tokenization – Noyes Payments Blog

Tilting the Networks… a MASSIVE Change

4 July 2015

Payments make up far more than 70% of my personal portfolio. This investment strategy has been a great bet. Take a look at the 5 yr investment performance of Visa and MA. 333% growth in MA and 247% for Visa.

From Mar 9 2015 Seeking Alpha

With this exposure, I keep close track on structural changes in the industry, which I outlined in my January blog Structural Changes in Payments:

Risk and Identity
Data/Commerce Value
Consumer Behavior/Trust/Acceptance
Issuance/Customer Acquisition/HCE
Regulatory/Rates/Rules (Fees)
Mobile/Payment in the OS

Will these structural changes… is my current V/MA at risk? Is there something else I should be moving toward? No way! I think Visa and Mastercard are start ups that have just begun realizing the value of their network as they EXPAND NODES and SERVICES Let me try to explain why am I such a bull on these payment stocks.

Network Tilt – Toward Merchants

As most of you know, V and MA were started as Bank consortiums (see Wikipedia and MA History). Rules (and rates) were thus defined by banks for both credit and debit (see this blog for debit history). As a former Banker I never fully understood the Retail view of Visa and Mastercard. For example, Walmart pays an estimated $1.3B in interchange. Most merchants would admit that the benefit from electronic payments and ubiquitious acceptance. Even Mike Cook says that “no one complains about the network fee side of card costs… it is the issuer side that everyone has a problem with”. In other words Visa and MasterCard earn their fees (it is the issuer reward schemes that drive merchants bonkers).

As stated previously Payments, in their simplest form, are a brokering business which manages value exchange between two entities engaged in commerce. Logically, a broker must be removed from the transaction to maintain the trust of both parties, and deliver value through managing the financial risk associated with the transaction. My view is that Card issuing banks, have lost the neutrality of their “brokering” role by creating a card rewards system that incents card use (paid by the merchant). However, this ideal “neutral” world is NOT the nirvana that we should seek, as no one would invest and we would be stuck with cash.

Complexity in payments is driven by the quest for control and margin of the various participants, NOT by necessity. This is what makes understanding payments so hard…. most of the changes are not logical, but political. The friction (inefficiencies and illogical design) in payments is what makes them work. As I’ve stated before, no engineer would design a payment system to operate the way we do today (see Push Payments). Thus there is beauty in this chaos! The V/MA model created incentives for 1000s of banks to invest in payments, and I doubt if we will ever see any other companies that could repeat this feat.

Both Visa and Mastercard realize that their future rests in leveraging their neutrality, thus “tilting” away from their prior “bank centric” model into something that is MUCH MORE merchant friendly. Bank issuers certainly WANT to be in this role, for example the largest US Visa issuer JPM has created a unique off VisaNet transaction routing (see blog) and is building a new data business (ChaseNet) to compete here. The bank efforts are completely stunted as there is no path for obtaining critical mass is a closed network that requires both merchant and consumer consent. American Express is the clear leader here, but their network is also stunted through its focus in T&E, affluent and business travelers.

Visa and Mastercard win when consumers and merchants transact. Encouraging use by consumers, and acceptance by merchants, is top priority… The future of the networks is COMMERCE. This may seem like a logical statement, but historically Visa and Mastercard acted as extensions of the large issuers. Look for both networks to create new teams to rebuild relationships with merchants.. they know they have work to do. Visa-AmEx-Are-up-MasterCard-Discover-Are-Down-3 (1)

What is “Tilt”?

Phase 1 – Rules and Facilities to Enable Competition
Phase 2 – Merchant Friendly Services / Merchant Rules Setting
Phase 3 – Competing with Banks (V/MA Opening up to non Banks)

The First Phase of tilting involves creating network rules and facilities that are favorable to the merchant and/or take away control from issuers (to enable issuer competition). 2015 winners include

#1 VDEP (Data protection and $0 wallet fees)

#2 Visa/MA Token Facilities

#3 ApplePay requiring debit card enablement

#4 Mastercard’s new Merchant Insight Service

Payment industry is very heterogeneous and highly tiered. Large merchants like Walmart, Target and Kroger are able to support strategy teams that can negotiate very competitive payment rates with issuers and acquirers. Similarly the large banks can build multi billion dollar fraud and square pricing authorization infrastructure. My rule of thumb is that the bottom third of any acquirers merchant accounts (SMBs) result is approximately 60% of their earnings (hence the success of Square). As an example, try to find the cost of payment acceptance at Chase Paymentech, now do the same at Square or Paypal.

Tokenization and EMV have taken away issuer advantages (control points), enabling smaller issuers (competition). They have also enabled competition in eCommerce and POS acquiring (bringing down merchant costs). Take a look at this must read article from paymnts.com 13Nov14. “Tokenization has opened up this whole world for us to be able to use digital devices to be a meaningful part of the payments flow in a way that (those payments) wouldn’t have in the past,” – Scharf at BAML Banking & Financial Services Conference global digital snap

On this last point, Visa and MA are growing from 1.9B cards to their “network” into mobile, creating services that will be critical to deliver payments and authentication/authorization in the channel that is capturing consumer time like none other.

Phase 2 – Merchant Friendly services. The number one Retailer issue is “who are my customers?” As I outlined 3 years ago in Payment Enabled CRM, payment networks are well placed to solve this (given consumer consent). These articles provide an overview of 2 new services coming out.

4 June 2015 – Loyalty360. Visa Commerce Network. From Michael Lemberger (Visa VP Offers and Loyalty Solutions) “creating strong connections across commerce is an important piece of the payment ecosystem. As such, Visa also is developing and employing innovative loyalty platforms for merchants to engage with their customers in meaningful and compelling ways”
Mastercard Market Insights. [Report] analyzes extensive purchasing data to provide insights into restaurant level econometrics and trends, such as changes in sales, average ticket prices, and customer frequency across fast-casual, casual and family dining restaurants

Phase 3 – Competing with Banks. Banks tend to believe that everything V and MA do is “theirs”. The predominant view was best captured by a former head of strategy “we built these companies once, and we can do it again”. Thus the definition of competition is rather squishy as banks believe that they own everything. Today every Visa “member” must be a bank. We are starting to see consumer direct services and merchant direct services (Mastercard MoneySend/Omney, CYBS/Visa Checkout, Mastercard Local Market Insights, …). This is MORE THAN ANYTHING turns Issuers apoplectic.

From an investor view I believe that Visa is much more cautious in remaining neutral, whereas Mastercard is much more aggressive in delivering new services. For example few know that Mastercard holds money transfer licenses, or may have purchased a processor (Omney). A key objective of MA may be to create a commercial payments business with debit cards as the key “down line” for disbursements. See http://apps.mastercard.com/#!/app_details/omney#top

The real battle will be on DATA. Issuers strongly feel that they have 100% ownership of payment data. Yet Visa/MA data also belongs to the merchants (for the restrictive and squishy purpose of loyalty and redemption). JPM felt so strongly about this rule that is specifically took its data out of VisaNet purview as part of the 2012 deal. Every payment player is chasing after ADS and Amex in their capabilities to become a “super charged marketing scheme”.

Mastercard has a BIG win by becoming the payment network behind the ApplePay private label enablement (as I discussed on twitter). Take a look at the private label graph above (relative to total number of cards). Private label is a super charged loyalty scheme that I’m keeping a very close (investor) eye on. I believe this may be the first REAL driver of Merchant Friendly “tilt” that delivers substantial revenue. It is also a reason why I believe ADS will be aggressively chased as an acquisition target.

Revenue/EBIT

Visa and Mastercard are trading at roughly 30x earnings. Today they take less than $0.02 per transaction. Incremental revenue on existing volume through tokenization (see MA Digital Enablement Fees), and new retailer friendly data services should add at least 10%-15% in near term depending on “wallet” success and merchant adoption. The future for V/MA profitability rests in their ability to balance the merchant Tilt with neutrality, and “stepping on Big bank toes”. As if this growth opportunity were not enough…

Global electronic payment growth is still positioned at 25%+ CAGR. The best industry payment report (IMHO) is from Cap Gemini https://www.worldpaymentsreport.com/ a must read for anyone. Globally electronic payments are in their infancy. Roughly 90% of the world’s electronic transactions happen in the top 10 markets (< 10% of the world’s population). What happens when the other 7B people on the planet get a card (with their phone)? The global growth opportunity for V/MA is 35% CAGR in just about any economic environment and independent of local market payment schemes (ie CUP, Rupay, ELO, …). The payments world continues to look for the “next Brazil” (BTW it is NOT RUSSIA), but it is everywhere. Paypal is another network that capitalizes on this global growth trend (in an eCommerce segment that is growing even faster than the “payment market”). The emerging markets I like best? China, Columbia, Peru, Ghana, Nigeria, Tanzania, Pakistan, Philippines, Indonesia… The markets I stay away from? Europe (see SEPA Blog).

Have a great 4^th of July…. And go buy V/MA.

CEO View – Battle of the Cloud Part 5

There is a payment cluster war going on right now and it is the subject in the C Suite in Banks and the Payment industry. The battle is happening at every level. I’ll be leading a panel at Money 2020 which addresses several of these items, with participation from V/MA… should be interesting. Here are a few updates.

22 July 2013

This post is a continuation/update to my post back in March Network War – Battle of the Cloud Part 4. Sorry for typos.

There is a payment war going on right now and it is the subject of C Suite strategy talks. The battle is happening at every level. I’ll be leading a panel at Money 2020 which addresses several of these items, with participation from V/MA… should be interesting. Here are a few updates.

Network/Routing/Rules

$8B Revenue Impact. I apologize to my EU readers for my constant US focus. Let me break the mold now to emphasize the earth shaking changes going on in the EU (See today’s NYT blog, and today’s WSJ). Going from 250bps + cross border fees to 30 bps will be tremendous, and may set a precedent for the US litigation between Visa/MA and top retailers.
EU provides a glimpse at what a world of payment “dumb pipes” and least cost routing looks like (see Blog Payments Innovation in Europe). Canada and Australia also follow these lines in debit (see Blog). Also see my favorite case study in Europe Sofort – ECB analysis, and Push Payments.
Networks, and their members are reacting to regulation and positioning themselves (individually) to “push” their respective vision of innovation in order to protect their brand and network (see Visa Money Transfer, and Visa Portfolio Manager). I don’t mean to limit this to just Visa and Mastercard (see picture, and blog).
New networks are forming (see Blog on Clusters)
Large issuers like JPM have successfully forced Visa to break/segment its Visa net, and run under unique JPM/CMS rules with new capabilities. Visa’s CEO comments to investors: “rules must be consistent with Visa”.. My view is that this is a major crack in Visa’s network ownership (see Golden Goose on the Menu).
From a wallet perspective the rules on “wrapping” are killing much innovation (see don’t wrap me). Top issuers are actively working to inhibit wrapping of their payment products (ex Mastercard’s staged digital wallet fee of 35bps on PREVIOUS years volume of over $50M.. which only impacts paypal). Similarly Amex and Visa are working to ensure their cards are not wrapped.
Rules are being issued and ignored, from Visa Money Transfer to EMV (see below). Banks tell Visa “do you want me to write the waiver or will you send it over… as we are not going to do this”.. which is one reason JPM just created its own unique rule set. Similarly US merchants face a liability shift (on to them) if they do not accept EMV cards (chip and pin). All are playing a game of chicken as no one wants to re-issue plastic. Visa has created a new type of EMV, chip and SIGNATURE, which makes absolutely no sense at all, but helps them keep customers away from PIN (which Visa despises, but everyone else loves).
Cross boarder fees (see blog). As 20%-30% of network revenue moves to these fees, it is becoming a substantail pain point for global banks like Citi, HSBC, Barclays, .. A big topic I can’t fully cover here

Issuance

US Banks are spending 90% of their time in innovation around Credit Cards. Exception is Bank of America and to some extent my old team at Wells. In either case the banks have hit a wall, and recognize that innovation can’t happen in a 4 party network. American Express is 5 years ahead of them and they can’t catch up.. they must change.
The NATURE of card completion is changing in both credit and debit. Traditional Payment revenue is being REGULATED AWAY as payments become “dumb pipes”. The goal most have recognized is that the real value to be unlocked is in commerce data, particularly Payment Enabled CRM (see blog). Examples of just how focused this effort is: 22 Banks working in Secure Cloud, ~$1B in Google Wallet Investment, ~$500M in ISIS investment, JPM just hired Len Laufler (former CEO of Argus Data) to be the new CEO of Data in Chase.
Banks thus need to build a network which can accommodate both payments and “other data” which they own and control (like Amex)… hence “tokenization” (see Blog, and TCH Announcement).
Tokenization is currently going nowhere.. but it is “impacting” the industry and many start ups as banks and networks position themselves (see JPM/Visa Blog, Start up implications).
Visa and MA also have their own secret token efforts. Merchants have a much better short term win in this approach with a liability shift and reduction in interchange, but they also know from past experience that if the issuers are not on board, there will be a much broader business impact in declines (see VBV post, and Visa’s Token Strategy).
Retailers are attacking from below. Bottom 40% of mass market customers are not profitable for banks (Durbin related items ranging from NSF fee changes, to debit interchange) . These customers are profitable for retailers like Walmart, Tesco, Target, .. (see Blog).
Telcos have a chance to own a new payments network, as they have both physical distribution, customer relationship, connectivity and device.. but they are focused on controlling a handset in a walled garden strategy. To succeed they must refocus efforts on COMMERCE, which means partnering with all participants to construct a value proposition (see blog).

Acquiring

The first hurdle of any “New” network is to get the merchants and acquirers on board.

This is NOT going well for companies like Paypal … hence the complete failure of their DFS partnership (see blog). Specifically, there is at least one major acquirer which is refusing to route traffic on any of these new Discover/Paypal BINs, as well as at least 2 major retailers. Although Discover is a 3 party network, they only acquire directly for their top 100 merchants. Therefore Paypal must “incent” and negotiate with every single other acquirer AND merchant.
Chase is working to build a new CMS acceptance brand, which will be different from Visa.
Retailers are building their own network (MCX), and have hired Dekkers Davidson, a tremendous executive, to lead it.

Roughly 60% of acquiring profits come from bottom 30% of merchants. There are small independent merchants that are paying over 5% in acceptance fees thanks to the poor transparency within the ISO sales process. Companies like Levelup and Square are changing this (2.75% flat, or free if you commit to marketing). I’ve eaten my shoe on Square, as I never fully understood how badly the ISOs were treating small independent retailers. Their solution solves a short term pain point and also improves customer experience.
Acquirers are making POSITIVE headway in merchant friendly services (see blog), particularly helping merchants “merge” consumer data to gain new insights for loyalty and incentives. They are challenged to quickly ramp up this services revenue, in order to overcome the new aggregators acting on the side of small independents (ie Square).

POS Acceptance

Has anyone seen the graph of Verifone’s stock? Market cap of under $2B. A hardware company that could not adapt to a software world. At the bottom end they are being eaten by free Roam/Square dongles at the top end are facing integrated POS Terminals from IBM/Toshiba and Micros. Dedicated payment terminal are commodities, and thus suffer from commodity like competition. Grand hopes for re-terminalization with EMV and NFC are not happening (see blog). New dongles and mobile acceptance infrastructure is developing even in the complex EMV space (see Tedipay.com )
POS strategy centers around data as well. Google’s Zave purchase has given them opportunity to help retailers focus advertising and eliminate paper coupons independent of payment network. Other leaders like Fishbowl and Open Table in Restaurants have integrated into the POS. The BIG idea here is to integrate the POS to the cloud and Google is now 5-7 yrs ahead of everyone (2 yrs engineering, 2 yrs IBM Certification, 3 yrs to sell and test w/ retailers, +++ yrs in content/ads/targeting).
Square’s new Stand is an integrated payment, POS, inventory management, CRM, marketing and loyalty system.. all on an iPad.
Payment Terminal “software”. Verifone’s Verix architecture and equivalent schemes have failed. Idea was to allow 3^rd party developers to create “apps” for a non-secure space in the payment terminal. For example, 2 years ago, Google’s first version of wallet leveraged NFC to communicate “coupons” to the payment terminal, which then relayed to the POS. Problems are obvious.. A grocer like Safeway has 2,000 person development team around their IBM 4690 POS, guess how many engineers support the payment terminal? NONE. They don’t want apps on a PCI compliant payment terminal.. it goes beyond question of who will manage them. Also note that payment terminal interaction with the POS is simple today (payment request and authorization). There is also significant development work to RECEIVE coupons from a PAYMENT Terminal.

Services

This section could fill a book, so I will make this brief. All network participants are working to deliver services. The 4 party networks cannot innovate. For example, take a look at my very first blog, topic was Googlization of FS. Visa built an offers services with Monitise and Clairmail 3-4 yrs ago, but the large issuers refused to use it, preferring to innovate themselves. Another example is V.me, a topic which makes Card CEOs red faced. These points exemplify the dynamic w/ V/MA and the large issuers.. Issuers want to dumb down the pipes and limit services, V/MA want to grow them and relationships with consumers.
Current state is myopia.. everyone is working as if they uniquely own the customer. Banks and Card Linked offers are top example. When you go into a bank branch, do you want to buy socks? dog food? Of course not! Banks have great data but they are in no position to run an advertising campaign. I’ve run 2 of the largest online banks in the world (Citi and Wachovia) and can tell you retail customers spend about 90 seconds with me, they log on check their balance make a payment and leave. They don’t stay around to click on coupons. Commerce, and retail, is in the midst of a fundamental restructuring as online and off line worlds converge in new ways (beyond show rooming).
Payments are just a small part of the overall commerce value chain, yet they have by far the highest cost. The proposed 30bps EU fee cap may occur in other markets, thus banks are working feverously to build services to replace this revenue (primarily around credit cards), with CLOs largely failing to deliver value (see blog). Yesterday we say Ally Bank discontinue Card offers, following Amex last week.

Payments – Wrapping, Rules, Acquiring and Tokens

if Google had challenges pulling off POS innovation (after ~$1B in investment), rest assured you will too. Banks are well positioned to throw sand in your gears … focus on delivering value within merchant –consumer relationship.

18 June 2013 (sorry for typos)

Thought it was time for blog this week. Primary objective is to inform the venture community of changes which may impact payment related start ups. Sorry that the title isn’t a little more polished (you can tell I’m rather left brained). The exec summary of this blog: don’t ever bet your business on someone else’s rules… particularly if they themselves don’t own them.

Background

All Networks are working on unique token schemes (as I outlined in: Payment Tokenization, “New” ACH System, Visa’s Token Plans and Business Impact of Tokenization). The business drivers here are: #1 Control, #2 Mobile Payments. The US Banks have gotten together in The Clearing House (TCH Tokens) and are in the midst of piloting with 2 providers. In this TCH token initiative, the banks have logically determined that if a customer doesn’t need to see their Primary Account Number (PAN), then they will provide a number which they can uniquely resolve. For example, in mobile payments Citi could put in a unique Citi 16 digit number that is not a MasterCard, not a Visa card, not an ACH account number.. its just a Citi “token”. Citi can decide how to resolve this number adaptively.. based upon what the customer wants, or what products they have with them. There are MANY benefits to this approach:

Banks control account
Banks control DATA (transactional and account information)
Banks own network rules
No fees to other networks
Set unique (NON DURBIN) pricing for a NEW payment product.
No restrictions on “Routing”
Enables banks to “switch” providers of any payment service or network clearing
more detail here…etc

This is a BRILLIANT move by banks. I believe that this central bank “facility” within The Clearing House will be their centerpiece for consolidating all of Debit, in addition to the mobile play.

TCH Tokens are not the only game. Visa, Mastercard and Amex (through Serve) are also in this token game, and others like Payfone (through phone number as token at VZ/ATT), Google (through TXVIA) are also on the periphery. My view is that the BEST tokens are ones you don’t have to issue (ie Square/Voice, Apple/Biometric, Google/Facial Geometry, Payfone/Phone #…). I outlined dynamics of the strategies in my blog last year “Directory Battle Part 1 – Battle of the Cloud”. Its amazing that this topic is not covered more broadly in the mainstream… of course most of these efforts above are not discussed at all, and sometimes denied.

Of all the token initiatives, I believe Visa is most likely to succeed. This is not a typo… I’ve been very negative on Visa in the past.. as they have alienated everyone. But Charlie has started to change the culture, he has pulled the JPM relationship out of the toilet and has made a tremendous hire with Ryan. Why do I like Visa’s token prospects? They failed in their first initiative (non 16 digit PAN required big changes by everyone), and learned their lessons. However, most importantly, they can change the rates through rules on CNP and risk “ownership” creating a “new” version of VBV, with the best payment brand.

Wrapping

Currently the networks are at war with anyone attempting to wrap their product and add incremental value. As I outlined in Don’t Wrap Me, and Battle of the Cloud Part 3

The threat to banks from “plastic aggregation” at POS from solutions like Amex/Serve, PayPal/Discover, Square/Visa, MCX, Google is real. Make no mistake, Banks have legitimate concerns surrounding ability support consumers and adjust their risk models. But the real business driver here is to “influence” mobile payment solutions that do not align to their business objectives. Key areas for bank concerns:

#1 CUSTOMER DATA

Top of wallet card (how does card become default payment instrument)

Credit card ability to deliver other services (like offers, alerts, …)

Ability for issuer to strike unique pricing agreements w/ key merchants

Brand

…etc

Visa, MA, Amex, DFS are in a great position to “stop” wrapping. What does this mean? They have initiated new rules, fees, cease and desists, threats of litigation …etc. Banks are thus looking to circumvent these restrictions by placing their “token” with the customer. This token is thus a new quasi acceptance “brand”.

Acceptance is therefore the new battle arena (who can convince merchants to accept their tokens, rules, rates, …). eCommerce may have slipped away from the banks and networks (PayPal), but they are determined not to let this happen in mCommerce, or at the POS. JPM has structured its new agreement with Visa to give them the flexibility on rules in acquiring and network routing for a new acceptance brand (Chase Merchant Services – CMS).

Retailers

Retailers are not the dumb mutts that banks assume. The MCX consortium realizes that greater bank control does NOT benefit them unless the service is ubiquitous and standard so that banks can compete against each other, with no switching costs. Analogy here is internet traffic routing…They just want the payment cleared, with transparency/control in price, speed, risk. Retailers also want the death of bank card rewards schemes, and if they can’t kill them instantly, want the ability to deny “preferred” cards. I told a major retailer yesterday that they should offer an “X Prize” to anyone that can make sense of Visa’s rate structure in a youtube video.

Many Retailer’s also have a “token” in form of a loyalty card.. with Target’s Redcard, and Starbucks demonstrating the model in which a retailer led payment scheme could work. For retailers, their loyalty program is fundamentally about selling data, and trade spend.

As a side note, the “big” secret in acquisition is that most (~60%) of profits come from the bottom third of retailers.. specifically the small independents that don’t know enough to negotiate (hence the ISO business). Companies like Walmart negotiate heavily with the top issuers to reduce rates from “standard”.. and still end up paying over $1B a year.

I see a substantial opportunity for acquirers to participate in what I would discussed within Payment Enabled CRM. This would change their profitability from one driven by small merchants to data/analytics. This is undoubtedly what JPM sees within CMS. Retailers know that they can’t further empower the big bank with their data, but rather need an independent party to run the CRM platform for them.

Summary

I’ve already spent a little more time than I was anticipating here. For start ups my message is quite simple, if Google had challenges pulling off POS innovation (after ~$1B in investment), rest assured you will too. Banks are well positioned to throw sand in your gears … focus on delivering value within merchant –consumer relationship. The Mobile-retail interaction is greenfield, and there are 1000s of different flavors.. no one company will be the centerpiece here. Avoid POS payments.. or be the “arms provider” to the big institutions as they duke it out. My view is that the key for MNOs, Apple, Amazon, Google and Samsung’s future value is

#1 Authentication (Linking the Physical and Virtual World)

#2 Orchestration (Coordinating Virtual and Physical World Processes, Data and Value Chain)