The Misaligned Opportunity in Payment
“The shiny new tech in payments tends to be in the retail space, but the opportunities are actually behind the scenes in the B2B space.”
- Retail payment technology is most talked about as it’s most visible. However retail payment has the least opportunity
- The most opportunity is behind the scenes with B2B payment as it’s the largest sector of payment and the technology is the most behind.
The focus in payment is not totally aligned with where the opportunity is! I often hear people talk about the payment disruption or the amazon effect of payments, but when I look closer, they are only talking about one area in payments: the retail sector. Sure, it’s easier to understand and see the shiny new tech in retail payment, but in the overall payment spectrum, this sector is also the hardest to disrupt / enter given “red-sea” competition. Comparatively, there are more opportunities in the business sector, especially in B2B payments. Below is my view of the payment landscape, and my reason.
For simplicity, I will break payment into 3 broad categories: retail, B2C (business to consumers), and B2B (business to business). Retail refers to individual users. B2C refers to merchants accepting payments from consumers. B2B refers to business paying another business.
1. Technically within retail, there is C2C (peer to peer payments) and B2C (consumers paying merchants), for simplicity we have grouped them under retail in this article.
2. There are more classifications such as procure to payment under B2B, for this article, that will all be generalized under B2B.
3. The same misalignment also happens in international payments, but without turning into a research paper, we will keep our discussion to domestic payment (USA) only.
This is the area that has received the most coverage. Whether it’s C2C or B2C, the target audience are everyday individual users. As I have written in the past, we will not have 10 apps for finance, but more like 1 or 2. In the US, This sector of the market is not as fragmented as the B2B, and we are starting to see the effect of aggregation. The aggregation theory according to Ben Thompson:
Aggregation Theory describes how platforms (i.e. aggregators) come to dominate the industries in which they compete in a systematic and predictable way.
Aggregators tend to have following 3 effects:
Zero distribution costs. Zero marginal costs. Zero transactions.
As several of the payment hubs are emerging and the flywheel effect accumulating, I believe these payment hubs will dominate retail finance as Amazon did to e-commerce.
This has already happened in China with Alipay and Wechat Pay, and the most likely candidate in the US are Apple Pay and the newly launched Google Pay.
The advantage that Apple and Google have is that they own the platform, currently it’s the mobile phone. Though history might not repeat, it certainly will rhyme. This is similar to back in the PC days. Microsoft owned the platform, the windows OS. That’s how IE took over Netscape in the internet browser market.
However, even with the dominance of IE, Google Chrome was able to take market share because it’s a better product: the benefits of the product outweighs the cost to make the switch. So, there are still opportunities.
But what should a company consider in this tough sector? The fundamental requirement of payment is free, real time, and convenient. Of course that’s not enough. I believe the following trends are relevant:
- user data
- hygiene / contactless
- more frictionless
Companies need to find a way to efficiently collect data and effectively apply the data to benefit users. Data has become the bedrock to differentiator functions such as tailored advise, self-driving money, and other areas of financial AI.
To make payment truly contactless and reduce the use of cash is another trend, as hygiene has become a big issue. One of the solution is QR codes as both PayPal and Cash app are experimenting with the technology. We will talk more on QR codes in B2C payments.
Lastly, on the convenience part, companies need to find ways to make payments more frictionless. For example, China is already testing biometric, facial, payment with the public. Such payment methods simplifies the checkout process further as users don’t even need to take out their phones or cards.
In the US, companies like CarIQ is experimenting payment from cars, imagine going to gas station, and able to leave right after gas has been filled.
The merchant side of the B2C payment tries to answer the question of how do merchants accept payments? There are a number of parties involved, so I will use a graph to illustrate the landscape:
Gateway / merchant processor / POS: authenticates payment methods by performing a PIN check or verify card details, then sends the authorization request to the appropriate card network.
Payment processor: routes authorization request from card network to issuing bank’s authorization system. They can also stand in to provide authorization for transactions and provide basic fraud checks. Payment processors are the bridge between card networks and banks.
In a typical offline transaction, consumers will swipe their cards at the merchant’s POS. While in an online transaction, the merchant’s checkout is connected to a payment gateway. The POS / payment gateway is connected to the cards’ network (Visa, Mastercard, Amex). The cards’ network connects to banks.
The pandemic has jumped ahead the shift to e-commerce by 5 to 6 years in the US. Despite such shift, Fintechs are disrupting successfully in both online and offline payments.
Square disrupted the typical acquiring solution incumbents (TSIS, Global Payment, First Data) by offering SME a cost efficient solution to process credit card payments. PayPal started the online payment, then came along Stripe with embedded payment solution.
As a result, we saw incumbents merge: Global Payments acquires TSIS, Fiserv acquires First Data, and FIS acquires World Pay to better fend off the competition.
I see a number of opportunities in this sector:
- Payments getting cheaper, easier, and simpler for both offline and online transactions.
- The unbundle to rebundle of the payments markets: PaaS (Payment as a Service) -> FaaS (Fintech as a Service) -> Market place
Prior to square, the threshold to accept non-cash payments for merchants was way too high. Some ‘of the POS costs~$1000. Square’s reader disrupted the market by allowing small merchants to use their phone to accept cards payment. However, we shouldn’t stop here.
For example in offline transactions, QR codes is a cheaper solutions for merchants. Any merchant could just print their QR codes, and start to accept payments.
When I was running my retail technology business, I was looking for a payment solution for my robots. My options sucked. I was stuck with a cash & credit card processing machine (hardware) that cost $1000 on top of 5% processing fee! If I had QR code, I could just put the QR code into the monitor of my robots, and not having to deal with buying, installing, and maintaining the payment acceptance hardware. The extra work and costs involved can have a significant impact into SMEs’ profit margins.
Additionally, QR codes is contactless, which has come to importance given the pandemic. With credit card, I had to either sign or confirm the amount on a device that has been used by who knows how many people. But for QR codes, we can just confirm the transaction on our phone, truly contactless.
So, from POS -> Square reader -> QR codes (or some other better option)
Online transactions: A2A payments
Look at the payment flow diagram above, I believe the current B2C payment landscape is too complicated! Well that was built 50 to 60 years ago. Credit card is a digital payment, but one of its biggest problem is acceptability. How often have you gone into a mom and pop store that either just don’t accept credit card or has a minimum balance before they will accept the card? Of course that has to do with the fees. And I don’t think we can lower the fee much without simplify the payment structure first.
How bad is this problem? Study shows that US merchants paid more than $100 billion annually in swipe fees, and the trend is only going up.
There is got to be a better way! One of the way to simplify is with A2A payment (account to account payment). And there is already proven successful examples with A2A payment, such as China’s Alipay and Wechat Pay. These 2 A2A payment companies offer merchants cheap solution to accept digital payments, Alipay charges merchants .6% in processing fee. The affordability of the solution is one of the main reason why it’s so widely accepted in China. The adoption is so high that even street beggars have QR codes to accept Alipay or Wechat Pay.
Such solution is not hard to implement in the US given that we already have a solution / very similar one in debit card transaction. In addition, there are already improvements in the underlying rails such as the RTP by the Clearinghouse and same day ACH. So, my gut feeling is that a much improved solution is not that far away in US.
Though, there may be some protectionism or push backs by the incumbents, like Visa’s acquisition of Plaid and the following law suits by DoJ, I think the true winner is one who embrace new technology.
PaaS -> FaaS -> Market place
As embedded payment are becoming more popular. I see PaaS(Payment as a Service) provider extend to complementary services. For example, Stripe announced Stripe Treasury, which is a BaaS (Banking as a Service). This allows Stripe’s users to make ACH payments through Stripe’s banking partners. The benefits: 0 customer acquisition cost for Stripe, and possible improvements in both user experience and functions as Stripe owns the end to end cycle. I believe this trend will continue. PaaS will also offer BaaS, and vice versa, basically resulting in the rebundling of financial services to become FaaS (Fintech as a Service). But again, we are not done yet.
The APIs provided by PaaS has lowered the threshold to entry, but it didn’t solve the problem of what to choose. I believe picking a payment service provider should be as simple as buying an everyday product (like a backpack) from a catalog or Amazon.
As these APIs are becoming more modular and simpler to integrate, there should be another layer that sits on top of all FaaS that help customers pick and integrate the best options for each individual needs. The benefits of this layer is to achieve functions such as smart order routing for debit card transactions to save on fees; or to mix and match the best from each service providers. For example, I may use vendor A for regular payment processing, but use vendor B for chargeback fraud detection.
So, from PaaS -> FaaS -> Market place integration layer.
Last, there is the B2B payment, which is the largest sector of payment in terms of volume, currently ~$127 trillion worldwide, and expected to reach 5 times the B2C and retail market combined over the next decade. Yet the technology is the most behind in this sector. This is why this area has the most opportunity!
It’s estimated that pre-pandemic over 50% of the payment is processed manually and made by checks, and the problem is even worse in the small business sector, where check payments accounts for 80%. This creates great revenue and saving opportunities
Though it’s industry common knowledge that the technology for enterprise payments typically lags behind retail payments, but I disagree that we should accept such “common knowledge”. Jeff Bezos said “your margin is my opportunity”, I feel “this misalignment is innovators’ opportunity”.
Checks are very inefficient compared to digital payments. There is tremendous saving opportunity for both labor and processing time. For details on inefficiencies on manual process and checks, see my previous article: a better future lies ahead for B2B payment.
A study on B2B payments by Goldman Sachs suggests new generation of payment software solution can unleash $1.5 trillion in small business productivity, and the revenue opportunity for the software providers is a $1 trillion market.
What’s more attractive is perhaps the fact that since every company has different process and systems, this is a highly fragmented market with no clear winner.
One of the main reason companies stay with checks, and didn’t want to move to ACH has to do with reconciliation. They are getting more information from checks than ACH payments. In fact, there is no information attached with ACH payment. Imagine the hectic chore of company’s AR department getting 10s to 100s of payments, and having to match those payments to invoices.
With the improvement of the underlying rail to real time (RTP), and infrastructure enablers such as Visa and Mastercard providing digital payment solution that carries data, a new infrastructure platform is forming. And what companies can build on top of the new infrastructure is where the disruption will likely occur.
For example, real time payment will allow companies to maximize their treasury management. For account payable, companies can schedule payment to right before they are due. For account receivable, companies can use digital solution to calculate whether it’s worth while to receive early payments, and offer discounts to encourage such behavior.
Another example is that companies can run code to scan and maximize discounts offered by their suppliers for early payments.
In summary, the opportunity in B2B payments is the largest due to the lag in technology and the large market size.
Though the shiny new tech in payments tends to be in the retail space, but the opportunities are actually behind the scenes in the B2B space. The focus in payments will likely stick with the retail sector, even after this article is published ><. I believe we will finally see more behavior change and disruption to the B2B market, partially thanks to the unfortunate pandemic.