Payments Innovation in Europe

So in Europe see the consequences of ubiquity. While SEPA was designed to increase competition and create new European schemes, there are few business models capable of supporting investment. Hence Europe is not the place to start a retail payments business. This is why I look to Asia, LATAM and Canada as great places to start a payments business (my picks: PH, HK/China, Brazil, Malaysia, SG, Colombia, Indonesia and New Zealand).

8 March 2011

Why do I like the Payments business? It is ubiquitous, sticky, with good margins and strong annuity revenue.

What do I hate about the payments business?

In the US, it is over regulated, concentrated, difficult to change and frustrating enigma driven by large FSIs with unlimited resources…. Within Europe the situation is little different.

After coming back from last week’s trip the Valley, I was attempting to develop an investment hypothesis on Europe, mobile, payments and innovation in general.

While Europe’s individual talent is second to none, and capital is plentiful, the European market is designed to resist change and thus impedes the development of early stage ideas and companies. Early stage companies can incubate within a single country but are challenged to expand beyond, due to complex regulatory and market dynamics. Navigating these dynamics causes early stage companies to develop more slowly, thus a requiring a higher risk premium on invested capital.

                   – Tom’s European Venture Capital Hypothesis

SEPA Overview 

(European colleagues can skip this section). 

SEPA and PSD (SEPA’s enabling legal framework) attempt to create harmonization of payment schemes across the EU (See SEPA Blog, and excellent PodCast). The result?  837 pages of detailed and contradictory EU law with no business incentive. SEPA has been plagued with delays and issues, as should be expected given that there was no business incentive nor a PAN EU regulator to enforce it. SEPA Credit Transfers and SEPA Card Framework have been in place for a few years (2008). While the SEPA framework commoditizes payments, and while this is consumer friendly, there is no business incentive to for large banks to implement it (see Barclay’s consumer support on SCT).  The same can be said for the SEPA Card Framework (See MA’s Self Assessment). The main points from ECB’s regular status report:

  1. Banks must create greater awareness of SEPA, and must offer better products, based upon the SEPA infrastructure. Government should accelerate programs to adopt SEPA as the standard for its disbursements.
  2. The banking industry must commit to work together to remove obstacles which might compromise the Nov 1 2009 launch date of the SEPA Direct Debit. Debates on the launch date, the validity of existing DD mandates, and interchange fees must be closed out rapidly.
  3. Bank systems need to be improved to enable end-to-end straight-through-processing, originated by files submitted or by e-payment, e-invoicing, and m-payments.
  4. The ECB wants to see a target end date for migration to SEPA products, and for exiting out of older credit transfer and direct debit.
  5. The SEPA card framework in its current form has not yet delivered the reforms which the ECB wants. In particular, ECB wants to see a European card scheme emerging.
  6. The ECB perceives a lack of consistency in card standards. It wants to ensure that a clear set of standards are adopted and promoted throughout the industry.
  7. A common, high level of security for Internet banking, card payments and online payments is needed.
  8. Clearing and settlement organizations in many countries have made good progress on SEPA, and several are upgrading from national to pan-European.
  9. The banking industry, and its representative body, the EPC have not sufficiently involved other stakeholders.

 SEPA’s Impact on Innovation

European harmonization is a fantastic objective, but translating EU guidance in to country law, with each country’s banking regulators responsible for interpretation and guidance, is problematic. This becomes even more difficult when Banks (who were not included in the SEPA design) have an inverse adoption incentive. An analogy in the telecom world would be telling the land line carrier that the must open up the switch to anyone that wants it at no cost.. and they have to assume all of the risk and operational responsibility.

Early stage companies and “payment innovators” are left with a complex set of constraints.

  • Dependent on local national relationships to launch a product,
  • SEPA creates harmonization, but country specific laws and regulatory guidance are unique
  • ECB initiatives (ex. See ELMI) create opportunities for non-bank participation in payments,  but SEPA has removed all margin from the business

So in Europe we see the consequences of over regulation.  While SEPA was designed to increase competition and create new European schemes, there are few business models capable of supporting investment. Hence Europe is not the place to start a retail payments business.  Hence Asia, LATAM  and Canada are all great places to start a payments business (my picks: PH, HK/China, Brazil, Malaysia, SG, Colombia, Indonesia and New Zealand).

Europe and Advertising

I don’t have time to finish the thought here. For those of you that read my blog you know I’m very enthused about the prospect for advertising to be a future payments revenue driver. Unfortunately for the EU, consumer privacy regulations (and subsequent “tracking” issues) are the most onerous in the world. In Germany for instance, my Citi team was forced purge the web log of IP addresses every 30 minutes.. for our own customers. The point here is that we could not even maintain loosely correlated consumer information in regulated accounts. Google has similar problems today (see Das ist verboten).

Where is the EU opportunity?

Where there is an intersection of: low margin payments, businesses with frequent cross border (within EU) transactions, without need or desire for banking relationship. MoneyBookers is an excellent example of this model in gaming.

Other possible  investment drivers relate to when payment transaction infrastructure is a commodity:

Arbitrage – Move intelligence to new regions or countries where the cost of maintaining it is lower

Aggregation – Combine formerly isolated pieces of dedicated infrastructure intelligence into a large pool of shared infrastructure that can be provided over a network

Rewiring – Connect islands of intelligence by creating a common information backbone

Reassembly – Reorganize pieces of intelligence from diverse sources into coherent, personalized packages for customers

 Thoughts appreciated.

Banks Will Win in Payments! … But Which Ones?

Banks will win in payments…. with one provision… payments that are profitable. Every successful payment type has at least one bank behind it. But WHO are the banks? Target, Sears, American Express, Wal-Mart, Tesco, General Electric, BMW …etc all have banking licenses. As the lines between retailers, banks and mobile network operators start to blur..

25 January 2011

Part 1

Previous Blog – Bank Payment Councils

Banks will win in payments…. with one provision… payments that are profitable. Every successful payment type has at least one bank behind it. But WHO are the banks? Target, Sears, American Express, Wal-Mart, Tesco, General Electric, BMW …etc all have banking licenses. As the lines between retailers, banks and mobile network operators start to blur.. who will be successful? Now that MA and V are public companies, how are banks vested in their continued success? Will there be a new wave of creative destruction?

Bank Structures

This blog has a “payment view” on these answers. Typically, large banks do not view payments as a business, but rather a service that supports multiple products. Exceptions occur when the “product” is payment (Credit Card, Retail Lockbox, …). Within retail, credit cards are either a separate LOB (BAC, JPM, AMEX, C) or aligned within the retail Asset side of the business, while debit cards are managed within the consumer deposit team. A review of this organizational complexity is necessary in order to understand retail bank “initiatives” in payments and their corresponding business drivers.

 For Retail Banks, credit is the primary business driver of payment investment. As a side note, this is one reason why there is such poor payment infrastructure in emerging markets. Bank credit is of value to the merchant and the consumer. Although not all Retailers seek to be depository institutions (ie Tesco and Wal-Mart), most are assessing how they can ensure access to credit, and are experimenting with differentiated credit value propositions. Most card issuers are quite confident in their ability to retain customers with substantial consumer data confirming strong loyalty.

Retailers have a different perspective, their consumer data indicates broad dissatisfaction with bank services particularly in segments below mass affluent (ie switching preference, satisfaction, bank fee sensitivity, store loyalty and general anti-bank sentiment). In addition, although Retailers are firmly in support of store credit, they have moved “beyond” the tipping point with respect to interchange, and are quite proud of their roles as architects of the Durbin Amendment.

For the US retailers, that have already expanded into the banking business, the most common structures we see are the ILC (See KC Federal Reserve Article) and Federally Chartered Thrift (moving from OTS to OCC). For US Retailers, Target (see Target RedCard) may provide a model case study with significant assets in team, infrastructure, and capabilities.  UK and EMEA banks face a much less complex regulatory scheme, with Tesco PLC taking the global lead in innovative banking services (Wal-Mart Mexico is a very close second).


There are several excellent resources for those looking into the history of credit cards (I recommend Paying with Plastic: The Digital Revolution … ). Retailers and manufacturers have long realized that earnings from the credit business can well exceed that of the core business (GE Finance, GMAC, Target, Sears, ….etc.).  But these endeavors are not without risk, as retail/mfg driven finance companies have also suffered the same fate as banks in consumer credit (ex Target looking to sell its own $6.7B Card portfolio ). Credit is the lifeblood of most retail, and while there are few issues with credit access for affluent consumers, there are many consumers with FICO scores below 800 that retailers want to serve.

Credit Card businesses have been hemorrhaging cash over the last 3 years because of NCL, and anticipated impacts of the new financial regulations. The most striking example is BAC’s $10.3B write down in 3Q10. 4Q10 earnings show that the credit environment is improving, with banks improving the quality of their credit portfolio (sub prime). US card issuers released earnings this week demonstrating improved credit quality as they also release reserves, toward the top of the list is JPM (card 27% of $4.8B Net Income).  Citigroup’s card also returned to profitability in 4Q10 with North America Net Income of $203M for 4Q and -$164M for FY2010. But there are other indicators which point to a change in prime consumer credit behavior (ex TransUnion reporting that 8M fewer consumers used their credit card). Perhaps this behavior change is driven by card rates climbing to all time highs (today’s CNN Money). Regardless of the behavior correlation, it is clear that consumers VIEW of credit cards AND consumer ACCESS to credit is changing. Consumer access to credit and change in payment behavior are both critically important to retailers.

Historically speaking, the data clearly shows that most retailers DO NOT offer a better credit value proposition (See US House Store Card Rates). Intuitively this makes sense as their ability to manage credit risk should be below that of banks, hence requiring a larger risk adjusted rate of return on capital. Today many retailers are questioning the value of the Bank Card products in delivering credit. Prior to Dodd-Frank, merchant card agreements prohibited: card exclusion, steering, payment incentives, …etc. Today US retailers can offer incentives for cash purchases, steer, deny and develop their own cards (ex. Target RedCard).

As the US consumer credit market has matured, the industry has spawned numerous specialists to manage the various functions of credit issuance, from acquisition and credit scoring through processing, collection and portfolio risk management. Consumer credit application cycles have gone from 2 weeks in the 2002 to under 2 min in 2007. This specialization allows non-banks to develop turn key credit offerings.. and approach risk management with tools that are equivalent to best practice within established banks. Of course the ability to manage risk is more than tools, it takes solid credit/fraud risk management processes and talent… but I digress.

What do retailers want? Credit availability and brand.  Given that most Retailers don’t want to form a bank, they pursued private label cards to achieve these goals. Banks were badly burned here, with both Citi and Chase disposing of their private label card portfolios. In many cases consumers took the one time discount and never used the card again, those that did continue use were largely sub-prime borrowers and the banks did not adequately manage the portfolio risk until after the economy tanked.

My biased credit summary is thus

  • Bank card rates are at an all time high and consumer use of credit cards is declining
  • Retailers are always willing to pay interchange for access to consumer credit, but credit access is shrinking
  • Private label cards have been a very bad bet for banks
  • Retailers have new opportunities within Dodd-Frank and are evaluating plans (credit, steering, loyalty)
  • Retailers are expanding into banking and credit through licensed structures. Growth in industry specialists allow them to create new products quickly
  • Visa/MA/Amex are facing new competition from store derived cards, and merchant relations are at a low point

How can Banks Win?

Trust, value, credit, relationship, anonymity, protection, security, service, brand. With debit interchange revenue legislated away, what incentives to banks have to continue pushing network debit? A: None. The US will begin to resemble Canada, Australia and Germany with unbranded debit cards. From a retail bank perspective, the focus is back on credit and loyalty with ONE NEW CAVEAT: Value.

Will there be retailers that develop their own cards and banks? Yes.

Will Consumers jump to these offerings? Only if they can price risk better than you can.


They offer a better value (ex. Target 5% off everything).

As a baseline, let’s establish a common view of what is a payment. For Banks, payment system profitability is a function of: fees, funds, risk, value, control and network.

It is this value element that many banks are overlooking. Loyalty based reward programs have been at the heart of most card schemes. My guess is that many of you are hooked on AMEX’s membership rewards (as I am). Why would you pay any other way? The merchant pays for my points and I get the goods at the same price.

The model of interchange revenue driving payment system revenue (and rewards) is about to undergo fundamental change. Interchange is being regulated down and new “merchant friendly” value propositions driven by advertising revenue are being created. Given that most bankers are not retailers.. a quick 101 … in retail profitability nirvana is something called price optimization. Retailers, CPGs and manufactures want to influence consumer behavior and product selection based upon price/promotion. (I’m purposely vague here). 

Most banks do not fully appreciate this consumer incentive dynamic. In a future scenario, it will not be convertible loyalty points driving payment selection behavior, but real dollar savings on every purchase with consumer behavior driven through rich personalized marketing. Retailers and advertisers will be able to influence behavior and generate revenue from it. In a conversation with a senior card exec on this he said  “I can negotiate interchange down with any retailer I want to.. this is just a price issue”. I related my often used Wal-Mart quote “can you pay them for taking your card?”

Where is value creation … and the business case? 

During my Holiday reading I ran across some old HBR articles: Skate to Where the Money Will Be (Clayton Christensen) and Where Value Lives in a Networked World (Mohanbir Sawhney and Dave Parikh). In the later, Dave and Mohanbir articulated a key principal:

In a networked world, more money can be made in managing interactions than in performing transactions.

This 10 year old HRB article was particularly thought provoking. These value tenants have broad applicability in assessing strategies and plans within both current and future network business models. Specifically,

Value at the Ends. Most economic value will be created at the ends of networks, At the core-the end 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.

Value in Common Infrastructure. Elements of infrastructure that were once distributed among different machines, organizational units, and companies will be brought together and operated as utilities.

Value in Modularity. Devices, software, organizational capabilities, and business processes will increasingly be restructured as well-defined, self contained modules that can be quickly and seamlessly connected with other modules. Value will lie in creating modules that can be plugged in to as many different value chains as possible. Companies and individuals will want to distribute their capabilities as broadly as possible rather than protect them as proprietary assets.

Value in Orchestration. As modularization takes hold, the ability to coordinate among the modules will become the most valuable business skill. Much of the competition in the business world will center on gaining and maintaining the orchestration role for a value chain or an industry.

I will leave this section unfinished, it is clear that banks are uniquely capable of leading in all of these roles. What is also clear is that the business environment is ripe for a new network. What roles should banks have in its formation? Is there a downside to being a late follower and acquiring the “winners” after they have built the infrastructure?

Bank Action Plan

What are the bank assets here? Payment Infrastructure, Consumer Data, Trust, Existing Payment Mechanisms, Consumer Behavior information, Credit, Risk, Support, …

What do Banks need? A collective plan for action.  Card Networks will not solve your problems, their initiatives to date around this have been complete failures and are severely challenged in creating a merchant friendly value propositions.

Recommendations for Banks

  • Assign a senior exec.. #2 in your card organization
  • Develop regular data backed trends and reports. Example: how is Target RedCard impacting your card profitability, spending shift, ANR
  • You have 5 years.. develop a strategic plan that is multi-pronged. This is about standards, legislation, technology, IP, advertising, network, consumer data protection, innovation, payment, mobile, …
  • Assess where there are synergies with existing consortiums particularly around standards and legislation.
  • Partner with non-banks. Google is active here now.. what do you know about their plans?? Have you seen their ZetaWire Patent?
  • Assume your competitors are moving on this. BAC’s $10.7B write down is a level set on the investments which will go into this area.

Part 2 – Payments that are not profitable (at least not for banks).. this is beginning to look like Debit AND emerging markets.