Retail Card Payments: Friction then Explosion

I recently had a conversation with William Fisher, otherwise known as Fish. Fish is just about the wickedly smartest man I know in payments and core banking products. The fact that he has a wonderful sense of humor helps his cause tremendously. I met Fish as I closed an investment in D3 Banking with the R66 team and subsequently served on the board of D3 with him. By the way, check out D3 and its CEO Mark Vipond as this fintech company is executing quite nicely. But I digress.

Anyways, my conversation with Fish led my to think about card payments and the cycles of friction and explosive growth the industry has experienced since the late 60s and early 70s and how one could read between the tea leaves going forward.

Credit cards were introduced to the masses in 1970 - at a time when the original incarnations of what we now know as Visa and MasterCard were bank owned. The early goings were slow because there was FRICTION. I remember my parents using their cards at that time. I remember the slow, cumbersome and painful process for paying with a card at a restaurant or a clothes store. Paying was not instantaneous. You had to wait for the merchant to get confirmation from whoever they were calling that your credit was in good standing and your card valid - and your card was manually imprinted on a paper receipt which the sales attendent half of the time botched. Not a process that led to mass adoption and explosive growth.

The industry then embarked on a journey to tackle this friction and new hardware, software and transaction/data procession platforms were born which led to completely different card presentation, data verification and transaction processing work flows. In other words, the card terminal industry, Hypercom anyone?, allowed for a transition of card/data capture and processing from a manual and physical world to an automated and electronic world. It took time and effort and pain but this transition happened. FRICTION was taken out of the equation which led to EXPLOSION and massive growth in card transactions from the 80s to today.

There were other friction/explosion cycles during this period, one of which was the growth of debit card products. The US card industry resisted debit cards while the rest of the world eagerly rode that growth which led to FRICTION. Ultimately the eco-system sorted itself, the industry changed its ways and debit card payments went through their own EXPLOSION in the US.

We are now at the cusp of of another FRICTION/EXPLOSION cycle. This one is focused on mobile digital payments. I see three types of FRICTiON: a) friction due to the the ever increasing fraud, data breaches and identity thefts the card industry is experiencing, b) friction in the US due to the move from swipe to dip with the introduction of EMV and c) friction due to the introduction of mobile digital payments in app or web app.

The first type of friction, contrary to what some believe, will not go away with the introduction of EMV in the US. The only way for this friction to be dealt with in a material way is for consumer card data not to be exposed during processing or to be kept by merchants.

The second type of friction is US centric and has to do with consumer expectations and behaviors. Will a solution that does away with swiping and introduces dipping and signing, and ultimately dipping and keying in a pin code be well accepted by consumers? Swiping is so easy and engrained by now.

The third type of friction has to do with how payments will be handled via a smart phone. Consumer expectations and behaviors are, as with the second type, central to adoption. How technology solutions are and will be architected will play a crucial role.

What with ApplePay, Android Pay, Samsung Pay each having come out or coming out with their current solution; What with new card terminals that are both EMV and contactless compliant; What with tokenization solutions being marketed; What with MasterCard and Visa hard at work with their own responses around digital payments and tokenization; What with banks not particularly thrilled with the current solutions; What with merchants working on their own solutions; it is clear the industry is in a messy middle of FRICTION.

What is clear beyond a doubt, at least for me, is that a body of solutions will emerge to materially mitigate this FRICTION - optimal tokenization, solving for data presentation and storage, solving for a payment process that meets consumer wants within the framework of a smart phone, solving for IoT, solving for biometrics... - and will lead to EXPLOSION of mobile digital payments. 5 years out we will wake up to a world where mobile digital payments will make the majority of "card" payments in the US and Europe.

Current solutions such as ApplePay and Android Pay have an adoption issue on their hands. ApplePay is a focal point that needs to attract adoption from consumers, merchants and banks. We all know these network propositions are difficult to pull off at scale. This does not mean that ApplePay will fail by the way. I actually think ApplePay will be very successful and profitable for Apple. It might not be the solution that lords over all others though.

Fish pointed out to me that American Express or Discover may be a good analogy to ApplePay or Android Pay in as much as consumers can go directly to either and get a card while all other cards (Visa or MC) need to be issued by the banks a consumer banks with. Further, we know debit cards make up half of all card payments in the US and banks own this market which they will not let go easily. As such, I fully expect bank led mobile digital payments solutions to crop up and compete alongside the ApplePay and Android Pay's of the world.

To me, it is not a question fo who will win as there is ample room for many competitors to carve market share. The question is who will have the lion's share of the market.

Looking at the current card circulation in the US and rest of the world as of beg. 2013 we see the following:

- Amex: 52 million cards in US, 51 million cards in rest of the world

- MasterCard: 178 million cards in US, 544 million cards in rest of world

- Visa: 277 million cards in US, 518 million cards in rest of world

In keeping with the Amex/ApplePay analogy and with the fact that issuing banks will not easily relinquish their card money making operations, especially on the debit card side, I would venture to say that, in a science-fictionish way, we may end up with a similar market share breakdown where ApplePay and Android Pay solutions will be successful but bank solutions (Tier 1 banks may build while Tier 2 and 3 banks will partner and white label) may rule. Interestingly enough I have recently been pitched by many startups that want to offer "ApplePay like" mobile digital payment solutions to banks and by startups that are working on solving for data presentation/data breaches via tokenization. I have also heard that both Visa and MC are working on their own tokenization schemes and that many banks are none too pleased with the current terms they had to agree to with ApplePay. This tells me the eco-system is about to figure out how FRICTION may be removed.

I also fully realize banks are notoriously slow adopting new technology and slow working with service providers, do not have a stellar track record when it comes to convincing customers to adopt new products - credit/debit cards withstanding - and have been suffering a trust deficit of late with the public at large. Should banks stumble on the way to market, this would give the ApplePay's of the world the opportunity to consolidate their lead.

Either way, watch out for a mobile digital payments EXPLOSION.

For full disclosure, the R66 team has invested in Judo Payments, a mobile digital payment processing company based out of London, UK.