Wednesday, December 23, 2009

Indian credit card industry looks black

I have been looking at the profitability of online card payments in India, specifically from a card issuer's perspective.  This post is following up on a related post (Oct 09).  A couple of trends triggered this post:
  • 2FA (Two-factor authentication), mandated by the RBI, deployed since Aug 09 seems to be a success.  The timing of this deployment is helping increase the size of the ecommerce pie in the nascent Indian market, at just the right time.  Early indicators are that both merchants and issuers are seeing reduced fraud.
  • Stung by the credit defaults during the [temporary] recession of 2008-09, card issuers are offering credit backed by a card holder's asset (e.g., a fixed deposit / CD)
Recognizing that the main cost drivers for card issuers are credit risk, fraud risk and transaction processing costs, the relatively high interchange fees (3% and higher) and lower costs must be making the balance sheets of Indian credit card issuers look nice and black.

What are the implications of the above trend/development as we step into 2010? 
  • Aggressively pursue new markets [in India] to get credit cards into more hands?
  • Migrate to EMV [finally]?
  • Any other suggestions?
Looking for dark clouds on the horizon.  India Pay initiative is a major development which could have far reaching impact.  A possible course for card issuers would be to milk the current profits while not growing the market until the picture clarifies around India Pay, and MasterCard's and Visa's reaction to it?

Though the above post has focused on the online payments space, the dynamics of the F2F / payments at stores are similar leading to the same conclusion.

This is to wish all a wonderful holiday season and a great 2010

Friday, December 4, 2009

Engines powering disruptive innovations in Payments industry

As I get to look at the payment card economics for online retailers in the US and elsewhere in the world, a couple of things jump out
  • Merchant Discount Rates (MDR) are higher in the US (about 1%)
  • Fraud rates are higher in the US (about 1%)
Even though online retailers are picking up the costs associated with online fraud, online retailers still pay a higher MDR.  A double whammy.

What stumps me is the basis for higher online fraud rates in the US.  In the online world, payment cards are all magstripe cards (you can't use chip-n-PIN cards onine).  Therefore, the US being a straggler in adoption of smartcard-based payment cards does not hold.  US prides itself on having a lot of intelligence in the payment network to detect fraud.  In spite of this, the US has $4 billion in online fraud.

Are the above indicators part of the landscape which can't be changed, or are the above indicators indicative of staid incumbents with little incentive to change status quo?  If it is the latter, we must be able to see evidence on innovations from challengers.

PayPal has been a disruptive innovator.  Though the MDR charged by PayPal is about the same as what the rest of the industry charges, PayPal's merchants have immunity from chargebacks (a 1% saving to merchants).  The fraud levels (transaction losses) experienced by PayPal is about 30bps (100bps = 1%).  A 1% premium MDR charged by PayPal while experiencing only 30bps of losses is a good business model.  So here we have a disruptive innovator offering a true win-win offering.  The online retailer saves 1% in chargeback costs, which is about 20% increase in net margins.  PayPal gets a 1% premium MDR while managing losses at 30bps (resulting in 70bps larger margins).

PayPal has been and expected to grow at about 18-20% CAGR while the incumbents are growing at half the rate (around 9%), which is proof of the relevance of the disruptive innovation of PayPal.

This posted started off evaluating the [possible] uniqueness of the US online payments industry, but is ending up looking at how a challenger is disruptively innovating at the cost of staid incumbents.  Please look forward to a follow-up post which examines why PayPal is an anomaly in the world of payments systems.