PAYMENTS: THE NEXT STRATEGY

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PAYMENTS: THE

NEXT STRATEGY

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ABOUT CVA

For more than two decades, CVA has been providing strategy advice to boards and client teams to help resolve some of the most critical and complex issues facing business today.

Founded in London and Paris and now with 17 offices around the globe, our unique approach to strategy consulting is summed up by our name:

Corporate: providing strategic design and implementation support to help major organisations achieve their goals;

Value: helping clients deliver sustainable value for their customers, owners and other stakeholders, remembering that value starts with the customer;

Associates: working collaboratively with clients and our network of 300 high-calibre consultants worldwide.

These clients tell us that we provide a very different consulting experience to our competitors. We enjoy working closely with a select number of clients, for whom we consistently deliver, using a fact-based approach with strong emphasis on quantitative analysis to support decision-making.

CVA has an ethos of strong senior involvement in delivery, with teams that are flexible in their ways of working and able to adapt to client requirements.

A focus on knowledge transfer means we are transparent and open in our working, which builds client confidence and capabilities for the future.

FIND OUT HOW WE COULD WORK WITH YOU To find out more please feel free to contact us by email or call us on +44 (0) 20 7559 5000.

OPTIMISING VALUE –

STRATEGIES FOR

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The evolving issuer landscape

With penetration fairly static and many consumers owning more than one card, the main opportunities for issuers to achieve bottom-line growth come from existing customers. A profitable business today means: keeping costs low, optimising pricing, growing volume through further cannibalisation of cash, and building a position as the preferred card provider to maximise share of spend. While issuers have tools at their disposal to address each of these areas individually, the near future is going to see three major new evolutionary challenges occurring more-or-less at the same time which collectively will mean higher costs, reduced revenue per transaction, and the risk of a permanent reduction in share of spend. Will issuers adapt and embrace the changes that will occur and turn them to their advantage, or try to defend their existing positions and revenue streams for as long as possible? In either case, issuers need to be clear on their strategic response. The three new challenges we see are:

1. Squeeze on issuing margins through

interchange caps and cost increases

Revenue per transaction will be cut substantially once European regulation caps interchange and the impact of SEPA is fully realised. There are also scenarios in which some external costs – for example card scheme fees – rise in the near future.

This superficially seems like a pure pricing problem, at least on credit cards. For example, banks in Australia successfully recovered much of the margin lost to a credit interchange cap, via a combination of increases to interest rates, card fees and late payment charges. However, this may not be as straightforward in the UK: the concept of free banking is ingrained into the British psyche; penalty charges have already been under scrutiny, with a principle established that such charges should reflect legitimate costs; and crude price rises from big business – most notably the energy companies – are being seen as profiteering, generating a substantial public backlash and resulting in severe damage to consumer trust that may prove impossible to repair.

01 PAYMENTS: THE

NEXT STRATEGY

By

Simon Vessey

, Partner

Issuers face a squeeze on margins, possible consolidation of

consumer spending, and the threat of disintermediation. If that

were not enough, acquiring may be about to get a whole lot more

interesting. In a sector undergoing long-term evolutionary change,

banks must answer four sets of key questions if they are to respond

effectively to the challenges they face, and capture future value.

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It also leaves open the question of what to do on debit, given that debit cards are so closely linked with current accounts and interchange is the only revenue stream. Here, technology may provide the answer with new debit services such as Pingit and Zapp allowing banks to completely bypass card scheme rails for domestic payments. However, the long-term consumer take-up of such services remains uncertain. It will depend almost entirely on the specifics of the user experience, rather than any inherent conceptual attractiveness. At this stage, we regard investment in these areas as a sensible hedge, rather than a certain game-changer.

2. Consolidation of spending into fewer cards

Multiple card ownership is common in the UK, with roughly twice as many issued cards as cardholders for both debit and credit. Furthermore, with 62% of credit card customers paying their bill in full every month, there is a substantial sub-set of customers with three or more cards each, that are effectively used as debit cards. A situation in which average customers are spreading average spending levels across three separate cards and paying no interest will no longer be sustainable once interchange is capped. The most likely outcome is that issuers will make it uneconomic for consumers to behave like this, and drive consolidation of spending into a fewer number of cards – perhaps even just one. The strategic questions raised here are twofold: 1) which customers does the issuer want to keep; and 2) for those customers, how can it make sure its card is the one retained, rather than cut up?

3. Disintermediation threat from m-commerce

The feared threat to incumbents from ‘new payments’ has, so far, largely proved to be a false alarm. While PayPal has developed its own infrastructure, other businesses such as Apple have not expanded their

is because existing payments players are by far the best-placed entities to manage trust, security and fraud issues, and the existing payment infrastructure, developed over many decades, works extremely well. There are thus two competing bases for m-commerce offers. One makes use of the interbank payments system to create transfers directly between bank accounts. The card payments network of the international card schemes underpins the other, at the heart of which lies the 16 digit card number the customer already possesses. While only banks can easily develop the first kind of offer, the latter is trivially deliverable by any app developer so long as the end user has the relevant payment card. Since there are many more app developers than there are banks, the vast majority of m-commerce innovation is focusing on offers leveraging the card scheme rails. Plastic cards became ubiquitous because they offered a substantial convenience and security advantage over cash, removing the need to carry round large quantities of it. When consumers have a solution that already works perfectly well, they are notoriously inert and m-payments needs to create substantial value-add beyond that of plastic in order to make major inroads into the consumer’s arsenal of payment solutions. This dynamic strongly favours the 3rd party app developer / entrepreneur (of whom there are many) over banks (of which there are few) in the battle to succeed in m-commerce – especially when we remember that it is the ability to design a value-adding offer around payments, not expertise in banking, that will be key. Hence, there is a strong risk of disintermediation and further commoditisation of the card offer, so that the payment card becomes no more than a 16-digit enabler of a smartphone payments app, with almost all the perceived value-add being provided by the wider functionality of the app, not the underlying payments system. The obvious first question is: does this really matter to banks? Are issuers happy to sit upstream on an extended payments value chain, so as long as they continue to

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happen to this revenue stream in the long term? Generally, where customer value migrates elsewhere, revenue does as well. Put another way, if merchants can provide tailored and targeted financial incentives and rewards to drive card spend, directly to the consumer via an m-commerce app (of which numerous examples already exist), there is no longer any point in continuing to fund rewards offered by the card itself, leading to even further downward pressure on interchange. Putting things into perspective, m-commerce remains small and the offer is both driven and constrained by what is technologically possible and the existence (or not) of a business case for merchant acceptance. However, we believe there are fundamental strategic questions to think through regarding future ownership of the payments interface, the role banks want to play themselves, and what bets it makes sense to place, within a cone of certainty that encapsulates different ways the market might evolve. If banks do not provide the answers themselves, others will eventually do so.

A changing competitive

dynamic for acquirers

For banks that also have substantial acquiring businesses, there are additional challenges. Today, large European acquirers doubly benefit from their scale – first in terms of operational cost efficiencies, and second because the international card schemes have tiered or stepped pricing structures that offer lower per transaction prices to acquirers with higher volumes. This latter may be at risk.

Card scheme pricing has little bearing on whether an acquirer offers the scheme to its customers or not – to all intents and purposes acquirers must offer all major international card schemes, otherwise they provide an easy opening to competitors. Thus there is no fundamental economic reason why card schemes should offer acquirers volume discounts – they simply do, largely for historic reasons.

We believe there is a non-negligible risk that the major card schemes will move to flat-rate acquirer pricing in the future.

Published tariffs indicate that such a pricing structure is already present in the US market. Any such move in Europe would substantially level the playing field between large and smaller issuers, and as such would almost certainly be looked on favourably by the European Commission, strongly supported by the numerous small and medium-sized acquirers who currently struggle to compete on price with the largest, and welcomed by merchants who could see their choice of acquirer open up dramatically. Clearly the very large acquirers would retain their other scale advantages, but almost overnight the non-price elements of the acquirer offer would become much more important for both acquisition and retention of merchants. The acquirers that prosper in such a scenario will be those that understand what propositions (other than low price) different kinds of customers are looking for, and are able to create the relevant offer.

In summary: the four sets of key

questions banks must answer

1. What is the bank’s pricing and mix strategy for cards once interchange is capped, and if other costs start to rise?

2. Who are the bank’s priority card customers and how can it become (or remain) their preferred card provider if and when spending consolidates?

3. As m-commerce develops, where does the bank want to be on the value chain? Does disintermediation matter? What will the revenue model be? Where does it make sense to buy options?

4. For acquirers, what propositions (other than low price) are attractive to different kinds of customer? How can such propositions be delivered? Where should the initial focus be? To discuss how CVA could help your business answer these questions, please contact the author or one of the other CVA team members featured on the next page. We would be delighted to talk about our approach with you.

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SIMON VESSEY

Partner

Simon has worked in the consulting industry for 18 years, advising financial services clients in the UK, Germany, Belgium, Japan, South Korea and the USA.

His most recent focus in this sector is in payments, building on very broad experience in the financial services arena, including retail and SME banking, commercial lending, life and pensions, private banking, capital markets and auto finance.

During his career with CVA he has also worked on projects in energy, the automotive sector, and defence.

His areas of particular expertise are strategy, customer insight-led growth and business optimisation.

Simon holds a BA in natural sciences from the University of Cambridge, and a PhD in radio astronomy from the Mullard Radio Astronomy Observatory, University of Cambridge.

JOHN SIMLETT

London Managing Partner

John is a specialist in corporate strategy, organisation strategy, revenue growth and portfolio management. He has provided high-level strategic advice to a range of sectors including financial services, utilities, automotive, higher education, and the public sector.

He has also advised across a broad range of geographies and cultures, including Australia, North America, China, Russia and Europe. He has been an invited advisor to the British Prime Minister’s office. John began his career with Ford Motor Company before leaving to study for his MBA at London Business School. Prior to joining CVA, he held senior roles at Strategic Planning Associates (now Oliver Wyman), Inchcape Plc, Retail Solutions, and Optima Consulting, a division of Maritz Inc.

Dr. MARKUS COLLET

Partner

Markus co-heads CVA’s financial services activities in Europe. He has an engineering degree from the University of Stuttgart and ENST combined with a PhD in Management Science from HEC / Stern-NYU. Markus has worked as a consultant for about 14 years, joining CVA from Roland Berger. He started his career as an academic expert and co-founded a consultancy in strategic management alignment.

Markus develops CVA’s activities in international retail banking and specialised financial services – in particular consumer credit. In this context he has developed extensive experience in payment and loyalty cards, and other payment tokens such as internet and mobile.

Markus has worked on projects including optimisation of card operations, market comparisons, and the merger of payment activities (including IT infrastructure, payment scheme synergies and outsourcing contracts) across European specialised financial services businesses.

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