Payments 3.0

New payment opportunities in a context driven world

Payments are adapting to a shifting market In most markets payments has historically been a relatively slow moving industry dominated by large

scale providers and payment schemes. Big changes in payments technology have tended to be long

winded processes often involving major consortiums and regulatory mandates, typically alongside

large scale and highly disruptive technology implementations. Payments for the most part was a

steady, predictable market.

The situation today is different as multiple disruptive technologies have emerged simultaneously. This

is now the catalyst for major change across the payments industry. As a result the payments market

for merchants, acquirers and issuer is alive with major opportunities to improve the customer

experience, improve processes and ultimately drive new business and revenue opportunities.

Much of this recent change is due to the nature of the relationship between payments, merchants and

the broader consumer technology space. Shifts in one area has a tendency to have impacts on the

other, often in a mutually reinforcing fashion. These new technologies are in turn creating new

disruptive business models and emerging revenue opportunities. The pace of this change compared

to the calm and steady approach of the past has inevitably proven bewildering for many, who remain

unsure of how to proceed or what these changes mean long term.

This whitepaper aims to put these payments industry shifts into a broader context of what it means for

issuers, acquirers and merchants today, and where things are likely to go from here. The future is not

something that will come automatically, but those organizations that can prepare for the future of

payments today will see the most benefit tomorrow.

Payments builds on what came before

Much of the discussion on payments in recent years has revolved around which payment instrument,

service or business model will prove dominant long term, and how these new forms of payment will

eventually supersede all that came before it. The pace of change happening in the payments space

has hit an unprecedented rate, and models that were once certainties now look less sure. For many

payment providers this has led to confusion over what strategies to follow and which technologies to

invest in.

In many ways instrument centric perspectives are based on older payment development models,

where change was incremental, and usually only undertaken at a mass scale. Essentially payments

evolved only when the industry agreed it would evolve, and the broader merchant space had relatively

little flexibility in what they could offer to consumers and how they could accept payments. When

merchants or issuers offered new payment instruments to consumers, chances were all of their

competitors were able to offer similar products. Consumers could pay with what they were given, and

for merchants the ways of accepting payment offered little choice or flexibility in how they shaped the

customer experience.

Slow and steady does not win the race

This model of payments development is no longer relevant. The rapid changes in consumer

technology, most notably through the growth of smartphones and ubiquitous online access means

that the commerce environment is evolving in unexpected ways. These shifts have created major

disruption to payments as new players from the technology space, such as Google, Apple, Samsung,

and Alipay amongst others, leverage new technologies to create new services and upend existing

payment business models. New disruptive platforms and business models are launching all the time,

and payments is now undergoing a multi-pronged approach to technology development. A cursory

glance at payment news over the past few years highlights the multifaceted nature of payments

technology today.

Long term some new payment technologies may ultimately replace what came before. For instance

cards at the POS may eventually be fully replaced by mobile proximity payments, but realistically we

remain some way away from this. Established payment tools and infrastructure have been and will

continue to be a critical backbone for consumers and merchants alike, and remain essential for the

functioning of the payments market. Rather than focusing exclusively on what is coming next, it is

more useful to look at the growing layers of complexity that are emerging that all payment providers

must contend with.

A better way to think about these changes is in terms of a broader payments stack. At the bottom of

the stack comes the most basic technologies which in most instances are universally deployed and

understood by consumers and payment providers alike. As we move up the stack, consumer

convenience and value added service capabilities increase, but at the cost of growing IT complexity

for service providers. Lower levels of the stack are impacted by what comes above them, but more

advanced layers, cannot exist without the lower ones.

Figure 1: The payments technology stack adds convenience with each layer

Source: Ovum

Established payment technology is effective and still important

At its lowest level, Payments 1.0 technology is physically driven and provides a purely utilitarian

function, moving funds from point A to point B. This includes cash and coins, as well as cheques and

paper based instruments. The identity of the consumer in most instances has little impact on the

transaction itself. While some instruments of Payments 1.0 are disappearing, such as cheques, the

ubiquity of cash indicates it will never disappear outright. Despite the excited proclamations of the

death of cash, it continues to serve a crucial role for most merchants and consumers, and as such

needs to be somewhere on payment providers radar.

Payments 2.0 is driven by electronic transactions, as best typified by payment cards and ACH

transfers. This still represents the vast bulk of retail payments by value today. Payments 2.0

introduces major efficiencies and convenience factors over Payments 1.0, with payment, clearing and

settlement occurring more rapidly, dramatically increasing the velocity of money. This has major

economic benefits for consumers, and businesses alike.

Key to the success of Payments 2.0 is its universality. A payment card works the same in any

merchant location that accepts that card. This adds major convenience and speed over Payments 1.0,

while still holding the benefit of near universal acceptance. This convenience underpins why

Payments 2.0 has become so commonplace in many markets, as consumers increasingly shift away

from Payments 1.0 for many, if not most, of their day-to-day transactions.

Despite the fact Payments 2.0 infrastructure such as the payment scheme networks were originally

designed almost 50 years ago, Payments 2.0 has been crucial to the growth of multi-channel digital

commerce. Established payment 2.0 instruments such as cards still underpin most digital transactions

today and will remain crucial for the foreseeable future.

However as new consumer touch points continue to emerge and evolve, Payments 2.0 is being

stretched further than it was ever intended to go. Payments 2.0 is particularly ill suited for card not

present scenarios, and provide major frictions to transactions, while raising risk levels due to the

potential for fraud. As the consumer technology and merchant space evolves with the next wave of

technology, such as augmented reality, artificial intelligence, and the internet of things this will provide

major new opportunities to create new revenue streams and develop new business models. Achieving

this however will be dependent on using the latest payment technologies.

Payments 3.0 reduces frictions and enables new business models

The market is now seeing the emergence of Payments 3.0 capabilities. Payments 3.0 builds on top of

older infrastructure to enable a more convenient and more contextually specific transaction. In

Payments 2.0 a card is a card anywhere you go and the payment experience is uniform. In Payments

3.0 the point of purchase can be made unique for the specific context it is being used, down to the

individual consumer, or even become a completely invisible process with payment becoming

automated as part of the overall service, as best typified with Uber.

Central to Payments 3.0 has been the growing application of contextual data to the transaction, to

help reduce payment frictions, increase security and ultimately drive spending. Payment 3.0 is

essentially about taking the practical components of Payments 2.0, namely enablement over an

electronic network, and adding significant functionality to that. Central to this is the flexibility that

Payments 3.0 provides in shaping the moment of payment itself, and in turn enable new business

opportunities for merchants, acquirers and payment providers.

Merchants need new ways to engage with consumers

Consumer touch points, such as online, mobile, instore interactive displays, social media platforms,

and so on, are evolving at incredible speeds. According to UK consultancy Patel Miller, mobile

devices accounted for 3% of traffic to retail websites in 2010. By 2015, 53% of traffic to retail sites was

from mobile devices. Despite the surge in mobile browsing, older desktop platforms continue to make

up 73% of online sales. Alongside this, shopping cart abandonment rates remain extremely high, with

average abandonments rate of 68% for online merchants as the existing frictions to payments remain

too high. The point of payment is a key moment of abandonment.

With the value of remote mobile commerce forecast to reach over $700 billion globally by 2019, the

sales potential of these new emerging channels has rightfully grabbed the attention of many.

Inevitably merchants and issuers are now actively pursuing strategies that will help them convert this

new channel activity into new revenue streams and business models. To achieve this they need to

enable new customer experiences, and payments plays a critical role in this.

Figure 2: The retail m-commerce market will reach close to $700bn by 2019

Source: Ovum Mobile Payments Forecast: 2014-2019

Payments 3.0 reduces frictions by introducing flexibility to the customer

experience

With merchants seeking the means to engage with consumers, and lower the frictions stopping

transactions from happening, payment providers are adapting their technologies to enable this

through greater flexibility over the payment experience itself. This means that payments are evolving

from being a purely universal tool, working the same way for everyone everywhere, to a more

contextual experience depending on the merchant or on the consumer themselves.

As Payments 3.0 technologies evolve, this is having an impact on the form factors being used for

payments, and the type of transaction experiences that are possible. The launch of PayPal in the

early 2000s in many ways signified the first step to Payments 3.0 with merchants able to offer a more

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Forecast global retail purchases through mobile channels

user friendly experience that was purposely designed for the online space. Since then Payments 3.0

technology continues to expand into new form factors and customer experiences.

For merchants and payment providers, enabling this flexibility is now becoming increasingly critical as

the market shifts away from one size fits all solutions. Even for relatively simple Payments 3.0

services like PayPal, the consumer and merchant are offered significant flexibility and convenience as

critical data such as shipping address, and payment credentials are stored and tied into the

authentication of the payment itself, in this instance with a simple username and password.

Figure 3: Payments 3.0 is happening in steps, all aimed at providing more flexibility

Source: Ovum

The application of data to payments is critical for Payments 3.0

Data is central to the development of Payments 3.0. Whether it is stored card credentials, through to

location based data and Internet of Things (IoT) driven services, Payments 3.0 is characterized by the

need to tie in additional data to enrich the transaction and enhance the overall payment experience. In

many respects the data around a payment is more important than the payment itself, as this additional

data helps to create new delivery models and ways of engaging with consumers. More than just a

means to improve existing payment instruments, Payments 3.0 is about using contextual data to drive

new business models and create unique experiences that weren’t possible before. Many of these new

business models do not yet exist, but Payments 3.0 will be crucial in their development.

The contextual data that can be applied to Payments 3.0 scenarios are broad ranging and can come

from a multitude of sources. This can include data such as previous shopping behavior, personal

identifiers such as biometrics, location based data, predictive analytics, and so on. The types of data

applicable to Payments 3.0 will continue to expand over time as new data sources become available,

and as such it’s impossible to clearly define what is and isn’t relevant Payments 3.0 contextual data.

The use of data in a Payments 3.0 world is not restricted to front end developments only. The use of

biometrics, and tokenization for instance can help to prevent fraud, while also reducing payment

frictions and create new business opportunities. Even in situations where the impact on the payments

experience is less visible, applying additional data to transactions can provide significant benefits

such as the improvement of fraud detection capabilities through machine learning tools.

As technology and commerce evolves, Payments 3.0 strategies must remain adaptable to new forms

of data as they emerge. Already today the first instances of artificial intelligence and digital assistants

such as Amazon’s Alexa are creating new retail experiences that are likely to develop in unexpected

ways. With the growing use of API’s in financial services new payment opportunities will arise that will

call for the application of more forms of data to payments in new and often unexpected ways.

Identity creates major possibilities for Payments 3.0

The combination of identity capabilities in Payments 3.0 technologies is particularly well placed to

drive innovation and the development of new instruments and payment services. The identification

and authorization of purchasers has always been a critical component in payments in the past, such

as through the use of signatures, and later PINs, but with Payments 3.0 authentication can be more

assured due to the use of contextual data points. This in turn creates opportunities for new services

and business models.

At its most basic level, Payments 3.0 and identity means that security can be improved, and the

correct identification of a particular consumer is significantly enhanced. When combined with

Payments 3.0 technology, such as mobile wallets, and one click in app payments, large amounts of

data is then shared with issuers, acquirers and merchants. This data can then be used for a variety of

marketing and targeting purposes, and the development of new payment instruments and services

from that. Through identity behavior can be better tracked online and in the real world.

Payments 3.0 means that banks and other payment players are well placed to become the providers

of identity services to other institutions. For instance if mobile wallets are already a repository for

payment credentials, it’s a small step to using them for identity credentials as well. With banks already

holding a mandate to securely store and manage highly sensitive payment data on behalf of their

customers, this could be rolled out to broader identity services for areas such as government or

commercial services. Few other sectors hold the same KYC requirements as financial services, and

as such are incapable or providing the same level of security. Some jurisdictions have already begun

experimenting with allowing payment providers to create digital identity services for logging into online

government portals, and this market segment will continue to expand.

Identity itself could soon replace existing payment tokens. Rather than consumers handing over a

personal account number (PAN) or other token to a merchant and this getting processed via the

traditional four corner payments model, payments could work purely by authenticating who the

consumer is, and processing the payment from there. Already the first steps towards this are now

occurring via biometrics. This further opens the possibility to create new customer experiences and

new business models.

Payments 3.0 is visible in big and small scale developments Payments 3.0 is already here and live in the market. The deployment of Payments 3.0 capabilities

however is not limited purely to large scale initiatives and can also be seen in small scale

developments among regional players. Payments 3.0 is reflective of broader shifts happening in the

consumer technology and commerce market, and as such it is relevant to merchants and payment

providers of all types everywhere.

Wechat Pay is driving payments through a social media ecosystem

One such example of a large scale new ecosystem is the growth of new engagement platforms such

as Chinese online giant Tencent’s WeChat platform. WeChat Pay enables WeChat’s 700 million+

users to make payments between themselves, within apps, on e-commerce platforms and in-store via

QR Codes.

Unlike other social media payments which typically revolve around basic P2P functionality, WeChat is

a fully fledged social and engagement ecosystem between consumers, merchants and service

providers that goes far beyond simple messaging. Users are able to book appointments, make

reservations, pay bills, tip for posts they like and so on. Rather than existing as a payments dedicated

platform, WeChat integrates payments seamlessly into its broader consumer experience, enabling a

simplified and near seamless transaction experience.

The role of WeChat Pay is now growing further as owner Tencent opens up its payment capabilities to

third parties via APIs, and WeChat Pay is now expanding internationally. With the platform likely to

reach 1 billion users in the near term, it’s likely that similar platforms like Facebook Messenger, and

What’s App will at the least be investigating launching similar capabilities.

For banks and merchants, WeChat Pay highlights the potential benefits of tying in payments

capabilities into these broader ecosystems. Issuers who can enable their payment tools to be used on

such platforms will likely find a high degree of consumer ‘stickiness’. For merchants, these sorts of

ecosystems provide a new way to directly engage with consumers but will still require integration with

their broader payment acceptance capabilities.

Payments 3.0 can create new opportunities in more subtle ways as well

Social platforms with hundreds of millions of users are the most visible aspect of Payments 3.0, but

the benefits of Payments 3.0 can also be seen in more small scale examples. For instance, following

on from an overhaul of its core payments infrastructure in 2013, Cambodian Bank Hattha Kaksekar

launched biometric authentication capabilities for POS and ATM transactions. While this was not a

major ecosystem play, it enabled a subtle refinement to existing processes that helped to improve the

customer experience, drive transactions, and reduce exposure to fraud.

Once registered either in branch or at an ATM, Hattha Kaksekar customers are able to log in and

retrieve funds from ATMs, or enact a transaction at the POS using their fingerprint rather than a PIN.

This has helped to decrease fraud loses and improve overall security for the bank. The use of

biometrics also reduced overheads caused by consumers who had forgotten or lost their PIN details,

an all too common occurrence in all markets.

Unlike older forms of security technology, many of which treat all customers the same, new forms of

smart authentication, are not only able to help reduce fraud losses and protect both banks and

customers, but they are also able to reduce payment frictions and create new payment experiences.

Touching a finger print scanner is easier than entering a PIN, while providing an enhanced level of

customer identification.

Competitive pressure to deliver Payments 3.0 is rising

Capabilities are expanding due to global increases in payments technology investment

Banks everywhere are increasing their investment in their payments infrastructure and this is

inevitably leading to an expansion of Payments 3.0 capabilities. Growing levels of spending are driven

by a number of factors including coping with growing volumes of Payments 2.0 transactions,

compliance considerations and broader bank IT modernization strategies. As investment grows,

capabilities grow, and Payments 3.0 is becoming more common.

Between 2015 and 2020, banks globally will see an increase in spending from near $25bn to over

$30bn. Although North America and Europe are seeing the most overall spending on payments

technology, Asia Pacific, and the Middle East and Africa are seeing the highest levels of growth

overall, with a forecast CAGR of 6% and 5.9% respectively between 2015 and 2020.

As banks continue to increase their investment in payments this is leading to new capabilities, and a

greater ability to enable Payments 3.0 technologies. As investment levels continue to rise, Payments

3.0 capabilities will increase, and this will in turn create competitive pressure for market laggards to

follow suit. Innovative banks and payment providers are leading the charge when it comes to the

development of Payments 3.0, but this competitive pressure suggests these capabilities are fast

becoming hygiene factors that all payment providers will need.

Figure 4: Banks will spend over $30bn per year on retail payments technology by 2020

Source: Ovum Payments Technology Spending Through 2020

Legacy infrastructure makes it hard to enable Payments 3.0

While the need for data driven, customer centric payments is becoming more apparent by the day,

most organizations continue to rely on legacy infrastructure that does what it needs to do and is

critical to their continued operational success. While many would wish to start from scratch with a

fresh greenfield installation, this is usually not possible or at best remains a hugely disruptive

undertaking. Despite these challenges, payment providers are developing their capabilities as best

they can, and this is helping fuel Payments 3.0.

Within the merchant space alone, many organizations are predominantly focused on transforming or

enhancing the infrastructure they already have in place, and relatively few are maintaining their

systems in their current state. According to Ovum’s ICT Enterprise Insight Survey 2015, less than one

in five surveyed merchants reported they were maintaining their systems for driving sales via digital

channels as they are.

While 12% of merchants are undertaking full scale replacement or new installations of these systems,

the remainder are undergoing major transformations or enhancements to what they already have in

place. Rather than a big bang approach to driving Payments 3.0 capabilities, many of these changes

are occurring on a more incremental step by step basis. This approach is aided by the use of wrap

around technology deployments, where new features and capabilities can be launched in a more

manageable incremental fashion.

The path to Payments 3.0 is undoubtedly a complicated one, but the size of the opportunity means

that most organizations are focused on developing their capabilities and enhancing their broader

customer engagement capabilities. Payments and payments related tools are a key component of this

and will continue to see major development in the near term.

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4.5% CAGR

Figure 5: Full system upgrades are relatively rare for merchants

Source: Ovum ICT Enterprise Insights 2015

Investment in Payments 3.0 should be happening now

If existing providers can’t enable Payments 3.0 someone else will

Unlike older payment forms, Payments 3.0 is not defined by any single core technology, nor is there

any clearly defined end state. As a result implementing Payments 3.0 capabilities is a more complex

proposition than simply launching a new card or other payment instrument. Payments 3.0 is in many

ways a broader ideological framework for payment providers to pursue as they seek to modernize

their payment capabilities and build upon their existing technology.

While the long term end state of Payments 3.0 development is fairly opaque there is a risk that

payment providers of all descriptions freeze in developing new capabilities. Building a business case

based on unknown or untested future revenue models is a tough challenge for any organization.

However, the need for, and opportunities created by Payments 3.0 will continue to expand, and any

gaps in the market will be filled. Those organizations who take the necessary steps now and invest in

their infrastructure and payment capabilities, will gain an advantage that will only become stronger

with time.

There are immediate steps to take to deliver Payments 3.0

There are several critical steps that all payment providers, merchants, acquirers and issuers alike

should be pursuing today. All of these considerations will have a part to play in the development of

payments, however it is labelled, and should be a central component of all payment providers’

roadmaps.

In practice the development of Payments 3.0 capabilities necessitates adding complexity to existing

payments infrastructure. In many respects the data surrounding a payment is becoming more

important than the payment itself due to the broader business value it unlocks. Tying this data

together is a challenge, particularly when the forms of data being used continue to shift. While many

have pushed legacy payments infrastructure further than ever expected, sometimes a bit too far, long

term such an approach remains untenable. Technology designed 40 years ago to drive Payments 2.0

technology is a critical base, but it’s not enough to enable, flexible, customizable, data driven

Payments 3.0 experiences.

All payment providers should be focused on modernizing legacy payments infrastructure. As

the underlying data needs of Payments 3.0 becomes more complex, legacy infrastructure will become

more costly to run, and more problematic in launching Payments 3.0 services. This means that banks

need to optimize for change and efficiency. Achieving this involves updating critical infrastructure such

as card management systems, payment switches, fraud and acquiring capabilities. Wrap around

technology deployments can act as an extremely useful means of enabling modernization, but those

core payment processes will likely eventually need to be modernized as well.

Payment providers and vendors must ensure connectivity and integration between enterprise

IT and payment systems. Data portability will become a growing issue as more systems aim to do

more, with more data in turn generating yet more data. With many sectors relying on industry specific

ERP and CRM technologies, payments compatibility and integration will be a focal point for

development. This can be aided through the use of centralizing technologies such as Customer

Service Hubs which unify disparate streams of consumer information into one location.

Security is more critical than ever for payments in a 3.0 world. Although data breaches are

becoming increasingly common the reputational risks remain severe. Combining already sensitive

payment information with other forms of personal data only compounds the negative impact these

breaches can have. Security in payments can in their own right act as catalysts for new customer

experiences and the launch of new payment tools and services. Technologies such as biometrics and

tokenization not only help to secure payments, but also create new revenue opportunities.

The most difficult aspect for any provider to contend with when it comes to Payments 3.0 is

the need for partnership and in some instances to relinquish control over the payments

experience. The data rich nature of Payments 3.0 means that no provider can act as a closed off

island of activity and partnerships will be critical long term to drive flexibility and new experiences. The

growing use of open API’s in payments and indeed wider financial services in turn creates major new

opportunities to develop new payment services and revenue streams. Exploiting this will require

payment providers to change their mindset over how payments operate and is likely to prove the

hardest component of Payments 3.0 for many organizations to adapt to.

Appendix

Author

Gilles Ubaghs, Principal Analyst, Financial Services Technology

gilles.ubaghs@ovum.com

Ovum Consulting

We hope that this analysis will help you make informed and imaginative business decisions. If you

have further requirements, Ovum's consulting team may be able to help you. For more information

about Ovum's consulting capabilities, please contact us directly at consulting@ovum.com.

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