Inside Baseball for Payment and Data Geeks
Sandy Weill’s financial supermarket vision is coming to an inglorious end…. The Blockbusters of Banking…
Last week, in his annual shareholder letter (page 28), Jamie Dimon stated “Banks have enormous competitive threats — from virtually every angle,” he said. “Fintech and Big Tech are here… big time!”
Continue reading “Retail Banking’s “Blockbuster” Moment?”Over the last 20 yrs, most countries have implemented an RTGS system. A CBDC is a generational leap: Money itself becomes an immutable digital object that is assigned and can’t be destroyed or created without the specific direction of the Central Bank.
I doubt if this blog will be beneficial for the crypto and CDBC experts. But for my friends, I’ve linked several very detailed articles and reports… which I’ve tried to summarize.
With respect to payments, let me start with the quote of the week
“Tom look at the pace of change in China as a model. 15 yrs ago they were cash. 7 yrs ago they were China Union Pay, Now they are Alipay/WeChat Pay.. 3 tremendous changes in 10 yrs. I believe change will happen much faster than anyone could imagine.”
– Top 5 US Retailer
Continue reading “Digital Dollar – Biggest Threat to V/MA (and USD Hegemony)”
My quick read on Visa’s acquisition of Plaid
I’m back to blogging after a successful exit last month. The Plaid acquisition is a great way for me to jump back in. Why read this? A key to understanding payments, banking and data is to balance historical knowledge with a network of people that know what is really happening behind the scenes. As the former head of two direct banks, former Senior Director of Oracle’s advanced technology solution’s practice and Yodlee’s first customer I have an informed perspective on the market for this one.
Continue reading “Plaid – Quick Take”Banks/Non-Banks and Commerce Networks (Why I love V/MA)
27 July 2014
This blog has been in 50% mode for 2 weeks! Obviously summer is not my productive time (I must be German). There will be a noticeable change in my blogs these next few months as I work on a newco launch. Blog will therefore focus more on concept, much less G2. This will be a transition piece…
What is the benefit of becoming a bank? Would Paypal buy a bank? That is the rumor… I have no idea on this one.. 0% confidence.. my guess is no way. There are some great payment+bank companies (Amex, Wirecard and Alliance Data), and some great payment non-bank companies (Visa, MA, Stripe, Paypal, …etc). What are the business drivers of becoming a bank? What are the Pros/Cons?
Summary
For those without time to read below, a bank license brings on enormous compliance cost and restricts: what business you can do, how you manage consumers and their data, and what risks you can take. The upside for being a bank? You get to take risk with other people’s money. Simply put, any company contemplating a bank license must have a business plan MORE dependent on managing risk than on orchestrating commerce value. Today there are many bank licensed “specialists” which support non-banks (TBBK, Meta, Alliance Data)… so why would you want to become one? Paypal is on the fence here, as historically they won in eCommerce because of their ability to manage risk (CNP Fraud). Do they want to grow in risk management? or in everything else?
When looking for the right regulatory structure of any company, we must assess their current network plans in the context of commerce AND banking. Not just how your network delivers value today… but rather how you deliver value in the future? Banks tend to make most of their money within their own node, whereas others in commerce are highly dependent upon other partners (manufacturers, distributors, agencies, sales, …). Electronic payment growth and network services are set to grow geometrically, yet payments are very very sticky and hard to change. This is the start up investor conundrum: How do you make intelligent investments in payments/new networks? There are 3 basic options
1) Help others expand their networks
2) Build new networks
3) Build communities with minimal need to network outside of your environment (Facebook, Amazon, Alibaba, BANKS?…)
92% of all electronic transactions are done in the top 10 markets. (Cap Gemini’s World Payments Report is a must read). 90% of the worlds population is not connected to financial services. There is a n-squared dynamic when this takes place.
Many entrepreneurs, journalists and technologists miss THE CORE facet of Visa and Mastercard: a business platform where thousands companies invest billions of dollars. There is no way to compete technically with this business model, rather the ONLY way to “compete” is on value and services. Where Amex has the ability to deliver much broader and richer services (as they own both merchant and consumer accounts), they have a downside: no one else investing in their network (scale/adoption).
My firm belief is that both V and MA have the opportunity to grow Revenue 4-10x in the next 5-10 years. Their principal challenge is to “tilt” their models away from Banks and toward the 2 parties that matter most in commerce: Merchants and Consumers. Payments work well, but so did the Sony Walkman. The bets that Google, Apple, Amazon, Facebook and others are making is on value orchestration (in a new network). Does this involve payment? Not really.. at least not as a primary focus.. Payment is there.. but orchestration is about commerce; payment is just one of many important processes (See blog Payment in the OS). Don’t look at payments as something in isolation, payments are the “connections” made in commerce; they are made for a purpose. These payment connections are rapidly changing from many environmental forces:
Payments = Network
Payments are the connections of the GDP. If we were to map payment flows, we would unlock a map of the global GDP at the micro level, from employment to shopping, behavior and preferences, to demand and supply. Perhaps this is why our government loves payment information. Oh.. the stories here.. (for another time). Free information flow on the internet is enabled through openness and a single primary protocol, whereas payments operates within 100s of proprietary networks with a complex series of clusters and “switches” (there is effort in connecting, authenticating and managing risk). Just as it would be nearly impossible to change the protocol for the internet, it would be difficult to bring abo
ut fundamental change in payments (see Rewiring commerce). Connecting business is much different than connecting information (the core of my NewCo.. but I digress).
From a network strategy perspective, the business opportunity of changing “payments” pales in comparison to the opportunity to influence connections in commerce, banking and manufacturing. Payments support business and consumer needs; they do not alter their path. This insight is the downfall of bank payment strategies around “control”, and their inability to “tilt” toward merchant friendly value propositions.
A top 5 retailer provided my favorite commerce quote “I think of Commerce as a highway, the payment networks are like a toll bridge. I don’t mind paying them $0.25 to cross the bridge, but they want to see what is in my truck and take
2-3% of what is inside. Hence I’m looking for another bridge… “ (See Rewiring Commerce). Google, Amazon, Facebook, Alibaba, Rakutan, V, MA, Amex, eBay all understand this. Rather than charging toll for crossing their bridge, these networks are beginning to execute against plans to grow the size of the goods in the merchant’s truck.
Intelligent use of data increases the effectiveness of the merchants, and in a way that also benefits consumers. Tilting more toward merchants and consumers.. means tilting away from banks. This is VERY hard for a bank to do. It is a change worth making however, as assisting merchants could meant 4x-10x of their current value creation (payments is roughly a $200B US business, marketing is $750B).
My favorite book on networks is Weak Links by Peter Csermely (viewable on Google Books here). If I had one book for you to read this is it. This book is tremendously arcane, detailed, technical, deep.. but I guarantee you that you will have a new view of commerce, banking, advertising, biology, social networks, payments, and society after reading it. In connecting to networks, each of us have limited resources. Therefore optimize our connections through finite set of “hubs” (unless there is some larger orchestrator).
Think about the battle in connecting networks, as each of us have limited resources we can connect only to a finite set of “hubs” (unless there is some larger orchestrator). Examples are Wikipedia and Google… these serve as the directories of information. It is almost IMPOSSIBLE to displace an efficient hub. This is why I love Visa, MA and Amex. If they can shake the issuer legacy.. and add a few merchant friendly services, they could drive 4x of their current value. Specifically, payments is roughly a $200B business, whereas marketing is $750B (in US).
Against this network strategy and services backdrop, there is an enormous transformation taking place in Commerce and Banking. In other words existing networks are evolving their services, as the “hubs” that they connect to (banks, retailers, manufacturers, aggregators, ..etc) undergo change within their “core”. See Remaking Retail, Future of Retail Banking: Prepaid?.
The regulatory/compliance “headache” for payment “innovators” revolve around connecting networks and engaging in non-commerce transactions. I’m not just talking about just small guys.. but BIG ones too (think Google, Apple, Amazon, Walmart, MCX, …etc). Existing networks have an existing value proposition, and many don’t like to have their services leveraged by competitors (see Banking and Commerce: What is the Difference?, Don’t Wrap Me).
Banking Services
This leads us to Banking Services… expanding beyond commerce. This is area is very nebulous because of the complexity of regulatory authorities covering “banking” and money services. Here are just a few of the US regulators
Source – 2012 Dimon Letter to Shareholders
What are Banking Services? Anything the regulators say are banking services. I’m not joking.. this is why I put the Paypal 2002 prospectus at the top. Banks are highly regulated, and the compliance costs are extraordinary. Regulators are attacking all things payments and banking with renewed vigor. Along with compliance constraints, there are constraints on how you can use data. As an example, my online banking team in Germany had to purge the server logs of IP addresses every 30 minutes (regardless of use for fraud). (see Banking and Commerce: What is the Difference).
So what is the upside of being a bank? It’s certainly not the regulation or the mandatory compliance courses forced on every employee. The “benefit” of being a bank is the ability to take risk with other people’s money. Unfortunately, the BIG downside to being a bank, is that data can no longer flow outside of your organization. I cannot understate this limitation.
Banks have much clearer and hence stricter obligations as regards the sharing and protection of sensitive information, commonly known as ‘bank secrecy’. This matches the generally more extensive regulation of a bank, as opposed to the regulation of an ELMI or MSB.
Acquiring a new consumer financial account is hard, even if you get the consumer to create an account with you, you must get them to fund it, or take credit risk on them. These are the problems that banks have dealt with for 100s of years.
Banks have much clearer and hence stricter obligations as regards the sharing and protection of sensitive information, commonly known as ‘bank secrecy’. This matches the generally more extensive regulation of a bank, as opposed to the regulation of an ELMI or PI. Based on the same reasoning why non-banks require less strict regulation for their business and prudential risk involved, it follows that also their activities and also access and handling of certain information and data is restricted accordingly.
Would Paypal Buy a Bank?
Again, I have no idea here, but it doesn’t seem to make much sense. Considering a bank license is like watching flies in your kitchen window: the ones on the outside want in, and the ones on the inside want out.
For long time readers, I put together a blog about 4 years ago covering this topic Payment Startup: MSB or Bank? and US Payment Regulations. As I outlined, there are very few payment regulations covering purchase of tangible commercial goods (this is true globally). We can see the evolution from 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.
How does Paypal operate today?
US
Europe
Asia
I see little upside for Paypal expanding it’s EU bank model to the US, as its current network assets and future opportunity revolve more around supporting commerce than managing risk. Paypal’s current structure and partnerships (with ADS, Discover, MA, GE, …) provide the flexibility to deliver banking/lending services. For Paypal, Bank ownership would only hinder their broader efforts to deliver value to consumer (through data). Alternatively, a bank structure does work for other companies like Wirecard. The Wirecard bank model is a tremendous fit within a network where mobile operators serve distribution channels for financial services.
With respect to the Paypal/Bank rumors, my guess is that there is an “opportunistic” assessment going on .. and that this rumor is just one of the paths they have looked at. I also have a strong feeling that Discover is looking for a “partner/acquirer” that can make use of its network while it is still somewhat relevant. Particularly since its M&A discussions with a top 5 bank 2 years ago did not happen.
6 April 2014
Sorry for the poor flow here. jumping on a plane and wanted to get some of this out. feedback appreciated.
Objective
A brief view on what is happening in global payments growth, debit, banking and data. Why moves here are so important to banking, commerce and payments.
Background
Nothing will dent the 20%+ CAGR of Visa/MA, as 92% of electronic transactions are completed by less than 10% of the world’s population. Perhaps the best analysis done on global payments is from Cap Gemini (2013 World Payments Report). Markets like Asia and CEMEA are growing electronic payment volumes by over 22% CAGR. The network effects are enormous, it is like mobile in the late 90s, or the internet since the mid 90s. No investor can stay out of payments.
Payments is a rather complex environment. I’m not speaking from a technology standpoint, but from a value, control, political and regulatory one. Just as electronic payments are exploding internationally, there are several forces that are acting against established payment networks in OECD markets. For Example
Thus, It is important to view the changes occurring in payments with changes in other networks: social, telecommunication, retail, mobile, supply chain, demand chain, advertising, banking, commerce, education…etc. The lines that separate retailers, advertisers, platforms, MNOs, Banks, … are beginning to blur much more substantially. For example
Historically Banks supported commerce by providing access to capital, support of markets, specialized instruments, all of which created value through their unique ability to manage risk (using their information advantage). Consumers chose banks based upon their physical presence to support the interaction with (and transformation of) different forms of value: cash, check, electronic, …etc, as well as gain access to credit, and provide return on assets. Bank strategists created retail financial “supermarkets” where transactional accounts acted a loss leader to cross sell 100s of other consumer financial products. The majority of consumers never participated in this cross selling effort, and therefore the mass remains unprofitable to these “supermarket” banks.
As cash, and check are displaced by electronic payments, the value of the branch and “supermarket banking” has shifted to the value of electronic payments for a large majority of the population. The information advantage that best positioned banks to manage risk has decayed. Further, the billions of dollars spent in transactional risk management has been eliminated by mobile authentication (see Perfect authentication a nightmare for Banks). Regulators are working globally to open up payments to non-banks (ex EU ELMIs), but conversely holding banks responsible for everything. Governments and Banks have grown addicted to data surrounding electronic payments, leaving many consumers to search for anonymity (ie Bitcoin).
The entities that are currently best equipped to deliver consumer value and monetize data are companies that the consumer most frequently chooses to interact with (Apple, Amazon, Google, WalMart, …). Banks are working from a position of control, and must pivot to a position of value, trust and choice.
A Story….
Most of you know that today’s Google wallet has a central transactional account of a non-Durbin Mastercard (see blog). Google pays each issuer with a card in its wallet the FULL rate on its cards (example 210 bps to FDC/Visa/Chase) and the merchant incurs a debit fee of 105bps. Google eats the cost.. In this model the bank wins, and the merchant wins. The consumer wins because they can put their preferred payment instrument in the wallet (ie Debit). In fact Google is the ONLY wallet that has debit cards in it.
You would think everyone would like this right? NOPE. Banks want Google to stop wrapping their cards. What are Banks upset by?
#1 Banks don’t like Google seeing the data,
#2 Banks don’t want debit use on mobile.. they want mobile to be a premium credit service
#3 Banks want part of GOOGLE’s revenue in addition to their full interchange.
This story should scare the pants off investors in the payment space, Google has invested a billion dollars, takes a loss on every transaction and has a value proposition for everyone. (see blog)
My recommendation to Google? Tell the banks that they can shut you off whenever they want to. It is in their control to decline your transactions. I can just imagine the customer message from Google to a consumer “your bank has decided they don’t like you using your credit and debit card with us, here are a list of banks that you can use, ….” .My recommendation to the Banks? Don’t trust Google with your data, find a way to work with them to accomplish your objectives. I have several ideas for you if you want to chat.
Five important takeaways from this section:
Durbin – What Happened?
As reported Friday (see Bloomberg), the 3 judge panel at the US Court of appeals upheld the Federal Reserve rules, overturning Judge Leon’s ruling that “The court concludes that the [Federal Reserve] Board has clearly disregarded Congress’ statutory intent by inappropriately inflating all debit-card transaction fees by billions of dollars.” and the Federal Reserve failed to ensure that merchants enjoy access to “multiple unaffiliated networks” to process each debit-card transaction, as also required by the Durbin Amendment. Senator Durbin reacted to this Friday stating that the appeals ruling was “a giveaway to the nation’s most powerful banks and a blow to consumers and small businesses across America.”
Retailers and Senator Durbin argue that the clear language of the law directed the Fed to set the price of Debit at “reasonable and proportional to the cost incurred”. The Fed’s internal team came up with $0.12, but the Fed then came up with $0.21+5bps. Judge Leon had struck that fee down in July 2013 (see analysis here). For more background on Durbin and Fed see this this Federal Reserve Article.
Debit – Industry Perspective
Debit is the most frequently used payment product in the US, with the lowest fraud rates (see Charts, and Federal Reserve 2013 Payment Study). Debit is a product that evolved from your Bank’s ATM network. This is why you have all of those logos like NYCE, PULSE, STAR, Interlink, … on the back of your card, and why you also use the card to get cash out of the ATM. I covered this topic 2 years ago in Signature Debit is Dead. Visa’s big innovation was turning their 1987 interlink win from a PIN debit acceptance network to a signature network. By placing the Visa log on the debit card, and forcing the “honor all cards” rule on merchants, they successfully drove network expansion. As the NYTimes outlines
Seizing on this odd twist, Visa enticed banks to embrace signature debit — the higher-priced method of handling debit cards — and turned over the fees to banks as an incentive to issue more Visa cards. At least initially, MasterCard and other rivals promoted PIN debit instead.
Why all the regulation? A picture is worth a thousand words
Clearly the pricing here does not seem to indicate that effective market forces are at work, as debit network expansion was followed by tremendous fee increases.
Canada, Australia, UK, most of Europe have debit pricing of around $0.12. A fantastic analysis of all these countries was done by Europe-Economics in The Economic Impact of Fee Regulation in the UK – June 2013. The universal regulatory goal is to establish (or retain) debit’s role as the central access point for transaction accounts. As in the Australian example, the hope was that the removal of debit fees would result in merchant savings, which would in turn result in consumer savings. Unfortunately, banks successfully recovered most of the lost interchange through new bank fees, and merchants did not pass along the cost savings.
In Australia, 85 per cent of debit card transactions are processed using an EFTPOS terminal. Interchange Fees (IFs) for such transactions are imposed in inverse direction to that of credit cards as they are paid by the issuing bank to the acquiring bank. [Post regulation] Issuing banks suffered from a revenues reduction from IFs worth AU$647m for 2006. However, as in the Spanish case, banks responded to the reduction in their revenue from IFs by increasing the level of other fees. Annual fees increased by AU$40 on average, which for 2006 represent an estimated AU$480m in issuer revenues. As a result, issuing banks recovered 74 per cent of the lost revenue from IFs.
Beyond debit, Europe is considering caps on credit card as well (see Digital Transactions – Europe’s Fee Conundrum). Visa Europe Fee structure provided below for background.
For more detail see my blog Debit Wars. My summary view is that debit payments are going toward a common bank owned service operating at cost (Average $0.12 globally). Visa is impacted slightly here as 19% of revenue is from debit. Thus banks are working aggressively to move payments to high margin credit.
Retail Banking Impact
This debit dynamic plays heavily into a larger retail banking strategy (see Future of Retail Banking, and theFinancialBrand). The business of managing your transactional account was never a great business for a bank. Gallup estimates that retail banking is unprofitable for 80% of consumers, McKinsey’s analysis shows it is over 40%. Durbin’s impact on debit fees cost US Retail banks over $7B (see Forbes).
Branches have historically been the #1 factor in consumer acquisition. During my time at Wachovia, over 80% of our customers selected us because we were the closest branch to home or office. This branch convenience is still the primary factor, although actual use of the branch has gone down dramatically.
This, together with the maturing of digital channels, has led to a culling of branches with banks like Chase looking to take upwards of $1B from branch cost.
The US is progressing along the lines of Australia, as the non-exempt banks add new fees to make up for the debit loss (see American Banker). However, unlike Australia, the US has 2 alternatives: Exempt Banks/Credit Unions (CUs), and Pre-paid Cards. Deposit growth in the exempt banks is growing 5-6% YoY, but the real winner seems to be pre-paid with growth over 36% (See 2013 Fed Payment Study and Bank Innovation ).
My simplistic analysis of pre-paid is that the growth is driven more by a need for access to electronic payments (by the unbanked), than a need for “banking”. Example.. need to buy something on Amazon. This seems to fit well with experience of other unbanked success stories globally. A way to view this is that value of traditional “banking” is shifting to the value of electronic payments for a large majority of the population.
What we have seen is that the Value of a big bank brand is diminishing very quickly. The brand, infrastructure and data advantages that banks held are rapidly diminishing in value. The big buildings and beautiful vaults have no advantage over an Amex Bluebird card in a box (deposit insurance levels the field for everyone). Retailers, MNOs, and Platforms have better brands, better pricing and more physical distribution and/or direct consumer “touch” than banks could ever hope for.
Nothing in this area changes quickly. But here is what I see as the most likely strategies by key players.
Non Exempt Banks (Citi, JPM, BAC, WFC, …)
Strategy #1 – Try to leverage data advantage, and grow data services (JPM)
Strategy #2 – Go up market (Citi)
Strategy #3 – Be the best retail bank (BAC/ WFC). Protect consumer information
Strategy #4 – Get into the Mobile/data/advertising space
Strategy #5 – Develop new bank lite product (ex Chase Liquid). Seems to be going poorly as they just killed the product
The modern form of retail banking envisioned a “financial supermarket” (see Forbes Sandy Weill) where the transactional account was a loss leader for cross selling 50 odd other products, the new “banking like” product is centered around electronic payments with an access network (think Greendot, WU, ATMs, …) to get money into and out of the system. Ubiquitous merchant acceptance, and employer direct deposit further drives out the need to provide “cash out” facilities (branch like services) within the network. This simple payments product fits nicely into retail environments with regular foot traffic.
The Non-Exempt Bank dilemma now becomes apparent. A classic “innovators dilemma” where the loss leading core deposit account has been undercut by pre-paid for a majority of consumers, as the services surrounding electronic payments has made branch distribution a significant millstone in cost to serve. As if that weren’t enough, 90% of the money supermarket products must be sold face to face (need a branch). While the retail bank could adapt to compete, the rest of the organization is forcing it to keep the branches and move upstream to the affluent high margin clients.
Tech Companies
The biggest news for payments investors is that Apple, Google, Amazon DO NOT want to have their own payments network. They are all consumer CHAMPIONS.. They all want the consumer to have their CHOICE of payment instruments “Let the consumer decide how they want to pay” is their common mantra. I heard again this week that Google wanted to buy paypal and I spit out my coffee laughing.. “where did you hear that bullshit?” Not only is this a regulatory headache, it is not the centerpiece of how any of them make their margin. Customer choice is highly disruptive barrier to entry in a commerce/mobile platform. This is why Apple’s BOD decided not to buy Square in Jan/Feb.
Apple: Consumer Champion and Gatekeeper
Apple is setting itself up as the consumer champion. They are not great at partnerships, advertising, data… but they are great in just about everything else. Apple’s will keep your data safe in the phone, in the store and in the cloud. Consumers anonymity will be protected… even wi-fi tracking will be nearly impossible. UUIDs are a thing of the past for advertisers. If you want to know who an apple iPhone customer is.. you will need to work with Apple.
Apple is well positioned to benefit from the future tsunami of issues concerning data privacy. They are most focused on adding value to the consumer.. rather than retailer, advertiser or bank. They have the best consumer demographic on the planet and you will work with them in their model if you want to play.
Funny story here. The big banks were approached by Apple a few months ago to “pay” for getting their cards into the new iPhone wallet. The banks immediately called up V/MA and said “you guys are going to let Apple PATENT the process by which my card goes from their phone to the POS!!?”. Hence the rushed joint announcement on tokens (see PR here). Yep.. Apple made that happen. The funny part comes in later.. Apple now has some small changes to accomodate new V/MA standard but the banks ask apple.. “we would really like that biometric.. can you send it to us”… my guess at Apple’s response “price is the same as card registration we told you before announcement”.
Consumer Champion.. but with all of your data too. Much less robust security plan, but the best in class company for orchestration. See blog for detail. Google is attempting to work with Retailers, banks and advertisers. They are proving their value to consumers everyday with services that help them gain more consumer insight which in turn feeds better services. Google has no desire to be a bank, or a retailer… their value is in bringing everyone together. Just like apple, their fist priority is to the consumer.. everything else flows from that.
Retailers
… will need to make this a part 2. Obviously retailers differ on consumer choice just a little..
23 Jan 2014
First off, congrats to the T-Mobile, Bancorp and Blackhawk teams. I love this product and the unique capabilities of the team that put this together. https://t-mobilemoneyservices.com/
What is the value proposition?
As I’ve stated previously, the bottom 40% of mass market retail banking accounts are no longer profitable for the large banks. New banking regulations (and regulators) have eliminated fees like NSF as well as Debit interchange for the largest banks. I covered most of this in my blog Future of Retail Banking. The top tier of banks are actively running away from the lower mass segment, and working to drastically reduce the cost of servicing. For example one Top 3 bank CEO I met with was looking to take $1B out of branch costs in next 3 yrs, by actively working to push consumers into mobile/online.
In one of my oldest blogs, MNOs Rule in Emerging Markets, I laid out the basic business case for Telecos to enter banking. Where Banks are burdened by a physical distribution network of branches that only sell banking products, MNOs (and Retailers) have physical distribution which can be leveraged to sell many products. In fact MNOs and Retailers can offer banking services at cost and still create a sustainable business case as banking/payments enhance foot traffic and loyalty. MNOs have a better short term prospect of delivering these services in the US as post paid customers go through a credit check process, thus consumer sighting and credentialing are very similar to what is necessary in opening a bank account (see my MNO KYC and Who do you Trust blogs). Add to this MNOs unique capability to enhance fraud controls in payments, and you have a set of VERY unique business platform that exceeds what a bank can deliver.
Prepaid?
My blog 2 years ago Future of Retail: Prepaid? spelled this move out.
…the business case for pre-paid is rather strong, and Banks themselves are assessing if they can make this the new “starter” account (ex Chase Liquid). However Three Party Networks (Discover and Amex) have a significant advantage. From Digital Transactions, March 2012
While the Federal Reserve’s rule implementing the Durbin Amendment has its greatest effect on traditional debit cards, it affects prepaid cards too, especially its provision that banks’ prepaid cards can avoid Durbin price controls only if cardholders can access the funds exclusively through the card itself. That provision thwarted banks’ efforts to make prepaid cards more like demand-deposit accounts and led them to scale back or end bill payments through prepaid card accounts.
But American Express and Discover are not subject to Durbin’s controversial provisions, Daniel and Brown noted. Both companies are so-called “three-party” payment systems that function both as merchant acquirer and card issuer. In contrast, Visa and MasterCard debit and prepaid cards are part of “four-party” systems in which the issuer and acquirer are usually different companies and rely on the Visa and MasterCard networks to route transactions among them. The Durbin Amendment exempts, or “carves out” in industry parlance, three-party networks from its provisions, including interchange regulation.
“There’s no restriction on what AmEx can pay itself” for prepaid card transactions, said Brown. Thus, AmEx and Discover have a new opportunity to grow their prepaid businesses, the attorneys said.
Clearly Discover (DFS) and American Express (Amex) have an opportunity to “Kill” prepaid cards, what are they missing? Physical distribution, service and reach in the mass market. These are the very things that retailers like WalMart can provide, and in fact economically benefit by providing them.
T-Mobile may have started this project as a result of Deutsche Telekom’s WireCard Success. Proving that it is not just emerging markets where Teleco’s can lead. In my view there are now 4 solid models for US MNO/Retailer as Bank (see and MSB or Bank)
1) WalMart/Bluebird through Amex/Serve
2) TMobile/Bancorp (DT/Wirecard) in Visa Product
3) Target .. Obtain the Banking License Directly (see Blog)
4) Prepaid non reloadable
Amex/Serve is the Leader, Bancorp #2
Why? Best example is the Chase Liquid Reloadable. Because of the Durbin constraints on funds access Chase had to pull Bill Pay capabilities from the product. Because Bancorp has under $10B in assets, it is exempt from this provision (?apparently) and can provide bill pay. However if I was an MNO, or Retailer, I would lean in strongly toward Amex (and to a lesser extent to Discover). Bancorp is the best pre-paid issuer to work with and is winning through hustle…
Prediction Big Future for Discover
TMobile may represent a tipping point for retail banking in the US. Now it is not just Walmart/Bluebird… this is a real business model that enhances a core telecom value proposition AND provides a tremendous launch platform for REAL PAYMENT INNOVATION. This together with the launch of MCX will provide the mass market with new products, not all of which are understood by the customer (ex Direct deposit my paycheck to my mobile phone company?).
The advantages of 3 Party networks are beginning to hit the market in REAL products, and I therefore predict that Discover will see a few MAJOR new partnerships, or be acquired in the next 18 months. All of this is somewhat ironic given that the ORIGINAL ISIS consortium was ATT WalMart Barclays and Discover.
21 Nov 2013
Warning… long blog.. random unstructured thoughts
This is the question I came up with in a lunch chat with my friends at Omidyar Network and not exactly something I can adequately address in a blog, a book, or a lifetime.. but hey some idiot like me may as well throw it out there.
Why am I asking this question?
My investment hypothesis is that Banking and Commerce will be undergoing a fundamental rewiring. Therefore I’m wondering who the winners will be? What needs to be built? What are the signs that progress is coming? These are my selfish drivers.
On the altruistic side, how can we massively expand the global economy? Enable millions of businesses and billions of consumers to participate in the world economy? Within emerging markets, which is more important to invest in? Banking or Commerce (see blog Expanding Global Economy).
Where am I coming from? Network View
Well I’m certainly no economist, but I do know a few things about networked businesses. How are Banking, Commerce, Society, Government influenced by network effects? How has it evolved?
One of the most influential books I’ve read on this topic is Weak Links by Peter Csermely (viewable on Google Books here). If I had one book for you to read during the Holidays this is it. This book is tremendously arcane, detailed, technical, deep.. but I guarantee you that you will have a new view of commerce, banking, advertising, social networks, payments, and society after reading it. Example below on Peter’s insights into how the creation of money altered society, established “weak links” and Capital Markets (p 263)
Wow… just when I thought I knew everything about payments. The advent of money led to the development of concept of PERSONALITY!? (Certainly a new way of thinking about networks). The idea that increasing use of money drove new social and economic structures is obvious; less obvious are the connections formed, the “weak links”, beyond the flow of funds: non monetary data, relationships, reputation, …etc. I prefer to think of this “personality” dynamic, within weak links, as behavior (as influenced by Malcolm Gladwell).
These “weak links” represent the world’s most complex network, and this network is going through a FUNDEMENTAL change as communications networks have greatly improved the efficiency of network creation to a near frictionless flow information. There are 2 fundamental questions for me here:
Most surprising to me, within Peter’s work, was the idea that scale free distribution (completely open networks) is not always the optimal solution to the requirement of cost efficiency. For example, Peter states in his book
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.
Therefore, there is a case to be made for specialization and “semi open” networks when it comes to COST efficiency. Logically, the boundaries for star network size are associated with the value of connection exceeding the cost.
Given the complexities of weak links discussed above, we can see (from a networked view) why managed economies (like the old USSR) lost to social structures where dynamic networks could be formed on value. We can also see how consumers at the bottom of the pyramid are more heavily influence by the the few links they have (ex social programs, corrupt dictators, populists, …etc).
This all leads to a question for us, as a society, where should we try to “centralize” services and functions? Would it be better to provide the tools to “connect” and educate the mass market on how to discover services (ie value, reputation, price, …)? Or force everyone into a network with no other options? (Sorry for the Healthcare tangent).
Star networks naturally occur, but they also occur artificially. Banking has both dynamics, as connectivity and strong links are required for efficiency. Banking System’s network dynamic is also strongly influence by regulation that manages the connection and the information flow. What would an unmanaged banking system look like? This is what we see today in BITCOIN.
US Bank regulation impacts participation, services, value, location, communication, … etc. In a world of free information flow, should consumers have a choice? What choices should they have? The need of government is to track financial information for the purpose of taxes and management of economic activity. The need of consumers is to connect to the economy efficiently. Thus star networks exist both as natural (self organized communities) and unnatural (regulated services, dictatorships) phenomena.
How do consumers select a Bank? Well back in 2006 we commissioned an analysis and found that branch location (convenience to home/office) was the number one factor in consumer bank selection. In the last 2 years we have seen a SEA CHANGE as US banks now work to thin out their branch network. Many drivers here, but it certainly doesn’t help that the fee restrictions from Durbin led to a consumer banking environment where the bottom 40% of consumers are no longer profitable (see Future of Banking).
Where are these bottom 40% going? Pre-paid (see Bluebird). Although Banks don’t want the bottom 40%, they also don’t want Walmart to succeed. Retailers like Walmart love these consumers, as they are their core. Banks products are becoming “banking lite” services productized and sitting on a retail shelf to buy. Pre-paid “specialists” have thus materialized, and established players hate the idea that consumers will to think of bank services in this light (a product which can be bought.. and switched). Of course it makes sense to ask your regulator from protection against consumer choice, but this is certainly not to benefit the consumer.
How do consumers select a retailer? Not all commerce is retail, and I can’t possibly do justice to answering this question. The CEO of Safeway also outlined how 80% of any given Store’s customers were within a circular proximity of his stores, and that store location was driven by density/competition/demographics. However, this is convenience selection process is NOT the dynamic with Amazon or Walmart. It would seem that the value of connecting to Walmart and Amazon is different for certain population groups. (see Future of Retail).
Quantitative Data
Big picture first. How can we measure “networks”? Perhaps the real question is what are we trying to find. We could look for efficiency of the network itself, or the financial health of the nodes, or the scale (number of nodes). The last one makes little sense as everyone participates in Commerce and Banking to some extent.
With respect to Banking and Networks, NYU’s Thomas Philippon published jaw dropping research detailing how Payments and Banking are one of the few network businesses in the HISTORY OF MAN to grow less efficient (rail, telecom, energy, …). Consumer banking examples are plentiful: is how can the banks justify paying 0.2% interest on your savings, but charge you 15% on your card? (See Future of Banking: Prepaid..?). Obviously regulators are protecting bank margins, with some Bankers ACTIVELY discouraged from rate competition. This is the DEFINITION of regulatory capture (regulators DISCOURAGING 
consumer competition).
Commerce is far too broad to generalize. It encompasses manufacturing, services, retail, infrastructure, rules, codes, …etc. Logically improved information flow should improve transparency, improved transparency should lead to improved consumer choice and growth of specialists focused on serving ever smaller niches of demand. We certainly see this dynamic today in HighTech manufacturing (Cisco, Samsung, Apple, …), US capital markets, telecommunications, professional sports, ..etc. How can we measure this? One of the best scholarly articles I’ve read on networks and global commerce is from Humels, Ishii and Yi (See paper as published by US Federal Reserve). From the abstract
Using input-output tables from the OECD and emerging market countries we estimate that vertical specialization accounts for up to 30% of world exports, and has grown as much as 40% in the last twenty-five years. The key insight about why vertical specialization has grown so much lies with the fact that trade barriers (tariffs and transportation costs) are incurred repeatedly as goods-in-process cross multiple borders. Hence, even small reductions in tariffs and transport costs can lead to extensive vertical specialization, large trade growth, and large gains from trade
From a Commerce (Manufacturing) network view, over 30% of export growth was fueled by network effects associated with specialization. These effects (growth) were highly correlated to trade barriers (ie, network friction) and infrastructure (payments, commercial banking, transport, logistics, communications, …etc).
How has information flow impacted Retailers? Net Margin in retail has taken a nose dive (from 4.2% in 2006 to 2.8%, see data by industry from CSI market). Retailers have no one to protect them from the forces of competition (ie Bank regulators) and therefore have a much tougher job as they work to sell commodity goods at the highest possible price, in a world where they don’t know the consumer’s name (see Retailer CRM). It seems obvious that data transparency (ex show rooming) and new networks provide price and reputation information and that consumers are changing behavior.
Commerce and Banking
Summary: the only difference between Commerce and Banking is REGULATION. Banking is a highly regulated activity…. Commerce is not. Providing access to financial services is a much harder problem to crack because of local regulatory hurdles (see my notes on MPesa and Reaching the Unbanked).
If commerce, networks, banking, government and society are evolving how SHOULD we change our artificial structures (ie regulation, government, …etc.) to support? Have we reached an apex where the pendulum will swing quickly from centralization to hyper democracy? And hyper capitalism? Where SOCIETY creates and evaluates rules which are established based upon their aggregate network effects, not on lobbyists, politics and junk science?
The most immediate areas impacted are those networks that do not deliver value, as barriers to entry and switching costs are overcome value and scale of alternative networks and new business models. 200 years ago we could walk into our local country store and ask the shop keeper to put our purchase on our account. We could barter for goods and services. Today, the regulatory hurdles for a store to provide this simple service are substantial.
Banks, manufacturers, retailers, service providers are all capable of issuing credit based upon identity, reputation, history, use, …etc. A home builder could take on the ability to sell, lend, lease and repair a home. Yet the enormous regulatory requirements on selling, lending, leasing inhibit the viability of this vertical service integration.
With respect to payments, as my friend Osama outlined to Tim Geithner, what if the future of payment profitability was driven not by interchange, but by the flow of data? What if Apple were to give away new iPhones, with free connectivity, with the provision that they share data on preferences and behavior? This is NOT some future state, these discussions are happening today. We tend to view these discussions in context of the companies, products and structures that exist today (ex. how could Visa enable this?). Yet existing networks have proven an inability to adapt, as they were formed around an existing value proposition in which each node became “attached”. If you change the core service, you change the entire network.
The inability of other networks to adapt is FAR less concerning to me than regulation that will destroy innovation and create artificial PROTECTIONS around existing structures. In the example above, what if the government mandates controls around PII making the prospect of free phones and free data non-viable. Who wins? Consumers gain increased protections on their PII, but loose a service. Should they not be able to make this trade themselves?
Another example is Prosper in social lending. A great example of innovation which was “guided” by the SEC to become a securities dealer (see Wikipedia, Crowd Sourced Credit, and my blog on Reputation). Now every loan must be registered as a security (see example) . This may be the right thing for us to do as a society, transparency and auditing are valuable functions which increase the flow of capital and efficiency of a market. But must we be required to submit to these regulations when we want to take on another type of risk? Having the government certify “accredited investors” or “accredited borrowers” may be best as an optional service that must prove its value.
In the emerging markets we see the MASSIVE success of MPESA. With few exceptions (Philippines, PK, Colombia, Peru, Ghana), we see every other country working to ensure this DOES NOT happen in their market. India is at the top of my list of offenders, where entrenched bureaucrats and regulators work to protect domestic banks at every level, regardless of the potential macro economic benefit (review IMPS for example). Beyond banking the same dynamic plays out in Commerce as well capitalized companies like WalMart are hammered for making unapproved INVESTMENTS in infrastructure (see WSJ).
Clearly the pain point is around banking, but it is not something that banks alone can address as they themselves are regulated, it is a regulatory issue (see US Payment Innovation and Regulation). Europe has done a fantastic job addressing the regulatory issue (within the ELMI construct, SEPA, …etc.), their problems are around nanny state consumer protections and EU rules do not make their way into domestic law or regulations. A government that protects against everything, inhibits free association, consumer choice and the assumption of risk. (now I sound like Milton Freedman).
“Many people want the government to protect the consumer. A much more urgent problem is to protect the consumer from the government.”
― Milton Friedman“Government has three primary functions. It should provide for military defense of the nation. It should enforce contracts between individuals. It should protect citizens from crimes against themselves or their property. When government– in pursuit of good intentions tries to rearrange the economy, legislate morality, or help special interests, the cost come in inefficiency, lack of motivation, and loss of freedom. Government should be a referee, not an active player.”
― Milton Friedman“The society that puts equality before freedom will end up with neither. The society that puts freedom before equality will end up with a great measure of both”
― Milton Friedman
Platforms
Just as use money enabled a specialization and concept of “personality”, telecommunications is opening up a new world of free form association, both business and societal.
Open Source is a model most of us are well familiar with. (further reading… I ran across a very nicely done paper from 2 MIT students: Implication of Open Innovation and Open source to Mobile Device Manufacturers). Given that mobile, advertising and payments are all networked businesses… business models supporting distributed innovation should advance at a faster pace than those controlled by a single entity. For example, Amazon, Samsung, Motorola, LG, HTC, Verizon, ATT, Vodafone, .. all make much larger investments in the Android platform (than in IOS). (I would love to see an analysis of combined capital investment in android platform)
From my blog Stage 4 Value Shift
…this distributed innovation hypothesis is NOT playing itself out (ie Apple). Apple’s 1Q12 showed iPhone revenue alone was $24.4B, which is bigger than all of MSFT revenue combined. Analysts have shown that Apple now garners 75% of mobile handset profits, with only 9% of handset market share. So while Samsung alone has outsold Apple in Units this quarter (41M vs. 32.6M), and Android just topped 50% market share (vs Apple’s 30.2%).. Apple’s handset business PROFITABILITY dwarfs that of all of the competition (COMBINED).
So… What are the factors of competition today? Can someone else change the game?
The big downside in distributed innovation is complexity, there is a need for a “channel master” or chaos reigns. Many Android users witness this chaos when an app won’t work on a new hardware/OS combination.. Distributed innovation is not something that established businesses are good at. It has proven most successful in product PLATFORMS where the pace of change in each component is changing at a rate where no one company can make the capital investment to remain competitive (ex. Moore’s Law, PC architecture through present day). Intel played a very important role in this process, as it worked outside the scope of the CPU in areas such as: Intel Architecture Lab (IAL, developed common standards like PCI), stimulated external innovation (developer training, testing, Intel Capital), industry marketing, patent/licensing. Intel defined what the PLATFORM was.. something that is common sense to us today.. but rest assured it was not given to them, rather it was something that they stepped into and took leadership of.
From Delivery to Discovery
Commerce and banking have many effective platforms to coordinate supply chains and payments. Today the nature of commerce competition is on quality, price and distribution (delivery). What if the nature of competition shifts from delivery to discovery? Shifting the model by which “weak links” are established today. Today an individual must sift through mountains of search results and travel sites to find the best deal. We see complete garbage in banner ads and TV.
Who can proactively help you form networks of value, and expand how consumers manage their network, identity, personality? Most would agree that Google is best positioned here. I’m also very excited about the prospects of a company I’m incubating in this space. Ok.. this is getting off track quickly
Summary (I just finished reading a few of the federalist papers last night.. so pardon in advance).
The key for global economic growth is allowing individuals, and companies, to assume risk. The lines between Commerce and Banking SERVICES should blur, and start from the Commerce side as regulated intuitions have an unfair advantage in their protection. New networks provide for free form associations, and will improve in their ability to organize as platforms mature. These networks are capable of higher forms of risk mitigation, but are throttled by bespoke institutions and regulations. Bitcoin is perhaps the best example of a disruptive force to hit banking. Europe is proving to be a role model in banking regulation, but their innovation in financial regulation has been offset with a local enforcement and complex environment where consumers cannot assume risk.
My message here is for Governments and regulators as much as it is for innovators. We must allow consumers to make decisions for themselves, and avoid regulating every behavior or government centralization and control will tend toward tyranny that is unaccountable and unchangeable.
