).

“Cash is King” may be too much of a generalization to extend to all markets, but in Malaysia consumer research indicates there are substantial consumer hurdles for FSIs trying to capture the unbanked population (trust, access points and overall committed to cash chief among them).  For domestic FSIs in SE Asia,  the consumer data shows that  MNOs are better positioned (reputation/brand/service/efficiency) to deliver on the mobile money proposition.  MNO’s position stems from the value that they deliver, with mobile money serving as the principle mechanism to retain access to MNOs services AND move from “informal” communication to money centered “business” communication. MNOs in emerging markets therefore have a unique opportunity to attract consumers to mobile centered “value store”.

Software providers (ISVs) attempting to address the “unbanked” world will face the following challenges:

  1. MNOs are adept at software development. Look at MPESA, GCASH, ZAP, …
  2. Business case separate from MNO is very, very challenging. Payments is a difficult business for banks.. it may be an impossible business separate from either bank or MNO.
  3. No private investment capital. NGO and micro-finance organizations I have spoken with are highly skeptical of technology use for unbanked (even for loan officers). Further, their involvement suppresses margins as government resources are allocated to achieve goals that are not following a profit motive. ISVs will need to make difficult decisions on whether to focus in the “For Profit: of “Not for Profit” areas.
  4. Many willing to listen to your idea, or let you prove out your value.. without much commitment for revenue.

This is not to say that there are no ISV opportunities in emerging markets. Once value is stored in the network businesses will certainly attempt to connect in order to attract and service customers. This is where developed country ISVs have excelled (HK, SG, AU, Korea, Japan, EMEA, …). However, the developed countries had a well established banking infrastructure PRIOR to channels like internet and mobile (with a commensurate evolution in the respective regulatory regime). Within emerging markets the “starting point”  is different (BOTH telecommunications AND banking services are immature) which may result in a different evolutionary path for mobile, banking, payments and regulations. Message to VCs: question your assumptions and adjust your paradigms.

A number of ISVs are attempting to establish a turn key payments system (the mobile money “switch”). However, Banks and MNOs business models are historically centered switching, and hence these established entities are highly motivated to continue control of both the infrastucture and all IP around it (opportunities for ISVs in this space may be limited). Fertile markets for ISVs may tend to be in areas which support either businesses or consumers in mobile commerce. Examples:

  • Hosted service that allows African governments to send pensions to multiple mobile banking plans
  • Text based “comparison” services for consumers,
  • Mobile banking infrastructure (ex: open new account, credit score using social networking data)
  • Mobile “bill pay” services for utilities

Regarding technology use in unbanked… Perhaps “unbanked” is too large of a segment.. perhaps we should separate out sub-groups like  “unphoned”… and consumers that own a phone but are committed to cash only (?traditional unbanked?). Given that some readers of this article may represent NGOs and governments that are focused on use of technology in microfinance, it is important to deliniate segments served by MNOs and MFIs. Perhaps creation of a segment such as “micro finance unphoned” MFU segment is necessary (I would love to see consumer demographic data here). The MFU segment is being successfully served without technology in lending models firmly established (See Grameen model).  Given this “success without technology” NGOs are particularly skeptical of the use of any additional costs (or intermediaries) to serve these consumers. Established (for profit ISVs) vendors will be challenged to create a sustainable low margin business in the MFU space given the influence of NGOs, and subsequent margin compression.

Focusing on “unbanked”, exclusive of the segments above, the entities most capable of tackling the range of issues here are: MNOs, large banks, large retailers, and state agencies. “Trust” is something earned over many years… In emerging markets, I would expect to see very simple services that can have very broad impact, with very little assistance from external vendors for following reasons:

  • Nature of network effects are that you must deliver value to everyone on the network (whether a bank or an MNO). Successful networks must have established physical distribution points.
  • Objective in payments is to establish use and acceptance. Example, receive your pension… now establish a savings account, or send money to your grandson.
  • Simplicity lends itself to better risk management, a key for reinforcing the “integrity” of a new payment system. Solid risk management is even more pronounced in the face of new regulations.
  • CEO visibility with MNOs, Banks and Retailers. Paying a “US Vendor” for anything relating to a payment function is not likely. Citi mobile teams have built tremendous SMS applications in weeks (sorry Silicon Valley).
  • Government Visibility. In addition to CEOs, governments and regulators are highly involved in addressing the needs of their citizens, whether “unbanked” or “unphoned”. Regulators globally are looking to share learnings from Kenya, Philippines, India, … Banks expect between 600M-800M people will gain first time access to financial services over the next 8 years. A tremendous market, that will be served much differently then banks (and retailers/MNOs) have operated in the past.
  • Consumer education…. Simple ( SMS). Side note: Did you know that there is a 20% failure rate on SMS in India? Perhaps this is old data.

Side note… Food for thought.

In this CGAP article, is it really access to “cashless payments” that is the issue? or is it the farmer’s inability to find a market for the goat and safely transfer/store the value? The deaths of the SKS workers are truly unfortunate, but if mobile enables value store, won’t thieves then adapt to this opportunity and force a transfer at knife point? Think of the poor farmer with all of his savings locked in his cell phone, overnight the money disappears. What consumer protections are in place so that he gets access to his funds immediately? Indian regulators are tackling these issues today, issues that the developed world has continued to refine over the last 40 years (for electronic payment).

Challenges for ISVs are many, as MNOs are very adept in software development and any “mobile money” value prop is Asia must be either strongly tied to a bank or MNO. VC is very tight here because compressed margins in payments are further exacerbated by injection of government and NGO money.

Feedback appreciated.