The payment landscape has been altered significantly in the last two decades. In part 1 of the payment industry series we gave an overview. In part 2 we look at one key aspect emerging across countries: “Instant Payments”. What this disrupter is about – and who are the beneficiaries?
Cash has been the dominant payment mechanism for centuries and continues to remain so. Until recently, there was no faster means to provide an instant transfer of value. However, cash has obvious shortcomings with today’s “smart lifestyle”. Moreover, cash transactions are expensive.
PayPal and the advent of “closed wallets”
Over the years, electronic clearing tools such as Real Time Gross Settlement system (RTGS) and ACH (Automated Clearing House) emerged. While the former is suited for large value B2B transactions to be settled same day (but expensive), the latter is suited for smaller value transactions (but takes 1-2 days!). Another challenge in these “batch processing modes” is the requirement to share and store complex account numbers, IBAN etc. between the payer and payee.
The emergence of e-commerce led to PayPal’s evolution – as a first step, it anonymized complex bank details into an easy-to-remember email ID or phone number. At the back end, PayPal created a data directory to initiate an electronic fund transfer. To facilitate instant payment, PayPal created an “e-wallet” – simply put, when I “top-up” my e-wallet, PayPal’s bank gets the money from my bank. In PayPal’s bookkeeping systems, I am the owner of the funds. When I transfer money to my friend’s PayPal account, PayPal changes the ownership of funds in its systems – the money never left PayPal’s bank. This concept of “closed wallets” continued to spread massively with PayPal now touching 300 million users!
Sequel and thereafter: Alipay, WeChat Pay and Starbucks
Other examples of such “wallets” globally are Alipay, WeChat Pay, Gojek , Paytm and Grab – to name a few. These wallets create their own “ecosystems”, including individuals, merchants and all kinds of service providers. Combining with e-commerce and social messaging capabilities, payments became embedded, and wallets evolved from storing & moving money into facilitating spending, lending and investing. Given their journey towards a super-app, these were seemingly good investment targets (but also caught the government & regulator’s attention in some cases!). However, the road to profitability has not been a given. In the Indian context, for example, customer acquisition by such an aspirational super apps such as Paytm, was predicated, amongst other things, on cashback offers which made it challenging to chart a path to sustainable profits. Cashbacks facilitate customer acquisition but not customer engagement, which is critical for profitability.
On the other hand, while the wallet companies were expanding their ecosystem, large merchants started foraying into wallets to foster customer loyalty. A good example is Starbucks, which is similar to PayPal, except that money in the wallet can be used only to pay at Starbucks. The aim of these merchant wallets was to facilitate profitable customer engagement; the “freebies” handed out by the successful ones were smart spends for customer retention, being easily absorbed by gross margin from their main products.
The new frontier: “Instant Payment”
While the private sector was monetizing these solutions, the ubiquitous presence of internet & smart phones prompted regulators to work on faster payment rails. The UK’s and Hong Kong’s “Faster Payment Systems” are examples where money moves across banks quickly (but still takes few minutes in most cases and sometimes upto 2 hours) – much improved, but not yet “instant”.
The idea of “Instant Payment”, however, is exactly what it says: Money can move across banks 24/7/365 within seconds. The EU definition of instant payments is 10 seconds, but in practice, it happens faster!
A very successful example of such an instant payment rail is the Indian Unified Payment Service (UPI). Amongst the many features, UPI replaces account numbers/BIC codes by simple identifiers such as mobile numbers or email address. The “Request to Pay” feature facilitates an e-commerce site to initiate a payment request at the end of my shopping journey, which, triggers a message on my mobile. I tap the mobile message and authorize the payment– in just few seconds the merchant sees money in his bank account and dispatches my purchase immediately!
At physical merchant locations, it eliminates the need for cards and swipe machine. Once the shopper reaches the checkout, he/she has to scan the Merchant’s QR code from their phone app to pay – easy, fast & safe. Being a national payment rail, money can be instantly transferred across participating banks thus achieving Interoperability, something that lacked in Alipay & WeChat pay.
Under the hood, the UPI architecture provides for a standard APIs across payment service providers – The key principle is ownership of bank account and customer experience is decoupled. This has led to the emergence of number of services providers, including Google, Amazon and Walmart (through its subsidiary, PhonePe) to launch their UPI-enabled services with their own business objectives of enhancing cross sell opportunities, data monetization or to unlock value in supply chains. To plug into the banking system, these companies tied up with banks.
The use-cases of for an Instant payment rail spans across other quadrants such as Person to Person, Business to Person and even Business to Business payments.
Exogenous events as turbo accelerators
Exogenous events have also furthered the spread of instant payment rails. In addition to the above features, two “shock” events catalyzed digital adoption in India – in November 2016, the Government announced that certain high value currency notes would be invalid legal tender from the following day (called ‘De-monetization’) and could only be exchanged at banks for new legal tender. Shortage of cash unfolded and digital Wallets such as Paytm (investee company of Alibaba) saw tremendous growth. In 2020, came the second shock- Covid -19 resulting in businesses moving online and contactless payments being preferred. Compulsion proved to be a faster change agent than conviction!
Another important factor that facilitated UPI’s growth was a “Zero MDR regime” pursued by the Government for Person to Person and Person to Merchant payments. This meant that merchants did not have to incur any costs for UPI (unlike cards and cash).
All the above led to UPI transactions seeing a 9x increase in 3 years at about 46 billion transactions in FY 2022 accounting for 60% of all non-cash transactions. QR code payment was accepted by 30 million merchants, growth of over 12.5x in 5 years whereas POS machines stagnated at 6 million during this period. On a relative basis, card (likes of VISA & Mastercard) and wallets lagged significantly. The purpose of a plain wallet is challenged with emergence of this robust instant payment rail.
While PayPal exited Indian domestic business, other wallets integrated with UPI to create new business models. The three biggest UPI apps in India today are PhonePe (owned by Walmart Inc), Google Pay (owned by Google Inc) and Paytm. Due to the “zero MDR regime”, revenue comes from charges on other payment modes, commission on bill payments and mobile recharges, monetizing data for transaction-based merchant lending/BNPL, distributing products and providing in -app ads.
Beyond UPI: Europe and Brazil
Instant payment is on the rise globally. In 2020, Brazil launched an instant payment system similar to UPI called PIX. While it has most of the UPI like features, there is one striking differences – while end customer is not charged in both systems, Brazil has not set any caps for acquiring banks to charge the merchants and no interchange fees are prescribed. Thereby, there is a direct revenue source for the participants.
In Europe, the SEPA instant credit scheme was launched in 2017 with the aim to create an EU-wide instant payment rail. This has had mixed results and there is still some way to go in terms of feature build out and adoption. The US is expected to launch its instant payment rail in 2023 and Google Inc is lobbying the Fed to promote UPI-like features in the proposed US system.
Building an instant payment rail is positive for the entire system. These platforms build innovative, over-the-top solutions, speed up commerce, add customer convenience and eliminate expensive low-value cash transactions. However, building a technology and getting people to use it are two different things – The timing of the build-out and incentives for scaling up adoption is matter of national choice.
Calling out the winners and losers
From the Indian experience of UPI in the last few years, we can hazard a crystal ball gazing exercise into likely winners and losers by the advent of such payment infrastructure: In my view, there are likely three categories of winners which can harness such rails for a profitable business model, though with riders:
- large deep pocketed giants such as Google, Amazon, Reliance Jio, Walmart (through its subsidiaries, Flipkart and PhonePe) which can harness data to facilitate customer engagement and/or transition from embedded payments to embedded finance for the merchant ecosystem where value can be unlocked from merchant lending opportunities.
- large merchants (such as Starbucks) who can create their own wallets to drive customer engagement.
- last but not the least, neo banks/digitally agile banks can create robust customer engagement and transaction-based lending models.
In all these three categories, the payment ecosystem is created to unlock value for the core business of these players. Needless to say, execution risk needs to be managed well.
Stand-alone payment apps which depend on payment revenues or distribution of third-party products may find a challenging path to profitability, if at all. The incumbent networks (such as VISA/ Mastercard) and less agile banks may go through the phase of slow growth, stagnation and then gradual dip in market share. In some sense, the disrupters of the last decades are also likely get disrupted if they don’t adapt with the Instant payment rails!