PP004 - Prepaid & European Card Payments
Participants: Peter Jones, Managing Director of PSE Consulting, Peter Scott of Sun Microsystems and Mike O’Hara of Voices in Business.
Mike O’Hara: Hello, and welcome to The Payments Podcast, sponsored by Sun Microsystems and brought to you by Voices in Business.
SEPA, the Single European Payments Area, is undoubtedly going to have a huge impact on the European Retail Banking System. There will be significant new costs for banks, but there’ll also be all kinds of new revenue opportunities as the dynamics of the market change, particularly in the processing of card payments. So what’s driving these changes, and what does the future hold? What kind of consolidation and fragmentation is likely to occur within the card space, and will the growth of pre-paid cards, digital micro payments and other new technologies like contactless payments eventually displace cash? I’m your host, Mike O’Hara, and I’m here once again with Peter Scott, Global Head of the Banking Sector at Sun Microsystems, and this week’s guest is Peter Jones, Managing Director of PSE Consulting, a research and advisory firm specialising in European banking and payments. Gentlemen, good afternoon.
Peter Scott: Good afternoon Mike.
Peter Jones: Good afternoon.
MOH: Peter Scott, over to you.
PS: Thanks, Mike. Okay, well, Peter Jones, I think the first question that we’d like to talk about is drivers for change in the card sector, and what do you see and how do you see the SEPA initiative really driving change?
PJ: That’s a very big question to answer in a relatively short space of time. SEPA, in relation to the cards business, really goes to the heart of how the bankers see harmonisation being implemented, and, as most people will know, over the past three years, the banks, through the European Payments Council, have got together and developed something called the SEPA Cards Framework, and this framework really sets out a set of rules for Europe’s card schemes to adapt to the harmonisation process. It’s not a replacement scheme, it’s an adaptation approach.
Out of that rulebook has dropped a whole host of actions and events, and I don’t think the people who conceived the framework really realised the forces that they were releasing. And it’s had a significant impact on the landscape in Europe well before the planned implementation date of the change.
Yes, I think, to a certain extent, the European Payments Council actually looked at the existing card infrastructure within Europe and recognised that the Card Industry itself was already somewhat ahead of the game in having systems which were closer to a SEPA model than a lot of the existing debit and credit framework within the banking sector.
I think yes, I think the two quite important issues to bear in mind: right across Europe credit cards are almost SEPA compliant, because all of us can use our Visa and MasterCard anywhere. The same is true of Amex and Diners. The big issue that they had to face was what to do with the national debit card schemes, and remember that, UK excluded, Mainland Europe is predominantly 80% debit. So 80% of the transactions, and there are about 27 billion transactions per annum, 80% of those are debit, and they’re all run to local rules and practices. So the idea behind the framework was to try and to get each national market, and remember, initially we’re talking here about just the Euro zone, something like 12 or 13 markets to harmonise and conform and implement common process for predominantly debit cards, and the way in which they’re used.
Right, and a part of that regulatory approach, actually looked to the separation between the scheme rules and governance and the operational side of those existing card schemes.
Yes, and that’s probably the most, sort of, powerful and significant statement that has been made, and what the criticism has been about Europe’s card business, it this word “vertical integration,” in that schemes and processes were all integrated in monolithic constructs, and that the same banks were owners and members of the whole operation. And so this idea of separating processing or delivery platform, it’s a theme that’s applied not just to the cards business, but also to the new rules books that are being set for credit transfers and direct debits. Keep the processing separate, let the commercial side, the scheme concepts and all those pieces, be entirely separate, and by this the hope is that it will increase competition and open up quite a few markets in Europe.
Right, and we know that, at present, I mean, I think there are only a few remaining scheme rules that have their operational environment somewhat still embedded within the scheme rules and governance, and the others have already separated into that operational framework with the separation in between that and the scheme rules. Now, what I’m wondering is, is that really leading to a change in the competitive landscape in terms of a commoditisation of the operational environment, and a growth in the opportunity for some of the larger operational players to go and offer services to some of the smaller players?
It has. Just before I answer that question, a couple of supplementary points, which are just important about the big change that this separation’s created. Important point to remember is the reason why separation’s been important is that some domestic schemes have chosen not to continue to exist and have elected to replace their national schemes with Visa and MasterCard products. And that’s a very, very important issue. That has meant that there’s been significant change.
In addition, out of the market, or out of this scheme change has come a new competing scheme, which is called the European Alliance of Payments Cards, and that’s created a third force scheme which, in the longer term, may well be able to compete with Visa and MasterCard and the other international schemes. So scheme separation has created, on the business side, some very significant events.
Now coming back to your question about what’s been the knock-on effect on the processing business, as groups of banks in national markets have looked at their schemes and they’ve separated them away, they’ve then been left with what you could almost call, like, a pure play processing company. And, of course, in the SEPA market, instead of just being a player in one national market, suddenly these quite large processing companies find themselves being players in 12 or 13 markets, and the bankers have had to really say, “Well, it was okay when we built this business just to meet our needs, but can we really manage and organise this business to be a player in 13 markets, because that’s a very, very different business model and a very different set of competitive forces?” So that’s generated a lot of change.
We did a study for Visa in 2004, and we asked people to predict, at that time, how many of the 80 or so processors would be around in about five years’ time. Now people thought something in the order of about, maybe 30 to 40. Now what has been very interesting is that, in the two years, or two and a half years since we did that survey, we’ve seen at least six or seven or eight changes in the ownership of interbank processors, and what’s happened is, that more particularly, I think FDC or First Data Corporation have, because they’ve got lots of money, been walking around Europe and making very compelling offers, and buying up many of the interbank operations. That’s number one.
Number two, many of the interbank companies have decided they can’t survive on their own, and have sought to merge with other players. Two significant ones, which is really the cards business and what we would call the ACH or credit transfer and direct debit business, have got together, and that’s Interpay and TIA of Germany, Interpay of Netherlands, and that’s called Equins. And here in
Britain we’ve seen VOCA, who are our – used to be BACS, and link our ATM network joined together. Two very significant events. And the third one is in Italy, SSB, who were a big card player have merged in with SIA, an interbank organisation in Italy. And there are also a couple of others that have just happened in the last month; the Norwegian processor, BBS, has struck an alliance with PBS in Denmark, and we’ve also seen some consolidation in a couple of other areas as well, and a couple of other nations, so, very significant change, interbank mergers, and sale of interbank processors to commercial processing companies.
Right, so a very exciting and a very changeable market, a lot of consolidation actually taking place. To what extent do you think that some of these European payment processes are going to fall prey to competition that comes from outside of the EU, and I’m thinking specifically of operators, very low-cost operators like China UnionPay? To what extent do you think there’s an opportunity for those type of operators to enter into the European marketplace?
Well, I think they will, on the basis that the Chinese population is now travelling and travelling widely. China Union is rather like the JCB card scheme that is out of Japan. I think what is very significant is to see the way in which major powers are owning their card schemes. So we have JCB, which is Japanese, China Union, which is Chinese. We then have four schemes out of the US.
Yes.
And one question that is being asked was, “Where’s the European card scheme?” Have we got anything of significance which will enable us to compete in this world? And we haven’t. And I think that’s a very key issue, and, to some extent, rather disappointing because we did have our card scheme six or seven years ago called Europay, and for a variety of business and other reasons, Europe’s bankers sold that off to MasterCard. And I think some people now regret…
That move. Yes.
…that we did that.
There is, certainly a sense, I think, looking at the European Commission, that they would like to see a European organisation in this place, and I wondered, to a certain extent, looking at the drafting of the PSD recently, and some of the amendments that have been proposed, one of which was that transactions relating to inter-European payment transfers should be actually processed within Europe. I don’t know whether this is a move on the part of the EU to fend off external competition, or whether, in fact, it may be something more relating to the governance and privacy of the information, relative to some of the disclosures that SWIFT has made recently.
I think more the latter than the former. This really flowed from suggestions that detailed data on clearing and settlement from Visa and MasterCard might be required to be processed outside Europe. MasterCard has quite a chunk of its processing activity outside the European environment. Visa much less so. But I think this idea of detailed transaction data being made available outside the EU, it comes back to the issue that SWIFT had to face, which was the extent to which Europe feels comfortable in relation to its data protection laws, whether it wants this to happen or not.
Right. Before we move on, is there anything more that you can tell us about this potential Euro alliance of card schemes that could coalesce?
Well I’ve always been a strong supporter of the idea because I think healthy competition is really necessary. The difficulty that everyone now perceives is that, trying to create, in a relatively short space of time, you know, perhaps only two years, a scheme that’s capable of competing with Visa and MasterCard who, let’s face it, have taken almost 40 or 50 years to develop. Those two schemes have enormous resources. They have members and reach right across Europe. Starting from scratch, trying to create a scheme which involves selling to all the banks, making a sales case, knocking on every door, on every floor, as I say, it’s a very, very difficult activity to achieve, and I think that issue, despite good support from the German banks, and banks in the southern regions, it’s a terrifically complex and ultimately expensive task to achieve. So our view is that it will be successful, but whether it can match Visa and MasterCard I think we’d have – I would have my doubts that it will do so, unless there’s some positive discrimination and strong encouragement from the stakeholders, over and above that which they’re doing at the moment.
Right, well, perhaps we can move on from having looked at the factors driving change within the marketplace to really some of the more practical issues facing those card companies, and particularly the operating environments for those card companies, in acquiring more volume, and I wondered whether you had some views about how some of those card processors will differentiate their services going forward? Certainly we know, relative to some of the ACH wholesale payments processes, they’ve got great advantages in terms of economies of scale, and higher service level attributes in terms of speed of processing etc, but clearly they’re now competing with each other, and I wondered whether you’d got some views as to how they will be differentiating their services?
I think there are quite a few strategies that all sorts of processors develop, but if we’re talking here about those interbank companies that are still owned by banks in their national markets, there are varying strategies. Obviously some of their owners decided to sell, simply because they couldn’t build a business strategy. But those that have stayed, obviously some have looked to merge cross border as we’ve said earlier. Others would seek an independent existence by, what we would say, commercialising themselves. And that really means they want to be players in the SEPA pan-European game. So what that does mean is, of course, is offering multi-country, in some cases multi-currency outside the SEPA zone services. So I think we would see those organisations are having to make quite a radical change. Quite a few are not for profit, so they’ve got to rethink the basis on which they’ve constructed their business model. They distribute all cost, and don’t show a profit. Changing that, becoming a market-facing, customer-focused organisation, some big hills to climb for some of them.
Yes.
And quite difficult. Some will struggle. If we’re talking about, maybe seven or eight who are thinking about that, I would say alliances will be quite important. I think those alliances are likely to be not just with similar processing companies, but with technology companies, with people who can help them integrate systems, deliver solutions. I think that’s going to be a very – it is a very important step forward. I think we’ll see these companies; a lot of them are very cash rich and buying up the supplier sector.
Value added services, things like dynamic currency conversion, mobile top-up, VAT rebates, pre-paid cards, processing, all of those new areas, and even contactless payments. All of those new areas I think we’ll see these companies moving into, because it will add extra value to their processing business.
I guess you could say, “What’s the owner’s objective?” I think the owners, given they’re not, you know, they’re all banks, and you could say, “Well, they’re not players in the processing business really.” I think, number one, if they can get more volume through a domestic processing plant, that will reduce their costs, and that’s good for them. But number two, I’m sure some of them look to the five year vision and they might say, “Well let’s IPO, let’s get a private equity company.”
Yes.
But the big target, and one I haven’t mentioned is that, there’s a perception that, unless you can get beyond about one and a half billion transactions per annum, you’re not going to be a player.
I was going to ask you what the inflection point was, in terms of transaction volumes.
And quite a few of the smaller players who are seeking to be pan-European processors, are in that band between half a billion and a billion, and it’s struggling to get up to that one and a half to two billion when processing costs do start to – they’ve come down significantly by that point, you get a big reduction in processing costs up to about two billion. After that, it, sort of, levels off a bit.
I think the Scandinavian countries in particular are, kind of, hovering around that, below that inflection point, in fact, for most of them.
They would be, most of them, because Scandinavia’s sort of a modest group. But, you know, countries like Portugal would be probably in the order of 800, 850 million, not far off the billion. Countries like Denmark, Finland, are probably around that middle band. So more to go, but if the owners don’t want to sell them, then they’ve got to find more transactions to run through that plant, and increase the value of each transaction as well. Add value to it with new services.
Right. I was wondering, for those who are below the inflection point, the, sort of, business and financial issues that these smaller processors would be considering when evaluating, sort of outsourcing propositions?
Well, I mean, remember they are the people who sell the outsourcing services, so most of them, most of them won’t put their core services out, but what has happened as a generality is that nearly all the players are F-Boss providers, so they’re providing terminals and networks, and also ATM providers. And quite a few do CardIssuer processing as well.
Peripheral activity is like terminal provision are being outsourced to either terminal manufacturers or people who have those capabilities, so we’ve seen that bit being cut off. What we don’t see so much is that these people, and one of their particular value adds is what we call Manage Services, and that’s being able to offer call centre support. What we do see, though, is some players moving those activities to one place, let’s say Poland or Slovakia, low cost areas where you can get better economies, people costs are much lower. But broadly, when it comes to outsourcing, I think that’s not so apparent, but there are one or two who have entered into what I call, sort of FM contracts, one I can think of particularly, where they have actually FM’ed the whole of their IT out to one of the big players. So IBM or EDS or whoever, so there are one or two instances of that happening, but in the generality, these people are looking to win outsource business. They want to persuade their member banks and players to give them outsourcing business.
Moving away, then, from card processing, which we’ve talked about in terms of what are the forces for change? It would be interesting, Peter, to understand what you think the card processing landscape is going to look like in, say, five years’ time, after many of the smaller consolidations that we’ve talked about have taken place, after, perhaps, some of the initial investments that some of the countries and super regional groups have made, have either paid off or they’ve actually woken up and said, “Well actually, we can’t afford to continue,” and the second round, if you like, of consolidation is taking place. What is the landscape likely to look like, and how many players do you think there will actually be in the marketplace?
I think that’s partly driven by what banks and consolidation happen in banks. I mean, we’re seeing Barclays and ABN Amro merging, and that’s going to mean two very big processing plants, particularly on the payments side, you know, compressing and consolidating. We have Banco Santander with a similar, you know, initiative. So, I think what we will see is that, as we get bank M&A, we will get efficiency improvements through operating on one common platform. That’s one view.
The second point is that the big pan-European banks, KBC, Nordea, all of those people are seeking one common platform for their operations in multi-countries. So I think we would definitely see the development of the, I would hope in five years, the true pan-European bank, and I don’t just mean SEPA zone. It’s people with a platform that’s multi-country, multi-currency, able to support retail payments in all markets. So that would be a very significant event.
I think that if we’re looking at banks’ efficiency savings. I would hope that, as a result of common software, common terminals, common platforms, and this is on the card and on the ACH side of the business, that probably we’d begin to see – we would have begun down that move towards, perhaps, a 20% saving in transaction costs. In five years’ time we won’t be there, but we might be at the ten to 12% by that point. So I think we’d see banks having operational costs, as a result of harmonisation dropping substantially.
Now if we talk about the processing business, either the interbank and the commercial side, I think if we’ve got – let’s say we’ve got eight or nine independent interbank players, my view would be that that might’ve shrunk down to five or less. Based on the current trends, less, rather than more. We might be at the level of three or four in five years’ time. And what I think that means is that a big chunk of the processing business will have moved to First Data Corp, to the TESIS, two American players, so two American players and probably ATOS, as the primary European player. But, I think in there, well, I would say that organisations like SSB, SIA, VOCA, Link, and some of those conglomerates where people are putting cards and ACH together, I think we’d see them as big commercial players, potentially buying up more as well. They may have absorbed one or two other interbank operators. Their costs? Well, difficult to say. They might get the savings faster.
Now it’s interesting that FDC, through its private equity buyout just recently, one of the interesting events that will flow there is that they’ve absorbed six or seven companies in the last 18 months, but because they’re no longer in the public gaze, they can take money and rationalise their platforms far more rapidly, because they don’t have to give quarterly reporting results. That will propel the market almost certainly to show savings, and my guess is that, looking at the five year point, we may see in the processing business costs down by 15% in five years, again with a ten year objective of being 20% lower than they currently are.
Yes, it’s funny, isn’t it? I think, to a certain extent sometimes, that the payments business is going to end up like the automotive business, and one of the things they’re saying is that the automotive business ultimately will become a branding and design business, and the whole business of building cars will be something that will be simply outsourced to commoditised, low cost high quality manufacturers. And I think we’re beginning to see that trend as well, and I wonder, to a certain extent, whether the Financial Services Industry is going to go the same way, where branding and specific packaging of service propositions and the design of those service propositions is what’s going to differentiate the banks, and we’re going to see far more commoditisation of processing by very, very high volume throughput operators.
I think so. I think – I think I would, I mean, just off the top of my head, I would have said there were perhaps three models you can see. You’ll see the commoditised big volume ones, and probably that will be, like, for core, central processing, and the big banks will be seeking that. I think you’ll then have what would call almost like bespoke but multi-country, multi-bank, but for all of one bank. So one big bank with 20 operations across Europe, might well have outsourced a complete bespoke solution but it’s a, sort of, a mini multi-client processing.
And then I think, last of all, you’ll see people who are the, sort of, niche players, who are high in value add, who maybe are just at the billion threshold or a little below that. And what they will do is deliver the specialised tailored solutions which are merchants, Corporates and to some banks. There’s a real market for those players, who can offer something that is, sort of, unique and distinctive, and I think that means moving up, probably up the merchant and Corporate value chain, but putting in many more things that will suit a pan-European Tesco, or a pan-European hotel chain. I think we would see those niche players winning in that market.
Well, we’ve talked about the card space and the processing issues, the competition, the likely structure of the market going forward. Let’s just spend a little bit of time talking about innovation in the card space and where we perhaps see that going. The pre-paid market, I know, is something that your company has a speciality in. We’ve talked about the wholesale card processing space. We’ve talked about competition, forces for change. We’ve looked at how the landscape of the card processing is going to alter, and what it potentially is going to look like in five or so years’ time. Let’s now, in the remaining minutes, just turn our attention to payment innovation in the card space, and talk a little bit about the pre-paid market, which I know is an area of speciality for your company, Peter. We’ve seen pre-paid emerge in areas such as travel cards, sponsored by people like Lloyds TSB, onto which you can put Euros, you can put US dollars, almost in replacement of the old Travellers’ cheques business. But we’ve probably seen a much greater preponderance of pre-paid in the low-value market. Would you like to just talk about where you see that business going, and perhaps what you see as being the major current initiatives?
Yes, I think PrePay really grew in America out of the gift card business, which is obviously highly paper intensive, and Americans, and probably Brits as well, are very lazy and, you know, will go and buy, do all their shopping the day before Christmas and buy gift cards to hand round the family on Christmas Day.
These are the gift vouchers that you can get, and so book tokens and things like this.
Book tokens and whatever, because it avoids you making a decision or the wrong decision, which is the sort of thing I always do when I’m buying presents for my wife. So that market is about 70% of the pre-paid business, and all really prepay doing in that sector is creating an electronic account, a card is attached to that account, the person receiving the card can either spend on that card anywhere within a chain, and that’s a, sort of, closed loop, or, in some cases, in quite a lot of cases, the card gets issued with a Visa or MasterCard brand on it, and the individual can use that card anywhere a Visa and MasterCard sign is shown, so it’s a much bigger offer than just a simple gift voucher. And some of these gift cards also have facilities to enable you to top it up, and you can use it, by putting more value in, it can be used, you know, more or less continuously if that’s what you wish.
So if you can imagine, this was the founding basis of PrePay, but the prepay application it’s more than just gifting, and you can build on that same platform all sorts of offers for remittance processing on cross border, for benefits payments, for the payment of student grants, the whole concept really relates to the ability, very often, to put money into an account from a variety of sources, and also to take cash, and load that onto the account as well.
So, typically, about 12 or so different products can be built in the prepay market. It’s grown very rapidly in America. It’s now growing pretty rapidly over here inEurope, partly because, and back to one of your first points, it’s quite attractive to the unbanked sector. It’s quite attractive for immigrant workers over here, let’s say, people from Poland working in Britain, or British people working in Brussels, or students, and whatever it may well be. All of these pre-paid offers enable people to do things more simply, provided they meet the money laundering criteria.
I was about to say, the regulators may be concerned about this.
If they meet the regulatory criteria, then there’s a nice new offer that can be made, and just recently, today, I think in the Financial Times, quite a big focus, as you mentioned, on all the British banks, focusing on immigrant workers, making them offers, and many of those will be based on the pre-paid card concept, lower cost, more convenient to use.
Yes.
I think the second point you raised about low value transactions, I think this is really linking a part of prepay, but much more the contactless payment concept to linking that to the chip that’s already on the card. And here in London, we’re going to see two major initiatives. I was going to say pilots. They’re more than pilots.
The first one is that Barclaycard will be issued with the Oyster Card. And that means it can be used in the Underground as your Underground and partly surface-travel card, but more importantly, it can be used for low value payments wherever the Visa sign is available, and where they’ll have the contactless technology. The thing about contactless is that, not only is it what we call tap and go, you can dematerialise the receipt, you don’t have to have a PIN, and so, because it’s very convenient, very speedy, it’s the sort of thing we’ll all be using for our cup of coffee or whatever it is, in the station and probably at lunchtime as well.
Do you see an upper limit to the transaction value there?
Well, typically, what it’s doing is working in conjunction with the E and the chip and the rules, and beyond a certain number of transactions, the card will have to go online to be authorised, and then it will move on again to another.
So a certain daily limit, in terms of the…
Yes, a daily limit, a value limit, or a transaction limit. It may well be – it’ll be a combination of both. But a similar pilot’s being run by RBSG using their MasterCard brand, and if that proves successful here in London, then I think that will be a model for, I think, the rest of Europe. As you probably are aware, that about 75% of the 350 billion cash transactions in Europe are probably below 20 Euro in value, so it’s a very, very significant market. We all tend to be, in the cards business, card centric, but card payments only represent about 7% of total payments. Six out of seven transactions are in cash. So there’s an enormous opportunity for cash to be displaced in Europe, and I think if we’re coming round the loop to see where does SEPA fit into this, this vision of using new technology, pre-paid contactless, mobile payments, what that can do is deliver more volume, terrifically high volume and it’s a terrific opportunity for banks to grow their businesses as harmonisation takes place. So, my view would be that you’ve got to innovate if you’re actually going to recover the cost of harmonisation under SEPA.
Yes, I think there’s certainly very powerful arguments behind the removal of cash and the impact on the growth and prosperity of the region. It’s interesting to note, actually, that when we were talking about cash displacement, that one of the lobby groups in Brussels actually represents the people who drive round in vans carting cash around, who are expressing concern at the implications of the SEPA, sort of, direction, that it’s going to, effectively, put them out of business, which is probably a good sign for all the rest of us.
Yes, that’s true.
And a good point to end on there, I think.
Indeed, yes. So, Peter Jones, thank you very much for that. I understand that PSE Consulting put out White Papers on a range of topics around payments. Where can our listeners go to find out more?
They can get that from our website.
And we’ll put a link to the PSE Consulting website within the show notes for this episode.
Just a quick note to our listeners, if you would like to subscribe to The Payments Podcast, then go along to paymentspodcast.com and on the right hand side of the screen there you’ll see full details of how to subscribe, using iTunes or via email or using RSS. I think that’s it for today. Peter Scott, thank you very much.
Thank you, Mike.
Peter Jones, thank you for coming along today.
Thanks indeed, Mike.
And thanks to our listeners for listening. Speak to you next time.
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