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« It's all about density | Main | Is that what you wanted? »

Payments, profits, competition

By davebirch posted Nov 6 2006 at 9:54 AM
[Dave Birch] It's a bit of a paradox. Lots of people want to get into payments. It seems as if a new scheme (especially around mobile) is announced every week. This is presumably because they think they will make money -- as, in fact, Paypal have done with net income of $281 million last quarter -- and can grow a business. Yet people who are in payments (eg, banks) don't find it such a great business. Here are some rough figures for the spreadsheet: in Europe, payments account for a about a quarter of bank revenues and about a third of bank costs, contributing less than a tenth of bank income (in the US, payments account for a slightly bigger proportion of both revenues and costs and the contribution to income is slightly higher). The scale of the business is so huge, though, that this small net income is still in the region of 10 billion euros for EU-25 banks.

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There will soon be a new framework for payments in Europe, the Single European Payment Area (SEPA). This will put pressure on banks, amongst others, to deliver payment services more efficiently. If SEPA is successful, then there ought to be substantial efficiencies. As McKinsey, Tower Group, Accenture, Cap Gemeni and just about everyone else has been pointing out in their reviews of the payments industry, these efficiencies will serve to reduce bank payment margins significantly over the next few years. (And banks will spend billions to facilitate this transformation.)

So what should banks do? Abandon the field to third-parties, non-bank entrants who can start fresh with a lower cost base, or find ways to cut costs and grow revenues? The FinancialTech Insider reported from SIBOS in Sydney this year that “I heard the key speaker, David Morgan, CEO of Westpac Bank in Australia, take banks to task for not doing enough to stifle competition from non-bank providers in the payments space”. Perhaps another strategy is required then. Since the biggest component of bank costs is still the cost of handling cash, joining the war on cash (in the banks' case, the war to replace cash transactions at POS with card transactions at POS) both reduces costs and increases income. So no problem, this analysis would imply, and new entrants will find it difficult to build the merchant base that debit cards (especially the pan-European SEPA-compliant chip-enabled debit cards that we will all have in 2010) already reach.

That's not to say that the provision of payment services doesn't need improvement and that third parties couldn't step in. The noted American uberinvestor Warren Buffett once remarked that he was surprised how profitable banks were, given the commodity nature of their offering. As far as I can see, this is because there isn't as much competition as people such as Buffett might imagine from looking at other industries. This is largely because regulation, while undeniably a massive cost to incumbents, is also an effective barrier to new entrants -- yet in the case of payments, there are less heavily regulated structures in Europe (eg, Electronic Money Institutions regulated by the Financial Services Authority in the UK) which might provide a vehicle for competitors. But there may be another factor lurking. Michael Porter, the “Competitive Advantage” guy, told Banking Strategies that he is surprised by how “inefficient and siloed” the payments world is. Note that in the same interview he also says that “One of my rules of strategy is that the more you outsource, the harder it is to have a competitive advantage”. So the message from a variety of experts seems pretty clear: banks need to spend on building and differentiating debit products -- using new technologies such as contactless and mobile to drive both acquisition and usage -- and keep them in-house in they want to make them part of a competitive advantage and not merely a business-as-usual product.

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