The Green Sheet Online Edition
January 10, 2011 • Issue 11:01:01
The convergence of traditional and alternative payments
While most payment professionals agree that credit and debit cards, both plastic and virtual, will remain the country's predominant payment forms into the foreseeable future, the growing importance of new payment methods is undeniable.
Even the card brands have begun to recognize alternative payments as legitimate competition, which is reflected in their new-found willingness to explore emerging channels through partnerships with alternative providers. This may indicate that, as alternative payments become more mainstream, conventional and unconventional payments will move toward co-existing within the same channels, rather than continuing to inhabit primarily distinct worlds.
A number of trends are driving the use of alternative payment methods and the proliferation of companies that offer them. These include the ascendancy of debit over credit payments and new legislation designed to regulate electronic commerce. The most significant enabler, however, is the growth of the Internet and mobile commerce sectors; observers say the latter, in particular, may be fostering an alternative payments explosion that is already bubbling to the surface.
"We view mobile as this disruptive event that has upset the plastic-centric world, as we now have a new device and no one leaves home without it, which is like the American Express tagline," said Conrad Sheehan, Chief Executive Officer of mobile and Internet commerce solutions provider mPayy Inc. "People are thinking, 'What can I do with it?' And payments are one of the big things."
Alternative payments can be defined as those that do not run on the conventional credit or debit rails. They include automated clearinghouse (ACH) payments that use bank account numbers for routing; gift and closed-loop prepaid cards that use intra-company networks; payments made through third-party providers like PayPal Inc.; and mobile payments that draw from prepaid accounts or charge consumers with an add-on to their phone bills.
Though most modern alternative payment forms have sprung from the use of new technology around mobile and e-commerce, conventional and alternative payments are not distinguished by the level of technology involved. For example, under the definition used in this article, cash and checks are alternative payment forms, but mobile transactions that use a virtual credit or debit card are not, because the transaction is still processed through Visa Inc. and MasterCard Worldwide networks.
Sources say it is critical that card-based ISOs and other conventional payment entities not view new technology as the exclusive province of alternative payment providers, but rather as an important sales tool that can benefit any type of payment provider if properly utilized.
"Mobile is just one more case in which we're promoting electronic commerce, and one more way we'll use a credit card instead of cash," said Scott Zdanis, co-founder and co-CEO of Merchant Warehouse. "Cash, I think, is maybe our toughest competitor in alternative payments, as much as it is not typically acknowledged as one."
Yet while an increasing number of ISOs and merchant level salespeople (MLSs) are testing the mobile market - primarily by incorporating mobile payment acceptance into their offerings - mobile commerce has been rocket fuel for alternative payments. PayPal may have led the charge toward alternative payments with its third-party payment e-commerce product, but the alternative providers popping up today are almost entirely centered on mobile - firms like Zong Inc., Boku Inc., Obopay Inc., Bling Nation Inc. and Moneta Inc.
All of these companies are leveraging the mobile phone to bypass traditional card payments and replace them with a different mechanism, be it a short message service message or a user's mobile phone number, in conjunction with billing methods that draw from prepaid accounts or consumer bank accounts or charge cell phone accounts.
"Alternative payments have always struggled with that chicken and egg scenario of which comes first [consumer or merchant adoption]," Zdanis said. "With mobile payments, they have the device in the hands of the customer already. Therefore, there could be a good base when that merchant says, for example, 'I'll accept a near field communication device now because I know there are already a number of people ready to do that type of transaction."
Alternative providers tout a range of advantages. For merchants, the cost of transacting tends to be lower because payment providers don't levy interchange and, in many cases, bypass the services of third-party acquiring channels and the fees they impose.
Certain alternative payments may be more convenient for consumers because the information entered for payment is less voluminous than what's required of typical card payments; in addition, some alternative platforms can perform person-to-person (P2P) payments with mobile phones and may also be deemed safer than payment cards because they commonly use less sensitive information for transacting.
For the unbanked and underbanked consumers - 30 million in the United States, according to the Federal Deposit Insurance Corp. - alternative payments are often the only available method for making Internet purchases.
Skeptics point to the potential dangers of using a brand new system, compared with the proven risk management protocols of the card networks.
The card world has multiple parties (acquirers, processors and issuers) that play important roles in risk management, the Payment Card Industry Data Security Standard for protecting card data, and policies that indemnify consumers victimized by card theft.
Critics contend that alternative channels lacking anything close to this level of oversight are missing a critical piece for enforcing digital security, adjudicating chargeback disputes and assessing liability.
Perfecting new systems is time-consuming, and it may be especially difficult to establish one governing body to oversee the wide and varied disbursement of emerging alternative providers, in contrast to the relatively monolithic credit and debit card world. Also, setting up such a system would inevitably force providers to raise their merchant fees to pay for it, possibly eliminating the crucial selling point of being a lower cost option to card acceptance.
"There's nothing in place, no set dispute resolution mechanism in place where you know you're not going to have to pay if you're the victim of fraud or if you don't get your product," said California-based payment attorney Paul Rianda. "If a third party is just initiating an ACH transaction without these controls, there's nothing really in place to contest it."
Micro payment niche
For the time being, most alternative payment providers have confined their services to smaller payments - especially "micro payments" (which PayPal defines as transactions of less than $12), which have proven to be a perfect fit for alternative channels. For one, smaller dollar amounts have minimized repercussions involving liability.
Second, many low-dollar payment platforms require alternative channels because such platforms aren't geared to the interchange system, under which fees can be too high to make the transactions worthwhile.
Some of today's dominant micro-payment providers are in the burgeoning virtual game space where players can make in-game purchases, many of them exceedingly low-priced, using real-world money.
"There is an opportunity to deliver a service completely outside of traditional Visa/MasterCard," Sheehan said.
"Within a business context, the type of payment that is traditionally challenged by credit cards is the micropayment and bill payment. Take those two sectors and weave in a mobile device, and it's a confluence of those things that creates an economically viable electronic [alternative payment platform]," Sheehan added.
While micropayments have proven a comfortable niche for many alternative payment companies, debit and credit cards still have the lion's share of the overall market - although that territory is shrinking, and most of the ground being ceded is online.
Online payment provider Moneta's 2010 report, Alternative Payments Come of Age: Threat or Opportunity?, citing a report from Javelin Strategy & Research, states that alternative payments made up 15 percent of U.S. online transactions in 2007, 18 percent in 2008 and 20 percent in 2009, and are projected to grow to 31 percent by 2013. Meanwhile, the online market share held by credit cards dropped from 60 percent in 2007 to 52 percent in 2009. The report forecasts it will drop to 40 percent by 2013.
What should traditional payment providers do to stem the defection of consumers and merchants to alternative payments? Is the best course to seize a share of the growing alternative payments market or to hunker down and adopt methods for combating this challenger?
If decisions by the card brands are harbingers of the industry's future, they point to the increasing involvement of traditional players in the alternative space.
It appears that the card brands, which have kept themselves in a cone of isolation for decades, are beginning to yield to outside influence.
"Let's face it: our whole lives we've heard Visa, Master-Card, American Express and Discover, and then maybe one or two others that have popped in and out of the world," Zdanis said. "But new players are entering this market more than we've seen in the past, and in the future it will be even easier for new players to enter, and that will keep the Visas and the MasterCards on their toes."
In October 2009, First Data Corp. partnered with PayPal to promote enrollment in the alternative service among cardholders using First Data's STAR debit network; in November 2009, American Express Co. bought Revolution Money, which enables online P2P money transfers; and in August 2010, MasterCard acquired online processor and alternative payment provider DataCash Ltd.
In addition, two new mobile consortiums suggest a buildup of interest in near field communication (NFC) payments, which allow POS purchasing with a chip-embedded mobile phone.
One involves a pilot program for NFC delivered by a partnership of Visa Inc., U.S. Bank, DeviceFidelity, Monitise PLC and Fidelity National Information Services Inc.; the other will be delivered by a new venture called ISIS, made up of AT&T, T-Mobile USA, Verizon Wireless, Discover Financial Services and Barclays Bank.
Visa and Discover's involvement in NFC projects may indicate the brands intend to share, but not cede, control of their stronghold: the POS market. Some observers foresee NFC as the first true enabler of the convergence between alternative and card-based payments, with consumers enjoying a host of options within their state-of-the-art mobile wallets.
"I see them converging," Sheehan said. "We've got 300 million people in the U.S. and for all intents and purposes one debit card - Visa has something like 70 percent of that market, which is remarkable. We're not a one-size-fits-all society, and I do see Visa, now that they're being publically traded, having to develop new products and services."
A major driver of the card brands' expansions may prove to be the implementation of federal regulations governing payment cards, and particularly the Durbin Amendment to the Dodd-Frank Wall Street Reform and Protection Act of 2010, which will allow the Fed to set caps on debit interchange.
The anticipated lowering of debit rates may prompt issuing banks, whose healthy profits from interchange rates seem imperiled, to look elsewhere for revenue.
Likewise, to the extent that the card brands remain complacent about the status quo, regulations like the Durbin Amendment may help push them toward new frontiers.
The involvement of the brands and issuers in alternative payments would naturally seem to pave the way for acquiring players.
Many ISOs have been driving expansions at the POS with the proliferation of sophisticated gift and loyalty programs that, among other features, use customer data to shape merchant marketing campaigns.
However, ISOs and MLSs must also balance their merchants' interests with other factors when considering new payment options, including the risks of partnering with less established players and the possibility that new channels will be underutilized.
"If they get anxious and get involved with an alternative payment provider, and the player is not successful in the long term, they would have placed a bet and wasted resources they can't afford to lose," said Ashish Bahl, CEO of Acculynk, an e-commerce company whose core offering is an online PIN debit service.
"I think [alternative payments] are going to be a high-growth area, but be sure the company you select to do business with has a critical mass right now. ... The last thing acquirers want to do is to spend energy boarding merchants and not have any volume," said Bahl.
Strong ISO partners
Opportunities for alternative growth may be particularly good for ISOs serving mobile and e-commerce merchants. While a large portion of alternative payment companies do not market through third parties, that may change. As alternative payments mature, reach more customers and raise the caps on amounts they're willing to transact, the need will increase for third parties that expand a company's sales reach and help manage the myriad problems common to all commercial enterprises.
"I think acquirers will become more valuable because you, as a merchant, need someone who can understand the different options out there. I think the advent of alternative payments, whether online or in a brick-and-mortar store, inherently creates more value for merchant level sales reps because they can help the merchant understand different issues around security, the settlement process and chargebacks - and those processes will differ across the different payments. And while business margins are compressed right now, this offers some opportunity to open up new revenues," Sheehan said.
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