Mobile Payments Today (Image Credit: Payments Journal)
The largest sector of growth in financial services is Payments. The industry disruption of the last decade from financial technology (FinTech) has ushered in an era of innovation, enhancing convenience and customer experience for consumers and businesses, and adding a new layer of competition from FinTech payment startups — in a space that has been dominated by credit card processors and financial institutions.
The growth of mobile, e-commerce, and connected devices, along with the decline of purchases made in-person (at brick and mortar stores) has dramatically shifted the sector towards digital payments.
The payments ecosystem has an assortment of public and private firms that include payment processors, credit card companies, banks, e-commerce, technology, and messaging enterprises — across Asia, Europe and the U.S.
How did we get to this current state of FinTech impacting the payments sector? What public FinTech companies / startups, payments business models, or FinTech trends will influence the industry’s future?
The payments industry has evolved from a barter system in ancient civilizations to a modern-day structure involving cash, debit & credit cards, and / or electronic transaction processing.
Multiple categories and players exist in today’s FinTech payments landscape such as credit card networks, payment gateways, payment processors, banks — each playing a part in the process and charging fees along the way.
Past payments models were dominated by banks and card networks, but present models offer faster and low-cost payment processing through FinTech startups that provide multiple (or all) parts of a payment framework; future models are anticipated to be driven by the adoption of blockchain platforms that would remove all intermediaries.
Multiple technology, consumer, and regulatory trends are impacting the future of FinTech in payments such as enhancements in security and fraud prevention, regulation to protect consumer data, consolidation of financial services providers, and increased collaboration between banks and FinTechs.
BRIEF HISTORY OF PAYMENTS – FROM BARTER TO CASH & CARDS
Evolution of Payments (Image Credit: Zeta @Medium)
The roots of the payments sector (and finance industry) come from ancient civilizations that traded goods and services through barter (exchanging one item for another). Paper money was created in the 13th century both in Europe and Asia, making exchange easier and efficient for both buyer and seller. Checks and cards (debit and credit) made cashless payments possible (starting in 1966). In the last 15 years, the internet combined with smartphones has allowed people to pay bills, transfer, and buy products and services globally with cash or cards.
Today, the global payments market is an estimated $1.75 trillion, comprised of cards, domestic transfers, international remittances, and deposit accounts (that fund debit cards) — for both consumers and businesses. The projected annual industry growth rate is 7% through 2021, with 34% of banking activity coming from payments — developing countries in Latin America and Asia are the leading hubs of growth.
Credit card networks and big banks have been the dominant industry players, but FinTech payments companies continue to grow and influence with disruptive models that have removed layers in legacy payment flows, and have added new infrastructures that address multiple transaction channel.
TODAY’S PAYMENTS ECOSYSTEM – CATEGORIES AND STAKEHOLDERS
Players in the Payment Value Chain (Image Credit – CB Insights)
Within the current payments business models, there are four categories that work together to execute a transaction, with top payments companies leading each category. A growing trend (discussed later) is the number of FinTech payment companies that have expanded from one of these categories (to multiple or all) in the last 10 years.
Payment Gateway: used to send the payment to and from the consumer and bank, notably with online and cashless transactions; transaction data goes from the vendor’s website directly to the processor for validation and fulfillment. Top payment gateway companies — Apple Pay, Google Pay, Samsung Pay, PayPal, Square, Stripe, Adyen;
Payment Processor: used to send payments between banks and consumers for transactions at physical stores usually involving processing equipment (e.g. card readers / terminals), which is leased or purchased by the merchant. There are two types of processors – front end (bank works with credit card network to initially approve the transaction), and back end (controls the flow of funds from consumer to bank after approval). Top payment processing companies — PayPal, Square, First Data, WorldPay, Stripe, Adyen, Flagship Merchants;
Credit Card Networks: as sponsors of their specific brand and clearing house, these firms dictate fees, guidelines, and oversee transactions between banks. Top card networks — Visa, MasterCard, American Express, Discover;
(Bank) Card Issuers: banks that distribute cards to their clients within a specific credit card group, are responsible in verifying balances and approving transactions (while also charging fees for approvals). Top banks for cards — Wells Fargo, Bank of America, JP Morgan Chase, Barclays;
Within these categories, there are also major industry stakeholders improving the current state of FinTech payments. Offering both key benefits and challenges, each party is continuously striving to improve its overall impact and influence.
BIG BANKS: Bank of America, JP Morgan Chase, Citi, Wells Fargo
PROs: global reach, established financial services brand, multiple capabilities in financial services, experience in highly regulated environment;
CONs: legacy structures delay transaction processing, high fees for merchants;
BIG TECH: Apple Pay, AliPay, Google Wallet
PROs: convenience and access (through smartphones), known tech brand;
CONs: not widely accepted by businesses, requires upgrades by the business, fees to the merchant;
PEER-TO-PEER: Square Cash, Venmo
PROs: fast transaction processing, small (or no) fees, convenient for smartphone users;
CONs: mostly for domestic transfers, requires sender and receiver to have specific app, integration difficulty with bank accounts;
PAYMENT PROCESSING: Stripe, PayPal, Square
PROs: low setup and no monthly fees, quick and easy installation;
CONs: transactions costs (as % of purchase), integrating with legacy applications is challenging, security risks;
CROSS-BORDER REMITTANCE: Western Union, MoneyGram, Xoom
PROs: trusted transfer option globally, especially to developing countries;
CONs: high cost per transaction, lengthy processing times;
CREDIT CARDS: Visa, MasterCard, American Express
PROs: established network globally, cashless alternative, offers data insights, top fraud prevention controls;
CONs: requires strong credit standing (from consumer to qualify), international transaction fees, merchants pay purchase percentage as a fee, customer data sold;
BLOCKCHAIN: Ripple, Circle
PROs: low transaction costs, quick and convenient processing globally for every country;
CONs: low adoption and trust as a new technology, requires costly infrastructure upgrades, dependent on cryptocurrency volatility and complex regulatory environment;
Overall, the Big 3 (Visa, MasterCard, American Express) of credit card networks control the industry with 75% of transaction volume, followed by FinTech payments companies. However, established payment tech firms (PayPal and Square), have been able to grow in market capitalization with innovative API integration models for merchants to run their business.
PAYMENT BUSINESS MODELS – PAST AND PRESENT
Payment Models and Options (Image Credit – Business Sight)
PAST MODELS: Banks were exclusive providers of payments services in the pre-Internet era of finance. As both debit and credit cards were launched abut 60 years ago, revenue was split between banks, processors, and credit card companies. Competition in the payments sector of the industry increased with technology giants, which pushed both banks and established payment processors to offer new services in peer-to-peer payments (P2P), and point of sale (POS) structures.
PRESENT MODELS: In today’s industry landscape, both public FinTech companies and payment startups have started to diversify their services and options to cater to all types of merchants and customers for a seamless, holistic experience. The meteoric rise and dependence on mobile devices, along with the ease and speed of connectivity, has created a significant trend towards a cashless marketplace both online and offline.
E-commerce and messaging sites also act as new robust payment platforms that exist outside of banks, holding money and processing transactions on their own.
THE FLOW OF PAYMENTS TODAY
Payment Flow (Image Credit: 360 Payments)
The payment ecosystem starts at point of sale with a customer conducting a transaction with a merchant, utilizing a card (debit or credit) at a physical location (or through an e-commerce app / site).
The gateway (such as Apple or Samsung Pay for mobile) encrypts the transaction request data and sends it to the processor, who then relays it to the issuing bank.
Upon approval, the amount is transferred to the seller by the processor. All parties involved charge a fee, with an estimate of 2-3% of the transaction being charged in total. Some companies (such as PayPal, Square) act as both gateway and processor to increase overall efficiency, and take a larger portion of the merchant processing fees.
FINTECH TRENDS SHAPING THE FUTURE OF PAYMENTS
FinTech Payment Trends (Image Credit – Visa)
Critical trends in connectivity and preferences have created the current state of payments in financial services. What are the upcoming FinTech trends that will shape the payments sector in the next 5 years?
Mobile Growth in Payments Apps and Wallets: China is the global leader in app based payments, the majority coming from AliPay and WeChat due to the country’s lack of debit and credit card access. These platform giants have been able to expand from peer-to-peer transfers, to include other financial services such as deposit accounts and credit cards (e.g Apple Card). The most anticipated entrant is Facebook due to its enormous user base from Messenger and WhatsApp — the social media giant is planning to pilot its own cryptocurrency platform called Libra.
Cybersecurity enhancements: Authentication methods continue to improve with technologies such as biometrics, card chips, and facial recognition; Google and Apple lead the way in security improvements for payments.
Improved Fraud Detection: As the ease and ability to make payments globally grows, so does the tremendous risk of fraudulent transactions, losses, and a negative customer experience. Fraud on credit cards has been growing at 18% over the last 10 years. Artificial intelligence (AI) and machine learning are helping maneuver through multiple data points in near real-time to help deter and prevent fraud in process. As volumes of data continue to train and improve detection models, many businesses will become more confident in switching from being “cash only” to electronic and digital payments.
Combining services and features in payments: As mentioned earlier, emerging startups have started consolidating individual components of the payment flow structure into a single platform or model in order to improve revenue in a competitive marketplace. Much of this activity has taken place through acquisitions, such as PayPal’s purchase of iZettle, to enhance their point of sale features. Big banks have also started to become active in the payment processing function, going beyond merely issuing debit and credit cards.
Banks and FinTech companies joining forces: As traditional banks struggle to innovate their legacy structures with updated customer-centric designs and processes, FinTechs have started to partner and offer their ability to be agile and efficient with technology. Application Programming Interfaces (APIs) have become a popular new tool for banks to customize financial services and improve client experience — top FinTech companies such as Plaid, Stripe, and Synapse have successfully collaborated with institutions, and will continue to do so going forward.
Push towards real-time transaction settlement: Global technology improvements in the payments ecosystem are making an infrastructure for instant processing a possibility. The benefits would reduce cash flow delays for businesses due to enhanced liquidity, and consumers would avoid overdraft fees and confusion with pending / processing / authorized status of transactions on their bank accounts.
Increased regulation to enforce compliance and security challenges: Data breaches continue to be a common theme in today’s world, leaving established firms partnering with tech startups especially cautious when it comes to consumer data protection. Partnerships can enhance customer experience but also increase operational risk which can lead to losing market share, fines from regulators, and a negative reputation in the industry.
Payment Services Directive (PSD2) and General Data Protection Regulation (GDPR): Both regulatory actions came from the European Union — PSD2 focuses on opening up customer data that banks have traditionally held; without banks acting as gateways, merchants can directly verify and approve transactions by accessing bank data without any intermediary. Banks must also allow API access to third parties (with the consumer’s authorization). GDPR is a deterrent for companies to avoid misusing consumer’s personal data by regulating how a company can use this data, and forcing firms to report breaches in a timely manner (or pay a significant amount in penalties and fines). Both PSD2 and GDPR will push compliance to higher standards than ever before, requiring companies to solidify operating policies and processes.
FUTURE OF PAYMENTS – BLOCKCHAIN
Cross-Border Payments (Image Credit – Pymnts.com)
The long-term future of payments will be driven by blockchain — rising in popularity as the next disruptive technology over the last 2 – 3 years due to cryptocurrencies such as Bitcoin. With a distributed ledger technology (DLT) infrastructure, transactions can be initiated, verified, processed, and completed — all within a single platform in an efficient, seamless, and low cost manner.
Cross border transactions involving foreign currency have been the best use case for blockchain companies (such as Ripple and Circle), removing intermediaries such as clearing banks. The current flow for international wire transfers involves high fees and lengthy processing times.
The regulatory landscape and volatility within cryptocurrency markets will directly impact the speed and depth of adoption in the next decade.
Sharespost – Payments: Star of the FinTech World
Seeking Alpha – FinTech Trends: M&A and Mobile
Marketplace – Short History of the Debit Card
McKinsey – Global Payments 2018