The credit card sector is a large, growing, and profitable segment of financial services, but it must soon address four emerging challenges.
Who would have thought that the payments sector would be so prominent in 2014? Once a quiet corner of the financial world, the industry has been on a roller-coaster ride lately.
Data breaches involving more than 100 million credit and debit cards at big retailers, such as Target and Home Depot, have grabbed headlines. But there have also been unexpectedly exciting and innovative developments.
In October 2014, for example, Starbucks said that about 15 percent of purchases in its U.S. stores were paid through its mobile app and that by the end of 2015 the company will launch a Mobile Order program across the United States so customers can preorder — avoiding long queues and wait times. In September 2014, Apple announced that its new iPhone 6 came equipped with an e-wallet called Apple Pay that would store payment information and let customers pay for items by holding the iPhone in front of a reader and placing a finger over the fingerprint sensor. And perhaps the most striking illustration of the payments sector’s vitality can be found in eBay’s surprise decision to spin off PayPal in 2015, a move intended to let the unit take advantage of the many anticipated opportunities for partnerships with offline and online retailers.
Viewed broadly, the payments industry (worldbank.org) (which includes organizations that store, process, and transmit cardholder data) has three quite attractive attributes: It’s large, it’s growing, and — thanks to its relatively stable and predictable transaction volumes combined with low capital intensity — it’s highly profitable.
In emerging markets, the growth of the middle class and expanded consumer activity represent vast untapped pools for payments companies, particularly involving mobile money applications, because cellular penetration in these regions tends to be high. In more established economic zones, however, like North America, the landscape is more challenging than in the developing world, for a number of reasons:
- The shock of the global recession and the tepid growth since, along with subsequent new capitalization restrictions, have forced financial institutions to tighten credit standards and consumers to deleverage.
- Increased regulation combined with the zero cost of money has minimized interest-rate spread and lowered margins, forcing payments players to look for new revenue streams.
- The competition is getting keener as several monolines, such as Discover and Capital One, expand into a broader set of financial services.
- Large online and offline merchants continue to increase market share, stiffening the rivalry among co-branded cards and programs and fueling adversarial relationships between merchants and financial institutions.
Given this complex and thorny environment and the prospect of reaching millions of new customers in emerging regions, payments firms must be responsive to customer preferences, prepared to develop valuable new features, and sufficiently nimble to anticipate and counteract competitive activity in order to thrive. To facilitate this, we have identified four key trends that we believe bear watching for their potential to reshape the payments industry in the next three to five years.
Branding battles
Increasingly, prominent e-commerce sites such as iTunes, Amazon, and the ride-sharing service Uber store consumer credit card information, which speeds up purchases because the data does not have to be reentered upon each visit. The problem is, customers rarely remember what card is stored at a given site, diluting the free marketing and brand reinforcement that payments companies typically enjoy when a consumer takes a credit card out of his or her physical wallet.
However, for credit card providers that are able to have their products listed as primary cards at the most popular e-commerce destinations, “stored credentials” can be a significant competitive edge. Consequently, issuers would be wise to create aggressive incentives for merchants to highlight their cards through cross promotion deals and increase their chances of becoming consumers’ primary card choice. Numerous examples can be found of financial-services firms partnering with hotels, airlines, retailers, and others to offer rewards for using their credit cards. But credit card providers should also consider the substantial opportunities available now to be the leading payment option for e-commerce and other digital startups, which are targeting a younger and more potentially lucrative, active, and long-term consumer demographic.
Innovation in underwriting
Traditional credit scoring is an imperfect measure of borrower risk, one that keeps many consumers out of the marketplace. A medical student, for example, who graduates with US$180,000 of student loan debt, a thin credit file, and a high debt-to-income ratio might not qualify for a loan based on traditional metrics, but could actually be a worthwhile risk for a creditor.
For that reason, companies like LendUp, Kreditech, and Zestcash are working on models to assess creditworthiness using new criteria, including rental records, cell phone payments, and behavior on social media sites such as Facebook. Financing activities also appear in the crowdfunding arena, which involve extending credit — usually at relatively high rates — to consumers seeking to raise money outside traditional financial institutions. These crowdfunding sites, which are effectively self-policing because a nonpayer faces exile, have proven remarkably good at attracting reliable borrowers.
Rewards 2.0
In the technology sphere, we see opportunities for companies in the payments industry to mine customer data and create analytics that can support increasingly sophisticated merchant-funded rewards programs. These programs are becoming more and more pervasive, offered by an ever-broader assortment of national and local retailers, and their success in an era of “big data” is determined by how well they are integrated with the consumer’s path to purchase. The customer’s location — physical store, mobile computer or desktop, smartphone or tablet — as well as recent purchase history, browsing habits, checkout completion rate, response to marketing impressions, and type of credit card used are among the many data points that payments providers can help retailers evaluate to make rewards programs more relevant to individual consumers. This, in turn, should increase sales per active customer and improve retailer marketing ROI.
Mobile wallets
Consumer adoption of mobile wallets depends on a compelling commerce experience. Mobile wallets need to speed the checkout process and make a consumer’s life easier, or they must offer some reward. And despite the existence of numerous mobile wallets provided by merchants, banks, and telecom providers — and most recently Apple — no single entity has gained significant traction in the marketplace. To break the competitive logjam and allow different players to build mobile payment applications more easily, we foresee more collaboration on open technology platforms.
As the payments sector deals with these potentially disruptive changes, the issue of protecting individual data will only grow in importance. Incidents like those at Target and Home Depot cast a poor light on the entire industry and could make consumers less willing to share their credit and debit information, thus hindering the industry’s ability to innovate. For this reason, the industry must work together to earn the confidence of the consumer. But those companies that innovate best around branding, rewards, underwriting, and mobile usage are bound to realize the greatest profit and market share gains.
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