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Finding The New Klondike in the Payments Business

Finding The New Klondike in the Payments Business

Finding The New Klondike in the Payments Business

The Klondike gold rush is known for its impact on a monetary system driven by the gold standard. Starting in 1896, more than 100,000 "stampeders" flooded the Northwest, and within a few years, almost 400 tons of gold were extracted from the Yukon River.

The frenzy of immigration led to the foundation of the Yukon Territory, the definition of new borders between Alaska and Canada, and the United States' adoption of the gold standard in 1900. The Klondike gold rush coincided with the end of the Great Depression and the beginning of a period of stable economic growth before World War I. While the rest of the world witnessed the bankruptcy of Argentina and the subsequent first insolvency of Barings Bank, a few pioneers in Alaska were striking gold and laying out the rules for the future distribution of a fortune still to come.

Does any of this sound familiar? It should to those in the bank-driven payments industry. After years of improving the payments infrastructure—transactions made by credit transfers, direct debits, and credit and debit cards—the industry is now facing restructuring. Whether in domestic or cross-border transactions, traditional wire transfers or newer card payments, the industry sits at a critical junction between low-margin electronic payments and the high-margin growth areas that go well beyond traditional banking.

It is high noon for the European payments industry as customers demand more convenient services and regulators put more pressure on the commercial framework. The far-reaching changes include, but are not limited to, convergence across different types of payments, deepening cost pressure, competition between new and traditional payment service providers, and co-innovation with payment users.

Leaders in this "New Klondike" will push the frontier of electronic payments further. They will find solutions for the unbanked, lucrative ways to displace cash, and, perhaps most notably, a new way to view their business, understanding that users select payment methods not by format but by which features and services are best for them. The factors that once determined our view of the payments world have fundamentally changed.

Growth and Challenges

Growth in the industry is strong. Based on our research, we expect non-cash payments in Europe to increase at a CAGR of around 7 percent in the next five years—close to the historical trend—to reach nearly 118 billion transactions by 2014 (see figure 1). For cards, this positive trend is even stronger. As more merchant categories accept cards, particularly for low-value payments, the volume of card transactions is growing faster than retail sales. In 2010, card payments are expected to grow at almost 10 percent, after a slight dip to 8 percent in the past two years. During the recession, the growth rate has fallen faster for credit card transactions (used more for large-value purchases) than for debit card transactions (used for day-to-day purchases).

Figure 1: Non-cash transactions in Europe are rising

As cards are used more often, other non-cash instruments, such as checks, are used less. While these other non-cash instruments are expected to grow at a 4 percent CAGR from 2000 to 2014, they will be used less overall, from 74 percent of all non-cash transactions in 2000 to 57 percent in 2014. Checks, in particular, will decline steeply from 9 billion transactions in 2000 to an estimated 4 billion in 2014. The United Kingdom, in fact, has targeted 31 October 2018 as the end date for the use of checks.1

As a whole, non-cash payments have proven fairly resilient to the crisis. While their standard growth rate has dipped more heavily since 2008 than during the 2001-2003 recession, the situation is nowhere near the 40 percent drops in asset management, custody and brokerage fees. Considering that between 60 and 80 percent of payments in Europe are still made in cash, further growth in non-cash payments seems quite likely, in particular for processors.2

A closer look at the industry, however, reveals some significant challenges. For one, there remains continued defiance by most against—and limited opportunity for a few in favor of—standardizing and expanding automated clearing house (ACH) payments in cross-border payments. Another factor is the ever-increasing investment requirements that are leading to further tiering of payment service providers. Also, the entry of new competitors, particularly in the mobile and e-commerce space, is taking away some of the volume from traditional providers.

Payment service providers have their own challenges. How will they deal with a newer and larger playing field, while addressing new regulations and subsequent changes to the commercial framework? How will they address convergence between traditionally separated payment types while also reducing transactional costs? Can they pick the right places to compete, and the best ways to involve users in co-innovation? How will providers meet customers' demands for new and better features?

Certainly, even as growth continues, there is no time to lose in rethinking existing paradigms and anticipating a new framework.

A Changing Playing Field

Traditional, bank-driven payment systems—including credit transfers, direct debits, and credit and debit cards—still account for more than 90 percent of non-cash payments. These systems are fairly efficient and trusted across most geographic regions, especially with respect to domestic electronic or bulk payments. Utilities, telecommunications firms, insurers, retailers and consumers use these systems for recurring and one-off payments. And now, thanks to the Single Europe Payments Area (SEPA) project, European companies and citizens enjoy these efficient payment instruments across all 30 countries in the European Economic Area and Switzerland.

The "gold" in payments is out there, but it remains hidden beneath tons of sand—location unknown.

Are these traditional payment instruments sufficient going forward? Not if you examine the interests of users and regulators. Many European payment practitioners and regulators believe that cost is the top factor for determining a payment method, and significant efforts have been made to generate low-priced, fast, and reliable payment services across Europe. This goes back to the European Commission's Regulation 2560/2001, which reduced the price of cross-border European payments to that of domestic payments under certain conditions. The SEPA project, while not directly regulating pricing, has sought to harmonize infrastructure to bring costs down. Additionally, the efforts of antitrust authorities around the globe to fight interchange fees reflects this desire to cut prices.

However, how people choose to make payments is not just about price, it can also be about convenience. People continue to use currency exchanges and remittance services, despite their high prices, and they still opt to withdraw cash when travelling abroad, believing point-of-sale (POS) payments are expensive and risky even if they are not. In some countries, companies now understand that a bill-payment option using credit cards might eventually cost them less than a direct debit followed by a costly collections process. And in the e-commerce space, new players are bundling payments with insurance and other services and charging a comparably high percentage to consumers or merchants.

A handful of new players have been first to respond to these needs. Some telecom operators, for example, are offering convenient person-to-person payments. Yet success stories in Europe (such as Mobipay in Spain) have been fewer than international plans such as Vodafone's M-Pesa payment service, which originated in Kenya and has expanded to Afghanistan and Tanzania. DoCoMo demonstrates how mobile operators can break into the domain of banks, with roughly 60 percent of the Tokyo-based company's 55 million subscribers using phones that allow contactless payments, and 10 million customers using the company's contactless credit cards service, DCMX, which also allows customers to store tickets and retail loyalty cards. This service seems destined to replace wallets. Dutch virtual network operator Rabo Mobiel and Poland's mBank are also tapping into this area.

Leaders in the "New Klondike" will find solutions for the un-banked, displace cash, and view their business in a new way.

In many places, 2009 was the year that e-commerce surpassed mail and telephone orders in sales volume, with online payment services experiencing double-digit growth. and eBay now rank among the top five retailers in many markets. Of course, getting paid is as tricky for an online merchant as getting proper merchandise is for an online customer. Therefore payment providers have the vital dual role of trusting both parties: The buyer must get his item delivered safely and timely, and the merchant must get paid. In fact, trust is more important to customers than the payment function or the cost. Providers such as Paypal and, to a lesser extent, Google Checkout have successfully capitalized on ensuring safe payment and delivery. Today, roughly 200 million customers (including 40 million in Europe) use Paypal, which charges between 2 and 5 percent of transaction value.

Also, very small purchases, such as to buy online news articles, require quick, safe and reliable payments without a long registration process; entertainment may require higher-value payments—and a certain level of anonymity—that most cards currently don't allow. While parts of the online entertainment segment are experiencing double-digit growth, traditional payment methods and service providers are still observing these developments remotely.

These changing commercial and technological dynamics are sparking the emergence of new payment providers, and helped along by the ubiquitous availability of Internet and broadband, the growth of chip and contactless technologies (such as near-field communication and radio-frequency identification), and emerging alternative identification methods such as biometrics. Regulators are also paving the way. For example, the EU's Payment Services Directive (PSD), effective in November 2009, allows these new providers to apply officially for Payment Institution Licenses and compete with the existing giants.

New Rules for a Bigger Game

Regulators have kept up with the development of payment services both by setting the parameters for new areas such as e-money and by encouraging self-regulation. In Europe, four areas have helped build the new regulatory framework for payment services: SEPA, the PSD, the E-Money Directive, and myriad smaller decisions by European and local authorities (see figure 2). Let's look at these four areas.

Figure 2: Four areas are helping build the regulatory framework for non-cash transactions

SEPA. Designed to create a uniform set of payment services and products available across Europe, this agreement focused on new payment schemes for credit transfers (in place since the beginning of 2008) and direct debits (mostly implemented in November 2009). While usage of these schemes remains low—currently, fewer than 6 percent of all credit transfers in Europe use the SEPA format—it is expected to increase as legacy domestic formats are phased out.

SEPA for Cards, which seeks to standardize card usage in Europe, is a different story. Rather than defining a product, regulators instead focused on setting rules for European card schemes and processing. Whether this leads to an integrated cards market with full user choice and availability remains to be seen, because forcing too much homogeneity may in fact reduce innovation and fail to meet the needs of different customers. The SEPA initiative has also advanced toward creating frameworks for new services in mobile and around e-invoicing, for instance.

Payment Services Directive (PSD). In place since November 2009, the PSD is best described as the legal framework for SEPA. It focuses, among other aspects, on user rights, execution times and the eventual reduction of float income for payment service providers, and on the Payment Institution license, which allows payment service providers to offer payment services without applying for a more complex banking license.

E-Money Directive. Similar to the Payment Services Directive, this will allow e-money providers (companies that store electronic money for e-commerce users) to apply for special e-money licenses that are somewhat less restrictive than banking licenses. This directive is supposed to create a reliable, European framework for these providers in light of the cross-border nature of this business.

Considering that between 60 and 80 percent of payments in Europe are still made in cash, further growth in non-cash payments seems likely.

Rulings by regulators. Banks have been particularly challenged in their traditional commercial framework by decisions from both the European Commission and local antitrust authorities. For example, the Commission has hardened its tone with respect to card interchange fees, and it has given guidance (although not an official ruling) to local authorities to abolish them after 2011. It has also rejected attempts to set a European direct debit interchange fee, which affects local interchanges currently in place in a number of countries. While we know this will affect card issuers and banks with large direct debit payments, it is unclear how the Commission and industry players will approach these challenges.

Which specific regulations are posing serious challenges to the commercial framework for traditional payment instruments and players?

Float. The structure of the PSD is reducing float income.3 While interest rates and subsequently float were at historic lows when the PSD went into effect, we do not expect float income to return to previous levels, when it accounted for approximately one-third of payment revenues. Most banks have reviewed or will revisit their pricing arrangements with cash-management customers, but overall it appears that some pricing leeway is gone forever.

Interchange fees on direct debit. The absence of an interchange fee on direct debit is certainly not increasing the appetite of large retail banks to receive payments on behalf of their customers. At the same time it probably will not halt the uptake of direct debits by large users such as insurers, telecommunications firms and utilities across Europe, particularly in the United Kingdom and France, where check displacement is occurring. However, this means the loss of a revenue pool in some markets, such as Italy, and, by extension, price increases for some consumers and companies.

Interchange fees on cards. The ongoing reduction and pressure on card interchange will leave four major effects on payments in Europe. First, cash displacement will be encouraged as a quick way to increase transaction volumes. Second, to replace the lost revenue, some issuers may increase annual fees, at least for debit cards. Third, new opportunities to charge acquirers and merchants eventually will be pursued. Lastly, credit cards will become less attractive compared to debit cards in terms of generating transactional revenue, triggering the creation of new products that lie between debit and credit.

The "Four Cs"

Four trends, which we call the "Four Cs," will determine the future layout of the payments industry. The convergence of different modes of payment is shifting volumes toward lower-margin products, changing the industry's revenue stream. Cost reduction through scale and IT-driven auto mation remains a priority. Competition is heating up, with new entrants, particularly in mobile and e-commerce, eating into the current leaders' profits. To succeed in the long term, the winners will use co-innovation in payment services to connect with users and get them what they want.

Convergence. European and international integration, technological advances and standardization are removing the differentiation that had existed among different means of payments. Going forward, there will be less separation between urgent and bulk payments (or, in different terms, high-and low-value payments), and among domestic, European and other international payments. SEPA has accelerated this process, but it is far from over. The far-reaching effects of convergence should drive payment volume from higher-priced payments to mass payment instruments that generate a fraction of original revenues.

Four major developments are driving convergence.

European payments become domestic. In past decade, most cross-border intra-European payments have lost their pricing premium, as Regulation 2560/2001 forced banks to offer these payments at the same price as domestic payments. At least half of all cross-border payments have been affected, cutting their revenue pool to a fraction of what it once was.

Domestic payments become European. SEPA achieved the opposite result of Regulation 2560/2001: Through the SEPA Credit Transfer and SEPA Direct Debit schemes, "domestic" payments are now simply European. This will likely mean further harmonization of payments pricing, and slowly eliminate the historical pricing differences that exist across borders inside the EU. All this will further reduce the profit pool. However, as only 6 percent of European credit transfers are using SEPA Credit Transfer thus far, the banking industry is asking for an end date on legacy formats in order to stop operating duplicate infrastructures.4

Wire payments become ACH payments. The underpinnings of SEPA are going global. A number of banks, payment service providers, clearing and settlement mechanisms, and central banks have engaged in replicating the SEPA schemes and standards for international payments (often called wire or correspondent banking) under the International Payments Framework initiative. To start, European, North American and Latin American users will benefit from cheaper, standardized instruments. I t remains to be seen how the cost benefits will be shared between users and payment providers.

Urgent payments become bulk. The upgrade of mass-payment systems to offer same-day or following-day settlement (mandatory through the PSD starting in 2012), and the ability to run numerous clearing cycles per day, often removes the need for companies and treasurers to use urgent-payment modes such as TARGET or EBA Euro1, at least for payments below €50,000. This creates further revenue pressure on the so-called high-value or urgent-payment infrastructures.

A.T. Kearney analysis reveals that the overall revenue effects from convergence will be significant. For example, in the 10 years following Regulation 2560/2001, the average European bank will see a 40 percent reduction in transactional levels, while in the same time period they will make significant investments in SEPA upgrades and infrastructure.5

Cost. In Europe, only a handful of card and payment providers come close to 10 billion transactions per year—VocaLink (United Kingdom), GSIT (France), Equens (Netherlands), Atos-W orldline (Belgium), Postbank's BCB (Germany), and Visa Europe are a few. Some of these firms have achieved a cost-per-transaction that is one tenth or less than other European payment institutions, according to the 2009 A.T. Kearney Payments Benchmarking Study. As highlighted in our bi-annual study, successfully meeting cost challenges, particularly those related to SEPA, will be a major differentiator, especially regarding infrastructure, scale and cross-border payments.6 The following are seven cost reduction opportunities:

Accelerated de-commissioning domestic payment platforms. While the banking community bore most of the costs of SEPA compliance, mainly by offering customers the ability to send and receive SEPA payments, they still have to operate parallel infrastructures for legacy and SEPA payments. During this SEPA migration period, the average cost per domestic payment transaction is expected to more than double (see figure 3).

Figure 3: Legacy costs for non-SEPA payments will skyrocket

In other words, when volumes are low, running SEPA on top of legacy platforms raises per-transaction costs. It is not surprising, therefore, that payment practitioners generally support the idea of determining a common European end date for SEPA migration. A strategy to implement converter-based solutions is an option to decommission legacy payment systems earlier without depending on a speedy SEPA up-take (see sidebar: Introducing SEPA: The Last One Out Turns Off the Light...).

While revenues will fall following Regulation 2560/2001, banks will have to make significant investments.

Accumulate scale of SEPA payments. SEPA interoperability offers an opportunity to create economies of scale and to reduce processing costs below current levels, yet few banks have established a single platform for operations across different countries, or initiated outsourcing to draw on a provider's scale benefits. There are several reasons for this.

For one, the vague nature of the SEPA standard allows for different interpretations, and as a result, the full benefits of outsourcing are not straight-forward. Because banks would need to eliminate the differentiation achieved through client-specific functionality, only a few are willing to go this route. In addition, the optimal depth of outsourcing is hard to determine and probably varies across players. Outsourcing individual activities (for instance, pre-processing) only makes sense if the supporting IT systems are easy to separate, but few banks have such a modular IT architecture. Further, the transition is generally costly and risky due to complex systems integration and, as payments processing is at the heart of banking, locking in with an external service provider is cause for hesitation.

Despite the concerns, a holistic approach for payment processing outsourcing may work. As most banks re-think their IT architectures, this could be an excellent starting point for renewal.

As SEPA addresses the issue of decommissioning domestic payment systems, cross-border payment platforms pose a different, but equally relevant, challenge. For banks in the eurozone, international transactions represent only 1 to 2 percent of all payments, and a third of this is on cross-border platforms. Without countervailing actions, cross-border, non-euro payments could triple in cost. For small banks, a full-fledged international payments platform may not be viable anymore. How are banks reacting?

  • Improve online payment order delivery channels. A main focus for banks is to reduce paper transactions. The straight-through-processing (STP) rate of60 to 70 percent of paper-based payments (including capture) is much lower compared to domestic payments. This suggests that the banks that have achieved higher STP rates are not necessarily more cost efficient, and the investment needed is not measuring up to the efficiency gain. Some banks are focusing on further improving online channels for smaller companies to deliver their payment orders electronically instead. These banks even contemplate abolishing paper-based, non-euro payments altogether.
  • Improve investigation processes. An often-over-looked area for improvement is investigations. Leading practices include qualifying relevant cases in the front office, clear separation between simple and complex cases, an active policy to shifting cases to call, and workflow automation. Some banks with operations in multiple countries have bundled investigations across borders and locate their investigations team in low-cost locations.
  • Reduce currencies accepted. Limiting the number of currencies processed could bring down costs and refocus efforts on larger payments streams such as the U.S. dollar, British pound, Japanese yen, Swiss franc and Chinese renminbi. Operationally, trimming down client offerings may seem logical, but commercially it may be unacceptable for some. Banks could collaborate for other currencies.
  • Pool volumes. Consolidating cross-border payment engines and operational teams could also save money. Needless to say, this option is only open for larger, international banking groups— and was present before SEPA at banks such as RBS and Deutsche Bank. But SEPA creates extra impetus for other banks to reconsider earlier decisions.

Competition. The competitive landscape is changing across countries and the value chain. With IT costs high and complete reliability a necessity, achieving scale is a vital yet elusive differentiator generating fierce competition and driving consolidation in payments.

Tiering will increase in nearly every segment. Fewer banks will be able to compete in the high-value segments (because of the investments needed), and scale requirements will limit the number of players in mass segments. Tiering has already occurred in some areas: For example, there are roughly five main players in global cash management.

The biggest question for the future is the position of emerging new players—can they go head to head with the industry's long-standing giants? Mobile operators, e-commerce providers and remittance offerings all require capable infrastructures, often with a global footprint. For now, higher prices for these services have kept down cost pressures, but growth in these segments will soon change that.

New players can establish a foothold in payments in three ways:

Stand alone. As in their current model, stand-alone entities will use payment systems as the backbone of their business. They will operate their own infrastructure for all front-end and value-added services.

Connect with existing payment infrastructures. These new players will package their services to join up with existing networks. Examples include some bill payment providers' use of card acquisition and ATM infrastructures, and services such as giropay and iDEAL, which build on existing payment and online banking infrastructures.

Use proprietary infrastructures. First remittance providers are among the companies going down this route to compete in the bank-driven payments space. For example, some are using their infrastructure to take in cross-border payments for banks that lack an international network.

The possibility to apply for a Payment Institution or e-money license will certainly spark more competition, allowing more providers to offer payment services to end-customers, rather than through banks. However, this will require processing scale and access to a large customer base in order to justify the ample investments into infrastructure and innovation. Therefore, in most cases the greatest focus will be on cooperation between new and incumbent players rather than head-on competition.

Co-innovation. Cooperation is not just about the competitive landscape, but also about improving customer satisfaction. As new players' success has shown, incumbent providers have struggled to reach the forefront of payment innovation from a user perspective. It is widely acknowledged that the SEPA project failed to involve users early on. At this point, how do providers spur payment innovation?

Thinking benefits, not technology. Banks and incumbent payment service providers have put the thrust of their innovation on improving the payments infrastructure in terms of standards, performance or security, be it e-signatures and encryption, ISO 20022 formats, or clearing and settlement architectures. For users, however, these elements are no more than a necessary prerequisite —today's users want and expect more than efficiency and reliability. Convenience, control over payment flows, payment guarantees (for merchants), reporting features and insurance are important to the point that many consumers will pay a premium for them. Likewise, corporate users seek not just low costs and high speeds, but also total procure-to-pay savings and solutions for collection issues. As other industries have discovered, the next generation of payment innovation starts with these deeper benefits rather than with current technology and infrastructure (see sidebar: Co-innovation: Inspiration from the Outside).

Going beyond payments. For a business or merchant, payment is a small part of the entire shopping or ordering process. While improving this process is indeed worthwhile, the greatest gains will stem from redesigning the broader shopping, ordering and payment process. Examples include e-invoicing and collections in a business-to-business context, or redesigns of the shopping experience, such as self-checkout by supermarket customers. Payment solutions should meet a broader group of user issues, since payment costs are marginal (around 0.3 to 2 percent) while non-collection can cost five percent in many industries.

Involving users. Most of the new payment services in e-commerce, mobile banking and remittance combine a decent service with access to customers. Paypal likely would not have become successful without its link to eBay, while operators' success in the mobile payment space is tied to their link to customers. These examples highlight how critical it is for payment providers to link up with users—mainly on the business side—that can offer access to a significant customer base and trusted consumer brands. Payment providers can then develop convenient services for those users in the partner's environment.

By putting these principles into action, banks and incumbent payment service providers will be better able to take advantage of their infrastructure. The truth is that no retailer wants to become a payment services provider—considering the infrastructure, scale and performance needed for what is a low—margin business—unless current providers cannot cater to their needs.

The Four Cs highlight the advantages and drawbacks of the industry, with traditional providers facing more pressure than those in opening up to new markets and users? Where is the broader, more sustainable growth?

Pushing the Payments Frontier

The gold in payments is out there, but it remains hidden beneath tons of sand, location unknown. In addition, the adventurers attracted by the promise of unknown fortunes are finding a hostile environment, a cold wilderness with no convenient infrastructure around. To be successful, the modern "stampeders" must expand their search area and find the right tools to emerge from the pack.

Traditional arenas have already been harvested, including normal and high-value consumer payments, businesses and public administration. Yet there are still many places that have not been mined. Three stand out as particularly valuable:

Low-value payments. Displacing cash, used mostly for low-value transactions, is a huge opportunity, according to A.T. Kearney analysis. This area is vital for sustaining debit card profits as interchange fees decline.7

Various surveys have found that 60 to 80 percent of retail payments in Europe are still made in cash; among low-value payments (less than €15 or $20), nine out of 10 are made in cash. Some specific retail segments are dominated by cash, including all sizes of food retail, fast food restaurants, gas stations, confectionaries, newspapers, tobacco and pharmacies. Many merchants in these segments believe cash is quicker and cheaper than other forms of instant payment, despite calculations that the total cost of handling cash costs Europe €130 ($180) per person yearly.8

Technological innovation is addressing both the cost and speed issue, and it can also combine ticketing, loyalty and other lucrative solutions. For example, contactless cards offer cheaper, speedier transactions while not requiring users to preload their cards, one of the disadvantages of earlier purse concepts. Successful everyday examples include the combination of London Transport's Oyster card with contactless payment cards; the widespread use of cards combined with loyalty and cash-back programs in Turkey; and NTT DoCoMo's Osaifu-Ketai suite.

Banking inclusion. Across Europe, the number of people with bank accounts varies. More than 95 percent of German adults have a current account, but only 50 to 60 percent of Romanians have one. Ongoing cross-border migration is putting more people in unbanked situations for certain periods of time. A number of offerings addressing this market have proven successful, albeit far from universal.

Prepaid cards. Prepaid cards have proven successful in addressing several population segments, including young customers and social welfare recipients. Still, in many countries prepaid cards are in their infancy, particularly with respect to social welfare. Furthermore, more work is needed to encourage these customers to use their cards for more than withdrawing cash, which will in turn only create more electronic payments and aid banking inclusion in general.

Remittances. Remittances of international payments are a further growth area, well established by now but still offering growth potential, even for traditional payment players that have failed to develop this segment on time. Current offerings are fairly pricey, although more convenient thanks to new card offerings and mobile confirmations.

The modern "stampeders" will find the right tools to emerge from the pack

Mobile payments. Mobile payments fall into a similar bracket. Roughly 4.6 billion phones are in use worldwide (the world population is almost 7 billion), making it the most available interface tool, even though some people hold multiple phones. Services such as Vodafone's M-Pesa have attracted large portions of the unbanked population in these countries.

The "shadow" economy. Bank inclusion means taking business from the so-called gray or shadow economy, which includes legal activities performed outside the purview of tax authorities. Analysis has shown that electronic instruments are available for convenient, safe payment mechanisms for this large segment of the economy, estimated at more than €1.4 trillion ($2 trillion) in Europe, or roughly one-fifth of the official economy.9 Despite the tax and social security advantages of staying under government radar, a significant portion of the shadow economy—perhaps as much as €300 billion ($413 billion)—stands to become official if red tape could be removed, particularly in areas such as household services.

Travel. A smaller yet attractive area is consumer transactions when traveling abroad. Only one to three transactions per card are cross-border transactions, and when most Europeans travel abroad they prefer to take or withdraw cash. Language issues, different payment experiences and distrust in foreign merchants drive the use of cash, yet the benefits of SEPA have not yet been widely explained to consumers. Additionally, extra-long bank identification codes and international bank account numbers do not help consumer acceptance either—an unfortunate example of services developed from the standpoint of technology rather than user ease. Nevertheless, growing travel transactions may be as important to sustaining card profitability as low-value payments.

From Format to Feature

Traditionally, advances in payments have been focused on specific silos. Automated Clearing Houses were built to handle mass payments; correspondent banking dealt with cross-border payments; specific platforms satisfied urgent payment needs; and global cards ensured instant payment authorization. For each silo many different factors and mechanisms were developed — paper-based or electronic transactions, online or mobile banking, credit or debit card payments, credit transfers or direct debits. However, these silos often fail to meet users' needs.

In short, we believe the traditional paradigm of offering different payment instruments for different silos is fundamentally shifting. The old boundaries are falling, revealing a more fluid playing field and a huge growth opportunity for innovative players. The technical details of how a payment is made matters little to customers. Merchants are more interested in guaranteed payments than instant settlement. They care more about getting paid than handling collections issues, and would be open to integrating procurement, invoicing and payment if providers could handle it.

We believe a range of features matters to users, none focused around a specific payment technique:

  • Convenience. Can users pay from any location through any channel? Can all customers pay the merchant so that no revenue is lost?
  • Guarantee. As a merchant, are payments guaranteed before the merchandise is sent?
  • Speed. If not all payments can be instant, can due date, execution time and related price be pre-determined?
  • Control. Can spending be tracked and funds and accounts be controlled?
  • Insurance and trust. Can payment be held or reverted if the merchandise is defective?
  • Flexibility. Can users determine how to pay and repay, such as through debit, credit or installments?
  • Reporting. Can users tailor reporting to their needs, such as consumer, business for private-use-only, or for VAT reclamation?
  • Privacy. Is privacy guaranteed in environments such as mobile or e-commerce?

These features matter more than the payment mechanism behind them—not just in the consumer space, but also in corporate. The use of corporate cards, such as those that come at a certain transactional cost, and the benefits from sophisticated cash management solutions with the various payment options offer proof of the strong demand for services addressing diverse and specific requirements.

A New Klondike

Whether a payment is initiated by contactless cards, online banking portals, smartphones or cash management portals, the leading payment providers of the future will understand first and foremost what users want. As recent regulatory actions such as SEPA, and other actions across the globe take payment services out of traditional silos and into a much wider competitive space, the winners will find gold in new revenues, while users find new benefits. This will become the payments industry's New Klondike.


1 Payments Council Board Press Release, 16 December 2009,
2 Processors are institutions that specialize in transactional payment service.
3 Float income is the interest earned on customer funds between the time a bank receives the funds and when they are credited to a customer's.
4 European Payments Council (EPC) Newsletter, February 2010
5 Andreas Pratz (2009), Journal of Payments Strategy & Systems, Vol. 3, No. 3, pp. 194-203.
6 The 2009 A.T. Kearney Cards and Payments Benchmarking Study is the fifth in a series that began in 2001 based on an analysis of non-cash payments at 34 financial institutions across 17 countries in Europe. For complete findings, please send an email to
7 For more information, see "Cashing in on Cards."
8 Retail Banking Research (2010), "The Future of Cash." The estimate include the cost of distributing, managing, handling, processing, and recycling cash, and totaled €84 billion ($116 billion) in 2008.
9 For more information, see "The Shadow Economy in Europe" (Visa Europe, Prof. Friedrich Schneider, A.T. Kearney).

May 2010
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