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The Green Sheet Online Edition

March 27, 2017 • Issue 17:03:02

Thoughts on the future of payments (and the wine biz)

By Brandes Elitch
CrossCheck Inc.

In Wine Country (also known as Sonoma County, Calif.) where CrossCheck is located, people always ask about the wine industry, and I enjoy comparing it to the payments business. I've been looking for an opportunity to use our corporate collection and payment guarantee skills in the wine business, but, alas, I keep coming up blank.

The wine industry is doing well. It's a seller's market. Cash flows, profitability, balance sheet capitalization and the ability of wineries to price in the market are excellent. We've had three years of good quality. A reduced crop last year stabilized inventories. Total 2016 North Coast wine grape tonnage was 1.45 billion. The value of the Sonoma crop was $566 million, at 221,400 tons. The average price for all Sonoma varieties was $2,561 a ton. Land and vineyard values continue to climb (10 to 15 percent last year), as evidenced by a pension fund purchase for pinot noir land at $170,000 an acre.

Chardonnay is the largest varietal grown here, and it provides a faster cash flow for wineries than pinot. Wineries are looking to nail down their sources of fruit by buying more vineyards for their own consumption and expand production, forcing the price of land upward. The larger parcels have already been acquired by the big players, such as Jackson and Gallo.

It's harder to start a new winery now, because of increasing environmental and regulatory constraints. This is a credit-intensive business, too, because inventory turns at 12 to 24 months, or longer, hence the need for inventory financing. Water supply and permits are big issues now.

Unlike the old days, where the county was open to almost any winery project, today the grower must conform to the increasingly rigorous demands of all state and local agencies. A big issue is the supply of field workers, because many vineyards were planted before mechanization. What if you don't have enough workers to pick the grapes and manage the vineyard? Labor costs, availability, and immigration reform are pressing issues.

In February 2017, 14,000 people attended our annual wine conference, Unify Symposium. The tradeshow floor was the size of three football fields. People talked about things like tank geometry, managing oxidation and reduction, and managing oxygen reactivity. Smart bungs (stoppers or corks) now give the winemaker the ability to measure barrel temperature, pressure, humidity, fluid level, ambient light, and SO2 levels via remote mobile devices. Vineyard research is ongoing, on subjects such as water deficits, drought-tolerant rootstock, greywater, cold hardiness, effective pruning and the effects of red blotch virus.

As in wine, so in payments

Wine making involves significant technology and innovation. And you could say the same thing about the payments industry. There is an old winemaker saying, "It takes a lot of beer to make good wine," to which I would add, "It takes a lot of wine to create a successful new payment product."

What a confusing world payments has become. Remember the Gartner quadrant? It's also called the "Gartner hype cycle for emerging technologies." By my count, there are at least 30 emerging technologies in the payments space now. Gartner divides them up by "years to mainstream adoption." Some are less than two years, some are in a two- to five-year time horizon, some are more than ten years, and some are even "outdated before plateau," also known as "dead on arrival."

Emerging technologies start with an "innovative trigger," then move to a "peak of inflated expectations" and then to the "trough of disillusionment." They climb the "slope of enlightenment" and finally reach the "plateau of productivity." Most of the 30 or so I see are in the first stage. Some, like bitcoin, seem to have garnered a fair bit of disillusionment recently.

There's one big difference between a winemaker and a payment guru. To be a winemaker, you must have a university education at a school like University of California, Davis. Then you need to do few crushes in the United States, France, South Africa, South America, Australia or New Zealand. Next, you need to put in a few years as an assistant winemaker somewhere. All of this takes about seven or eight years, if you're lucky.

To be a payments expert, no formal education, training or experience is required. You just come up with a new product idea and try to get a pilot going somewhere, anywhere, and get enough traction to get funding. Here's the tricky part: not only does it have to work, but it has to present a real value proposition to the user, something that people will feel compelled to use. For example, in cybersecurity, there are all sorts of products: APIs, big data tools, employee tools, artificial intelligence, biometrics and the Internet of Things. How many companies working in this space will get funding and stay in business five years from now? Answer: very few.

Any new product is going to have a long gestation period, certainly not a year or two. Remember, the first website was put up in August 1991, 26 years ago. Amazon and eBay launched in 1995, Google in 1998, and PayPal in 1999. Facebook came out in 2004, and YouTube in 2005 – 12 years ago. It takes a long, long time for a product to reach commercial success.

Rude awakening for fintech

The fintech entrants are now finding that rather than compete with banks (their original idea), their best bet is to have a bank buy or license their technology, because banks have the numbers of business clients and consumers to get critical mass in a short time.

Finally, since ultimately somebody has to fund and pay for these fintech initiatives, it's always useful to follow the money and see who has access to the stream of future earnings from the innovators. Here's where it gets tricky, because when it comes to consumer payments, there is only one tollbooth, and it is jointly managed by the card brands and the 10 or so major card issuing banks.

While we live on what is called the "acquiring side," be aware that it's the five or six major issuing banks that call the shots in this world, and issuing cards will always have a higher priority than the acquiring side for these banks. This will continue to be the case because of the numbers, specifically, the card brands' operating margins. For February, it was 53 percent for both brands. The profit margin was 38 percent for both brands.

Now ask yourself, what other business has margins like this? Further, they are basically free of credit or operating risk, the optimal tollbooth. This is why their stocks trade at 22 times forward expectations. Analysts are predicting earnings growth in the area of 13 percent or more, and earnings per share growth at 15 percent annually for the next five years.

Look at the business model for the handful of major card issuing banks: half of their consumers revolve their card balances. The bank's cost of funds is around 2 percent, and they charge anywhere from 14 to 22 percent on revolving balances, with a 4 percent credit loss. Total credit card debt now is around $779 billion. The issuing banks collecting interest on this debt control over 80 percent of all checking accounts in the country, so they have the ability and wherewithal to promote any new product that makes sense to their customer base. This makes it daunting for a new entrant to provide significant incremental value to a financial institution, except in a marginal way.

To me, the real opportunity is to offer a lower cost alternative for the merchants who pay the freight for this whole system. It's useful to remember that merchants always pay the bill for payment processing, not consumers (except indirectly). The opportunity for innovators in the acquiring business is to lower the merchants' cost of processing from 2 or 3 percent of sales to perhaps 50 basis points.

The innovators who figure out how to do this will give the tollbooth operators a run for their money, and while it won't happen overnight, it will happen eventually.

Then you will see some real innovation in the payment system. end of article

Brandes Elitch, Director of Partner Acquisition for CrossCheck Inc., has been a cash management practitioner for several Fortune 500 companies, sold cash management services for major banks and served as a consultant to bankcard acquirers. A Certified Cash Manager and Accredited ACH Professional, Brandes has a Master's in Business Administration from New York University and a Juris Doctor from Santa Clara University. He can be reached at brandese@cross-check.com.

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