At Mercator, our analysts have a lot of very interesting and energetic discussions regarding the payments research that we publish across all of our advisory services. The following is an edited transcript of an email exchange that I recently had with Tim Sloane, Mercator Advisory Group’s Vice President of Payments Innovation, regarding his recent report From Card-on-File to On-Demand Payments: New Payment Model and Strategies for Payment Providers.
Alex: Here’s the thing that struck me when reading your report on the emergence of on-demand payments; apps like Uber are creating new payment volume! This isn’t a case of one payments mechanism stealing volume from a different mechanism (a zero sum proposition).These services are actually expanding the pie. My wife and I recently had a trip to San Francisco that is a perfect illustration. We mapped out a whole walking tour for our four days in the city only to realize when we got there that those hills are a lot steeper than we had thought. In the old days (defined, in this case, as before 2009), we would have gotten to the top of Telegraph Hill and given up. This time? We just summoned an Uber and rode to the next stop on our list (a restaurant solely focused on grilled cheese sandwiches). This obviously generated revenue for Uber, but it also enabled the grilled cheese sandwich restaurant to capture revenue that would have otherwise been lost.
Until I read your report, it hadn’t occurred to me just how significant the evolution from card-on-file to on-demand payments really is.
Tim: As ease of use and ubiquity (both spatial and temporal) increase, the opportunity to derive new transactions also increases. When e-commerce came on the scene, consumers discovered the joy of 24-hour shopping convenience. As the Web moved to mobile, so did e-commerce, and shopping became possible anytime and anyplace. But the Web doesn’t provide much context or engagement. Mobile apps, however, deliver all the benefits associated with the Web but with better context, which enables improved engagement. These benefits provide new opportunities to sell and drive new transactions.
Alex: So the question, for issuers, is how to capture this new volume on their cards. We are obviously still in the early days of contextual mobile commerce, but it seems like most issuers’ strategies are based on becoming the default card in these applications through short-term rewards. For example, Capital One has been offering a 20% discount on Uber rides when consumers use their Quicksilver cards, presumably on the assumption that even when the promotion ends, many consumers will keep their Quicksilver cards as the default payment method in their Uber apps.
It appears we are at the beginning of a “rewards arms race” in the credit card industry as issuers try to establish a dominant position in these new mobile commerce categories. That’s a somewhat depressing analogy. Do you see any other, more sustainable strategies for issuers to pursue in this space?
Tim: OK, the analogy is getting ugly! If in the race I develop a weapon that is far superior to yours, I might blow you out of the water!
I’ve been contemplating Chase’s efforts to win the arms race by redirecting network revenue to benefit the merchants (announced and implemented) and drive new value to consumers and merchants through integrated (bank/merchant) rewards programs (announced but not yet implemented to my knowledge). This strategy doesn’t obviate the need for incentives by Chase directly back to the consumer in all cases, but where Chase can get a merchant, such as Starbucks, to increase consumer convenience (one-tap pay and incentives/loyalty) and increase consumer value (Chase Points and Starbucks points together if consumer wants to), then perhaps Chase has found a new more powerful weapon that uses an alternate form of energy (less interchange, more rewards).
I don’t want to get too far ahead of reality here, but if we expect Apple and Google to also enter into the merchant rewards arms race in some fashion, the value of rewards (offered by issuers and merchants) may be the old gun used with new and improved tactics.
Starbucks has also reduced payments cost and increased rewards, as have PayPal and Cumberland Farms, by encouraging users to move to ACH payments. Savings on payments enables a more compelling rewards program. This will likely play into the hands of market participants with large portfolios of cards on file (Braintree, Amazon, Apple, et al.), in that they can leverage any savings they enable into incentives.
A major challenge in using rewards or incentive as a monetary asset is the challenge of keeping the books balanced and value settled across participating parties, which is one interesting area of fintech today.
Another potential play might be around a more dynamic credit transaction. If banks deployed their own payment apps, those apps could be tied to a number of credit alternatives—for example, no payment for 30 days for X% of the transaction value, or Y number of payments for X%, etc. Banks know the customers better than anyone and have direct access to their funds. If banks can get customers to use their payment app, with their cards, and their credit line, maybe they can establish a larger revenue stream on credit?
Alex: I’m intrigued by the idea of adding in more dynamic credit options. One of my favorite frameworks for understanding digital disruption is to think about the digitization of both the store and the end product. Take the music industry as an example. First, consumers transition from buying CDs in a store to buying CDs online. Then they stopped buying physical CDs and bought digital music through a digital store. The interesting part is when merchants transition to a digital product, they have the opportunity to redefine the value proposition of that product. Being able to buy a single song rather than a whole album in iTunes was a game changer.
Thinking of credit in a digital environment like a mobile wallet, I’m fascinated by the possibility of “unbundling” the traditional value propositions of a credit card into new, more dynamic offerings as you suggest.
In fact, in a recent TechCrunch article, Alex Rampell (a partner at Andreessen Horowitz) proposed the exact same idea:
“Right now, Lending Club will take your 18% APR Chase/Citi/et al interest rate and refinance it down to 10%. But in a world where Apple Pay controls the front and existing banks like Wells Fargo provide the source of funds at the end, there’s no reason not to “automate away” the credit selection process. Why wouldn’t they just skip right to the rate Lending Club would have given you, or even skip to the best “marketplace lending” rate?
The biggest dislocation once that happens will be that your “credit card” will no longer be the default source of medium/long duration credit. This has major implications for all of consumer finance.”
Fascinating (and terrifying) stuff.