On-line Payments: Cut Up Your Credit Cards!


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As the Internet economy has become an ever larger part of consumer transactions, the payments industry has slowly adapted to fill its needs.  Today, with the Internet accounting for roughly 5% of US retail transactions, and with new technology poised to add secure point-of-sale payments to basic capabilities of a smartphone, tension is rising between the traditional payments industry and the leading Internet players.  Given that payments represent a quarter of all banking revenue, the web-based interlopers will face stiff opposition from financial institutions already mobilized by a new regulatory regime.  Despite this, we believe Internet “meta-aggregators” like Google and Apple will be able to create attractive new businesses in facilitating payments

The traditional value chain for retail payments begins with a consumer who is issued a payment instrument – e.g. credit cards, debit cards, checks, etc. – by a bank.  Credit/Debit cards, the typical basis for non-cash retail payments, are associated with a payment network, such as Visa or MasterCard, which operates an infrastructure for merchant acceptance and consumer authorization.  Actual payments from the consumer bank to the merchant bank are facilitated by 3rd party payment processors, such as Global Payments, Fidelity National Information Services, or Fiserv.  These roles are strictly regulated, with particularly strong scrutiny of banks, which must underwrite the credit and manage the customer account, including collections

Advances in technology are beginning to disrupt the traditional value chain.  On-line leaders have begun to establish non-bank payment accounts to facilitate e-commerce via services such as EBay’s PayPal, Google Checkout, and Amazon Payments. These intermediaries aggregate payments and manage authentication, allowing users to fund purchase via low or no fee automatic bank transfers, disintermediating high fees charged by issuers, payment processors and card networks.  While some accounts do tie back to credit and debit cards, the largest on-line players have established scale and consumer brand equity, putting them in position to squeeze payment networks and card issuers.  Clearly consumers trust the web – in addition to the 17.7% annual growth of e-tail, 30% of American consumers used non-bank payment accounts in 2009

The dramatic rise of smartphone adoption raises an even more threatening prospect to the traditional payments industry.  The next generation of these devices will be equipped with Near Field Communications (NFC), a technology that provides fast, secure, two-way connections at very close range.  Using NFC, smartphones and tablets can act as electronic wallets, authorizing payments at retail via specialized terminals at the point of sale.  NFC transactions promise to be faster, more convenient, and less vulnerable to fraud/theft than card-based sales.  Gartner projects 349M global users and $429B in NFC transactions by 2015

The battle for NFC domination is underway and several platforms have already emerged. Isis, a joint venture backed by Verizon, AT&T, T-Mobile, Discover, and Barclays is pitting the carriers in one corner against payments incumbent Visa and it’s banking partners: US Bank, Bank of America, Wells Fargo, and JP Morgan Chase along with privately held startup DeviceFidelity which is providing the underlying NFC technology. Google has teamed with Citigroup, FirstData, MasterCard, and Sprint with it’s already announced open platform, Google Wallet. Apple is unlikely to sit idle considering its stake in mobile devices, and an announcement on NFC by year end would not be a surprise

Competition in NFC will be a race to critical mass on two separate tracks: consumer adoption and merchant penetration.  For consumers, adoption will be dependent on acquiring a device with NFC capability, activating an app, and opening a credit account, while merchant penetration will depend upon negotiations with merchants and the deployment of NFC readers to stores.  Carriers will look to push subscribers to their own networks, while smartphone platform architects will look to integrate NFC payments into an integrated user experience.  Banks and payment networks will look to leverage their existing credit relationships with consumers, and importantly, with merchants, to get a head start.  The disparate strengths of these categories of players, and the potential regulatory burden on non-banks, has driven the coalition approach by all serious players

We currently see the Google/MasterCard venture as best positioned given its head start and lead in  smartphone market share. Google Wallet NFC features come standard in several of the latest released Android devices. Visa’s solution is next best given backing from 4 of the top 6 credit card issuers and play with a technology that is compatible with most mobile devices including iPhone. Isis seems to be an attempt by the carriers, a distant fourth payments player, and the number 13 card issuer to get a foot into the marketplace. Neither Amazon or Apple have publicly yet announced an NFC strategy, but believe that the balance of power in the nascent NFC space could tip should they choose a side

Longer term, we believe Internet-based payments, both mobile and fixed, could grow to a large majority of non-cash payments.  While all of the first consortia for NFC platforms include both card issuers and networks, the balance of power will likely shift toward on-line players, allowing them to squeeze providers of credit underwriting and network services.  While it is conceivable that these companies could opt to cut out financial intermediaries entirely, the accompanying regulatory burden might be more than Google, Apple or Amazon would be willing to bear.   Nonetheless, returns for purely financial players in the NFC and on-line credit game will likely see significant pressure, while “meta-aggregators” earn fees for aggregating transactions, as well as providing added services to consumers and merchants

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