tpi business of payments wickenden & kettell 13 jul2011

© 2011 NACHA — The Electronic Payments Association®. All rights reserved. No part of this material may be

used without the prior written permission of NACHA. This material is not intended to provide any warranties, legal

advice, or professional assistance of any kind.

The Business of Payments

Chip Wickenden

Tom Kettell

The Payments Institute – July 10-13, 2011 – Washington, D.C.

© 2011 NACHA — The Electronic Payments Association®. All rights reserved.

Breaking News – UK Cheques back from the Brink

2

Slide not included in Handouts

Source: Finextra.com



Agenda

Basic Premise – it’s all about economics

Scope and scale of the market

Three tiers of the payments market

Channels / order management

Processing

Networks / Gateways / Core

Information aspects

Revenue Models

Item Fees

Value Pricing - interchange

Cost Models

Capital Allocation – Enterprise Solution

Expense / Outsourced Solution

Routes to Market

Major Market Concepts Affecting the Payments Market

Market Equilibrium; Growth Markets; Contracting

Markets

The Network Effect

Disruptive Innovation

Regulation climate

Dodd Frank,

FFIEC

Others

Risk Aspects and Models

The Promise to Pay

Fraud

Operational Risk

Building a Business Case

Marginal or incremental change vs Aggregate

change

Market share change

Payment System Architecture (Enterprise vs.

Outsource)

3



Scope and Scale of the Market

4

37.9 (17%)

• 107.5 (49%)

0 (0%)

0.2 (0%)

0.4 (0%)

7.7 (4%)

19.1 (9%)

21.6 (10%)

24.5 (11%)

$1,421 (2%)

$1 (0%)

$9,919 (12%)

$34 (0%)

$173 (0%)

$37,164 (44%)

$1,917 (2%)

$31,599 (38%)

$1,871 (2%)

SOURCE: McKinsey U.S. Payments Map, Release Q2-11

Cash

Check

Debit Card

Credit Card

ACH

Prepaid

Book Entry Transfers

Wire Transfer

Other

2009 US dollar flows

USD 84,097 billion

2009 US transactions

219 billionC2B

B2B

0%

%

CAGR

‘04-09

15

-7

4

12

14

20

1

33

1%

14

-5

4

8

12

42

9

30



If Forrest Gump Looked at the Payments Market . . .

• The top part – the smallest – is what everyone

looks at – that’s the customer interactions and

order management – the services – the routing

– the innovation – the razzle-dazzle

• The middle part is what most people eat – and

that is the operations and gateways – the

factories of payments processing

• And the bottom part – bakers often add extra

tasty ingredients to the bottom layer – and

that’s where there are hidden goodies to be

found in payments too – the information

aspects of payments, including loyalty

5

He could say it looks like a wedding cake



The Problem of Payments

Payments are processed in silos based on the transaction format and clearing method - developed in response to operational, not business needs

Cu

stom

er File

EBP

P Facility

Ch

eck Image

Syntax Edit

OFAC Check

Warehouse

DDA Interface

Returns and Exceptions

ACH

Bilateral A

greem

ent

Third

Party

Clearin

gho

use

Fed In

terface

Wire D

esk

Treasury

Mgt/O

nlin

e

Syntax Edit

Enrichment

OFAC / PEP Checking

DDA Interface

Network interfaces

Wire

CH

IPS

SWIFT

Fedw

ire

Item P

rocessin

g

Lockb

ox

Image D

epo

sit

Cash Letter Prep

Balancing

DDA Deposits


Check

Direct Sen

d

End

po

int Exch

ange

Fed In

terface

On

line / C

NP

Facility

PO

S Netw

ork

Authorization

Switching

Clearing and Settlement

Network Gateway

Cards

MasterC

ard

Visa

Disco

ver

Am

erican

Exp

JCB

Oth

er Netw

k

6

Vau

lt Op

eration

s

ATM

Counting / Strapping

Inventory / Safekeeping

General Ledger

Delivery

Cash

Arm

ored

Trucks

Recyclers

Teller Draw

er



The Business of Payments

Ch

ann

els

Gat

eway

sOutbound Payments

Ch

ann

els

Gat

eway

sInbound Payments

Cu

sto

me

rs

Net

wo

rks

Co

un

terp

arti

es

Business Logic Execution Gateways

Opportunity for:• Differentiation• Innovation• Revenue Strategic

Cost of:• Operations• Support• CapitalTactical

7



Cost of:• Operations• Support• CapitalTactical

The Different Worlds of Payments Are

Nothing Alike

Keys to Revenue Generation

• Customer experience

• Speed to market

• Integration across products and

channels

• Leveraging market forces

• Collaboration and innovation

Levers of Bottom Line Management

• High volume / Low fixed cost

• Minimization of errors and exceptions

• Minimize operational risk

• Delivery arbitrage

• Consistent operational excellence

8

Opportunity for:• Differentiation• Innovation• Revenue Strategic



Cu

stom

er File

EBP

P Facility

Ch

eck Image

Syntax Edit

OFAC Check

Warehouse

DDA Interface


ACH

Bilateral A

greemen

t

Third

Party

Clearin

gho

use

Fed In

terface

Wire D

esk

Treasury

Mgt/O

nlin

e

Syntax Edit

Enrichment

OFAC / PEP Checking

DDA Interface

Network interfaces

Wire

CH

IPS

SWIFT

Fedw

ire

Item P

rocessin

g

Lockb

ox

Image D

epo

sit

Cash Letter Prep

Balancing

DDA Deposits


Check

Direct Sen

d

End

po

int Exch

ange

Fed In

terface

FX Trad

ing

Op

eration

s

Treasury

Mgt/O

nlin

e

Validation

Warehouse

General Ledger

Counterparty Clearing

FX

SWIFT

DD

A

On

line / C

NP

Facility

PO

S Netw

ork

Authorization

Switching

Clearing and Settlement

Network Gateway

Cards

MasterC

ard

Visa

Disco

ver

Am

erican

Exp

JCB

Oth

er Netw

k

A Component Based Approach to Payment Services

Hubs Enables Rationalization and Transformation

The introduction of a common order management system creates opportunities for improved routing and customer interaction, while also providing the buffer necessary for banks to rationalize their payment management and gateway functions

Common Instruction Management

Payment Execution and Management

Payment Networks and Gateways

9



The Network Effect

• Theodore Vail, president of Bell Telephone, 1908 Annual

Report

• Robert Metcalfe, Metcalfe’s Law 1980, focusing on

devices

• Rod Beckstrom, Beckstrom’s Law, focusing on the value

of transactions within the network

• Bernard Lunn, Reverse Network Effect with Scale

• Rahul Tongia, The Cost of Network Exclusion

10

―The value of a network to it’s members

increases exponentially with the number

of users‖

V = N2

http://upload.wikimedia.org/wikipedia/commons/0/0d/Network_effect.png



Adjacent Markets

11

Payments

Market

Credit

Market

Retail

Store

Market

Trade

Finance

Market

P2P

Market

Analytics

Developing solutions that target adjacent markets, rather than the current market

offer appealing ways to tap net new sources of revenue, rather than simply battling

competitors. The risk, however increases, since the bank will be outside of it’s

core areas of expertise.



• Disruptive innovations are generally not

acceptable for the mass market when they are

introduced

• Only the fringes of the market pick up the

innovation in the first iteration

• As the innovator continues to refine their product

the utility value to the market increases

• While incumbents improve their product

performance over time, disruptive innovators are

forced to improve faster in order to survive

• A market incumbent is incented to invest only to

sustain current returns

• Additional incumbent investment requires a

higher rate of return

• A market insurgent will invest to reduce the risk of

not achieving critical mass

• In this context the telecom providers are market

insurgents

• The more complex the market, the higher the

stakes

12

―The Innovator’s Dilemma‖

Disruptive Innovation

For much more on this, refer to the works of Harvard professor Clayton Christiansen. His website is:

http://www.claytonchristensen.com/

http://en.wikipedia.org/wiki/File:Disruptivetechnology.gif

http://www.claytonchristensen.com/



Two Sided Markets

• The number of participant of a

given group create an attraction

for members in a related group

– Patients and hospitals

– Electronic billers and bill

payment service providers

– Fraternities and sororities

– Publishers using Adobe and

consumers using PDF readers

– Merchants and cardholders

13

http://en.wikipedia.org/wiki/Two-sided_market

http://en.wikipedia.org/wiki/File:2sidedmarketdiagram.gif






The Farther You Reach from the Data Required to

Post a Transaction, the More Value is Uncovered

14

Functional

Payment

Data

Minimum data

required to post

a transaction

Accounts

Amount

Date

Aggregated

Payment

Data

Provides insight

into market

trends and

customer

behavior

Associated

Data

Information

gathered

separately that

enhances the

insight

provided by

payments data

Meta-Data

Payment

Detail Data

Additional line-

item

information on

what was

purchased and

the identity of

the parties

Separated

Enhanced

Data

Detailed data

which needs to

be associated

with the

transaction,

component,

ingredient or

supply chain

data

Related

Data

Financial

supply chain

data i.e. billing

or invoice, FX

or capital costs

Transactional Data ->



A Componentized Approach to Payments Services Hubs

Allows the Bank to Focus on Strategic Imperatives

15

IndustrializeProcessing


© 2011 NACHA — The Electronic Payments Association®. All rights reserved. 16

Payment Methods

Bill Through Third Party

(Provisional Credit)

• Simple and Easy

• Carrier holds risk & cost of funds

• Merchants must subscribe

Closed Loop

Notional Account

• Franchise may go beyond

mobile

• Risk is managed based on

program specifics

• Program carries cost of funds

• Merchants must subscribe

General Use

Payment Methods

• Franchise extends into mobile

• Risks and cost of funds are well

understood and managed

• Broad merchant acceptance

• Generalized for the overall market, not

specific to mobile payments

• The method of payment is different than

the device or means of affecting payment

• A major factor in the utility of a payment

method is the breadth of acceptance



The Gartner Group Hype Cycle

17




The Hype Cycle Can Also be Adapted to Market

Development

18




Market Participants Behave Differently than

Pundits

19




End Customers also Behave Differently

20




Benefits

• Increased traffic• Increased per

ticket spend• Decreased cash

handling cost

Costs

• POS Equipment• Interchange and

Fees• Chargebacks

The Needs of Four Parties Had to be Addressed in Order

to Create the Credit Card Market

21

Benefits

• Fee income• Growth in

commercial accounts

Costs

• Sales costs• Processing costs• Credit risk• Association fees

Benefits

• Fee income• Interest income• Retail account

growth

Costs

• Issuing and Account Mgt.

• Processing • Credit / fraud risk• Association fees

Benefits

• Carry less cash• Short term credit• Status (early days)• Rewards (now)

Costs

• Fees• Interest• Credit / fraud

exposure

Consumers Merchants

Acquiring Bank

Issuing Bank

The Card Associations Delivered

• A means of sharing revenue - interchange• Standardized processes, rules and enforcement • Marketing to define the value to all participants• The Network Effect through membership growth



Similarly, the Needs of 8 or 9 Players Must be Aligned to

Ignite the Mobile Payments Market

22

Wireless Networks

Handset / SIM Mfrs

Point of Sale

ProvidersPay

me

nt

Net

wo

rks Consumers Merchants

Acquirer Bank

Issuer Bank

• In this new reality the role of the card associations shifts from market catalyst to another vested interest.

• In most developed economies, the situation is further complicated by the relative maturity of electronic payments, particularly card payments.

• The card associations’ situation is further exacerbated by pressure to reduce interchange costs.

• The new market entrants view the payments market as an adjacent space and an opportunity for new revenue.

• The earliest days of this market have been characterized by fierce domain defense; collaborative efforts are just now emerging and a network effect has yet to be catalyzed.

A catalyst is needed that will balance the benefits and costs for all of the market participants in mobile payments



• Cost vs. Revenue

• Cost vs. Compliance

• Cost vs. Cost

• Cost vs. Do Nothing

Building a Business Case

23



The Actual Cost of Doing Nothing

24

Source: Clayton Christensen; Failed Paradigms of Financial Analysis



Things to Consider - Risk Impacts

• Prior to implementing you should assess

– Is the product/service strategic?

– Have we identified and assessed all the risks to our organization?

• Legal

• Compliance

• Reputation

• Operational

• Security of personal information



Paym

ents

engin

e

Key decisions for a bank during the strategy and

planning phase of a payment project

Domestic

Multi-

national/

regional

International

Credit

transfers

Direct

debits

Cards …

ILLUSTRATIVE

Value and

risk

assessment

How many

hubs and

where?

Orchestrate

vs

upgrade?

Orchestration Orchestration

Paym

ents

w

ithin

Core

bankin

g

Paym

ents

engin

e

Paym

ents

w

ithin

Core

bankin

g

vs

Oth

er

syste

ms

Oth

er

syste

ms

New Legacy

Build vs

buy? Build

internally

Buy from

vendor

Buy and build

(framework

and SDK)

Partners?

Source: Celent

• How many technology

vendors? For what roles?

• What capabilities are you

looking for from a

technology vendor?

• How many

implementation partners?

ILLUSTRATIVE



Changing Regulatory Climate

Regulatory

Assessment

FTC Red

Flag

FFIEC

Dodd

Frank

Act

Rule

Making

Bodies

Issued November 1,

2008

There are 26

possible red flags

that fall into five

categories

Issued January 14, 2009

Addresses the necessary

elements of an RDC risk

management process in an

electronic environment, focusing

on RDC deployed at a customer

location, mobile banking

automated clearing house (ACH)

check conversions

•Check 21

•Image Exchange

•Regulation CC

•Regulation J

•State Law

•ACH

•Regulation E

•Agreements and Clearinghouse

Rules

•Interchange

•Patriot Act

•OFAC

•Title X: Durbin Amendment

•Title VIII: Payment, Clearing and Settlement

Supervision

•Title X: Bureau of Consumer Financial Protection



Unnamed lawyers make us include the following: The views expressed herein are the speaker’s personal views and do not necessarily

reflect the views of NACHA – The Electronic Payments Association

Questions and Legal Disclaimer

28

Chip Wickenden

Enterprise Solutions

FIS Global

[email protected]

1-904-422-1321

Tom Kettell

Emerging Markets

Epson America, Inc.

[email protected]

1-952-906-3996

mailto:[email protected]

mailto:[email protected]