The Future of Payments

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The future of payments: Markers for success

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The future of payments:
Markers for success
The payments industry faces uncertainty on many fronts. Historically, it
has been a business in which the incumbents were strongly advantaged
and able to enjoy stable or growing revenue streams. Now, however, a
disruptive mix of regulatory and consumer behavioral changes, emerging
technologies and new competitive thrusts is presenting industry
incumbents with unprecedented challenges. These changes are catalyzing
new and shifting alliances, which in turn are creating fresh opportunities
for industry entrants.

Monica Adractas
Dan Ewing
Kausik Rajgopal

In our previous issue we presented several
scenarios for how the payments industry
might unfold during the coming decade (see
“Payments 2020: Scenarios for dynamic evolution,” McKinsey on Payments, March
2011). In this shifting environment incumbents must consider how best to defend
hard-won market positions, and recent and
prospective entrants must determine what
they can do to successfully penetrate the
market and grow their businesses.

Markers for success
There are six markers that incumbents and
newcomers alike can use to define positioning and strategies for success. They can help
incumbents adapt current value propositions (or create more defensible ones), and

guide industry entrants in their efforts to
make any new power shifts a sustainable reality. For incumbents the attainment of these
markers will also define the major barriers
to market entry, enabling them to better assess any threat of displacement by entrants.
Instead of squandering management resources to fend off upstarts that have little
chance of attaining meaningful scale, they
can employ the markers as building blocks
to help them more appropriately manage
their respective partnership and acquisition
activities. Each of these markers is soundly
anchored in our fundamental beliefs about
the enduring nature and dynamics of the
payments business, as well as in our thinking about current industry disruptions.

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McKinsey on Payments

June 2011

Marker 1: Deliver significantly and not
just marginally more customer value
than the market alternatives

or chip cards (with which consumers are already comfortable) is marginal, and hardly
sufficient to induce a meaningful shift in behavior. On the other hand, in unsecured
consumer credit, new entrants such as Ferratum Group and Wonga in Europe have
seen success in providing consumers with
immediate and convenient access to microloans through online and mobile channels, despite higher interest rates.

Payments is a business with high inertia and
strong network effects. In such industries,
the marginally better customer propositions
of new entrants usually lose ground to those
of incumbents that have already won broad
acceptance. The founder of a payments
start-up once poignantly said, “Building a

As the now ubiquitous
QWERTY keyboard illustrates,
consumers tend to grow
comfortable with secure, reliable
and relatively commonplace
mechanisms, despite any
drawbacks they may have.
marginally better payments mousetrap is a
great way to lose money.” As the now ubiquitous QWERTY keyboard illustrates, consumers tend to grow comfortable with
secure, reliable and relatively commonplace
mechanisms, despite any drawbacks they
may have, and payments systems are no exception. Consequently, consumers are reluctant to adopt new technologies—though
they may offer advantages for other stakeholders—if the value for them personally is
unclear or unappreciated. An excellent example of this is contactless cards, which
allow buyers to wave their cards near enabled point-of-sale terminals instead of
swiping them. While the benefits of contactless cards may be clear for issuers, networks
and merchants, their advantages over swipe

Marker 2: Build value propositions that
go beyond cost reduction
As noted above, new payments mechanisms
that generate cost savings for merchants, regardless of the amount, will probably not
gain broad consumer acceptance on their
own. Consumers simply cannot appreciate
just how much a decrease of a few basis
points might reduce the merchants’—and ultimately their own—costs; similarly, they
have little concern about merchants’ ability
to shave microseconds from cash register
transaction times. This hardly means that
cost-based propositions are irrelevant; only
that success may also require delivering customer value that is functionally a step above
current alternatives. In the U.S., for example, Starbucks consumers can register their
pre-paid Starbucks cards online to receive
free drinks, add-ons and promotions. Consumers can also download a Starbucks mobile application that enables them to pay
with their registered cards using a quick-response matrix barcode on their smartphones. These approaches enable the
company to guide its customers toward its
preferred payment option by using economic and operational benefits, while also
adding meaningful value for consumers.

The future of payments: Markers for success

The Canadian market offers an elegant controlled experiment in added value. Canada’s
debit card system, Interac Direct Payment,
has historically been a zero-interchange system that charges consumers based on usage.
By contrast, credit card interchange rates in
Canada are higher, similar to those seen in
the U.S. Despite the cost differential, credit
card acceptance in Canada significantly exceeds that for debit cards. Merchants seem
to find enough added value in credit cards to
offset the cost of interchange fees.

It is generally advantageous
for developers of new payments
systems to target niche market
segments, where acquisition
costs are lower, before driving for
broad penetration.
Marker 3: Penetrate niche segments first
It is generally advantageous for developers
of new payments systems to target niche
market segments, where acquisition costs
are lower, before driving for broad penetration. Grandiose attempts to transform the
global payments industry will likely lead to
slow (and occasionally spectacular) failure.
Globally, more than 400 payments start-ups
came and went during the dot-com boom 10
years ago; fewer than five managed to survive. The most recognized of these is PayPal,
which early on grew by tethering itself to the
e-commerce giant eBay, for whom a unique
payment mode with superior risk management was critically important to its success.
In fact, PayPal displaced eBay’s own payment solution, eventually becoming the

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principal way to pay on eBay. The cost of
customer acquisition during PayPal’s early
growth, then, was essentially subsidized by
eBay. This was a critical strategy for building PayPal’s user base cost-effectively and
gaining significant scale – among consumers
as well as eBay’s power-seller merchants.
Notably, eBay sales remain a significant contributor to PayPal’s business today. By contrast, many rapid national introductions of
pre-paid e-purses in European countries did
not lead to success. In fact, after incurring
high rollout costs most European e-purse
programs have been discontinued.

Marker 4: Leverage established
infrastructure
The high fixed cost of building a payments
infrastructure that will be reliable, secure,
ubiquitous and convenient can be an insurmountable barrier to entry. Most successful
payments solutions are therefore designed
to leverage existing infrastructures. This
pattern tends to hold true for most markets
and applications around the world, whether
applied to online payment modes in the U.S.
that leverage ACH infrastructure, parking
payment systems in Europe that use SMS
capabilities, or open-loop prepaid cards
elsewhere. A good example is Alipay, a large
payments platform that facilitates cross-border online transactions in China and partners with Chinese banks for clearing and
settlement. While the leveraging of established infrastructure is frequently a necessity, its attainment is insufficient by itself for
success. Several cost-based point-of-service
ACH solutions in the U.S., for example,
clearly demonstrated this when they failed
to gain traction and scale.

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McKinsey on Payments

June 2011

Marker 5: Adapt offerings to market
context

ture phones or SMS-based technology prevail. In these markets, applications could
enable unbanked consumers to pay their
utility bills or receive government payments
via mobile phones. Hybrid online and mobile solutions are also emerging to form new
ecosystems; for example, consumers can
purchase digital products within the context
of games on social networks (Exhibit 1).

The payments industry varies significantly
from one market to another, chiefly because
of differences in regulations, technology
standards, consumer preferences and the
relevance of established payment modes.
Players that succeed in one market often
risk failure by applying the same models in
other markets, especially those that are in a
different stage of evolution. Success usually
requires that market entrants modify their
business models to reflect marketplace differences. For example, mobile payments approaches such as in-aisle shopping
comparison and purchasing draw customers
in developed markets where smartphone
penetration is high and growing; however,
approaches will probably have to differ considerably in emerging markets, where fea-

Marker 6: Tap adjacent profit pools to
differentiate offerings and add value
Regulatory and technological disruptions
will likely prompt an increase in business
propositions that actually sacrifice payments
economics in favor of generating greater
value elsewhere. An example of this is Walmart’s MoneyCard. In the U.S., Walmart is a
sizeable and growing player in alternative financial services, offering consumers core

Exhibit 1

Hybrid online-mobile
payments are
emerging as a
fast-growing
payment option for
purchasing digital
offerings

®

Overview

Advantages

Situation: Social networking sites and gaming are
growing rapidly, and seeking ways to monetize their
digital offerings, which represent attractive revenue
sources

No registration required

Complication: Entering and storing payment
information disrupts the user experience and raises
security concerns for those consumers who lack
credit cards or have other security issues
Resolution: New providers are linking payments
to users’ mobile phone bills, streamlining the
process and eliminating the need to enter and store
credit card and debit card information on numerous
Web sites
Source: McKinsey analysis and company Web sites

More security steps, e.g., PIN text is sent to phone
and entered on Web site
Potential for small-ticket payments
Challenges
Limited transaction size on carrier bill unless credit
card or debit card account is linked, e.g., $20
maximum charge
Economics for developers may be challenging, e.g.,
carriers charge 20-50% of purchase price, and
require clear business case on monetization

The future of payments: Markers for success

services at lower prices. The MoneyCard
provides open-loop prepaid capabilities with
pricing that is consistent with the company’s
well-established commitment to being a
low-priced leader. In this case, MoneyCard’s
link to the company’s core retail business is a
key part of the business model. When consumers cash their paychecks and replenish
their MoneyCard balances at Walmart’s instore MoneyCenters they typically spend
part of those higher balances before they
leave the store (Exhibit 2).
More likely than not, we will see a continuing
emergence of business models that sacrifice
payments economics in various ways,
whether to consumers, merchants or both.
Prepaid card pricing, for example, could
change further as issuers experience additional pressures, while monthly and other

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fees might even be eliminated. The reason
for such changes is that many issuers have
access to adjacent profit pools such as search,
couponing, mobile applications and loyalty
management programs that are closely tied
to payment mechanisms themselves.
Tapping adjacent profit pools, however,
could effectively transform the physical
point-of-sale in several ways, blurring and
eventually erasing the lines between payments and adjacent businesses. A catalyst
for this type of change could be new business models that we now see emerging to
improve the mobile commerce experience.
Their focus ranges from demand generation
to post-transaction loyalty management (Exhibit 3, page 8). Although several are still in
their infancy, the blending of technological
developments enabled by smart or enhanced

Exhibit 2

Walmart is
reshaping prepaid
card pricing

Walmart and prepaid cards

Broad impact

Walmart launched its
MoneyCard in June 2007 in
partnership with GE Money
Bank and Visa

American Express,
Green Dot, and
nFinanSe recently
lowered and simplified
their fees

In February 2009, Walmart
significantly reduced its
MoneyCard pricing to
stimulate usage and improve
its ability to cross-sell
MoneyCard with its checkcashing and other services
• Issuance fee reduced from
$8.94 to $3
• Reload fee reduced from
$4.64 to $3
• Monthly maintenance fee
reduced from $4.94 to $3

Source: McKinsey analysis and company Web sites

Today’s prepaid card
pricing suggests a
maturing industry, as
established players
compete on price, not
just size and scale

8

McKinsey on Payments

Exhibit 3

Adjacent profit
pools let players
discount payments
economics

June 2011

Pre-purchase
Purchase
decision
process

How
m-commerce
can change
buyer
behavior

Compare
merchants

Decision-making

Transaction

Post-purchase

Contact
merchant

Finalize
decision

Make
payment

Review
promptly

Build
loyalty

Generate
demand

Identify
merchants

Enhances
merchants’
ability to
target and
personalize
marketing
communications

Consumers
can do
local
searches
anytime

Review
apps help
users to
find best
local
merchants

Ability to
contact
merchants
for store
locations,
hours,
directions,
etc.

Can
compare
prices,
obtain peer
advice and
browse
competitor
offerings

Pay via
mobile
device

Ability to
immediately
send
reviews and
location to
users’
social
networks

Can trigger
couponing
and other
loyalty
programs

Sign up for
specific
deals and
receive
coupons
based on
triggers (e.g.,
location)

Find nearby
stores with
product and
compare
prices

Read
reviews to
find the
best
merchant
out of all
local
options

Use Google
Local to get
business
information

Use product
barcodes to
find nearby
sellers,
compare
prices

Pay
restaurant
bill without
waiting for
server

Share
comments
about local
venues

Postpurchase
offer
redemption
linked
directly to
bankcard

Examples

Use Google
Maps to
map route

Publish and
read reviews

Source: McKinsey analysis and company Web sites

phones with changing customer behavior
make this space well worth watching. Mobile-enabled consumer behavior shifts would
bring new and difficult challenges for industry incumbents, partly because it is generally
easier to compete with industry entrants
than with well-established rivals who use
their payments products as loss leaders.
***
Industry entrants will continue to find it
extremely challenging to compete effectively with well-established incumbents—
especially with the banks, payment

networks, acquirers and processors that
have historically “owned” the payments
business. The six markers for success defined here will help. They can serve not
only as reliable markers to guide incumbents as they evolve their business strategies and create new value propositions to
maintain their hold on the payments business, but also to guide those entrants eager
to tilt at the payments windmill.
Monica Adractas and Dan Ewing are associate principals, and Kausik Rajgopal is a principal, all in the
San Francisco office.

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