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Payments as the 'tip of spear' strategy for players in the global fintech landscape
The new breed of challenger banks and fintech players have used payments as hook into a broader ecosystem aimed at gathering service fees for distribution of financial products. Globally, the biggest testament to this is Ant Financial’s Alipay and Tencent’s WeChat Pay who dominate China’s $41T mobile payments market. In the US, Amazon, Facebook, and Google have their sights on winning the growing but competitive digital payments landscape, especially in emerging countries such as India.
As per CB Insights, Amazon has lent billions of dollars to its 2.5M sellers and over 45M people use Google Pay in India. Apple plans to launch a credit card with Goldman Sachs, and over 100M people in China are using all five financial features of Ant Financial’s Alipay app (payments, wealth management, insurance, lending, and credit scoring) in China. Today, 43% of the 900M global iPhone users have enabled Apple Pay, as Apple focuses on expansion into international markets such as Eastern Europe. Meanwhile, Facebook has declared ambitious plans for its forthcoming digital coin offering (Libra), which would allow users to transact with each other and make purchases on WhatsApp, Instagram and across the internet.
Big tech companies are leveraging their access to massive e-commerce marketplaces and high-frequency partners such as ride-hailing and food delivery services, and have also starting to engage directly with developers to integrate specific payments features. Newer fintech challengers will need to understand how big tech companies are attracting users to their platforms and how payments will be reshaped as they expand their payments strategies to new markets.
Ultimately, payments is being used as a 'tip of spear' strategy by these players who are tapping into high frequency customer use-cases, developing stickiness of balances and gathering massive consumer data to eventually build enough trust and monetization through these four large, high-growth verticals:
· E-commerce (sale of products)
· Financial services (e-banking, wealth management, lending, insurance etc.)
· Social interactions (ad-based revenue)
· Volume-based interchange fee
To further the discussion on how payments is being used as the 'tip of spear' strategy, a hook into a broader ecosystem mentioned above, lets look at some of the mega-trends and key moves by industry players that are defining this dynamic landscape:
1. Every tech giant is attacking payments
Payment evolution in China with Ant Financial & Tencent: Launched originally as the online payments gateway for Alibaba’s Taobao marketplace, Ant Financial is today the largest fintech platform in the world, spanning payments, wealth management, lending, credit scoring, and insurance. To drive revenue, Ant has historically focused on payments through its mobile wallet Alipay, which has grown to over 900M users worldwide. Now, it’s using its mobile wallet Alipay as a hook into its broader financial services ecosystem, where it charges financial institutions tech and service fees with high margins. Because Alipay now serves largely as a hook, Ant is aggressively doubling down on offline payments by promoting Alipay use cases in fast food, department stores, public transportation, and more in order to bring more users into its ecosystem where it can serve them loans, insurance policies, and wealth products.
Like its rival Ant Financial, Tencent is rapidly expanding beyond its start in digital payments into lending, wealth management, and insurance. Tencent’s fintech strategy has hinged on its ability to cross-promote financial products to its massive WeChat and QQ user base of 1B daily active users and to leverage its expertise in gamification techniques to boost growth.
Apple: Apple is undergoing a strategic shift away from one-time hardware purchases and toward recurring “services” businesses that boost revenue per user. The company hopes to boost Apple Pay adoption as it opens up opportunities into a broader financial services platform that encompasses payments and credit cards as well as personal loans, wealth products, and more.
Amazon: For now, Amazon’s strategy in financial services has been focused on supporting its core strategic goal: increasing participation (both from buyers and sellers) on its platform. However, Amazon has previously built core product pillars for itself and then transformed those into key, outward-facing lines of business. This was the case with Amazon Web Services (AWS), which was originally server infrastructure for Amazon’s e-commerce marketplace, and then re-purposed for external clients and third-parties. Amazon is finding ways to attract merchants to the Amazon Pay network: The company announced it would pass along savings it gets from card networks (which process Amazon’s payments at a lower cost due to Amazon’s large payments volume) to merchants that adopt Amazon Pay. Of note, Amazon Pay is also a key product in Amazon’s strategy in India, where it’s both a digital wallet (which consumers can load with cash) and a payments processor. Amazon also launched peer-to-peer payments via Amazon Pay for Indian users, allowing them to pay friends and family, as well as Amazon merchants and delivery workers.
Facebook: To jumpstart its payments initiative, Facebook reportedly plans to hire more than 100 people in London and Dubai to build out WhatsApp Pay. Meanwhile, Facebook’s broader plans in financial services may hinge on its development of the digital coin offering, Libra that would allow users to transact with each other and make purchases both on Facebook and across the internet. As of early 2018, WhatsApp had 1.5B users in 180 countries and 1B DAUs (daily active users). WhatsApp Pay is a peer-to-peer money transfer feature that is currently only available in India. Since February 2018, when WhatsApp launched a trial in India, the service has processed an average of 1M transactions per month. As users transact over WhatsApp Pay, Facebook can (1) earn payments processing revenues, (2) acquire and analyze a treasure trove of transactional data, and then (3) create an ecosystem of additional financial services products within WhatsApp. In January, Facebook announced plans to integrate its messaging services — WhatsApp, Instagram, and Facebook Messenger — under a single, unified technical infrastructure, allowing for cross-platform communications. Given this push, a single payments platform looks like it might also be in the works. A unified payments infrastructure would transform Instagram, WhatsApp, and Facebook Messenger into interoperable digital wallets. The move would also catapult Facebook into a potential major player in both digital payments and cross-border payments – both markets worth trillions of dollars.
Google: To avoid conflicts with its core search business, Google has largely focused on driving payments through its digital wallet, Google Pay. In Europe, Google Pay recently obtained an e-money license from Lithuania, while in India, Google Pay has grown to 45M monthly active users. Google Pay is another step in developing a deeper relationship with the user through both online and offline payments use cases, with the aim of boosting internet adoption and, eventually, future ad revenue through Google services. The success or failure of Google Pay will likely influence Google’s broader moves into financial services around the world. Thus far, India has provided a test site for such efforts. For example, Google Pay started offering instant bank loans from HDFC Bank, ICICI Bank, Federal Bank, and Kotak Mahindra Bank. Users can obtain a customized loan in the Google Pay app and get the money deposited directly into their bank account.
2. Lack of closed-loop ecosystem in US has led to inefficiencies and opportunity to eliminate high-fees intermediaries
US merchants pay high fees to participate in bank-backed, open-loop card networks. In a standard $100 credit card purchase in the US, $97.30 might go to the merchant. In a standard ¥100 purchase via Alipay/ WeChat Pay (non-bank), ¥99.30 might go to the merchant. Alipay and WeChat have built closed-loop ecosystems in China, and merchants benefit. Consumers and merchants are Alipay’s and WeChat’s primary customers.
The US payment system continues to operate on legacy rails due to the entrenched four party interchange system, regulatory blockers and intense free-market competition which makes forming partnerships harder due to concerns over customer data and control.
However, many players are launching financial products on the back of their initial successes to keep the customer transacting within its ecosystem – this erodes fees that intermediaries charge and increase customer engagement. For example, Square could build a full-fledged closed-loop ecosystem with its SMB debit card. SMBs who spend with the Square card at a Square merchant receive 2.75% off the purchase – the typical merchant discount rate in the US.
Apple is trying to do the same. Apple card’s daily cash back (deposited into Apple’s mobile wallet) injects liquidity into Apple Pay for e-commerce and peer-to-peer payments (Apple Pay Cash). This positions Apple to compete with Venmo, Zelle, and Square Cash, and keeps money inside Apple’s ecosystem. If merchants and consumers both transact via Apple Pay, a closed-loop could be established, cutting card networks and issuing and acquiring banks out of transactions.
Amazon Pay is leveraging network effects for both merchants and consumers to compete with payment gateways and online point-of-sale providers. In the near-term, Amazon is looking to collect processing fees, capture market share, and decrease fees currently collected by incumbents. Longer-term, this could be the first step towards a closed-loop ecosystem.
3. P2P players have witnessed rapid growth in the US during last few years
One of the features that propelled WeChat Pay into China’s second-leading mobile wallet was localized innovation around P2P money transfer. The WeChat Red Envelope was created by Tencent in 2014. The product, which allows users to seamlessly send small amounts of money to others in the form of Red Envelopes (or hongbao), drastically changed how users engaged with virtual money transfers. Around 14.2B Red Envelopes were sent using WeChat over Chinese New Year in 2017, compared to 16M in 2014. Another major way in which WeChat Pay established market share was by partnering with high-frequency mobile marketplaces such as Didi Chuxing in ride-hailing and Meituan Dianping in food delivery. Today, WeChat Pay has formed a gigantic payments ecosystem across major use cases, including shopping, food & drink, and travel.
Payments incumbents around the world could learn from WeChat Pay’s strategy in partnering with leading online-to-offline services. Some are already embarking on similar strategies. PayPal, for example, recently made a $500M strategic investment in Uber, and will “explore future commercial payment collaborations, including the development of Uber’s digital wallet.”
P2P might be the tip of the spear in sidestepping banks, card networks. We have seen the rapid rise of Square Cash and Venmo in US, the latter reaching over 40M users – one of the largest fintech apps just behind Credit Karma which has ~90M users. P2P is the gateway to empower customers to shop, both online and offline. As liquidity increases in Venmo, ‘Pay with Venmo’ now sits alongside PayPal, Credit at checkout. This huge deposit base can in turn be used to provide more consumer benefit. Kenneth Lin, the founder of Credit Karma, talks about the concept of ‘autonomous finance’. This could eventually result companies offering each dollar in a user’s account to ‘self-drive’ towards the most efficient allocation and risk/return through algorithms and personalization at scale.
4. Identity verification is becoming cutting edge – KYC/AML startups are booming
Today plastic cards reign supreme in the US. According to a Federal Reserve poll, most US citizens would pay for a $10 purchase at a local store with a debit card (37%), followed by cash (36.8%) and then a credit card (24.3%). The problem is that cards are slow and – for e-commerce transactions – quite insecure. US retailers, from Target and Starbucks to Walmart and Dunkin’, have started using QR codes to facilitate mobile payments and streamline the checkout process.
Mobile devices, payments platforms enable a more dynamic point-of-sale experience Mobile wallets digitize existing plastic cards and make them more secure by transacting at the point of sale with “tokens” instead of actual primary account numbers (PANs). This means that a merchant never knows a consumer’s credit card number or other sensitive information.
However, QR codes, NFC, and mobile wallets don’t shift the value chain all that much – the entrenched four-party interchange system remains. The customers are burdened with the need for Ownership (e.g. of a physical card) and/or Knowledge (e.g. of a PIN, password). China is already re-imagining this future with no ownership or knowledge required, with the elimination of point-of-sale, as biometrics allow for secure, ambient payments. China is leading here, with self-service stores using facial recognition to pay and checkout - from ordering at Starbucks’ 2,800 China locations to self-service WeChat and facial scan payments at Carrefour “smart stores”.
Many startups are focusing KYC/AML applications, especially back office solutions for Big banks which operate on legacy rails that have been built in-house over years – the market is ripe for disruption.
For example, Blockchain identity solution provider Shyft, in partnership with global data rights firm Trunomi and blockchain firm BurstIQ, has introduced an e-ID solution for online and offline personal identification and authentication. Onfido leverages machine-learning technology to scan multiple verification databases and run cross-sector background checks remotely. Verato, a cloud-based platform that cleans, validates, and links customer/patient records across systems to create a master centralized record. Trunomi provides customer consent and data rights management technology, which enables businesses to request, receive and capture customer consent to the use of their personal data. For the business, Trunomi creates consent receipts and convert them to customer data rights, which are accessible across all data systems. The company enables businesses to comply with regulations (EU GDPR) and data privacy laws and replace inefficient and costly legacy approaches. For the customer, Trunomi provides control and transparency over how their personal data is used. These startups are helping open up speedy access to customers for fintech players by providing an underlying tech backbone to identity verification and management. This could provide the springboard for payment players to obtain buy-in from regulators to expand their scope and scale of services.
5. Payment as a gateway to other services: Battle for deposits, wealth management, PFM tools, alternate lending
While mobile payments made up the bulk of Ant’s revenue in its first 10 years (accounting for 54% of total revenue in 2017), Ant’s decision to add additional financial services products sold by financial institutions to its platform has broadened its market opportunity to bring in more revenue per user. This matters because it has rendered the primary function of Alipay’s mobile payments service as merely the gateway to Ant’s broader suite of financial services. In order to bring more users into its ecosystem, Ant has been aggressively investing in offline partnerships and strategic moves such as Starbucks, its Hema grocery store chain, and public transportation systems such as Shanghai Metro
Wealth management has become the hottest fintech sector in China. Lufax and Ant Financial raised over $15B in funding as China’s broader fintech landscape consolidates. Tencent and Ant Financial’s expansion into wealth management and investing highlights their platforms’ power to combine massive data and distribution to rapidly launch and scale in financial services.
In 2018, the battle for millennial deposits became more aggressive as fintech account products hit the market. Monzo, Revolut, and N26 became unicorns and, though none went live, all established US operation plans for 2019. By attaining a customer’s paycheck, fintech challengers are able to make money on interest, and more importantly, set themselves up for future product innovation. If a customer’s money is already being deposited in an app, introducing new products — such as savings and investment accounts — can be seamless. Debit cards are often fintechs’ first crossover product because the service adds another product and revenue stream. Fintechs are also able to receive significantly higher interchange fees than traditional banks as a result of the Durbin Amendment, which limits the fees stores pay banks when customers make purchases with debit cards
Given regulatory hurdles and market differences, it’s harder for sudden aggressive moves by US tech giants into wealth management; however, there will be eventual shifts in how US tech giants are able to shape personal finance. Apple’s PFM tool for its forthcoming card offering with Goldman Sachs, for example, will provide an Apple-branded dashboard to track spending habits, a credit repayment calculator, integrations with Apple Maps to verify merchants, and integrations with Apple Messages to quickly contact Apple Card customer service.
The launch and closure of Google Compare illustrates conflicts between a massive ad business reliant on financial services incumbents and efforts to make deeper inroads into distribution of financial services. Meanwhile, Amazon is growing its efforts to bring Amazon Web Services to the insurance industry.
Another big vertical growth is alternative lending, especially to SMBs. Amazon’s ability to leverage proprietary data on sales, conversion rates, checkout metrics, and merchant ratings to provide loans to small businesses highlights the power of platforms to reinvent traditional business-lending models and provide capital to their clients. For example, Amazon requires borrowed funds to be spent on Amazon Marketplace inventory, which helps merchants fuel their sales growth. According to Amazon, 50% of borrowers take out a second loan. In recent weeks, Amazon launched a new lending service in China aimed at providing short-term loans to China-based merchants selling to Amazon customers in the US. Platform lending is expected to continue to grow and reshape small business lending as additional platforms such as Square, PayPal, Intuit, Toast, and others leverage the aligned interests with their merchants and the ability to use machine learning to analyze the growing private data on their platforms.
Personal finance management (PFM) is another interesting vertical. For example, integrating Apple Card’s PFM tool into the broader Apple ecosystem has serious implications for banking incumbents. The tool will provide an Apple-branded dashboard to track spending habits, a credit repayment calculator, integrations with Apple Maps to verify merchants, and integrations with Apple Messages to quickly contact Apple Card customer service. All of this means that Apple Card will seamlessly communicate with Apple’s most popular mobile apps. Longer term, this confluence of data across channels and apps could allow Apple to surface other financial products via its PFM tool.
With the launch of an in-app checkout feature, Instagram is transforming itself into a full-blown e-commerce platform. On the one hand, this means “selling fees” for Instagram, collected on each transaction. On the other, the combination of powerful network effects, data, and a streamlined checkout process positions Instagram to compete with e-commerce incumbents and offer more personalized, tailored shopping experiences.
So what are the big learnings for incumbents and new players?
Ant Financial’s open platform playbook proves successful for other challengers around the world. Ant Financial’s strategy of using payments as a hook into an ecosystem of higher-margin financial marketplaces serves as a case study for how tech platforms around the world could dislodge incumbents by developing into the primary channel to obtain financial services products.
In Latin America, for example, leading e-commerce marketplace MercadoLibre is rapidly building out its own payments wallet, MercadoPago, which did $5.6B in total payments volume in the first quarter of 2019. Similarly, in Indonesia, ride-hailing giant Go-Jek is activating its drivers into agents who ask riders whether they want to store change in its mobile wallet Go-Pay and earn future discounts. Eventually, we expect both MercadoPago and Go-Pay to develop into broader financial services ecosystems similar to Ant in which payments is merely a hook. As Ant’s international strategy focuses on partnering with, investing in, and building out leading mobile wallets in different local markets, one way incumbents can stay ahead is by seeking out and working with such wallets first.
PayPal offers a good example. In South Korea, PayPal made a strategic investment through its venture arm PayPal Ventures in leading digital wallet Toss, which counted nearly 20% of the South Korean population as users as of Q4’18. More recently, PayPal made a $750M investment in MercadoLibre with plans to integrate its capabilities into MercadoPago’s payments experiences in the future.
Ant’s open platform strategy relies on its massive digital payments service acting as a hook which, along with Tencent’s WeChat Pay, dominate China’s payments landscape. But Ant’s playbook also informs how growing fintech challengers using hooks outside of payments are developing into broader financial services platforms. In the US and Canada, for example, Credit Karma has used free credit scoring and education as a hook into more than 90M users. Like Ant, Credit Karma earns fees every time a user buys a credit card or obtains a personal loan through the platform. Meanwhile, Revolut and Robinhood have scaled to millions of users via features such as money transfer at the interbank exchange rate and commission-free stock trading to entice new customers. More incumbents look to replicate successful user acquisition features from fintech challengers. JPMorgan’s You Invest platform, for example, offers 100+ commission-free online stock and ETF trades, while RBS plans to launch a digital-only bank called Bó, which hopes to compete with challenger banks by targeting low-savings customers with services to help manage their money better.
I hope this article helps better understand the nuances behind the new breed of challenger banks and fintech players who are using payments as the ‘tip of the spear” into the broader closed-loop ecosystem opportunity.
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Sources & Credits: CB Insights, Newsletters, Trade Press, ISI Emerging Markets, 10K of companies