The Future of Payments

3The future of payments: Markers for success

Monica Adractas

Dan Ewing

Kausik Rajgopal

The future of payments: Markers for success

The payments industry faces uncertainty on many fronts. Historically, it

has been a business in which the incumbents were strongly advantaged

and able to enjoy stable or growing revenue streams. Now, however, a

disruptive mix of regulatory and consumer behavioral changes, emerging

technologies and new competitive thrusts is presenting industry

incumbents with unprecedented challenges. These changes are catalyzing

new and shifting alliances, which in turn are creating fresh opportunities

for industry entrants.

In our previous issue we presented severalscenarios for how the payments industrymight unfold during the coming decade (seePayments 2020: Scenarios for dynamic evo-lution, McKinsey on Payments, March2011). In this shifting environment incum-bents must consider how best to defendhard-won market positions, and recent andprospective entrants must determine whatthey can do to successfully penetrate themarket and grow their businesses.

Markers for success

There are six markers that incumbents andnewcomers alike can use to define position-ing and strategies for success. They can helpincumbents adapt current value proposi-tions (or create more defensible ones), and

guide industry entrants in their efforts tomake any new power shifts a sustainable re-ality. For incumbents the attainment of thesemarkers will also define the major barriersto market entry, enabling them to better as-sess any threat of displacement by entrants.Instead of squandering management re-sources to fend off upstarts that have littlechance of attaining meaningful scale, theycan employ the markers as building blocksto help them more appropriately managetheir respective partnership and acquisitionactivities. Each of these markers is soundlyanchored in our fundamental beliefs aboutthe enduring nature and dynamics of thepayments business, as well as in our think-ing about current industry disruptions.

4 McKinsey on Payments June 2011

Marker 1: Deliver significantly and notjust marginally more customer valuethan the market alternatives

Payments is a business with high inertia andstrong network effects. In such industries,the marginally better customer propositionsof new entrants usually lose ground to thoseof incumbents that have already won broadacceptance. The founder of a paymentsstart-up once poignantly said, Building a

marginally better payments mousetrap is agreat way to lose money. As the now ubiqui-tous QWERTY keyboard illustrates, con-sumers tend to grow comfortable withsecure, reliable and relatively commonplacemechanisms, despite any drawbacks theymay have, and payments systems are no ex-ception. Consequently, consumers are reluc-tant to adopt new technologiesthoughthey may offer advantages for other stake-holdersif the value for them personally isunclear or unappreciated. An excellent ex-ample of this is contactless cards, whichallow buyers to wave their cards near en-abled point-of-sale terminals instead ofswiping them. While the benefits of contact-less cards may be clear for issuers, networksand merchants, their advantages over swipe

or chip cards (with which consumers are al-ready comfortable) is marginal, and hardlysufficient to induce a meaningful shift in be-havior. On the other hand, in unsecuredconsumer credit, new entrants such as Fer-ratum Group and Wonga in Europe haveseen success in providing consumers withimmediate and convenient access to mi-croloans through online and mobile chan-nels, despite higher interest rates.

Marker 2: Build value propositions thatgo beyond cost reduction

As noted above, new payments mechanismsthat generate cost savings for merchants, re-gardless of the amount, will probably notgain broad consumer acceptance on theirown. Consumers simply cannot appreciatejust how much a decrease of a few basispoints might reduce the merchantsand ul-timately their owncosts; similarly, theyhave little concern about merchants abilityto shave microseconds from cash registertransaction times. This hardly means thatcost-based propositions are irrelevant; onlythat success may also require delivering cus-tomer value that is functionally a step abovecurrent alternatives. In the U.S., for exam-ple, Starbucks consumers can register theirpre-paid Starbucks cards online to receivefree drinks, add-ons and promotions. Con-sumers can also download a Starbucks mo-bile application that enables them to paywith their registered cards using a quick-re-sponse matrix barcode on their smart-phones. These approaches enable thecompany to guide its customers toward itspreferred payment option by using eco-nomic and operational benefits, while alsoadding meaningful value for consumers.

As the now ubiquitous QWERTY keyboard illustrates,

consumers tend to growcomfortable with secure, reliable

and relatively commonplacemechanisms, despite any

drawbacks they may have.


The Canadian market offers an elegant con-trolled experiment in added value. Canadasdebit card system, Interac Direct Payment,has historically been a zero-interchange sys-tem that charges consumers based on usage.By contrast, credit card interchange rates inCanada are higher, similar to those seen inthe U.S. Despite the cost differential, creditcard acceptance in Canada significantly ex-ceeds that for debit cards. Merchants seemto find enough added value in credit cards tooffset the cost of interchange fees.

Marker 3: Penetrate niche segments first

It is generally advantageous for developersof new payments systems to target nichemarket segments, where acquisition costsare lower, before driving for broad penetra-tion. Grandiose attempts to transform theglobal payments industry will likely lead toslow (and occasionally spectacular) failure.Globally, more than 400 payments start-upscame and went during the dot-com boom 10years ago; fewer than five managed to sur-vive. The most recognized of these is PayPal,which early on grew by tethering itself to thee-commerce giant eBay, for whom a uniquepayment mode with superior risk manage-ment was critically important to its success.In fact, PayPal displaced eBays own pay-ment solution, eventually becoming the

principal way to pay on eBay. The cost ofcustomer acquisition during PayPals earlygrowth, then, was essentially subsidized byeBay. This was a critical strategy for build-ing PayPals user base cost-effectively andgaining significant scale among consumersas well as eBays power-seller merchants.Notably, eBay sales remain a significant con-tributor to PayPals business today. By con-trast, many rapid national introductions ofpre-paid e-purses in European countries didnot lead to success. In fact, after incurringhigh rollout costs most European e-purseprograms have been discontinued.

Marker 4: Leverage establishedinfrastructure

The high fixed cost of building a paymentsinfrastructure that will be reliable, secure,ubiquitous and convenient can be an insur-mountable barrier to entry. Most successfulpayments solutions are therefore designedto leverage existing infrastructures. Thispattern tends to hold true for most marketsand applications around the world, whetherapplied to online payment modes in the U.S.that leverage ACH infrastructure, parkingpayment systems in Europe that use SMScapabilities, or open-loop prepaid cardselsewhere. A good example is Alipay, a largepayments platform that facilitates cross-bor-der online transactions in China and part-ners with Chinese banks for clearing andsettlement. While the leveraging of estab-lished infrastructure is frequently a neces-sity, its attainment is insufficient by itself forsuccess. Several cost-based point-of-serviceACH solutions in the U.S., for example,clearly demonstrated this when they failedto gain traction and scale.

It is generally advantageousfor developers of new paymentssystems to target niche market

segments, where acquisition costs are lower, before driving for

broad penetration.


Marker 5: Adapt offerings to marketcontext

The payments industry varies significantlyfrom one market to another, chiefly becauseof differences in regulations, technologystandards, consumer preferences and therelevance of established payment modes.Players that succeed in one market oftenrisk failure by applying the same models inother markets, especially those that are in adifferent stage of evolution. Success usuallyrequires that market entrants modify theirbusiness models to reflect marketplace dif-ferences. For example, mobile payments ap-proaches such as in-aisle shoppingcomparison and purchasing draw customersin developed markets where smartphonepenetration is high and growing; however,approaches will probably have to differ con-siderably in emerging markets, where fea-

ture phones or SMS-based technology pre-vail. In these markets, applications couldenable unbanked consumers to pay theirutility bills or receive government paymentsvia mobile phones. Hybrid online and mo-bile solutions are also emerging to form newecosystems; for example, consumers canpurchase digital products within the contextof games on social networks (Exhibit 1).

Marker 6: Tap adjacent profit pools todifferentiate offerings and add value

Regulatory and technological disruptionswill likely prompt an increase in businesspropositions that actually sacrifice paymentseconomics in favor of generating greatervalue elsewhere. An example of this is Wal-marts MoneyCard. In the U.S., Walmart is asizeable and growing player in alternative fi-nancial services, offering consumers core

Advantages

No registration required

More security steps, e.g., PIN text is sent to phone and entered on Web site

Potential for small-ticket payments

Challenges

Limited transaction size on carrier bill unless credit card or debit card account is linked, e.g., $20 maximum charge

Economics for developers may be challenging, e.g., carriers charge 20-50% of purchase price, and require clear business case on monetization

Overview

Situation: Social networking sites and gaming are growing rapidly, and seeking ways to monetize their digital offerings, which represent attractive revenue sources

Complication: Entering and storing payment information disrupts the user experience and raises security concerns for those consumers who lack credit cards or have other security issues

Resolution: New providers are linking payments to users mobile phone bills, streamlining the process and eliminating the need to enter and store credit card and debit card information on numerous Web sites

Source: McKinsey analysis and company Web sites

Exhibit 1

Hybrid online-mobile payments are emerging as a fast-growing payment option for purchasing digital offerings


services at lower prices. The MoneyCardprovides open-loop prepaid capabilities withpricing that is consistent with the companyswell-established commitment to being alow-priced leader. In this case, MoneyCardslink to the companys core retail business is akey part of the business model. When con-sumers cash their paychecks and replenishtheir MoneyCard balances at Walmarts in-store MoneyCenters they typically spendpart of those higher balances before theyleave the store (Exhibit 2).

More likely than not, we will see a continuingemergence of business models that sacrificepayments economics in various ways,whether to consumers, merchants or both.Prepaid card pricing, for example, couldchange further as issuers experience addi-tional pressures, while monthly and other

fees might even be eliminated. The reasonfor such changes is that many issuers haveaccess to adjacent profit pools such as search,couponing, mobile applications and loyaltymanagement programs that are closely tiedto payment mechanisms themselves.

Tapping adjacent profit pools, however,could effectively transform the physicalpoint-of-sale in several ways, blurring andeventually erasing the lines between pay-ments and adjacent businesses. A catalystfor this type of change could be new busi-ness models that we now see emerging toimprove the mobile commerce experience.Their focus ranges from demand generationto post-transaction loyalty management (Ex-hibit 3, page 8). Although several are still intheir infancy, the blending of technologicaldevelopments enabled by smart or enhanced

Broad impact

American Express, Green Dot, and nFinanSe recently lowered and simplified their fees

Todays prepaid card pricing suggests a maturing industry, as established players compete on price, not just size and scale

Walmart and prepaid cards

Walmart launched its MoneyCard in June 2007 in partnership with GE Money Bank and Visa

In February 2009, Walmart significantly reduced its MoneyCard pricing to stimulate usage and improve its ability to cross-sell MoneyCard with its check-cashing and other services

Issuance fee reduced from $8.94 to $3

Reload fee reduced from $4.64 to $3

Monthly maintenance fee reduced from $4.94 to $3


Exhibit 2

Walmart is reshaping prepaid card pricing


phones with changing customer behaviormake this space well worth watching. Mo-bile-enabled consumer behavior shifts wouldbring new and difficult challenges for indus-try incumbents, partly because it is generallyeasier to compete with industry entrantsthan with well-established rivals who usetheir payments products as loss leaders.

* * *

Industry entrants will continue to find itextremely challenging to compete effec-tively with well-established incumbentsespecially with the banks, payment

networks, acquirers and processors thathave historically owned the paymentsbusiness. The six markers for success de-fined here will help. They can serve notonly as reliable markers to guide incum-bents as they evolve their business strate-gies and create new value propositions tomaintain their hold on the payments busi-ness, but also to guide those entrants eagerto tilt at the payments windmill.

Monica Adractas and Dan Ewing are associate prin-

cipals, and Kausik Rajgopal is a principal, all in the

San Francisco office.

Pre-purchase Decision-making Transaction Post-purchase

Generate demand

Identifymerchants

Compare merchants

Contact merchant

Finalize decision

Make payment

Review promptly

Build loyalty

Howm-commerce can change buyer behavior

Enhances merchants ability to target and personalize marketing communi-cations

Consumers can do local searches anytime

Review apps help users to find best local merchants

Ability to contact merchants for store locations, hours, directions, etc.

Can compare prices, obtain peer advice and browse competitor offerings

Pay via mobile device

Ability to immediately send reviews and location to users social networks

Can trigger couponing and other loyalty programs

Sign up for specific deals and receive coupons based on triggers (e.g., location)

Find nearby stores with product and compare prices

Read reviews to find the best merchant out of all local options

Use Google Local to get business information

Use Google Maps to map route

Use product barcodes to find nearby sellers, compare prices

Pay restaurant bill without waiting for server

Share comments about local venues

Publish and read reviews

Post-purchase offer redemption linked directly to bankcard

Examples

Purchase decision process


Exhibit 3

Adjacent profit pools let players discount payments economics

Documents

The Future of Payments