By Patti Murphy
Jack Dorsey, founder and Chief Executive Officer of Square Inc., has a message for banks and their acquiring partners: we're not out to eat your lunch; we'll settle for table scraps. "For the last eight years, we've taken on a partnership mindset," Dorsey stated in an interview posted by Bloomberg on Aug. 3, 2017. "We're not out to compete with banks. What we're really good at is taking what they offer and making it more accessible to people."
That's what the company has done regarding the POS – making card-acceptance viable for millions of micro-merchants, Dorsey said. And it's a course being charted with Square Capital, which facilitates what effectively are merchant cash advances. In the second quarter of 2017 the division made more than 49,000 loans totaling $318 million, Square reported. "We're not really competing with financial institutions and banks and traditional lenders," Dorsey said. "Our average loan size is $6,000, so we're competing with people going to their friends and family and asking for a loan."
Thad Peterson, Senior Analyst at Aite Group LLC, agreed most banks, hamstrung by regulations and traditional customer acquisition models, aren't interested in pursuing small-dollar loans. But that isn't to suggest Square isn't vying with financial institutions (FIs). A merchant bundling Square's various offerings – POS and online payments, and cash advances – has little need for FIs. "If I were a merchant [getting all these services from Square] all I'd need from a bank is a DDA," Peterson said. "Also, the banks are not getting data" about customers and their transactions, he added. "Square is getting all the data."
Ben Brown agrees. Brown, a Senior Consultant at First Annapolis Consulting who specializes in financial technology (fintech) partnerships and payment strategy, related how successful small merchants grow and move up-market over time and come to resemble the merchants that acquirers and ISOs seek out. "Companies like Square and Stripe [an online and mobile payments firm] compete with acquirers," Brown said. "For a substantial minority of mainstream acquirers, attrition in the small merchant segment is being driven by these new technology players."
Some banking industry stalwarts are betting on Square and other fintechs. Visa was an early backer of Square, and according to public filings in 2016, it holds just under 10 percent of the company's Class A common stock. (Visa has made several investments in other high-profile payments startups, including Stripe.)
The mobile restaurant ordering network LevelUp revealed in June it had secured $50 million in new funding from an investor pool that included "long-time partner and investor JPMorgan Chase," according to a press release. Chase first invested in LevelUp in 2015, and in 2016, the bank said it had tapped LevelUp to enhance its Chase Pay mobile app with functionality like ordering ahead.
Chase is one in a growing army of banking behemoths investing in fintech firms. Since 2012, the top 10 U.S. banks (ranked by assets under management) have been involved in 72 rounds of financing totaling $3.6 billion for 56 fintech firms, according to analytics company CB Insights, which maintains a venture capital database. Wells Fargo & Co., Capital One Financial Corp. and PNC Financial Services Group Inc. each have investments in the electronic billing and payment upstart Transactis. Goldman Sachs Group Inc. has investments in six payments companies, including Square and MoMo, a mobile wallet and banking platform based in Vietnam.
While the totals seem large, Brandes Elitch, Director of Partner Acquisition at CrossCheck Inc., noted the money raised by fintechs pales in comparison to the capitalization of U.S. banks. "The large banks have about $15 trillion in assets, while last year the total financial technology venture capital investment was $12.4 billion, a mere rounding error in the scope of things," he said.
The potential for growing electronic payment volumes in emerging markets – where large swaths of populations are unbanked but have access to mobile devices – is huge. Ditto for cross-border payments, particularly in support of ecommerce.
Stripe, for example, operates in 25 countries. In July, Stripe heralded a deal with leading mobile payment providers in China that allows consumers there to use local mobile apps Alipay and WeChat Pay with ecommerce vendors accepting Stripe. Projections by the market intelligence agency Mintel Group Ltd. suggest cross-border ecommerce sales in China will exceed $190 billion by 2021. "Cross-border ecommerce growth is huge," Peterson noted. "Where are the banks?"
Ed Starrs, founder, Chairman and CEO of My ECheck Inc., pointed to banks' aversion to risk, as well as their investments in entrenched legacy systems. My ECheck developed a quick response code-based mobile payment application that clears transactions in real time with guaranteed good funds, but failed to interest U.S. banks in its offering.
Starrs turned to Africa next. The company now works with United Bank of Africa, in Nigeria, to support electronic payments via email, short message service and social media platforms. "We essentially put the U.S. system on ice," Starrs said. However, he noted that My ECheck could be used by U.S. entities sending money to individuals or businesses in Africa. "So if you're in Africa you can engage in commerce in the United States," he added.
While developing markets hold much promise for fintechs, particularly fintechs facilitating payments, a majority of Americans have long-standing relationships with FIs. (Just 7 percent of U.S. households are unbanked, according to the Federal Deposit Insurance Corp.)
And although fintech alternatives, like mobile payments, have been hyped for years, they aren't displacing credit or debit card transactions, noted Morgan Stanley & Co. LLC Executive Director James Faucette. "Consumer payment behavior is slow to change, as evidenced by the continued use of cash and checks," Faucette said. "It has taken several decades for the incumbents to establish the widespread presence they have in most developed markets today. This creates high barriers to entry."
It also provides banks and other payment titans with time to ramp up responses, either through proprietary or joint initiatives, or strategic acquisitions and investments, Faucette said. In the meantime, many fintechs are opting to use existing networks, like Visa and Mastercard, to support their new payment schemes.
Mobile wallets are the most obvious example. The leading wallets (Apple Pay, Android Pay and Samsung Pay) depend on the existing card payment rails. (So does Square.) A recent survey of consumers revealed that more than half of those using the leading wallets have more than one credit or debit card attached to the wallets. The survey, conducted by First Annapolis, also found consumer satisfaction levels with the wallets is high; however, many indicated they'd prefer mobile wallets provided by their FIs rather than device manufacturers. This trust factor can be an important differentiator. "It's not a small group of customers who don't trust anybody but banks," Peterson said.
Size also matters. Fintechs generally lack the financial resources of FIs. Even a midsize bank has more assets than the largest fintech," Brown noted. The consultancy McKinsey & Co. addressed this and other evidence of banks' "resilience" in a 2016 white paper – Cutting Through the Fintech Noise: Markers of Success, Imperatives for Banks.
"In the eight-year period between the Netscape IPO and the acquisition of PayPal [one of the winners of this era] by eBay, more than 450 attackers – new digital currencies, wallets, networks, etc. – attempted to challenge incumbents. Fewer than five of these survive as stand-alone entities today," the consultancy wrote. "[I]t is tough to disrupt banks."
FIs have been leveraging their infrastructure advantages through cooperative industry initiatives like Zelle, a mobile person-to-person (P2P) network developed by Early Warning Services LLC, a bank-owned technology provider. Participating FIs and payment processors, combined, serve more than 86 million U.S. mobile banking customers, according to Early Warning. Brown said many of these will likely continue working with competing mobile wallets, like Apple Pay.
Successful fintechs are those that "embrace 'co-opetition' and find ways to engage with the existing ecosystem of banks," McKinsey stated. PayPal, for example, gets merchant acquiring services from Wells Fargo, the consultancy noted. Hundreds of banks have partnered with Apple Pay, which also uses the card networks.
"There has been a shift toward more cooperative business models," Brown said. Analyses by First Annapolis revealed that about three-quarters of venture capital money invested in fintechs over the past year has involved companies with cooperative business models. "That's a major reversal from the past," Brown added.
In the 2017 Fintech Disruptors Report, produced by ACI Worldwide and MagnaCarta Communications, Paul Thomalla, Senior Vice President, Corporate Relations and Development at ACI, said collaborations will continue. "Banks are much less experienced at building ecosystems than the big tech players," he wrote. "However, there is a mutual advantage of partnering with fintechs that often find it easier to work with a bank that has passed regulatory compliance and can accept insured customer deposits."
Not every fintech is a potential partner. Some are purchase targets for banks and larger technology firms. "Many don't have compelling offerings," Elitch said. "So they're looking for bigger companies [buyers] that can take what they have and integrate" with their own offerings. Success is iffy. "Probably 90 percent of these companies aren't going to be around in a few years," Elitch said, adding that when selecting partners and acquisitions, "you have to be careful."
Fintech is burgeoning. Thousands of technology startups are focused on payments alone. Many are expected to merge, be acquired by bigger players (or banks), or fall by the wayside as the market evolves, experts noted. But a handful have made inroads and seem to have staying power. Here's a list of contenders with U.S. ties.
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