Digital Money Forum

What's the alternative?

[Dave Birch] There are plenty of extinct "alternative" payment mechanisms already: c2it, Yahoo PayDirect, Billpoint, eMailMoney and so on. And there are a few that survive. But where does the label come from? I saw the comedian/musician Tim Minchin tell an excellent joke when I went to see him earlier this year. I paraphrase, but the joke was essentially:

Q. What do you call an alternative medicine that he been tested and shown to work in double-blind clinical trials?

A. Medicine.

Quite. So when we call something an "alternative" payment method, what do we mean? What is it the alternative to? I made a note to ask a couple of people about this last year, when I read that

During this year’s holiday shopping season we project $7.8 billion will come from alternative payments versus $35 billion from traditional online payment methods.

[From Payments News: Javelin's 2008 Online Retail Payments Forecast - November 10, 2008]

The forecasts for the coming holiday season will be out soon, and they'll be even bigger despite the recession, and I never got round to asking the question then, so I'm going to ask it now. How are payment methods that account for more than 20% of the market "alternative" in any sense?

Regulation isn't a bad thing

[Dave Birch] One of the areas of great interest for this blog is the evolution of "alternative" payments in different environments. As a consequence, I am always very interested to see how alternative payment system differ between markets. For example, the Russian market for alternative payments is very different from the European market. This year, broadly speaking, it will break down into

• About 14 billion Roubles spent via the leading e-wallet schemes Webmoney and Yandex.
• About 9 billion Roubles spent via mobiles for digital content.
• About 10 billion Roubles spent via the near-ubiquitous "terminals", the reverse ATMs that are on every street corner in Moscow (more on these below), some of which goes into loading e-wallets and mobile prepay accounts.

So a big chunk of the alternative payments market in Russia is taken up by a payment system that simply doesn't exist in Europe (or, in fact, anywhere else so far as I can see), which is the near-ubiquitous "cash in" terminals or, as we tend to cal them, "reverse ATMs".

In the last ten years, a rapidly growing shadow banking system has sprouted up in Russia to service these small payments by turning cash into electronic currency, or e-money. And now that this sector has reached the $1 billion mark – and this in a crisis – and has expanded to include 10 million customers, e-money business owners are getting antsy about government regulation.

[From Crashing Russia's all-cash culture - Fortune Brainstorm Tech]

Estimates vary, but there are somewhere in the region of 400,000 of these terminals in use right now. On literally every street corner is a terminal that Russians feed with banknotes to top up their mobile phone, pay utility bills, obtain pre-paid virtual credit cards (I did this: you feed the cash in and the Visa card number, expiration date and CVV are sent by text to your mobile phone). You can see from this screenshot the wide range of services available:

It seems like a bizarre market arrangement, one that the laws of economics should mitigate against. As Evgeniya Zavalishina, the General Manager of Yandex Money put it rather neatly, people are taking money out of an iron box, walking a metre and then putting the money back in another iron box. Incidentally, Evgeniya will be joining an excellent line-up of speakers at the Electronic Money Association's 3rd annual conference in London on 24th November so if you are interested in learning more about the evolution of e-money regulation around the word, head on over to the EMA web site and sign up. But back to the iron boxes. By astonishing coincidence, the restaurant where I went to dinner with Evgeniya and other members of the Russian E-Money Association (set up by a good friend of the Digital Money Forum, Victor Dostov) had precisely such an arrangement!

How can this be economic? Surely you would expect banks to incentivise the terminals to take chip cards so that people could pay their bills with a debit card. Come to that, why can't they do that from a bank ATM in the first place instead of going to a terminal at all?

Well, one reason might be a lack of regulation. At the excellent Russian E-Money conference I attended, one of the speakers placed Russian banks as the 53rd most efficient in the world, but the Russian non-banks as the 4th most efficient in the world (for payment services). Yet both the banks and the non-banks would benefit from a better regulatory infrastructure. The problem that was discussed at the event was that everyone knows that regulation needs to come, but no-one is sure what that regulation might look like (and some of it, such as impending regulation on data protection) simply won't work technologically. Nevertheless, a good infrastructure for electronic payments would, I'm convinced, help both the alternative payment providers (ie, the terminal networks) to invest further and develop new services while at the same time enable banks to invest in their own terminal and enhanced ATM services. Everyone would benefit.

This reinforces something that has been said before on this blog: no regulation is not a way forward. We want to see digital money deliver real solutions to real problems all around the world and a good regulatory framework helps in this enterprise.

The price of everything

[Dave Birch] I've just read a couple of pieces about pricing: the Chicago Fed's Letter 266a (September 2009) "Payments Pricing: Who Bears the Cost?" and the SPEED piece by the Deputy Governor of the Bank of Finland, Pentii Hakkarainen, "The future of retail banking: more competition needed". Pentii says that one challenge (to retail banks) is the "dependence of banks on cross-subsidisation, especially of payment services". I agree and I'm not sure that the magnitude of the cross-subsidy from efficient e-payment methods that (because of SEPA) are going to deliver less margin to the least efficient paper and metal methods is appreciated. So the regulators are pushing down the amount of money available for subsidy but will (of course) go beserk if any attempt is made to remove the subsidy.

One way in which they are reducing the amount available to subsidise cash is by pushing interchange fees down. Setting aside whether that's a good thing or a bad thing, it's certainly a thing. Earlier in the year, there was a Federal Reserve Board report "Interchange Fees and Payment Card Networks: Economics, Industry Developments and Policy Issues" that looked at the situation (in the US at least) in some detail. Amongst other observations, it noted that with respect to interchange fees:

1. In general, an efficient interchange fee is not solely dependent on the cost of producing a card-based transaction nor is it equal to zero.
2. An efficient interchange fee may yield prices for card services to each side of the market that are “unbalanced” in the sense that one side pays a higher price than the other.
3. The efficient interchange fee for a particular card network is difficult to determine empirically.

I think the last point is worth emphasising. There doesn't seem to be any reason to suspect that regulators should inherently know what the correct level of interchange should be. It follows, I think, that if the regulators believe that interchange is too high (for whatever reason) then the appropriate path to correction is increased competition.

Faster faster

[Dave Birch] At the Intellect Financial Services group meeting, Paul Smee, the Chief Executive from the Payments Council, gave an excellent summary of Council's goals and objectives as well as making some suggestions for better co-operation between the technology industry and the financial sector, such as creating some kind of vendor forum. He said in passing that much of his focus over the last couple of years has been the Faster Payments Service (FPS). FPS is a little bit of a success story for the UK payments industry, so it's worth talking about.

The Swedish experiment

[Dave Birch]Within the narrow confines of this blog, Sweden is one of the favourite geographies, partly because it is struggling with cash and partly because it is more transparent than some other banking systems.

The Swedish central bank published some detailed figures on the cost of payments and they provide useful input to the debate on the future of payments. They show that on average the variable cost of an ATM cash withdrawal to the issuing bank is around 1.3 SKr

[From Digital Money Forum: Cost dynamics, again]

Well, that doesn't sound like very much. But in Sweden, it multiplies up to a big fraction of the economy because the Swedes are heavy ATM users.

Stefan Ingves (the Governor of said Central Bank) said that Sweden has “many more” cash transport robberies than its neighbours because, essentially, cash withdrawals from all ATMs are free (despite the large costs entailed in cash handling). This means, in turn, that Swedes use cash far more than Finns, Danes, Norwegians and (especially) Icelanders.

[From Digital Money Forum: The Cash Menace up North]

Mr. Ingves also notes (in the speech referred to above) that Sweden has far more cash-in-transit robberies than its neighbours and suggests an alignment of the private and social costs: the cost of armed robberies, he said, should be accounted in the cost of cash. This means that far from being free at ATMs, cash in Sweden should be expensive. He is, of course, completely correct.

What doesn't add up

[Dave Birch] I'm still curious about US debit interchange rates, just as I was a couple of weeks ago when i misunderstood a magazne article on the topic. Remember that in the US, PIN debit (which grew out of regional ATM networks) costs less than signature debit, so you would expect merchants to incentivise the use of PIN debit or you would expect signature debit rates to fall towards PIN debit rates. In fact, since signature debit rates (via Visa and MasterCard) have remained fairly stable, what has happened is that PIN debit rates have moved up towards signature debit rates. Looking for some recent figures....

the average interchange cost for a small retailer on a $50 face-to-face purchase processed on a PIN-debit card with a major electronic funds transfer network logo in 1996 was 9.9 cents. By 2007, that same sale generated 40.1 cents in interchange... In contrast to PIN-debit pricing, signature-debit interchange has been stable since 2005... a small retailer in a $50 card-present sale with a Visa check card would pay interchange of 66.5 cents, and 67.5 cents on an equivalent MasterCard Debit transaction.

[From News]

Now, I reckon that the same retailer in the UK would pay 10p for a transaction that they pay 40 cents (30p) for in the US. So, I'm missing something here. Why does a debit transaction cost a merchant so much more in the US? For $50 transactions, setting the cost at 15 cents or 30 cents is not a make-or-break decision. But, obviously, for many merchants (especially in the cash-replacement potential market sector that I am interested in) the average sale is much smaller and a 40 cent charge on a $4 transaction eats up a lot of the merchant's margin.

The chain’s average ticket is $6, a level at which it’s difficult to make money after deducting interchange, Jones argues. Currently, credit cards account for about half of sales.

[From News]

So unless I'm missing something else about the cost structure, the only interpretation of these figures is that merchants in the US simply pay a much higher fee than merchants in (for example) the UK do. Our friends at Payments News pointed me to a recent report that suggests that that is precisely the right interpretation.

U.S. swipe fees are: more than two times the rates in the UK and New Zealand, four times the rates in Australia, and over six times the cross border rates recently agreed upon by MasterCard and the EU

[From Merchants Publish A Look at Interchange Fees Outside the US]

Why is this gap so big? Surely the US market is just as competitive as the UK market? I read a recent analysis by the always reliable forum friend Peter Jones of Payment Systems Europe -- who put the average merchant fee at 1.8% in the US and 0.8% in Europe -- and he attributed the difference to the competitive issuing market in the US, with card companies competing to attract consumers by offering ever-higher rewards and charging the merchants for them. You can see why merchants object to this: but what should they do? James van Dyke of Javelin has some sage advice.

Merchants have some valid concerns about the payments industry, but they should push back on their advocacy-group partners and lobbyists on the viability of this interchange campaign. The interchange debate is fundamentally an issue between differing camps of business entities, and to position it as a consumer-advocacy issue will ultimately be fruitless for the merchant community in my opinion.

[From Javelin Strategy and Research » The merchant cost-of-interchange debate: what are the facts?]

Yes, the cost of cards needs to come down. But the way to do this is by encouraging competition, not by whining to regulators.

On the money

[Dave Birch] It's rather exciting for us transaction chaps to be centre stage for a change. In the space of a couple of years, payments has gone from being a dreary corner of banking, an unexciting cost base, to the future of the "narrow bank": the utility, as economist would say, that is attached to the investment banking casino. But if you were to go down to a real casino and put a bet on the next big thing in retail payments, where would you put your money?

One way to start thinking about this is to go back one economic cycle and look at what kind of innovation in that cycle led to real change in payments. At conferences and seminars, people tend to use the example of Paypal as a success forged in the last recession that has moved on to become part of the mainstream.

At Ebay’s first analyst day in three years, the contrasts it gave between its core auction business and Paypal were black and white. The company expects its marketplace segment, which only grew revenues 1% last year, to grow slower than the online commerce market this year. By 2011, it may finally surpass industry growth rates again. On the other hand, Paypal grew its revenues by 26pc last year and could see them double over the next three years to $5bn, with margins of 20pc.

[From Ebay’s future lies in payments not auctions - Telegraph]

Just by way of comparison, although it's not a perfect comparison, look at the value of the newcomer Paypal compared to the value of a long-established player such as Visa.

Visa trades at 14 times 2011 estimated earnings. On that basis Paypal would be worth $14bn – or $2bn more than Ebay’s total enterprise value today. Moreover, Paypal is growing faster than Visa, so it arguably deserves to trade at a higher multiple of earnings.

[From Ebay’s future lies in payments not auctions - Telegraph]

When you get transactions right, they become a thin but crucial layer between technology and the market, turning places into marketplaces, enabling growth and progress. But this thin layer must spread widely enough to make money as well and so any challengers to PayPal obviously need ecological niches big enough to expand into (although as the example of M-PESA shows, you only need one decent niche to get off of the ground).

Drifting eastwards

[Dave Birch] I'm spending a lot of my time at the moment, because of a variety of projects, building up roadmaps linking business, social and technology change to try and help our customers to make better decisions about their next round of investment into the retail electronic payments space. If we assume that the key technologies for the medium term already exist, so we can try and assess the relationship between those technologies and business and social change without drifting into science fiction, then we still have to make some informed decisions about which of these technologies will shape the roadmap. Moreover, if we are trying to look at the payments roadmap over the medium term, another factor that we must take into account is the global shift in focus away from the current developed markets. Thus, we need to look at the dynamics of the payment sector and how different technologies are affecting the dynamics in different markets. One of the easier predictions to make is that China will have much bigger role shaping the future roadmap than it has done over the previous 3-5 years.

China is fast catching up with the US and Europe as a growth market for non-cash transactions, according to the latest edition of the annual World Payments Report from The Royal Bank of Scotland, Capgemini and Efma.

[From Finextra: China emerges as a growth market for non-cash payments]

China accounts for about 9% of global non-cash transactions, and is growing fast, but it's important not just because of the size of the market but because of the nature of that market. It is interesting to speculate whether China will see a market maturing towards a "Western" model of card-based retail payments or whether "Asian" models informed by new technology will dominate. I mean, as you might expect, mobile. In-Stat says that the mobile payments in China will approach $18 billion in 2013, split between $14 billion in remote payments and $4 billion in local payments.

Recent research by In-Stat [in China] found the following:

• SIM cards with RF SIM solutions customized by China Mobile are expected to launch in mid-2010, and the company is currently working to develop retail partners and deploy POS devices.
• Over half of respondents to In-Stat’s survey express interest in using their mobile phones as a payment tool.
• The largest proportion of current mobile payment services users (36.7%) responded that they prefer to use payment platforms funded by banks, indicating that the banking sector is the most trusted by Chinese consumers.

[From In-Stat - Press Releases]

To see these figures in context, bear in mind the most recent Juniper Research forecast for the total world NFC payments market:

the application of NFC as a mobile retail marketing tool via coupons and smart posters will support the growth of NFC mobile payment transaction values from $8bn in 2009 to $30bn within three years.

[From NFC Mobile Payments to Exceed $30bn by 2012]

So the Chinese local and remote mobile payments market roughly equates to about half of the total world local mobile payments market, just to give an indication of comparative scale. The point is that from Western Europe, then, we may find ourselves looking east for inspiration. Look at the great work already being done on mobile platforms in Eastern Europe (where mobile banking has been growing rapidly), on the internet in Russia (look at the growth of Forum friends WebMoney) and in the mobile proximity worlds of Korea and Japan. The CEE and Russia mobile markets are huge, which is why they are fertile ground for mobile payment initiatives.

On a proportionate basis, MTS Group, which runs networks in six Eastern European markets including Russia and Ukraine, is now the second-largest operator group in Europe, trailing only Vodafone. MTS Group's main regional competitors - VimpelCom and MegaFon - are also now among the top ten largest groups, in both cases due mainly to their operations in Russia.

[From Developing Telecoms - Russian mobile firms are now among the largest in Europe - Wireless Intelligence]

In these markets, mobile payments occupy a more central position in the payments roadmaps than in some Western markets, although the fact of the matter is that any medium term roadmap of retail payments now has mobile as a key path.

Mobile isn’t “just” another credential to be utilized for payments. In fact, mobile payments are likely to emerge as the primary payment channel substituting the incumbent’s cash and plastic in less than five years.

[From Bank Systems & Technology: The Blog: Creating New Revenue Streams With the Mobile Channel]

For most people, in most of the world, for most of the time, electronic payments means mobile payments.

Paris match

[Dave Birch] We still have a couple of places left for the (free) CSFI Roundtable discussion on "Innovation and the Internal Market" at the OECD in Paris on Friday. See the research fellowship invitation for all of the details.

banking, innovation, payments, SEPA

What's in a name?

[Dave Birch] I got caught out in a meeting referring to the APACS Card Payment Group, which of course no longer exists. I thought I'd render a quick public service to help other people to avoid similar mistakes. Here's your handy cut-out-and-keep guide to the UK's new payment organisation landscape.

The Payments Council was created in March 2007 to set out the national strategy for UK payments. It has a Payments Council Board made up of banking representatives, some independent directors and an independent chairman (Brian Pomeroy). The principal UK payment schemes (listed below) have a contract with the Payments Council to set out rights and duties.

The UK Cards Association is the successor the much-loved APACS Card Payments Group (CPG). It is the trade body for the UK cards industry. Its 14 members, the major card issuers and acquirers, work together here on non-competitive issues.

Financial Fraud Action UK was created earlier this year to work alongside the UK Cards Association on the specific issue of reducing fraud.

The Dedicated Cheque and Plastic Crime Unit (DCPCU) is a specialist law enforcement unit made up from officers from the City of London Police and the Metropolitan Police and funded by the banking industry. It investigates serious and organised cheque and card fraud.

SWIFT (UK) Limited is the membership organisation representing the UK's SWIFT users.

banking, payments