volume 8, number 21 may 2015 mckinsey on payments/media/mckinsey/industries/financial s… ·...

May 2015Volume 8, Number 21

McKinsey on Payments

Foreword

Gauging the disruptive potential of digital walletsWhile they have established a solid foundation for growth, digital wallets are by nomeans a guaranteed success. They must continue to evolve if they are to have a trulydisruptive impact on the payments landscape. Providers can improve their chancesby focusing on six “markers” for success in payments innovation.

New partnership models in transaction bankingA number of trends are leading to a fundamental rethinking of the traditional modelby which banks offer transaction banking services to clients outside their establishedmarkets. Four distinct partnership models offer the best opportunities for banksseeking to succeed in an evolving landscape.

Toward an Internet of Value: An interview with Chris Larsen, CEO of Ripple LabsMcKinsey on Payments sits down with the co-founder of Ripple Labs to discuss thenuts and bolts of the Ripple protocol, the implications for the correspondentbanking model, and the emergence of an “Internet of Value.”

Faster payments: Building a business, not just an infrastructureA faster payments infrastructure is not an end in itself, it is an opportunity for banks to deliver innovative products and services in both consumer and corporatepayments. To monetize this opportunity, financial institutions should focusrelentlessly on design, customer experience, accessibility and convenience.

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Yet for many in the payments industry thequestion of whether digital wallets (see“Defining the digital wallet,” page 4) willultimately succeed is still an open one. Inthe U.S., PayPal and other early digital wal-lets attained scale through online com-merce, but attempts to bring mobilepayments into the physical world have hadlimited success.

To provide a structured perspective on howdigital wallets will evolve, this articleexamines the market through the lens ofMcKinsey’s six markers of paymentsdisruption success (first described in “Thefuture of payments: Markers for success,”McKinsey on Payments, June 2011). The sixmarkers are grouped in three critical areas:designing a compelling value proposition;executing a measured go-to-market strategy;and planning thoughtfully for expansion.

Design a compelling valueproposition

1. Deliver significantly more customer valuethan rivals. Entering payment credentialswhen shopping online is often consideredcumbersome, making convenience a long-standing consumer payments priority. In theU.S., McKinsey’s annual Mobile ConsumerPanel consistently identifies convenience asthe leading factor in consumer adoption ofmobile payments. Most digital wallets, in-cluding Apple Pay, Visa Checkout andGoogle Wallet, accordingly emphasize con-venience in their value proposition. Untilnow, however, paying with smartphonesoffline in markets where card penetrationis strong has been only slightly more con-venient than existing methods.

While most payments industry advancesmust overcome inertia and network effects,

3Gauging the disruptive potential of digital wallets

Sameer Gulati

Marie-Claude Nadeau

Kausik Rajgopal

Gauging the disruptive potential ofdigital wallets

Digital wallets are having a moment. The recent launch of Apple Pay and the

accompanying media attention are bringing them into the mainstream.

Technological and market developments have expanded their potential. Payments

networks have shown a willingness to unbundle their offerings and permit non-

bank players to use their tokenization protocols. EMV technology adoption in the

U.S. has accelerated. And consumers are more open to adopting digital-wallet-

like offerings like mobile boarding passes and Starbucks’ loyalty app.

4 McKinsey on Payments May 2015

motivating consumers to alter their funda-mental payments behavior is particularlychallenging. In online commerce, PayPal ini-tially added convenience by introducingemails and passwords. Today, Apple Pay usesits fingerprint recognition feature, Touch ID,for online shopping, which replaces pass-words with biometric security. However, be-cause consumers still perceive credit anddebit cards as a major convenience for on-site transactions, digital wallets will needeven stronger value propositions to displaceentrenched card-based payments.

Digital wallets that demand more effort andtime than currently favored payments meth-ods are also unlikely to gain widespreadadoption. For instance, requiring buyers toadd devices to their phones, narrowly limit-ing the forms of accepted tender, or requir-ing manual entry of bank information couldall hinder acceptance.

To significantly increase customer conven-ience, providers should expand wallet func-tionality beyond basic payments capabilities.Options include digital storage of ID cards,driver licenses and other items carried intraditional wallets (Exhibit 1). The Osaifu-Keitai wallet developed by NTT DOCOMOin Japan, for example, includes electronicmoney, credit cards, ID cards, loyalty cardsand electronic fare collection on public tran-sit. Digital wallets could include applicationsthat deliver targeted offers, which could bedesigned to redeem automatically at thepoint of sale—a major convenience forvalue-oriented consumers. India and severalother nations are even considering the is-suance of personal IDs that could be storedin digital wallets.

In addition to convenience, Apple is empha-sizing security and privacy in Apple Paymarketing. Other wallets, including PayPal’sand Turkey’s BKM Express, address theseconcerns by withholding payments detailsfrom merchants. Historically, consumershave considered security and privacy to beimportant primarily for online and mobiletransactions, but recent breaches of carddata at retailers suggest that value proposi-tions containing strong security and privacycomponents could be effective in drivingwallet adoption.

While most payments industryadvances must overcome inertia andnetwork effects, motivating consumersto alter their fundamental paymentsbehavior is particularly challenging.

Defining the digital wallet

The term digital wallet has been applied to diverse forms of electronic payments, even some as simple as

prepaid cards. In addition to money, however, traditional wallets also typically hold various forms of pay-

ment and identification that might be stored and accessed digitally. This article therefore defines the digi-

tal wallet as a software application that enables users to digitally store money, payments credentials and

more, and to use these to implement various types of cashless transactions.

2. Create broader merchant value proposi-tions.Minimizing cost is a top merchant pri-ority in payments. The Merchant ConsumerExchange (MCX), for example, which com-prises more than 60 U.S. member retailers,is establishing a digital-wallet platform de-signed to reduce members’ costs. The plat-form addresses member concerns about rivaldigital wallets, like Apple Pay, that indexheavily on credit cards and can thereforeskew a merchant’s payments mix towardhigher-cost methods. But excessive focus oncosts might also reduce consumer appeal—for example, by requiring shoppers to dis-close information they are unaccustomed toproviding for retail payments, such as bankaccount numbers in the U.S. Historically,payments disruptors that focused on cost atthe expense of customer experience have

failed to attain scale. So to succeed, digitalwallets like MCX will need to find otherways to drive revenue growth. Possibilitiesinclude improving the customer experience,more effectively delivering offers and loyaltypropositions, and collecting and sharingmore consumer data with merchants.

For online and mobile commerce, paymentsand digital wallet innovators like PayPal’sBraintree have recently gained a footholdby delivering seamless customer experi-ences that dramatically increase purchaseconversions. Conversion is valued highly bysmaller online and mobile merchants intenton winning new customers and gaining re-peat business. Some digital wallets build onthe shopping experience developed by retailgiants like Amazon and Walmart, who ex-


Digital walletPotential applications

In-person retail card/cash alternative

NFC, QR-codes

IdentityDriver’s license,

health cards, boarding passes

Mobile/E-commerce “check-out”

Mobile site or in-app purchases

Mobile paymentsPayments processing, card swipe “sleeve”

Mobile incentives and loyalty

Coupons, location-based offers,

“pay with loyalty points”

Peer-to-peer/digital goods

Pay friends and purchase

music, apps

Banking and bill pay

View accounts and transfer money

Source: McKinsey Payments Practice

Exhibit 1

The digital wallet presents diverse commerce-related applications extending well beyond payments


pedite the checkout process by storing andauto-populating previously used paymentscredentials. These innovators offer this ca-pability and conversion performance tosmaller merchants who cannot develop thetools themselves. The payments processorStripe, for example, minimizes cost whileproviding easy merchant integration and anuncomplicated customer experience. Ex-tending such merchant propositions to thephysical world is another way for digitalwallets to offer merchants more than justcost savings.

Execute a measured go-to-marketstrategy

3. Penetrate niche market segments first.Consumers’ expectations for digital walletsvary widely, so it is difficult to address themall at the outset. One approach is to initiallytarget smaller market segments. This enablesnarrow tailoring of product design, partner-ships and marketing, which not only im-proves the odds of early success and keepscustomer acquisition costs manageable, butalso lets the wallet provider offer merchantsquick access to customer segments, whichcan be an important incentive.

In the early niche-market stage, issuers canalso pursue smartphone users (Androidusers in the case of Google Wallet; iOS inthe case of Apple Pay). For merchants,these might be frequent users of their pro-prietary mobile apps. The issuer might, forinstance, create a simple link with existing-app functionality to avoid confusion be-tween the wallet and other apps. Definingand delivering a value proposition for thesecustomers will be critical to gaining earlyadoption.

4. Leverage existing ecosystem and infra-structure. The tokenization protocol devel-oped by EMVCo (used for the first time byApple Pay and likely to be adopted by oth-ers) illustrates this important successmarker well. By using 16-digit tokens—thesame format as existing credit and debitcard numbers—along with other existingdata fields, the protocol enables more se-cure routing of payments via establishednetworks and POS infrastructure whileminimizing requirements and network in-tegration costs.

Wallet-like merchant apps, including thoseof Starbucks, Otto’s Yapital in Germany andTarget’s Cartwheel in the U.S., also use ex-isting POS infrastructure to drive consumeradoption. Because these products use QRcodes, however, related apps do not requirenear-field-communication (NFC) termi-nals. By contrast, Apple Pay, Google Walletand others use NFC to deliver a seamlesscustomer experience that, in the U.S., hasthus far come at the expense of broad mer-chant acceptance. But, as merchants re-place older payments terminals with NFC-and EMV-enabled models, this obstacleshould diminish in importance.

When expanding into new marketsdigital-wallet providers should proceed

cautiously. Markets often differsignificantly in such critical aspects as

card interchange economics,regulatory environment, technologypenetration and consumer behavior.

Plan thoughtfully for expansion

5. Adapt offerings to other markets.Whenexpanding into new markets, digital-walletproviders should proceed cautiously. Mar-kets often differ significantly in such criticalaspects as card interchange economics, reg-ulatory environment, technology penetra-tion and consumer behavior. Markets withsubstantial economic differences, for in-stance, can present considerable challenges,such as lower levels of interchange. This canmake charging incremental fees to issuers(such as Apple Pay’s 15 bps fee) more diffi-cult, and can also negatively affect networktokenization economics. In markets with lowinterchange fees, such as the EU, wherecredit card interchange will fall below 0.3percent, wallet providers might need to findmonetization alternatives (Exhibit 2).

In addition to putting pressure on inter-change economics, regulations can also pres-ent challenges to data-gathering efforts andanalytics-based value propositions related towallets. Apple Pay has said it will not collectpayments information, but Google Walletand others might decide to gather and usepayments data, in which case they will facedifferent security and privacy constraints inthe markets they enter.

Established consumer payments preferencescan also have an impact on digital-walletsuccess. For example, bank account-fundedwallets might gain ground faster in marketslike Germany and India, where non-cardpayments methods (including direct bankaccount access) are more common. Intro-duced in the Netherlands in 2005, the


00

0.5

1.0

1.5

5 10 15 20 25 30 35

Average interchange level for credit cards Bps

Debit and credit card penetration Percent

Card penetration and interchange levels by country, 2013

India

Brazil

China

France

Spain

Sweden Germany

UK

Canada

U.S.

Source: Strategy Analytics; IDC

Exhibit 2

Digital wallet business models must adapt to diverse market conditions, such as varying interchange levels


iDEAL wallet platform, which does not usedebit or credit cards, gained acceptance at100,000 online stores. Conversely, in Euro-pean markets where rewards play a smallerrole, pay-with-points wallet features wouldlikely have less appeal.

In some countries, new entrant wallet prod-ucts, even those with advanced features, willhave to compete with incumbent offeringsalready embedded in the infrastructure. InJapan, a market that is highly conducive tolaunching new technologies, the Osaifu-Keitai wallet has 10 years of history and isnow used even for government-issued IDs.In South Korea, Bank Wallet Kakao was re-cently launched in partnership with 16 Ko-rean banks, as well as the Korea Financial

Telecommunications and Clearing Institute,making displacement a tall challenge.

From the technology standpoint, mobilewallet providers will also need to adapt todifferences in smartphone penetration lev-els and merchant-acceptance technologiesin different markets. Apple Pay, for in-stance, is likely to have a smaller presencein markets such as China, India and Koreawhere iOS penetration is low (Exhibit 3).Similarly, NFC wallets should gain quickeracceptance in places where that technologyalready has a strong presence, such as Aus-tralia and the UK.

6. Tap adjacent profit pools to differentiateofferings and add value. Convincing prospec-tive partners to pay for wallet services solely

iOS share of handset shipments Percent of units shipped, 2013

≤5 6-10 N/A5-6 >10

Source: Strategy Analytics; IDC

Exhibit 3

Apple Pay adoption could be slower in countries with lower iOS market share

on the basis of transaction volume may gen-erate only modest revenues because it tapsa profit pool that, in many markets, is al-ready under margin pressure. In the pay-ments value chain, the war over endpoints(such as the consumer and merchant inter-faces in the case of wallets) is already com-pressing margins in mature markets asproviders continually offer more compellingrewards and discounts.

In mature market pockets where inter-change revenues are under pressure, suchas PIN and debit cards in the U.S., tok-enization fees may provide a viable alterna-tive. While these fees tap the same revenuestream, they also promise to reduce riskcosts throughout the payments value chain.

Wallet providers therefore might need toseek alternative revenue streams that offermore meaningful growth potential—possi-bly commerce-related revenue streams (Ex-hibit 4). Coupons and data analytics, forinstance, have strong links to payments andtransaction data. In fact, the line betweenthe value chains of payments and com-merce is already blurring as paymentsprocesses blend into the purchase experi-ence—a change exemplified by Braintreeand rideshare provider Uber. This couldopen adjacent commerce revenue streamsto payments incumbents.

Given mapping capabilities at the device andcustomer levels, tracking the performance ofdigital-wallet marketing campaigns is also


3Wire 3Credit processing 4General purpose prepaid 5Issuer processing 6Cross-border 6Big data analytics Coupons 9Checks 10ATM 10Paid search 11Merchant acquiring 14E-commerce hosting 22Advertising

0.2Card-based loyalty programs 0.4General purpose prepaid

Mobile ads

7

0.6B2B card 1

Debit processing 2

ACH

1Cash

Money transfer 3Private label prepaid 3

134Card lending 134

2012 revenue streams, global $ billion

Commerce

Network

Payments value chain Source: McKinsey Global Payments Map;

McKinsey Payments Practice

Exhibit 4

Large revenue streams adjacent to payments blur the lines with commerce

easier in the offline world, facilitating theadoption of pay-for-performance models.This can become a winning situation forboth merchants and wallet providers,wherein merchants pay providers based onincremental rather than absolute sales, amodel which more closely aligns the incen-tives for both.

* * *

The recent convergence of payments andcommerce means digital wallets are here tostay. Yet, while they have established a solidfoundation for growth, to truly become apayments disruption they must continue toevolve. Many providers are, in fact, becom-ing more thoughtful about their go-to-mar-ket strategies, particularly as these relate to

initial market selection and building on ex-isting infrastructure. However, they alsoneed to develop more comprehensive con-sumer value propositions that can deliverthe magnitude of user-experience improve-ment that widespread consumer adoptiondemands. Finally, players will also need tothoroughly consider what is necessary to ex-pand successfully into other markets andrevenue pools—areas that present strongpromise for rapid growth, but in contextsthat may be especially challenging to digital-wallet economics.

Marie-Claude Nadeau is an associate principal in

McKinsey’s San Francisco office.Kausik Rajgopal is

a director in the Silicon Valley office, and Sameer

Gulati is a principal in the London office.


volume 8, number 21 may 2015 mckinsey on payments/media/mckinsey/industries/financial s… ·...

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