Current Payments Boom obscures Systemic Failures of Incumbents.

On the face of it, all is well in payments and industry leaders are at the peak of their power: Visa, Mastercard, and PayPal have surpassed $1 trillion in combined market cap [last year], they are innovating through acquisitions and building seemingly ever stronger defensibility. Consumer payment choices are constantly improved and are becoming increasingly ubiquitous and seamless. Merchants’ checkouts are consistently enhanced with great new features from high-performing new players such as Stripe, Klarna or Fast. Even the long-forgotten B2B payments are starting to be addressed from various angles by a multitude of new entrants.

And as if this trend were not strong enough, the COVID-19 pandemic has led to a surge in digital payments creating a strong market pull for payment providers, both from merchants and investors. Currently it is the payment fintechs that enjoy the highest valuations in tech: Stripe ($95 bn), Square ($92 bn), Adyen ($62 bn), Klarna ($31 bn), etc.

In short, payment providers seem to be triumphant and infallible, building great moats in a very profitable industry: VISA has a ca. 70% EBITDA margin, a stunning 20% points higher than more famous ‘monopolies’ such as Facebook or Microsoft.

However, under the hood, the payment system is not only failing its users, both merchants and buyers particularly in a B2B context, it is also threatening to fail its providers. Here are three inevitable trends we are observing:

1. Despite all their investments, payment schemes are struggling to keep their old infrastructure properly updated.

Visa, MasterCard and other payment schemes were all created in the 1960s or thereabouts. Their infrastructure is more than half-a-century old. Naturally, payment infrastructure firms are constantly updating and upgrading but in tech you cannot do ‘new’ with 50+ year old system.

If you start a new payment infrastructure you certainly have a technological advantage and Chinese players (such as Alipay and WeChat Pay) are proving this precise point.

Here are some concrete examples:

With the enforcement of the Strong Customer Authentication (PSD2 two factor authentication), ~20% of online payments are declined with only ~5% done so for legitimate reasons (eg: insufficient funds, etc). ~15% of online payments are now being declined illegitimately, for technical reasons¹.

Ultimately, each payment could be seen as a 1-eligibility check (identity + funds) & 2- information transfer (from the payer’s bank to the merchant’s). Many other services we use on a daily basis go through the same 2 steps, but none of them is failing us like payments do.

Imagine if 15% of the emails sent to you by your customers were lost or declined! This seems plain absurd.

Even if payment players were to successfully cut those declines by 2 or 3 times (which is not the trend we are seeing — quite the opposite in fact), this would still be unacceptably high. Impacting not only the payers experience but more importantly, adversely affecting businesses revenues.

Likewise, legacy payments have other absurd limitations such as low card ceilings, long processing delays and associated fraud as global online payment fraud losses are set, by 2024, to exceed $25bn per year (Juniper Research).

From my perspective, the current payment system is already broken and will simply not be able to support the fast-growing digital economy. But the legacy players do have large marketing budgets to cover these facts in the meantime!

2. Transaction fees are an unjustifiable and unlawful tax on commerce that cannot be sustained in the long term.

You may not know it but each time a merchant collects a card payment, a transaction fee (~2%) is directly levied from the collected funds. This fee is split on 3 parts:

• interchange fee, the payer’s bank charges to process card transactions,
• network fee, charged by card schemes (eg: Visa or MasterCard),
• processing fee, going to all other parties involved in the transaction (processors, gateways, etc), as the legacy payment system is built around multiple beneficiaries each increasing friction and cost of the transaction.

Furthermore, this tax is not only applied to the production (GDP), but to a much bigger base. While the global GDP is ~$85T, the global payments volume Total Addressable Market (TAM) is ~$240T, with 87% still un-carded. In the US alone, payment card volumes are approaching ~$8T, from which US banks (interchange fee) and card networks (Visa & MasterCard mainly) are appropriating a total of $125bn (~1.56%), a zero-sum game and which results directly in a loss for merchants. The smaller the merchants are, the higher the fee is: SMB segment represents ~55% of revenue and only ~17% of volumes in the US market². This is a preposterous way to support Visa’s 70% EBITDA margin.

Last year, the UK Supreme Court ruled that Visa and Mastercard have been consistently and unlawfully overcharging merchants. This final ruling provides merchants with a reliable precedent to leverage on and paves the way for a €68 billion³ claim against card companies in other European courts. Last month, two trade groups representing US businesses filed a lawsuit against the Federal Reserve, asking the agency to lower the fee banks charge to process debit card transactions (interchange fee)⁴.

In summary, the case for a severe backlash and extensive legal action against the payment providers’ exploitative business practices grows ever stronger and its sustainability is facing serious challenges in the medium term. .

3. Banks’ APIfication and the wider application of instant and free bank transfers will drive payment commoditization.

The APIfication of the banking industry (eg: Open Banking) enables Fintecture to connect with banks and directly initiate a payment, on behalf of the buyer. As Fintecture is also connected to merchants, we have built the missing direct link between buyers’ and merchants’ banks. This new payment system bypasses card schemes and their intermediaries removing fees and friction.

With this new payment system merchants collect low-cost, instant, and more efficient payments: instant funds availability, enhanced conversion (fewer declines, higher ceilings and smoother UX), less fraud and no chargebacks. Additionally, our new payment infrastructure is flexible enough to quickly embed new features, such as a one-click checkout, to further improve the user experience for both merchants and their buyers.

Some would argue that banks’ APIs are not standardized and perform inconsistently, and that instant transfer schemes are not free and still not widely used. Both points are relevant for now, but you don’t build the future of payment without a forward-looking vision. Banks’ APIs are being perfectly standardized by players like Fintecture and their performances are rapidly improving. Moreover, free instant transfers are expected to be the norm in the coming few years (see the European Commission roadmap).

With high performing APIs and free instant transfers, equilibrium price for a payment collection should approach zero, putting payment providers in an impossible position: why would retailers continue paying hundreds of billions annually to payment providers, while they could collect free and more efficient payments elsewhere?

Obviously, this commoditization will not happen in the short term: the payments addressable market is massive and fast-growing, creating a strong demand for digital payments and driving the prices up. Nevertheless, payment providers should prepare for this structural transformation of the industry to be able to survive the ongoing transformation.

At Fintecture we believe payment itself cannot justify, in the long run, the fee pool paid by merchants. Yet, we also are convinced that the same fee pool, or an even greater one, can be captured with adjacent-to-payments high value services.

We started by building from first principles a new payment system, successfully addressing the failures of a legacy one, enabling our merchants to increase their sales and significantly save on their transaction costs (~40% saving). And now we are bringing added value to our merchants by embedding adjacent services into our next-gen payment infrastructure. These include the ability for merchants to request payments by email and collect a PoS/in-store payment using QR codes, increasing their omnichannel capacities; or the ability for B2B merchants to offer net terms (buy now pay later), facilitating their transition into digital commerce.

From our perspective, Account-to-Account payments are only the first step to bring value to merchants by increasing their sales while reducing their payment costs, but we continue to fill other gaps in merchants’ financial services. We are redefining the role of a payment infrastructure, based on merchants’ needs and on our vision of the future of payments.

Since the beginning of Fintecture, we took the product leadership to spearhead the ongoing transformation. The next-gen payment infrastructure we are building is to legacy payments what smartphones are to cell phones: fund transfer is the basis, but the value lies in the adjacent services.

References :
1 Everything You Need To Know about card declines
2 CREDIT SUISSE (Equity Research): Payments, Processors, & Fintech
3 UK’s top court rules against Visa and Mastercard in interchange fee battle (finextra.com)
4 Merchants sue Federal Reserve over fees for debit cards (independent)