All change?

By Neil Davey

With credit cards and debit cards unlikely to usurp cash in the low-cost, high-volume sector, it is left to emerging payment technologies to do the job. But these new platforms could also present interesting implications for the banking industry.

The path that the evolution of payment processes will take is already clearly mapped out ahead of us. Whatever the payment venue – whether in-store, online or for bill payments – the migration of consumers from cash to electronic forms of payment represents an unstoppable trend. According to Forrester Research, around 30 percent of Central European consumers carry credit cards (hitting a high of 67 percent in the UK), whilst the Raddon Financial Group reports that 69 percent of consumer households possess a debit card. And the vision of a ‘cashless’ society would appear to grow ever clearer as customers continue to embrace the benefits of electronic payments.

“We have done a number of attitudinal studies looking at why consumers choose particular payment methods over the years, and convenience and ease of use is almost always the answer they give,” explains Mike Bowman, Senior Consultant for Policy and Markets at the Association for Payment and Clearing Services (APACS). “Cards made major inroads into cheque use 10-15 years ago because consumers have found them much easier to use at point of sale. And in recent years, consumers have started seeing them as more of a cash substitute as well. The internet has also had a substantial impact in terms of volume of card transactions. The amount of retail spending taking place over the net is substantial and it is almost always going to be a card payment. Overall, you are seeing card acceptance continuing to grow and more consumers using a card in the retail environment.”

But while the migration to cards continues, cash isn’t entirely capitulating. Indeed, some particularly stubborn resistance is being provided by the field of low-cost high-volume purchases. Getting merchants involved in this sector on board would represent a huge coup for card issuers in the financial services space. However, to date they have shown little interest. “Over a trillion dollars are spent each year on payments of five dollars and under,” highlights Dan Schatt, a Senior Analyst in global research and consultancy Celent’s Banking Practice. “But it has proven to be a very hard economic proposition to convince merchants that credit cards or debit cards are an economically viable proposition for them because of the interchange fees involved with cards.”

Nevertheless, while such charges may be holding back cards from penetrating the low cost purchases, other technologies are emerging that may have more success in usurping cash as the favoured form for low-cost payments. “By 2015, a substantial share of consumer payments globally will have moved from cash to other payment mechanisms," suggests Theodore Iacobuzio, Managing Director in TowerGroup’s Executive Research Office and content lead on the European Banking & Payments practice. "Many of these new form factors are already being tested in broad consumer settings in countries around the globe – from contactless payment terminals and fingerprint recognition payments, to mobile and micropayment roll-outs.”

Contactless payments

Certainly contactless payment systems are rapidly emerging as a major new area of focus for retail payment applications around the world. And whether they are made using a fob on a keychain or a contactless credit/debit card, they represent a viable alternative to small cash payments. Consumers can enjoy hands-free payment and the ability to pay for multiple services using one device, merchants experience faster transaction times, and for card issuers it is an opportunity to penetrate the cash payment market. And with contactless standards emerging as the large card issuers are rallying round, it is little wonder there is some excitement surrounding the field at present.

“The number of applications for contactless payments are growing, from quick service restaurants to other quick service environments such as gas stations, parking meters or vending environments,” says Beth Robertson, Research Director for the Global Payments service at TowerGroup. “It is convenient – you don’t have to manage things like having the correct change – and it accelerates the time that a payment transaction would typically take. It may have convinced some merchants in the quick service restaurant industry that just accepted cash before to actually accept contactless payments because it is much more convenient for their customers.”

The number of players involving themselves with contactless technology is indeed swelling, from the work that Mastercard has been doing with PayPass to American Express teaming with ViVOtech, while the latest names to look into the technology include JPMorgan Chase & Co, the world’s largest issuer of credit cards, and 7-Eleven Inc. the world’s largest convenience store chain. And while Jupiter Research estimates that proximity payments will represent only 2.8 percent of all retail transactions by 2009, in the longer-term most agree that it has a bright future.

“Contactless has quite substantial potential to cause migration away from cash in lower value cash dominated sectors like fast food, pubs and clubs, convenience stores and so on,” highlights Peter Finlayson, Director of Policy at APACS. “If you can get an economic card acceptance method in place for the retailer, it would effectively be just as easy to use as the Oyster card is at present in the tube station in London. And if you can make a payment with a debit card for fast food, for instance, then I think it has real potential for growth.”

Putting money where your mouth is

One platform that may provide further competition to cash payments is already front and centre in terms of penetration – the mobile phone. Whilst mobile phone payment initiatives haven’t historically proven successful – the SimPay initiative involving a number of operators looking to develop a cross network scheme for microtransactions was discontinued a year or so ago – there is a groundswell of opinion that the mobile phone will rise above its present place as merely a platform for purchasing ringtones and logos, and grab a share of higher value purchases in the future.

Dan Schatt highlights Motorola’s use of C-SAM’s platform for mobile payments, which is also used with NTT DoCoMo and Sumitomo card services in Japan to enable contactless mobile payments, and he has high hopes for where mobile commerce could go, further down the road. “Fujitsu released a phone in 2003 with a biometric touchpad that at present is really only used to unlock your phone,” he says. “But with the emergence of biometric payments with pay-by-touch, this could be a key piece in the equation in allowing you to authenticate yourself with your thumbprint and use your mobile phone as a contactless form factor for much higher ticket goods.”

Certainly this would hold all the benefits of contactless with added penetration, but Schatt sees further motivation for the merchants to play ball. “The exciting thing is that you are seeing a value proposition open up to merchants that wasn’t there before,” he continues. “The speed factor is good, but if you look at the mobile phone as the form factor, when you tie in payments with mobile you get something really powerful – the opportunity to electronify loyalty programmes. One of the only costs that is higher than the payment processing costs to a merchant in a low-value high-volume sector is the cost of keeping their best customers. So when you combine the convenience of contactless for consumers with the opportunity to touch those consumers on a regular basis and allow them to access their loyalty programs, you start to really offer up a valuable proposition to merchants that historically banks have been unable to penetrate in terms of electronifying cash.”

Payment competition

If the mobile phone does indeed emerge as a payment form factor to usurp cash then it raises the fascinating possibility of non-traditional players becoming a force in the payments field. But while there is only speculation that telecommunication companies may strive to carve a large slice of the nascent mobile payments space, in other fields such upheaval is already taking place. The internet is a case in point, where research by CyberSource has indicated that some sites now offer as many as four different payment options for the customer.

“Cards may be prevalent on the internet, but there are an increasing number of other payment alternatives emerging for use,” highlights Robertson. “These are attractive because they offer different sorts of flexibility. For example, some may essentially provide the ability to pay directly from your bank account rather than through a credit card. Elsewhere, some enable credit, but not through a credit card, so somebody who is not eligible for a credit card can still get credit to use for purchases in an online situation.” One alternative payment solution that has become increasingly popular is PayPal.

“PayPal already commands around ten percent of the market in the US,” says Schatt. “Card issuers are obviously getting some of that from people linking their PayPal accounts to their credit cards but it is really pushing people to link to chequing accounts. And if half of their volume consists of people that have linked their PayPal account to chequing accounts, it just intermediates payment that could have been done through a card. And this could serve as a wake up call to the banks as PayPal volume and market share continue to grow.”

Furthermore, Schatt insists that changes are also afoot outside of the cyberworld. “We are seeing merchants exerting a little more control than they have had over the payments process in the past,” he continues. “They are more active these days in steering customers to payment instruments that are less costly for them. Pay-by-touch could be a good example of this in the future, because a merchant can set up the sign-up process so that the first thing the consumer sees and knows about is that they can link it to their chequing account versus they can link it to their credit card.”

Emerging technologies

The question is, what impact would these changes have on banks? Is there a danger that while they are busy trying to mop up the low-cost high-volume sector on credit and debit cards, other non-traditional players could leverage new payment formats to stake a claim in the payments territory? Robertson believes that the majority of banks are failing to view third parties and non-banks as competitively as they should. “A lot of the alternative payment options are being offered by non-bank entities so there are issues for banks,” she suggests. “Banks should be aware of emerging technologies so that they’re at least positioned to compete effectively against or, ultimately, transition to those options. But banks tend to be less leading-edge in technology terms, they have been more followers than leaders with some of the new payments alternatives.”

Some forays into emerging initiatives have also failed to be effective. Two years ago a number of banks involved themselves in the person-to-person payments business on the back of PayPal’s success. However, despite their enthusiasm, the banks jumped in too quickly and the program proved problematic. Some suggest that that this experience has led to the industry taking a more cautious approach towards emerging technologies. But Robertson suggests there is a more ingrained issue – “While banks certainly view customer servicing as an important part of their role, I don’t think they necessarily view it in relation to their payments business.”

Others, however, would dispute this claim. Finlayson, for instance, highlights a new APACS faster payment initiative in the UK that will provide a service for payments by remote banking. “Instead of taking three or four days as at present, with the new payment service it will take around a couple of hours initially and potentially less going forward to make a payment through telephone or internet banking,” he explains. “The initiative was part of the industry's response to concerns about innovation in payment systems from the UK's Payment Systems Task Force. But the banks have gone beyond where they would need to go to simply respond to the recommendations of the Task Force. They have come up with something that is not just adequate but is a world-beater. In an internet world people expect rapid fulfilment so it was felt that it was increasingly untenable to have a payment infrastructure that took three or four days when you had an environment where everything was about speed or execution.”

Lose the ball

Even with initiatives such as this, however, Schatt still believes that in the long-term, banks will have to re-evaluate their strategies. “Banks will have to look at ways to insert themselves into the payments process,” he says. “They won’t necessarily push the credit card front and centre with a merchant as they have in the past. What will be more important to banks is to ensure that they have an active role in the payments process, and this may mean joining up with merchants and actively helping to link existing loyalty cards directly to chequing accounts, for instance. They may not make the interchange that they do on debit or credit but they are going to ensure that they have a role to play in the future with payments.”

How imminent such changes to the payment process are, however, remains a matter of debate. Is cash living on borrowed time? Will non-banks muscle their way into the payments sector in the coming years? Bowman is skeptical that there will be any rapid overhaul. “If you look at personal payments, around three in four are still made by cash because there is a huge volume of low-value payments in the market,” he highlights. “So cash is still going to be with us for the foreseeable future in huge amounts, although there will be substitution and market share will drop by around one percent a year. Similarly, I think traditional plastic is going to be with us for a long time as well. Culture change takes time and you are talking about not just what is technically possible but what people are comfortable doing. ‘Pay as you go’ is not going to immediately displace existing methods of payments. It might prove very attractive to younger customers and to the early adopter types but mass penetration is another matter.”

Nevertheless, Iacobuzio fires a warning to the banking industry. "While certain non-traditional players may make headway in taking share of new payments mechanisms, TowerGroup believes that the payments network as a whole will remain firmly in the grip of financial services institutions – though the definition of what constitutes such an institution is currently in flux,” he concludes. “The nature of payments form factors should ultimately be irrelevant to financial institutions, as long as they are willing to engage in innovative partnerships to keep up with both technology and consumer desires. If they ignore the issue, however, they could lose the ball.”