Evolution of V/MA – Moving Beyond Card

The Role of Operating Models Standards in Enabling Networks

Today’s blog is part 2 to my 2016 post Transaction Costs and Value Orchestration in Commercial Networks. The “Big Picture” questions I’m trying to answer today are: 

  1. How are bank products impacted by expansion of network services and change in consumer behavior?
  2. How likely is it that there will be an end run around V/MA or a new operating model that competes with them?
  3. Given banks are the creators of the most successful commercial networks, what actions will they likely take?
  4. Is there a new model (ie DeFi or CDBCs) that completely changes how we think about networks and money. 

Summary

  1. Operating models are the core components of all successful commercial networks
  2. Banks are have a proven track record as the leading creators of successful networks. 
  3. Standards alone are a double edged sword that don’t necessarily result in the best products (ex VHS vs Beta). Thus industry standard working groups like FDX are of little value without an operating model that defines roles and responsibilities, and an operating entity that can provide certification, audit and enforcement. 
  4. Sepa, PSD2 and Open Banking are regulatory constructs: operating models without economics. As such participant alignment is limited and enforcement is compliance driven. 
  5. Current banking products/customers are under minimal threat. However unbundling and the growth of alternative networks/providers should prompt bank assessment of expansion of V/MA beyond card. 
  6. In addition to the expansion of V/MA, the structure of money, trust and hurdles to starting a bank are changing (Crypto, DeFi, CBDC, Identity/Authentication, ELMI,  … etc). 
  7. Banks exist to manage risk between commercial and financial interactions. As the original data businesses, their advantages have atrophied. Products are becoming unbundled. Entities with the most frequent consumer touch are winning. 
  8. The largest incumbent banks seek to retain economies of scale (think IBM and Innovator’s Dilemma). These banks are likely to view changes as something they alone are suited to manage and adapt to.  Historically, friction was a driving force of profitability. It is likely to change very quickly. 
  9. Bullish long term on V/MA service expansion. They have established clear momentum and are advancing multiple areas concurrently. 
  10. There is a bank business case for a new bank entity. It is not focused on cards, but rather in how to enable banks to play a supporting role in consumer interactions. 

Background

Banks are authors of the most successful commercial networks: Visa, Mastercard, SWIFT, UPI, Interact, EFTPOS, TCH, …etc. A core innovation for the dramatic success of these networks is the collaborative operating model and its trust structure. I credit the creation of this structure to Dee Hock (Visa founder/CEO). As outlined in “Father of FinTech” blog by Marc Rubinstein:

Hock’s first big idea was that the solution to the problem faced by the licensing system was organizational, rather than necessarily operational. He envisioned a new type of organization:

    • What if ownership was in the form of irrevocable right of participation
    • What if it were self-organizing
    • What if power and function were distributive
    • What if governance was distributive
    • What if it could seamlessly blend cooperation and competition
    • What if it were infinitely malleable, yet extremely durable

A common operating model with shared ownership meant banks: 1) had a seat on the board, 2)  products, operations and compliance requirements were approved by bank participants in operating committees and working groups, 3) there was auditing and reporting of all participants/ functions and 4) there was a common brand, standard and marketing platform to create trust. Standards and message sets flowed out of the organizational design and operating model. New services in these networks were limited, because operating model updates required broad consensus. 

Today however, Visa and Mastercard own the operating model, and have undertaken a broad expansion of network services (beyond card). Rather than seek consensus in bank operating groups, networks push mandates (CHIP, tokenization and AFT/OCT – example mandate). Payment networks are quickly transforming into the only global ubiquitous connectivity infrastructure. They enable assembly of banking services and ubiquitous connectivity to every bank. A network of networks

Network service expansion is moving at lightning speed, in many directions simultaneously. They have established momentum with a large community that is now dependent upon their expanded role. A partial list of Acquisitions is below. Beyond the acquisitions, V/MA are also among the largest FinTech investors with over 100 investments spreading across: B2B, Remittances, Open Banking, Tokenization, Data Services, Merchant Services… etc.  

    1. B2B – Earthport, Vocalink, Net A/S, Vyze, +9 others …etc 
    2. Remittances
    3. Fraud and Risk
    4. Open Banking/Aggregation – Tink, finicity, …etc
    5. Tokenization
    6. Merchant and Data Services

This service expansion success is a surprise. I previously wrote that networks become more rigid as they scale, I no longer believe this is true of Visa and Mastercard. Quite simply, I did not believe Banks would comply with mandates (see my old VMT blog). While there is a clear case for banks to develop a new network for the services above, no progress has been made in constructing a new operating model that encourages shared investment. 

The card product was simple, and something the banks could completely own. New opportunities for bank service expansion do not look the same as cards. As banking becomes unbundled, banks will participate in a minor role as service provider. This “supporting role” is much harder to build consensus, and drive a new collaborative operating model.  However, Banks need a structure that enables consumers, OEMs, merchants and FinTechs to connect to them consistently. The battle isn’t about a V/MA alternative for card, but rather a V/MA alternative for service expansion. A few examples

    •  Apple launched new service that enabled the iPhone as a mobile payment acceptance terminal was enabled the new VAC service that changed the rules on POS terminal certification (see my blog). A 2 year device certification process was just eliminated.
    • BNPL – Integrating credit into a product price promotion strategy (see blog)
    • Metaverse banking – see The Financial Brand article
    • Connected car payment. Car manufactures are looking to enable Tesla like experience in integrating payment for charging stations (Visa Article). 

Are Banks Threatened?

While there is little near term threat to existing banking products or customers, the growth trajectories of new products/networks (PIX, UPI, Alipay, BNPL, Crypto, DeFi, CDBCs, Metaverse, …etc) should cause FIs to assess how they play/partner/compete. As I outlined in The New Economy,  Value is shifting from platforms executing transactions to entities coordinating interactions (orchestrators). 

Banks have lost their data advantage to these orchestrators. Banks are the original data business, the cornerstone of bank profitability is risk management (see blog). Read this 1970 Wharton paper excerpt below. Can banks retain a role? Not in the DeFi, or Web 3.0 world.  

“Financial institutions exist to improve the efficiency of the financial markets. If savers and investors, buyers and sellers, could locate each other efficiently, purchase any and all assets costlessly, and make their decisions with freely available perfect information, then financial institutions would have little scope for replacing or mediating direct transactions. However, this is not the real world. In actual economies, market participants seek the services of financial institutions because of the latter’s ability to provide market knowledge, transaction efficiency, and contract enforcement.?

While there is no near term threat, the nature of banking competition is changing from economies of scale (asset intensity) to information intensity (see blog) and value orchestration. Banking products are becoming unbundled and delivered by non-traditional FIs, such as: Chime, NuBank, SoFi, Klarna, and Affirm.  To participate as a supporting service provider (unbundling), banks must externalize their services within a consumer experience that they do not own or control. 

Of course banks are reluctant to undertake this, thus Plaid/Finicity(MA)/MX aggregate the bank data with no operating model (see Plaid blog). Thus data leakage further accelerates and diminishes the opportunity for banks to intermediate.  

For example, as founder/CEO of Commerce Signals we had exclusive access to key payment data sets for privacy centric distribution to advertisers. The payment data, plus SKU information, was leaking out of retailers and into Google/Facebook before you could get into your card (see blog). 

Banks compliance responsibilities have restricted their ability to share consumer insights or combine their data with external information. Banks ability to act on insights is thus limited (see blog – Banks pull data from CLOs).  Google, Facebook and FinTech’s virtuous cycles allow bank competitors to act with: 1) a data advantage, 2) reduced regulatory/privacy restrictions (non EU/GDPR) and 3) consumer and counterparty collaboration (see Banks as a Data Business, Data Games and Changing Economics of Payments). 

The payment networks have grown to be enablers of change while most banks have created friction (see NFC Times). As you know, payment networks do not move money. They are messaging networks. Banks may provide you with a message in your mobile banking immediately after you perform a transaction, but the actual movement of the money happens at the end of day in an ACH settlement (see blog). These messages (aka APIs) are how banks communicate with both customers and other banks. Do banks want to guide the structure and availability of their communication?

While V/MA are the “golden goose” in card products, banks may want to assess service expansion and a new operational entity that can coordinate and define how they can act collectively. This is not open banking but rather a “Stripe” of bank services. Stripe make payments easy. Their APIs power a 1M+ developer community, creating services and onboarding new customers in days/hours. Visa and Mastercard have an even larger community: approximately 85% of all FinTech’s are dependent on V/MA infrastructure.  What can banks do to unlock the power of their own internal development teams?

Unfortunately there is no simple product, like card, to build consensus or operating model around. Thus most banks are fighting yesterday’s battles in the creation of new “card like” products or alternate rails. What is needed is a new operating model which will provide banks with the ability to collaborate in new bundles or experiences.  It is hard to unbundle, yet the battle moving forward is how to take part in value creation where the consumer IS not where banks want them to BE (see Embedding Payments).  

Standards

This section is a tad arcane.. But I want to provide a few examples for context. 

Standards can advance an industry. While the measure of weight and length are likely the original standards, the first interoperable standard was likely the Railway gauge of 4’ 8 ½”, which was the result of a gauge war amongst the British railways (resolved by parliament in the  Regulating the Gauge of Railways Act 1846). This gauge “standard” allowed for specialists to create common products and components for all networks in the system, lowering the cost and fueling growth.  Enforcement and certification was proven by one measurement and the ability of equipment to operate. A simple standard to define and verify.

Standards enable simultaneous investment in periods of flux. For example a common definition of interfaces, or reference architecture, has proven to drive many simultaneous innovations within a common product (ex hard drive, power supply, RAM within PCs), and enable many companies to make investments (i.e. within complex systems). The challenge is in creating an effective organization (or organizer) that can drive the standards with an operating model providing margin for others: “the Orchestrator”. 

Standards create long term margin pressure and are a double edged sword. Established players seek margin, asset intensity, economies of scale and barriers to entry (see Product Standards and Competitive Advantage). A common definition does not always correlate to either the best product, or higher margins. In fact, standards can enable the opposite (think Beta vs VHS). As a product, industry or platform becomes “good enough” margin moves to proprietary architectures that produce the best integrated consumer experience (ie vs performance). 

The orchestrator of a closed standard has higher margin and creates significant hurdles to competition (most entrenched). For example Apple, Tesla, Microsoft, and Google have very few standards they don’t own and control. Potential competitors must not only create a product with superior price/performance (move consumer), but also move the industry of collaborators and the market (buyers/sellers) that derive value from these closed platforms.  A quick refresh on Microsoft/Intel

Perhaps the greatest proprietary “standard” of all time is the Microsoft/Intel (see WinTelPCI architecture) collaboration in the PCI standard. This standard drove billions of dollars in distributed investment in the platform, which in turn drove component performance and overall platform superiority. The Intel Architecture Lab – IAL provided testing and certification services to component manufacturers, and defined the technical interfaces to both Intel Hardware and Windows. The PCI standard contained all four of the categories listed above. Certified components were labeled and manufacturers were able to license from the Wintel IP portfolio. A fantastic book on this topic: Platform Leadership: How Intel, Microsoft and Cisco Drive Industry Innovation. The authors outlined 4 Levers of Platform Leadership:

    1. Scope of Firm: What is done inside, how they encourage outside investment and focus
    2. Product Technology: Architecture, Interfaces, Modularity, What do they expose to partners?
    3. Relationship with Complementors: Support of Complementors, acting on ecosystem needs, path to consensus and standardization, profitability
    4. Internal Organization: What is the “core”, and how are resources allocated to core activities vs support for partners

What makes for effective standards? With the exception of core infrastructure (railway gauge, TCP/IP, fasteners, …etc ), standards flow from a platform or operating model. While regulators (ie SEPA/PSDs), non-profits (FDX) or aggregators (ie Plaid/Finicity/MX) may create a “standard” there must be an economic model to encourage use. There are 4 key elements of a standard (see modularity):

    1. Specifiability – What is it? Length, quality, function, …etc.
    2. Verifiability – Can I verify that it operates to specification
    3. Predictability – Will it operate consistently (with other parts)
    4. Enforceability – Known source, certification, compliance, legal agreement

Example – The first interbank real time collaboration (designed by Visa). In the days prior to modern telecom networks, authorization for card purchases was challenging. Frank Fojtik of Visa solved this problem in 1977 (see Electronic Value Exchange: Origins of the VISA Electronic Payment System). 

Interoperability

https://usa.visa.com/dam/VCOM/global/ms/documents/veei-lets-talk-about-interoperability.pdf 

ISO 8583 (see History of 8583 – Medium Post) and EMVCo are the two primary standards groups within the payments system. Within ISO 8583, each network/card association has its own specification (see related) and certification requirements. To restate, the networks operate on a standard protocol with a proprietary specification and operating model. This ISO standard is extremely generic and brought to “life” by the network in which it operates through the associated operating agreement. The connectors to this include every merchant, consumer, processor, acquirer, issuer, hardware manufacturer, gateway and service provider 

Enough with this topic.. I never spend time with a standard. They are next to meaningless without the operating model in which it resides. 

Operating Model

Operating models define the organization, roles, legal responsibilities of each participant and how auditing/ enforcement will be performed. The model also defines the general economics, including:  product pricing, licensing, branding/use, …etc. Wintel was a very well defined technical standard, with a very weak operating model. Payment networks are bank only networks with well defined technical standards AND operating models (see Open Banking/Open Payments).Bank consistent success in creating networks is partially driven by the high bar set for participation (ie bank license) and the associated ability of each participant to consistently manage risk. This connection is the definition of a trust network.  

The Orchestrator is the organization in which stakeholders collaborate. As owner of the operating model, the Orchestrator is responsible for service definition, certification, membership, sales, marketing/branding, technical, legal, regulatory, compliance, auditing, compliance, …etc.  (see 2012 blog Distributed Innovation). Orchestrators also determine the core services they will provide and which they make available to other stakeholders. This structure provides a consistent legal/regulatory umbrella for bank interaction. 

As a tech geek my view is that operating models define the interactions of senders and receivers of technical messages (ie ISO 8583):

  • Who – clear understanding of the counterparty (ie “who”) 
  • How  the data will be used
  • Cost/revenue for request
  • Legal agreement governing the exchange
  • Regulatory regime(s) and reporting requirements for compliance
  • Permissions to act on and share the data

Bank collaboration within card network organizations, thus gave rise to other investment in shared utilities/trust facilities: credit bureaus (experian), reporting (Argus), fraud fighting utilities (EWS), …etc.  Banks have a tremendous ability to organize. 

Story - Commerce Signals

I founded Commerce Signals based upon the challenge of supporting non-payment interactions and the simultaneous advancement of message sets and necessary for banks to expand. The “signal” was a data exchange within an agreement. By establishing common templates, banks could chose to participate in any given exchange, and we would be in a position to enforce terms defined.  We were the first to access real time payment data of Visa and the acquirers. Our challenge was our starting point in advertising.. And were not aware that the retailers were unbasking the card information and sending it directly to ad platforms (with SKU). 

My point in this story, is that there are operating models which can work quickly. It is an organizational issue more than a technology one. Just like the first days of Visa it all starts with 3-5 entities that align on something. 

Wrap Up

Contrary to the HBR article above, value is not migrating to the nodes of the network, but rather to the entity that can create an operating model that connects participants and enables interactions. Visa and Mastercard have proven to be the only organizational model that can expand financial services messages (beyond card)

It is important to note, that the ECB has keen awareness of this dynamic and has undertaken several efforts to stymie payment network progress over the last 20 yrs (to no avail)

Banks need a Stripe, or Wintel. They need a common way for 3rd parties to invest in them. Today what they have is PSD2, Plaid/MX, FDX. Models that leverage bank data and power competitors with no economic agreement or upside. Banks win when they create an operating model with shared rules and defined access.

Where should Banks start?

    1. MUST OWN
      • Consumer identity and authentication
      • Consumer permissioning, consent and reporting
      • Core banking functions, A2A (alternative to OCT/AFT) 
      • Bank data requests (there is no reason Plaid/Finicity/MX should exist)
      • P2P/Zelle
      • Risk/Fraud
      • Credit Issuance
    2. Near Term
      • Installment lending/BNPL
      • Demographics that do not understand what a plastic card is
      • Custom integration of banking products into merchant/enterprise (ex B2B card alternative)
      • B2B
    3. Assess/Pilot/Experiment
      • UPI like services
      • Crypto
      • Metaverse
      • Web 3.0

Example – BNPL competitor

Visa and Mastercard have both rolled out new installment product standards. I find this a tad ironic given the battle 10 yrs ago on rules and wrapping. Back then the networks pushed against the bank initiative to create a new token that wrapped a card (see blog). BNPL breaks the card metaphor, consumers want flexible terms. 

While V/MA are simplifying the ability of any card product to compete with Klarna, Afterpay or Affirm, they are locking in the card “product”. Banks should create a standard API where existing card holders / PIL or HELOC can get a quote for flexible terms. 

Someone (like Shopify/Stripe) would need to own the consumer experience, but banks could enable stripe to compete with Affirm and provide Stripe/Shopify with affiliate like upside in loan origination. 

Example Process:

  1. Shopify passes consumer identifier (ex Prove ID) to Banks that currently have the consumer in a product, or banks that want to compete for the loan
  2. Banks respond to confirm interest or ability to respond
  3. Shopify send RFQ with terms (ex 0% interest, $0fees, 4 installments over 12 months)
  4. Banks respond with quote and consumer facing disclosures for acceptance
  5. Shopify registers consumer, presents disclosure and accepts terms OBO consumer. 
  6. Bank confirms/authorizes transaction

There is no need for V/MA in this process. Do I think this will ever happen? I think Cap One and BAC could do this easily. But others? Nope.. thats why I’m bullish on the network’s approach.

Thoughts appreciated

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6 thoughts on “Evolution of V/MA – Moving Beyond Card”

  1. Tom – Curious as to why you think C1 and BAC are uniquely equipped to take on developing an alternative financing rail but not say a Citi or other entities with private label product history?

  2. Could Zelle be the start of banks service expansion? Or Akoya?

    Interoperability is key imo and is it likely for banks to come together and create new service that work across them all? Doesn’t seem in their DNA but TCH does suggest differently.

    If banks were to lose their “this is our customer” mentality and collaborate, they could share data to help reduce risk and fraud across the ecosystem.

  3. Most important line: “Contrary to the HBR article above, value is not migrating to the nodes of the network, but rather to the entity that can create an operating model that connects participants and enables interactions.”

    Well put! Seeing this in crypto/web3 as well. Already there’s been huge consolidation of value because sane consumers don’t want to be free floating actors without structure to easily and safely interact. Maybe blockchains can “protocolize” more of such an operating model, but I suspect centralized entities will still play a crucial (and legitimate) role.

  4. Tom – Do you think GS’s acquisition of GreenSky was an expression of this vision or simply them trying to create a channel to deploy Marcus deposits? Do you think an ad-focused company like Cardlytics could (with expansion of their offerings) provide an avenue for banks to move this direction?

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