Sunday, January 31, 2010

Growing up in the land of the rich

Retailers and payment schemes (Visa, Mastercard...) jousting on the interchange rates and impact it has on the economy has been interesting.  Rates paid by retailers vary tremendously (based on many different factors which I shall not get into here).  To drive a stake in the ground, the rates are around 1.8% in the US for credit cards.  In a world where margins are thin, 1.8% seem like a king's ransom.

With this perspective, let us look at rates paid by online retailers to process online payments.  Using PayPal as a benchmark, PayPal charged merchants an aggregate fee of 3.54% in Q4'09, nearly twice as much what merchants pay in the physical world.  Additionally, PayPal's transaction processing expense rate and losses added up to only 1.36% [in Q4'09], resulting in a margin of a whopping 62%.

Fortunately for PayPal, their competition charge as much, but do not have the great business model of being able to keep most of the money.  In a traditional (Brick-n-Mortar) model, the fees paid by merchants are split between at least four parties, the acquirer, the processor, the issuer and the network/scheme, with most of the fees heading to the issuer (around 80%).  In the online world, there is yet another mouth to feed, the payment gateway (e.g.,  Thanks to the disruptive innovation of PayPal, they successfully created a model where there is only party at the table, PayPal.  In an increasing number of transactions, PayPal is the Payment Gateway, Acquirer, Network and the Issuer (and in these cases it costs them a few pennies to process a payment transaction).  Through this innovation, they get to charge what the competition charges (high rates), while being able to keep most of it.

Isn't it wonderful to participate in a sub-optimal world of online payments.  PayPal's large margins are funding their red-hot growth that is many times larger than the industry average.  With each passing year, PayPal will continue to grow (both top line and bottom line) at the cost of the other players, with competition only being able to watch PayPal demolish them.  The existing business model of Visa/MasterCard has tied the hands of the traditional players and forcing them to play in a playing field that is lopsided and favoring PayPal.

And, if you think that above situation is an unfair advantage for PayPal, wait for them to play their next card, Mobile Payments.  The above structural disadvantages are holding back the traditional players in mobile payments, as nobody wants to add yet another player who demands a cut (the telecom operator).  Guess what, the efficiencies and the margins that PayPal has can easily accommodate the player whom the competition is pushing out.

How do you think Visa and MasterCard, the public companies will respond to protect their turf and deliver shareholder value?

Saturday, January 9, 2010

Higher transaction limit breathes life into a comatose market?

 Over the holidays, RBI (the Federal Regulator in India) raised mobile transaction limits to Rs50,000 per transaction (source).  A gripe by the mobile payments industry has been that the prevailing limit of Rs5000 per transaction was not sufficient, for e.g., to pay for an air ticket. What is the impact of RBI raising the limit for mobile payments in India?  I'll look at this question in the context of urban India.

A quick survey of the possible demographic segments that the new regulation would appeal to:
a. The 80% of urban India who carry cell phones were held back because of the low transaction limits
b. The upwardly mobile tech savvy Indian (early adopters) did not have access to mobile payments
c. Those who are already paying for their sundry expenses using their mobiles phones, but couldn't pay for their airline tickets though
d. None of the above

As you might have realized, this is a rhetorical question.  Mobile payments in India has been a big yawn.  Mobile payment service providers in India are struggling, or are re-inventing themselves to stay alive / relevant (related post).

In India, the dominant perception (Cash Culture) is that cash is a preferred way of living, leaving no trail behind, being anonymous and not attracting attention of the government.  This holds true for purchases related to both durable goods and consumables.  Let's look at the traditional factors driving mobile payments, cash handling costs / cash displacement) in such an Indian context.
  • Merchant's perspective: Other than in exceptional cases, merchants prefer cash as they control / manipulate what is reported as sales, primarily for tax purposes (euphemism for tax avoidance)
  • Consumer's perspective: Do not want to leave a trail of purchases [for tax authorities to follow]
  • Significant part of India's retail economy lives in a parallel black market, some say as much as half of the economy!
Who would use mpayments in India
- Consumers who have and use credit cards and bank accounts, and merchants who accept them
- Organized retail
- Those interested in reducing customer service costs via self service channels

When you look at mpayments from the above perspective, there is a significant overlap between payment card users and mpayments target market. While this insight is not a revelation, in the context of India which has very few active card users (20-30 million active card users), the increase in transaction limits will do very little to the mpayment industry in India.  The change in the transaction limits has not raised the mobile payments market size which continues to be 20-30 million card holders (not the 500 million mobile phone users).

The above undercurent does not bode well for the industry.  If mobile payments changed the market size from 20 million to 500 million you get people's attention.  If the pie is only going to grow marginally bigger, there is little incentive for the various ecosystem enablers to invest resources and do the heavy lifting to deploy mobile payment technology. 

Look forward to dissenting or concurring opinions.  Have a wonderful 2010.