Mckinsey on Payments

Volume 8, Number 22 October 2015 McKinsey on Payments

Foreword 1

Payments in Asia: At the vanguard of digital innovation 3 Digitization of business processes and the emergence of new platforms for payments and finance bring both challenges and opportunities to payments businesses operating within Asia or serving clients who trade with Asia.

Supply-chain finance: The emergence of a new competitive landscape 10 Fintechs are changing how buyers and suppliers think about the supply-chain finance market, and starting to command a sizeable proportion of the value pool.

16 in 2016: Trailblazing trends in global payments 17 A look at the topics that are top of mind for global payments executives, from EMV migration to the battle for the “digital customer.”

Digital wallets in the U.S.: Minding the consumer adoption curve 26 Digital wallets seem poised to enter the mainstream. Now is the time for providers to identify which strategic market approaches will lead to success.

The new rules for growth through customer engagement 32 For banks, digital engagement with customers has become an imperative for preserving relationships. Five rules can help them thrive in the digital landscape.

No time for U.S. bank complacency over liquidity compliance 39 Basel III’s liquidity coverage ratio is no cause for panic for U.S. commercial banks. However, banks should not wait to define their strategic approach to the regulation.

The Singapore payments industry at a glance 46 16 in 2016: Trailblazing trends in global payments 17

16 in 2016: Trailblazing trends in global payments

Diverse trends are driving deep structural changes across the global payments industry. On the retail side, consumers’ use of mobile devices to shop both online and in-store is pushing merchants to adopt increasingly complex and powerful technology. On the corporate side, a new generation of solutions raises hopes among corporate treasurers of improved transparency and predictability of payments and the steady reduction of costly obstacles, especially in cross- border payments, where liquidity is trapped in document-heavy processes.

Matt Higginson To put these trends in perspective, this article lives—communications, planning, shopping, presents 16 predictions and observations dis- health, transportation—making “in-app” the Steve Krieger tilled from recent conversations with execu- new battleground for both online and in- Wings Zhang tives in the payments arena around the globe. store shopping. The persistent strengths of Each topic will help shape the payments arena cash—convenience (cash is versatile and and should figure in the strategic thinking of widely accepted), control (cash is final and banks, card companies, processors and tech- spend is limited to cash in wallet) and value nology providers as they determine the best (it’s free, at least in appearance)—vanish in a path and the right partners. Depending on digitizing world: size, client base and market position, their • Convenience: Stored preferences and ac- strategy will aim to defend core business, count information enable both the au- mount a charge of creative destruction, or tomation and personalization of strike a balance between the two. payments, which can be initiated anytime, anywhere, with virtually no geographic 1. As shopping moves in-app, boundaries. digital payments displace cash Multichannel shopping puts the consumer • Control: Smart tools to control expendi- front and center, and creates new sources of tures, increase savings and improve budg- value for merchants. Mobile devices have be- eting afford much broader control and come the “digital container” of our daily stronger financial management than cash. 18 McKinsey on Payments October 2015

• Value: Repetitive interaction enables mer- grams in order to determine the best deal by chants (usually in cooperation with their weighing card offers (e.g., extended war- payments and data analytics partners) to ranties, special financing), store coupons extend offers and services tailored to a and loyalty points, among others. While consumer’s location and needs. users value a unified, ubiquitous experience, data ownership and privacy have become As consumers increasingly use their major strategic considerations for consumers and merchants alike, as illustrated phones, tablets and computers to by Apple Pay’s insistence on not collecting shop anytime, anywhere, merchants payments data (see “Digital wallets: Mind- ing the consumer adoption curve” page 26). need to keep track of individual consumers across channels to ensure 3. Migration to EMV ignites mobile payments a consistent consumer experience. The migration to EMV standards across multiple regions outside Europe requires most 2. Multichannel solutions win as parties to invest in chip technology. While is- channels converge suers and acquirers bear the largest part of As consumers increasingly use their phones, migration costs (converting all cards and ac- tablets and computers to shop anytime, any- ceptance technology from magnetic strip to where, merchants need to keep track of indi- EMV chip), merchants who fail to install chip vidual consumers across channels—online, readers assume huge financial risks in the mobile, proximity—to ensure a consistent form of liability for fraudulent transactions. consumer experience. In order to stay in touch Some merchants are still oblivious to the with the consumer at each step of the search- new standards; however, many others are evaluate-buy-bond cycle, most merchants will using the conversion as an opportunity to forge partnerships and alliances with data an- implement mobile payments solutions, in- alytics specialists and digital innovators. cluding wallets, mobile payments terminals To keep up with merchant requirements, (e.g., Square, iZettle) and QR-payment ap- payments companies must, therefore, be plications (e.g., Zapper, LevelUp). As a re- prepared to deliver integrated, multichannel sult, mobile payments solutions will see exponential growth in specific regions and solutions that combine, for example, pre- verticals, such as gas stations, events and authorization, split payments and customer ticketing, and health and beauty. analytics across channels. This will require expanded capabilities (see #5) and strategic 4. Nonbanks will continue to lead in partnerships (see #15 and #16). peer-to-peer Digital wallets have a key role to play in Peer-to-peer (P2P) payments remain a multichannel convergence, and in order to stronghold for cash in most markets, as stand out from the competition, some wal- many incumbent banks, being risk-adverse lets will incorporate multiple loyalty pro- or unprepared to cannibalize traditional 16 in 2016: Trailblazing trends in global payments 19

sources of income, have yet to make an air- with legacy systems and a chronic deficit of tight business case for P2P solutions. By top digital talent, must adapt to a new era of contrast, digital innovators, including Pay- cloud-based data warehousing, application Pal, Alipay, TransferWise and Venmo, have program interfaces (APIs), faster solutions realized benefits from P2P payments far be- development and launch, and periodic relia- yond authorization, clearing and settlement bility-testing (e.g., hackathons) to reap the and threaten to displace traditional banks potential of big data in three areas: from this important category of payments. • Dynamic business steering, adjusting ag- The main sources of value in P2P include: gressiveness in specific customer seg- • Cross-sell opportunities with related serv- ments at specific moments of time (e.g., ices (e.g., through booking, ordering, risk appetite, pricing, payments condi- shopping, gifting, donating) tions)

• Marketing insights derived from pay- • Insights- and behavior-driven marketing, ments and browser data (e.g., used for including micro-campaigning, cross-sell- event-based offers, promotions and mar- ing, retention keting) • Data-rich consumer and enterprise appli- • High margins among small and medium- cations, simplifying onboarding and serv- sized merchants with consumer-like be- icing, reducing fraud and risk, and haviors enabling spend comparisons • Attractive currency exchange margins on cross-border remittances 6. Loyalty enters a new age Digital loyalty programs have become cru- Knowing how to extract cial for merchants to understand the needs value from data is the and behaviors of their customers and to maintain market share. As a result, mer- core competitive requirement in chants are increasingly turning to payments multichannel commerce. companies to integrate loyalty features with payments services, either as turnkey solutions or by supplementing merchants’ pro- 5. Bigger, smarter data requires prietary solutions. Depending on the bigger, smarter capabilities markets they serve, payments service Knowing how to extract value from data is providers should support one or more of the the core competitive requirement in multi- four main types of loyalty programs: channel commerce. Data-rich solutions use powerful technology to capture and process • Segment-oriented programs, enabling data across channels and along each step of micro-segmentation with tailored offers the value chain in order to provide real-time and service levels (e.g., Amazon Mom, insights into the needs and preferences of re- myWaitrose) or segment-specific plat- tail consumers, SMEs or large corporations. forms with tailored campaigning features Traditional payments companies, burdened (e.g., LevelUp, Belly) 20 McKinsey on Payments October 2015

• Personalized offers, leveraging consumer Partnering with data analytics specialists purchase patterns to craft specific offers and digital innovators, TPPs will be able to tailored to individual needs and behaviors compete directly with banks for consumer (e.g., Tesco Clubcard, BankAmeriDeals) and corporate transactions and the associ- ated data. • Geo-targeting, offering benefits linked to repeat purchase and consumer location To fend off the attack, leading depository (e.g., Groupon, Starbucks) institutions will need to integrate more diverse financial services on their digital plat- • Multi-merchant coalitions, where con- forms. This will likely entail not only full sumers can earn and redeem loyalty cur- functionality (account opening and closing, rency across a network of merchants (e.g., customer service, loan applications) on re- Air Miles, PayBack) tail and commercial banking apps but more competitive rates on financing (on the basis Increasingly, merchant point-of-sale of more accurate credit scoring), seamless applications operate in the cloud, access to mortgage applications and servicing, mutual funds and stock trades and reducing the need for bulky hardware comprehensive financial planning tools. and enabling faster roll-out of new 8. Cloud-based point-of-sale services solutions. Also, recent acquisitions by enable further specialization terminal hardware manufacturers Increasingly, merchant point-of-sale (POS) applications operate in the cloud, reducing signal the strategic importance of the need for bulky hardware and enabling pushing merchant offerings beyond the faster roll-out of new solutions. In addition, recent acquisitions by terminal hardware limits of POS hardware. manufacturers such Ingenico (which acquired Ogone and GlobalCollect) or Verifone (which acquired Point) signal the strategic 7. New regulations prompt new importance of pushing merchant offerings service offerings beyond the limits of POS hardware. Spurred by new regulations, depository institutions and third-party processors Commerce is too vast for a single provider to (TPPs) will compete directly for transac- address specific needs in multiple merchant tions and customer data. In Europe, for ex- verticals, and specialized providers such as ample, regulations cap interchange fees and Micros in the restaurant and hospitality seg- open the European Economic Area for ment demonstrate the relevance of vertical- cross-border acquiring. Similarly, the new specific value propositions (e.g., table Payment Services Directive (PSDII), now booking and mobile payments for restau- close to final approval, will enable TPPs to rants). Payments processors also recognize access accounts for information (e.g., bal- the value of owning both the payments plat- ance information) and payments initiation. form and merchant interface, while allowing 16 in 2016: Trailblazing trends in global payments 21

other service providers to broaden the offer- P2P and C2B mobile payments, and Earth- ing by using APIs to integrate their services port in cross-border corporate payments. with cloud-based applications. 10. Cyber attacks will increase 9. Domestic infrastructures move to Wary of increased costs and reputational real-time damage caused by cyber attacks, merchants’ Over 22 markets across the world are up- and payments companies’ investments in grading national payments infrastructures, cybersecurity are at an all-time high. Tok- improving speed, cost and security for mer- enization, where card details are replaced chants and consumers. In Europe, real-time by a substitute number (or “token”), is direct-to-account payments solutions are poised to become the strongest deterrent to becoming the norm, with Denmark, Swe- digital card fraud and a vital complement den and the UK in the lead. Current discus- to end-to-end encryption/point-to-point sions among regulatory bodies aim for a encryption. pan-European real-time payments infra- While competition among various tokeniza- structure. Domestic payments system oper- tion service providers in North America has ators in Canada and the U.S. have recently produced diverse standards, the rest of the begun to overhaul their systems as well. world remains at a nascent stage. Tokeniza- (See “Transforming national payments sys- tion comes in two forms: The current low interest rates • Issuer tokenization, where card schemes such as MasterCard and Visa tokenize in major markets challenge card numbers uploaded into digital wal- the economics of what has let applications such as Apple Pay been the prevailing model • Acquirer tokenization, where payments services providers tokenize sensitive data for the payments business: interest such as card details held “on file” by mer- income on daily balances. chants, thus reducing risk as well as the scope (and cost) of industry compliance requirements for merchants tems,” McKinsey on Payments, September 2014 and “Faster payments: Building a 11. New revenue models strengthen business, not just an infrastructure,” McK- fee income insey on Payments, May 2015.) The current low interest rates in major mar- By extending access to nonbank technology kets challenge the economics of what has companies, these upgrades are encouraging been the prevailing model for the payments faster innovation and setting new bench- business: interest income on daily balances. marks for cost-efficiency and accessibility, Taking a cue from digital companies, where as illustrated by online merchant payments consumers may buy a license, pay a sub- platforms such as Sofort (Germany) and scription fee or allow access to data in return Klarna (Sweden), Barclay’s PingIt (UK) for for using a service for free, banks are adopt- 22 McKinsey on Payments October 2015

Exhibit 1 Customer... Description Typical pricing model Examples Digital companies 1 Fee to buy and own the product or service Fee per transaction iTunes offer three main Pricing typically driven by the value of the product “Enriched” fee per Amazon pricing options Owns or service transaction the solution Product becomes the customer’s asset

2 Indemnity for using a product or service Subscription/ﬂat fee Netﬂix Product ownership remains with the provider; only License WhatsApp Uses subscribers can use the product or service the solution Pricing typically driven by usage

3 Customers do not pay for the product or service Free Spotify Customer information (proﬁle, behavior, usage) is “Freemium” Google Generates data monetized Facebook and insights which can be monetized Product ownership and customer data remain with the provider Source: McKinsey

ing pricing models that will build more sta- works. It also has the potential to replace ex- ble revenue (Exhibit 1). isting proprietary ledgers, enhancing transparency, improving the predictability of 12. Blockchain promises innovation settlement and reducing operating expenses in corporate banking business significantly in securities trading and similar models over-the-counter situations. If distributed Bitcoin’s blockchain technology, in which ledgers become the basis for the booking each transaction generates a “block” con- and transfer of public securities, they will taining an authenticated history of all prior bring about significant changes in post- transactions in the network, bonds partici- trade activities such as clearing, custody and pants in a marketplace without intermedi- cash management. aries. As the basis for distributed ledgers, blockchain technology is expected to be a 13. Digital banks prove the shift in key driver of disruptive innovation across the trust paradigm, starting with the financial services industry. While the im- daily banking pact of Bitcoin on the payments landscape Digital-native banks, such as Atom Bank has so far been negligible, leading financial (the first to receive a full banking license in institutions (including Citibank, UBS, the UK) challenge the deeply rooted as- Deutsche Bank and Standard Chartered) are sumption that physical branches are neces- starting to explore the capabilities of distrib- sary to generate trust. There is little uted and collaborative architectures to in- question, however, that in time consumers crease speed and flexibility and reduce costs. and corporate decision-makers will prefer The blockchain promises to streamline cum- the enhanced convenience, control and value bersome, costly and risky correspondent net- of digital banking to bricks and mortar. 16 in 2016: Trailblazing trends in global payments 23

Exhibit 2 Digital attacker banks Process/business model Non-banking technology Platform attackers Four attacker disruptors attackers archetypes, pursuing ING Direct Stripe Starbucks Apple different strategic Hello Bank! Pingit Tesco Google objectives Simple MobilePay Uber Alibaba Disrupt rather than be Address unmet customer Expand along the value Create the ecosystem disrupted needs chain Protect and grow core New use cases and revenue Deeper share of wallet with “Logged-in ecosystem” business models current customers around core offering (eCommerce, technology, Value proposition for new Enhanced customer Expansion along the value hardware, software) customer segments experience chain, providing end-to-end offering Lower cost-to-serve through Lower cost-to-serve through new channels increased efﬁciency Source: McKinsey

Digital banking apps have already become a Stripe, Danske Bank’s MobilePay) focus on standard offering across the globe, function- building market share through more coming in some cases as a “control tower” for pelling customer experiences, and “non- customer relationships. Ross McEwan, CEO banking technology attackers” leverage of RBS, has noted, “Our busiest branch in payments as a way to deepen their share of 2014 is the 7:01 [train] from Reading to wallet with customers of their core offering Paddington.” and provide an end-to-end offering. Posing a particularly broad threat to incumbents, While established providers gradually ex- “platform attackers” (e.g., Apple, Google) pand the functionality of their banking apps create logged-in ecosystems (often compris- (from view-only information to internal ing operating system, hardware, customer transfers, bill pay, external transfers, etc.), a relationships and servicing), thereby obtain- new generation of digital-native banks is ing an extremely rich view of customer be- bringing improved standards of cost-effi- havior and motivations (Exhibit 2). ciency to the industry. Regardless of the type of innovator, pay- 14. Digital challengers extend their ments remain the strategic enabler of new claim to “own the customer” commerce offerings and changed economics. Contributing to unprecedented levels of 15. Strategic partnerships competition for payments revenue among a increasingly crucial to serve the full widening field of players, fintech innovators value chain pursue different strategic objectives. If incumbents are to support consumers While “digital attacker banks” (e.g., ING Di- through the entire search-evaluate-buy- rect, BNP Paribas’ Hello Bank) go on the of- bond cycle, they must find the right partners fensive to solidify their core business, to gain the necessary access, skills and ex- “process or business model disruptors” (e.g., pertise (Exhibit 3). 24 McKinsey on Payments October 2015

Exhibit 3 Consumer decision journey Payments is Search (pre-visit) Evaluate (decision) Buy Bond (post-visit) increasingly Contact/ Review Generate Find store Merchants arrive at Decide on Pay business/ Loyalty integrated into the demand comparison store purchase tell friends search-evaluate-buy- bond value chain BBC Google Maps TripAdvisor OpenTable Groupon MasterCard TripAdvisor AAdvantage CNN Bing Trivago Booking.com LivingSocial Visa Facebook Miles & More Cosmopolitan Yahoo! Yelp Priceline Facebook PayPal Twitter Nectar

Example of new digital solutions combining offerings across industries

Barclays Commonwealth Bank

Square iZettle LevelUp

eBay PayPal

Google OpenTable Alipay WePay

Source: McKinsey

OpenTable provides an instructive example to build skills and scale rapidly, despite the of broad capabilities acquired over time known challenges of integrating cultures through a combination of acquisitions and and systems. partnerships (e.g., Yelp or Facebook). The Global investments in fintech ventures result is a best-practice example of end-to- reached an all-time high of $12 billion in end integration, which enables OpenTable to 2014, and the high valuation multiples of accompany consumers through their search recent transactions, including Global Pay- and comparison of restaurants, from table booking and transportation, to payment at ments, Micros, Clear2Pay or ICBPI, signal the table and loyalty. intensifying competition among investors to acquire payments innovators. The coming 16. The next M&A wave has started months will almost certainly see this wave While a number of large incumbents have of fintech acquisitions gain momentum. successfully launched next-generation pay- * * * ments solutions, most banks are still seek- ing an expedited path to develop and To win in the new payments arena, banks launch innovative digital solutions. With and other service providers must strike the nearly 5,000 fintech companies focused on right balance between defensive moves and payments, making it the most active cate- creative destruction. This requires deep gory in the fintech space (Exhibit 4), acqui- thinking and analysis along four strategic sition is at present a highly attractive way dimensions: 16 in 2016: Trailblazing trends in global payments 25

Exhibit 4 Distribution of ﬁntech activity Number of startups and innovations as percent of database total1 24% Payments has Product become the capabilities epicenter of ﬁntech Accounts innovation Markets4 Lending 14% Payments 13%

12% 11%

1 350+ commercially most well-known cases registered in the database, might not be fully representative. Customer 4% 5% 2 Includes small and medium enterprises. Segments 3 Including large corporates, public entities 3% and non-bank ﬁnancial institutions. Retail 4 Includes investment banking, sales and 2% 1% trading, securities services, retail Mid-corporates2 2% investment, mutual funds and asset management factory. Large corporates3 Source: McKinsey Panorama Fintech Database

• Organizing for digital payments, with a • Developing strategic partnerships to ac- clear digital payments strategy and cus- cess the necessary assets, skills and capa- tomer focus bilities.

• Defining unique, customer-centric value propositions that can be embedded into Steve Krieger is an associate principal in the the relevant ecosystems and search- Luxembourg office, Matt Higginson is an associate evaluate-buy-bond value chains principal in the New York office and Wings Zhang is an engagement manager in the Shanghai office. • Leveraging upgraded domestic payments infrastructures to launch cheaper, faster and more secure solutions