Why checks still exist and the state of B2B payments

The following post explores the complexities of business payments viz-a-viz consumer payments and the role of FinTechs in leading the innovation in business payments.

Source: Bank Rate

Consider this question: When was the last time you wrote a check to pay for something? If you are having a hard time coming up with an answer, there is a good chance that you belong to the growing majority of millennials or Gen Z, for whom checks and telegrams are antiquated technologies that only existed in the past.

Compare that with the fact that 51% of Business-to-business (B2B) payments in the US are made by checks, with the other 49% spread across Electronic Funds Transfer (EFT), pre-paid debit cards, Automated Clearing House (ACH) credit and debit transfers, according to AFP’s 2016 Electronic Payments Report.

With consumers switching to services such as Direct Deposit, ACH, PayPal and Venmo for all their Business-to-Consumer (B2C) and Peer-to-peer (P2P, also referred to as Customer-to-customer) transaction needs, an obvious question beckons: Why do then businesses continue to use checks, and what has led to a slow pace of disruption in B2B payments?

From the outside, B2B payments and P2P payments might look similar wherein there are two transacting parties: one provides some goods/services and the other needs to pay for those goods/services. But the similarities among B2B and consumer payments pretty much end there. Right from the number of people involved to the value and volume of transactions, B2B payments are a much more complex web of events. To give you an idea of the dollar value of these transactions and to make a clear distinction between these payments, consider the figure below:

*Source: Business Insider, The B2B Payments explainer

Let’s take a look at the key differences across the two type of payments:

  1. The volume and value of transactions: We can calculate from the figure above, that the value of B2B transactions is 25 times more than that of P2P payments. At the same time, some reports suggest that combined transaction volume of B2C and P2P payments dwarfs B2B payment volume by 9:1
  2. Number of people involved: P2P payments involve fewer people and typically involve a sole-decision maker on one end and another individual or a couple of people on the other end. However, businesses have many people working in the procurement, accounts, and billing departments within the same organization and as a result, B2B payments affect much larger number of people
  3. The duration of the entire life-cycle of a payment: The entire process that requires a P2P payment, from start to finish, will typically take a few hours at maximum and will have little to no dependency on any other event. A B2B payment life-cycle on the other hand can have a duration of as many as 60 or even 90 days. This is because of the complexity due to inter-dependency of multiple processes and payments that the figure below tries to represent:
PO: Purchase Order, which is sent to a supplier to initiate an exchange of goods/services — AP: Accounts Payable, a system to manage and monitor outstanding invoices

This starts to give us some intuition about why P2P payments are relatively easier to deal with and why innovation in B2B payments has faced many more hurdles. Now, let’s take a look at some of these hurdles and what it might take to cross the finish line.

Going back to our earlier argument of checks being representative of outdated technology, here are a couple of facts about the cost of writing checks:

  1. As per one report from Bank of America, a business check costs an organization an aggregate of $4 to $20 based on the price of the check, shipping charges, and other administrative tasks related to handling a check
  2. According to MineralTree Inc., dealing in checks costed businesses in the USA somewhere between $25 — $50Bn in 2010 alone. Businesses continue to use checks despite studies that have shown that electronic payments can help businesses save a lot of money

If it is indeed so costly, what haven’t banks aggressively pushed for newer and cheaper technology, and what will make businesses abandon checks in favor of cheaper options that are available?

The answer to the first question above is the lack of a syndicated effort by the banks in the US to deal with this issue. When the Eurozone moved to a single currency, the Euro, it gave them an opportunity to overhaul the entire banking system, making it easier to incorporate newer technology. As a result, a number of countries in the Eurozone have completely phased out or seen a significant reduction in the number of checks issued. The US on the other hand has a much higher number of banks, including the state and the regional ones, and an antiquated banking system that makes it hard to bring in new technology. Additionally, The Fed does not have the authority to mandate unified standards, which must essentially come from the Congress. This implies that change in the B2B payment space in the US will be more organic and come from bottom-up. This is where the role of FinTech begins to shine.

The answer to the second question above is more nuanced. While it is true that old habits, familiarity and reluctance to adopt new technology contribute to the continuing use of checks, there do exist other, more pertinent reasons.

  1. Some businesses continue to write checks to leave an easily verifiable audit trail without the need to setup new systems and put new processes in place. A technology enabled solution that works seamlessly out-of-the-box and does not cost a fortune will help address this issue
  2. Some businesses prefer checks over electronic payments for their reliability of remittance advice that accompanies each payment. Remittance advice is a slip that accompanies the check in the mail with details about the transaction and the payment it relates to. The problem with the electronic payment remittance advice is their non-standardized format because these are generated directly from the payer’s Enterprise Resource Planning (ERP) system, which is difficult to reconcile for small businesses that do not have such integrations
  3. A bigger problem still, for the businesses, is partial automation of processes in the complex web of processes depicted above. The complexity of processes often warrants manual intervention and forces businesses to often look at their entire payment process on a transaction by transaction basis. When this starts to happen, the flexibility, which writing a check offers, becomes a big value proposition, allowing businesses to have a better control over their cash flows. To overcome this challenge, we will need robust systems that allow partial and contingent payments without breaking the overall flow of processes
  4. Finally, a check that is in the mail and takes 2–3 days to process, also gives the advantage of money staying in the bank account of the payer for just a little bit longer even after the payment has been “sent”. This has to do more with people’s mindset than anything else. The prevailing low interest rate environment, which earns almost nothing on money sitting in the bank, might bring about the necessary change of “sending the payment” on the agreed date

So, are the checks going away anytime soon?

Probably not. Although there is no FinTech firm that has found the secret sauce to eliminate the use of checks and solve all of the aforementioned problems, companies have started out by solving a niche problem and then going on to tackling related problems, one at a time. While established companies like Paypal and Square are providing the tools and the infrastructure to carry out the B2B payment transaction electronically, other companies such as Taulia, Bluevine, C2FO, and AvidXchange are targeting other segments of the overall payment lifecycle. The core tenets of these companies are centered around creating value through operational efficiency, lower cost structure, customer-centric approach and a system that is frictionless.

The path going forward…

While no one in the industry is holding their breath for the B2B payment space to change overnight, we have seen incremental gains over the past few years and these shall continue with greater momentum than ever before. Eric Sager, Chief Revenue Officer of Bluevine, commented that businesses will also benefit from the network effects of a product such as Bluevine. He said, “As more businesses join the network, getting equipment financing, term-loans and other forms of credit, on a single platform, can be a viable option for businesses”. When asked about the plans for expanding to other parts of the payment lifecycle, he mentioned that one conceivable way to eliminate a step in the Invoice Financing space is providing credit to businesses at the POS, analogous to what Affirm does for consumer payments. On the question about partnership between Banks and FinTech companies, to tackle the challenges of B2B payments, Eric is hopeful of finding synergies as smaller companies continue to innovate and find meaningful ways to drive efficiencies.

2018 might not be the year when it all changes, but it sure promises to bear the footprints of huge strides in the right direction.