Senior Partner & Managing Director
Related Expertise Financial Institutions,
This is an excerpt from Global Payments 2016: Competing on Open Seas.
Although the digital crescendo in payments is under way, few clear leaders have emerged—and incumbents still have a good chance to become principals in the orchestra. They must practice hard, though, to develop and deliver a superior end-to-end customer experience, drive agile product development, and leverage application programming interfaces (APIs). Moreover, they will need highly focused strategies in order to fund investments in a lower-revenue environment. Fintechs, for their part, are creating superb user experiences, but few have generated a sufficient network effect or diversified their offerings beyond payments.
Indeed, banking incumbents today can still deliver more value to consumers than can fintechs—most of which tend to provide a single service. For example, many banks have a mobile-banking app that has successfully entered the thin ranks of frequently used apps—such as an m-wallet that allows the consumer to check account balances before making a purchase. Moreover, unlike fintechs (which rely on e-mail for customer support), banks have high-touch customer service channels in their call centers and branches. That said, the banks’ advantage is diminishing as fintechs strive to leverage their customer bases and increase the stickiness of their apps.
Below, we take a regional look at how incumbents in retail payments can excel in an increasingly digital world. Their focus will vary depending on the potential pockets of growth. In RDEs, both credit and debit cards are attractive areas, whereas in mature markets it is account revenues that tend to be the growth engines. Overall, growth in retail payments revenues will be driven by account and debit card revenues. Moreover, across regions, there are vast differences in both the retail payments revenue mix and growth projections through 2025. (See Exhibit 1.)
Although European payments providers are still digesting the interchange regulations that came into force in 2015, they are already bracing for the second Payment Services Directive (PSD2), which is likely to have an even more profound impact—not only on payments but also on overall daily banking services. (See “The Key Components of PSD2.”) PSD2 aims to create a more open banking landscape by granting third parties access to customers’ accounts in exchange for compliance with minimal rules and the application of strong customer authentication. After full implementation, scheduled for January 2018, third parties will be allowed to access account information and initiate payment transactions directly from the account, provided they have the consent of the customer.
The revised Payment Services Directive (PSD2) has five key components that providers of payment services must comply with:
PSD2 still needs to be adopted by individual EU member states but is expected to be in force by January 2018.
PSD2 will cause the retail banking landscape to be more open and competitive by enabling new value propositions and business models, such as the following:
In addition to new value propositions for individual consumers, we also expect disruption in corporate banking. In the highly profitable segment of midsize companies with complex needs and international business, attackers could launch cash-management solutions or provide the integration of payments with third-party software such as accounting software, enterprise resource planning (ERP) systems, or invoicing platforms.
The immediate effect of PSD2 will likely be tighter competition among banks, which will be advantageous to institutions that can leverage their agile organizations and infrastructure to seize opportunities. The second-order effect may well be a wave of bank disintermediation, with third parties “owning” the customer through well-designed interfaces, links with payment services, and personal-finance management tools. We expect a select number of digital players—either digital giants or new fintech players—to emerge as winners.
Our recent discussions with banks have confirmed that PSD2 is high on their agendas despite generally low levels of preparedness. Indeed, although most banks have ad hoc working groups, few have taken a bankwide approach to delivering a focused strategy and an implementation roadmap. Our view is that banks cannot afford to wait if they hope to withstand increased competition and turn PSD2 to their advantage.
To be sure, most banks will need to revamp the customer journey—streamlining and redesigning processes and interactions to remove friction, making better use of data, adding alerts and advice, and providing greater convenience and engagement. In addition, digitally agile banks with strong innovation capabilities can leverage PSD2 to develop new value propositions, push data and analytics to the next level, launch their own aggregator offerings, and selectively open the bank to third parties through APIs.
For banks that are able to act promptly, we believe that PSD2 represents a unique opportunity to capture additional market share and enhance control of the primary customer-bank relationship—all in a more open and innovative financial ecosystem.
With a retail-payments revenue pool of $242 billion (nearly 30% of the global retail total), it’s no surprise that North America has been home to 60% of payments-related investment in fintechs from 2010 through 2015. The largest source of revenue (63%) is being generated by the credit-card value chain, providing a strong rationale for focusing on this particular area. BCG also believes that incumbents should dedicate attention and resources to faster-payments initiatives, which are in various stages of development but likely to be mainstream within five to ten years in the US and Canada.
Credit Cards: Leveraging Digital Marketing and Engagement. The roles of issuers and card networks have been strengthened by the so-called Pays (such as Apple Pay, Android Pay, and Samsung Pay), which are using established card rails and tokenization standards. Moreover, the Pays have added a new form factor and enhanced security through touch ID.
Still, there are other developments—such as Pay with Amazon and new entrants offering credit at the point of sale—that threaten to overshadow issuers’ brands and erode net interest income. The Pays have raised the stakes and opened a new market-share battlefield: the quest to be the default card in m-wallets. Issuers need to be proactive and secure the future of their revenue streams. A successful strategy rests on marketing excellence and superior customer engagement that results in differentiated services and special offers (such as rewards and terms by segment).
In addition, optimizing the return on investment in digital marketing across search, display, and social channels is a key area of marketing excellence. BCG has found that credit-card issuers can increase their ROI in digital marketing by up to 40% with the right technology and processes. The key is precision—using customer data to deliver the right messages to the right customers at the right time. Rather than blanketing mass audiences, the highest-ROI campaigns are personalized. Each creative message, data source, and advertising impression is monitored closely, and budgets are reallocated to top performers.
Yet while access to richer data has enabled issuers to move beyond traditional mass marketing and to track impact better, issuers have had mixed success in unlocking digital marketing’s potential. One reason is that marketers still struggle to find the right balance between data-driven and human-driven insights. Measuring the impact of digital channels and devices is perhaps the greatest challenge facing issuers today—but it is a key enabler in correctly allocating marketing expenditures across channels, devices, and creative formats.
We have found three common traits among issuers that are successful in digital marketing:
By developing such traits, issuers can expand their reach while improving effectiveness and engagement and reducing wasteful spending—all of which will drive ROI. Generally speaking, value from digital marketing activities must be delivered across multiple dimensions while maintaining quality control and tailoring content to a greater degree. (See Exhibit 2.)
Issuers can also differentiate themselves by improving their daily engagement with consumers. Beginning with authentication, issuers can increase security and ease of use through biometrics. While many have initiated fingerprint identification, a further leap is voice ID, coupled with speech recognition. With consumer expectations being set by leading nonbank app providers, there is room for steady enhancement of app features. Issuers need to respond by developing an enhancement plan that includes features such as strengthened fraud protection and personalized alerts.
Issuers also have room to raise the bar on the mobile-app user experience, enhancing payment functionality and offering additional value-added services such as budgeting tools. The demand for such tools is clearly strong, as evidenced by the breakout success of Toronto-Dominion Bank’s MySpend app, which has been ranked #1 in downloads in Canada (and not just in the finance category but overall). The jury is still out, however, on whether top issuers should have a separate app for credit-card holders or embed such tools in their mobile-banking apps. Few have the issuer-acquirer scale required to launch their own Pay facility.
Beyond offering useful features, issuers need to think about how to spur usage by educating their customers. We have observed that leading players in m-banking spend up to ten times as much as competitors—both on marketing features and by tying promotions and rewards programs to successful external apps, such as those of quick-service restaurants.
Faster Payments: Making Preparations Now. Although the notion of faster payments was a mere hypothesis just five years ago, and often dismissed at that, today the concept is becoming a reality. For example, a US Federal Reserve task force is in the process of examining more than a dozen proposals for a faster-payments platform. In Canada, Payments Canada (formerly the Canadian Payments Association) is evaluating options. Given the fact that many North American banks’ core processing systems are batch-centric, it is imperative that banks address how to adapt their back-end systems to the requirements of faster payments. In addition to making order-manager systems and processing engines that operate in real time, all related interfaces, integration layers, and connectors must also be real-time ready. Depending on both the age and capabilities of the current system and the IT architecture, updating can easily be a multimillion-dollar effort with a time frame of more than two years.
Ultimately, the success of faster payments will rest on banks’ ability to ease customer pain points, improve transaction flow, and deliver value-added services beyond mere speed—such as real-time confirmation and contextual data that includes e-invoicing and rich remittance advice. BCG estimates that 5% of total volume benefits from speed, whereas at least 25% benefits from deeper, more granular data. The largest beneficiaries are businesses transacting with other businesses that receive checks and ACH payments without remittance advices (B2B), and businesses that make one-off payments (such as insurance reimbursements) to consumers (B2C). Given the monetization potential, banks should incorporate faster payments into their treasury-services product strategy. Interviews with businesses of all sizes have revealed that basic “request for payment” e-mail functionality—with a pay button and the ability to receive payment deposit confirmation—would be a significant digital leap forward.
Moreover, while B2B and B2C show direct monetization potential, person-to-person (P2P) can also generate indirect revenues both by deepening customer relationships and by educating consumers about faster payments, which in turn will drive adoption of B2C faster-payments platforms.
RDEs are showing robust overall growth in payments-related businesses despite the slowdown in GDP growth in some countries. Growth has been driven by generally stronger macroeconomics (compared with mature markets), government initiatives that are expanding the banked population, private-sector investment that is fueling card penetration and the growth of POS terminals, and a mobilization of consumers that is broadening browser-based and in-app commerce.
These drivers, in turn, are continuing to propel the migration from cash to noncash payment types, as seen in the growth of noncash transactions per capita. (See Exhibit 3.) Correspondingly, the estimated annual growth in the value of bank-card payments in emerging markets from 2015 through 2025 is estimated to be almost double the rate in mature markets (11% versus 6%). India and China are expected to lead the boom with annual growth in noncash payment values of 17% and 11%, respectively.
Yet while RDEs share common growth drivers, they are experiencing notably different transformations in different regions. The competitive dynamics, pace of digitization, and role of fintechs vary significantly. For example, incumbents are taking the digital lead in Latin America—but not so in China. The lesson to be learned is that incumbents must carefully monitor new entrants, develop scenarios, and anticipate disruptive business models in order to survive and thrive.
Latin America. Across Latin America, there are examples of incumbents that have responded to the threat of digital disruption, harnessing tech advances to their advantage and developing new business models and value propositions. One example is Prisma Medios de Pago (formerly Visa Argentina, a bank-owned merchant acquirer and payments processor) that has significantly and successfully boosted its digital lineup, including Todo Pago (an e-wallet, mobile POS, and P2P offering). Another example is Elo in Brazil, a payment network formed in 2010 (initially by Banco do Brasil and Bradesco, then joined by Caixa), which focused initially on domestic-only cards for lower-income Brazilians and later expanded to internationally accepted cards (through a partnership with Discover) and to wealthier segments.
While incumbents have thus far been able to go on the offensive, they must excel at effectively providing the newly banked with digital payment services. They must also continue to innovate in order to defend their market positions against new entrants such as Nubank, a mobile credit-card app in Brazil, and the recently merged micro-acquirers Payleven and SumUp. Incumbents further need to stay abreast of regulatory initiatives regarding fintechs and new payment rails. They must engage with regulators to strike the delicate balance between ensuring security and privacy and encouraging innovation.
China. Digitization arrived in China with fintechs bursting through the gate. Indeed, many incumbents underestimated both the early signs of the fintechs’ strength and the pace of consumer and business adoption. As a result, Ant Financial (which runs Alipay) and Tencent (which launched WeChat Pay) are winning the digital payments game and show no sign of slowing down. On the contrary, they are looking for new markets to conquer. Alipay dominates digital payments (in-browser, in-app, and proximity) with about 60% of the market and 450 million active users, or about three times the number of credit-card holders in China. While part of the fintechs’ success can be attributed to adoption by millennials (the largest population segment), older segments are also adopting digital payments, as evidenced by the increasing number of hotels—particularly luxury hotels—accepting WeChat Pay. Part of the appeal of digital payments over traditional credit cards is transaction speed and the absence of penalty fees, along with relatively low demand for credit.
The success of Alipay and WeChat Pay lies not only in being early movers in a scale- and network-effect-driven business but also in the ability to listen to the voice of their customers—both consumers and merchants—and respond with new services. For example, these players have embedded their payment functionality into apps that they have either built or invested in, such as ride-hailing, food delivery, and entertainment ticket apps.
India. In India, the digital crescendo is building. At the macro level, financial inclusion initiatives are enabling an increasing number of consumers to migrate from cash to e-payments. Within payments, two factors are generating new opportunities and potentially shifting the competitive dynamics. First, the Reserve Bank of India has established new guidelines to license so-called payment banks. Second, the National Payments Corporation of India is launching the Unified Payments Interface (UPI), which will provide an open-architecture payment layer (including APIs), a directory (with simple virtual account addresses), and easy authentication that enables mobile payments, including debit payments. UPI will act as a catalyst for innovation on two fronts-—wallets and acquiring—and in the process give incumbents an opportunity to establish themselves as digital maestros.
Critical to incumbents’ success will be developing a strategy that targets both consumers and merchants and that extends beyond traditional customer bases to the mass market. On the consumer side, UPI offers a chance to launch an enhanced m-wallet and to partner with payment banks to offer complementary services, such as a new bank account for those with balances above a certain level. On the merchant side, offering UPI acceptance services could improve merchant acquiring economics by increasing value per terminal and by potentially boosting margins as a result of lower interchange and network fees than on debit cards.