The New Business Model of the Payments Industry

How Startups are Creating New Revenue Streams by Adding Value to their Merchants On Top of Processing Payments.

Within the last couple of years, FinTech and especially Payments has seen some amazing companies emerge out of nowhere. Most notably are of course Stripe and Square, which have been able to amass valuations of $9.2 and $18.9 Billion (valuation Tuesday April 3rd, 2018) respectively. Being recognized for their ability to change the customer experience in both the online and the offline world, there are some that say that both companies have done very little to actually change the status quo. Having been build on top of the existing infrastructure of Mastercard and Visa, Stripe and Square, have not changed anything fundamentally about Payments, however they have been adding a new perspective on how to monetize payments in the future. In this post, I discuss how new startups are changing Payments and how they are leveraging data to create long-term profitable companies.

The E-Commerce Startup: Stripe

Drastically changing the way in which Payments was integrated into websites and apps, Stripe focused on a developers point of view. Making the integration of Stripe as easy as possible, while providing a user experience with the same objective. Gaining a lot of traction with highly profiled startups, including Lyft, InstaCart and Facebook, Stripe has been able to grow to over 100.000 merchants using their platform.

With Payments being at the core of Stripe’s platform, they have focused on launching products that provide the same easy integration and use. With the rise of the subscription model based companies, Stripe launched Subscriptions, to make subscription billing as easy as possible. Another fast growing business model was platforms, which through Stripe Connect reduces the PCI and KYC obligations for merchants, by providing companies the ability to simply manage who will receive funds as well as the identification of merchants/users.

In recent years, Stripe has launched services that focus on making it easier for merchants to run their business. Atlas gave non-US entrepreneurs the ability to start a company in the US, to expand their startup. To further protect their merchants from the increasing trend of Card-Not-Present Fraud, Stripe launched Radar, a Machine Learning based fraud detection tool, which in combination with rule-based logic is able to block possibly fraudulent transactions.

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The POS Startup: Square

When we look at Square, they have essentially done the same thing as Stripe, which is improve the customer experience on both the shopper and the merchant side. With the introduction of Square’s card readers, Jack Dorsey and Jim McKelvey, where able to change smart phones in to Point-of-Sale devices, creating what is now better known as mPOS (Mobile POS). Throughout the years, Square has continued on developing more advanced and user-friendly devices for both the shopper and the merchant, including the Square Stand and Square Register. Besides developing better hardware, Square has also been able to develop services based products like, Square Capital to provide loans to merchants and Square Payroll to help manage employees and salaries. Square also acquired a high-end restaurant meal deliver company called Caviar to replace it’s own app Square Order.

Is the current business model sustainable?

By adding more services on top of the core product, which is Payments Processing, companies like Stripe and Square are trying to diversify their revenue streams, because the increasing commoditization of payments is eliminating their largest revenue stream.

Within the Four Party Model (Gateway, Acquirer, Scheme and Issuer), Stripe and Square operate as a Gateway and charge a markup on top of the Interchange (Issuer), Scheme Fees (Schemes) and Acquirer Markup to generate revenue. Dependent on the size and volume of a merchant, this markup can range anywhere between 0% — 2%. As companies increase their processing volume, they are able to negotiate better rates, which mostly comes out of the pocket of the Gateway, because the Interchange, Scheme Fees and Acquirer Markups are hardly negotiable.

So one might ask the question, if payments is being commoditized and will essentially become free, how will payments companies make money and investors be able to recoup their investments?

As I already alluded to, Stripe and Square are already making deliberate decisions to diversify their revenue streams, by leveraging the data (Payments), to build new products and services and sell those to their existing customer base. But up until now Stripe and Square have been focussing on the low-hanging fruit, mostly because they have build their products on top of an infrastructure, which does not allow the kind of flexibility necessary to become truly innovative.

Creating a better (Full-Stack) Product

As we look at companies who own a larger part of the Payments Value Chain, the true opportunity lies in developing a better product by leveraging the Cloud and Big Data.

Within the Four Party Model, we have seen Gateway’s apply for Acquiring licenses, which have had a very interesting impact on the industry. Where traditionally the Gateway, Acquirer, Scheme and Issuer, operated as separate companies, the Full Stack Acquirer has become both the Gateway and Acquirer. This has created an opportunity due to the access to a richer data set that is available to Data Scientist to improve on the inefficiencies in the existing process.

A better alignment between the Gateway and Acquirer can lead to higher Authorization Rates, by analyzing the large quantities of data and developing features that use the insights to optimize the payment or processing rails. Another way of improving the product is by extracting the patterns that occur in fraudulent transactions, to flag or block new incoming transactions that have highly likelihood of being fraudulent and using those insights across the platform to help other merchants as well.

As every other technology company has build their platform in the Cloud, new players in the Payments industry are now choosing to host and process payments in the Cloud as well. By processing payments on AWS, Google Cloud or Microsoft Azure, these companies are able to leverage state-of-the-art Big Data technologies to create Machine Learning based Fraud Engines, enable GPU-powered data analytics or provide Payments Optimization by A/B Testing multiple variations of a Payment.

Improving Processes

As the Cloud and Big Data helps to improve the underlying Product, API’s and Real Time Processing help improve the Process. In the past PayPal has shown that building an API can provide new startups with the flexibility and features a larger PSP might not be able to build. Venmo used the API of PayPal, which sat on top of the existing Payments infrastructure, to build a Peer-to-Peer Payments service. Recently, Stripe launched Sigma, to give their merchants the ability to query their own data, reducing the necessity to create their own data warehouse, while at the same time re-enforcing that Payments are the single source of truth companies should be build around. Besides querying data, API’s could expose real-time access to Forex rates, Risk Scoring, Financial Positions, Performance Metrics, which could allow merchants to build even better customer experiences.

Another interesting development has been Real Time Processing, inspired by Cryptocurrencies and Blockchain technologies like Bitcoin and Ripple, card schemes are recognizing that their systems, which were build decades ago, are not meeting the expectations of users in the age of the Internet and Mobile. Even to this day, processing a credit card transaction can take anywhere between 1 and 10 days. But as Mastercard and Visa hold on to there dominance, they have been working on several “innovations”. Visa Direct and Mastercard MoneySend, use Peer-to-Peer technology using their existing rails, moving away from Batch Processing and more towards Real Time Processing to provide users with the ability to send and settle transactions in seconds rather than days.

Mobile and Apps

As with all technology the back-end, which does most of the heavy lifting, never gets the same kind of attention as the front-end. This is where companies like Stripe and Square have been able to put a “face” to the name. The branded checkout pages from Stripe and sleekly designed devices from Square have helped in creating the brand and eventually the higher valuation. From the issuing perspective ApplePay and AndroidPay have changed the way that people pay by making transactions with their mobile phone as simple as possible.

As more consumers are placing orders on their Mobile or using Apps like Uber (Transportation), Deliveroo (Food), Amazon (Shopping) and Facebook (Social) to provide goods and services, PSPs need to ensure that they provide easy integration into these platforms to capture the transactions that are taking place. By leveraging the hardware technologies as well as build features to provide faster checkout and security, PSPs can differentiate themselves from companies that are not as flexible and innovative.

SDK’s a.k.a. Software Development Kits, have become the new standard that PSP’s have to provide to ensure that the integration into the App is as quick and as easy as possible, while still giving businesses the flexibility to play around with functionality and design.

But even though companies are developing more Apps that feel more native to the devices that consumers are using, shopping through a browser is still huge, on desktops, laptops, tablets and even phones. So by providing the Plugin’s to support E-Commerce shopping platforms like Magento and Shopify is equally important as providing a great API and SDK.

The Opportunity Still Exists

As the Commoditization of Payments continues, we are already seeing consolidation, not just on the Acquiring side with Vantiv and WorldPay, Ingenico and Bambora, First Data and Acculynk but also on the Scheme side with Visa Inc. and Visa Europe, Mastercard and VocaLink.

However Gateway/Acquirers that are still agile enough to improve their core product by leveraging data, improve processes by creating API’s and enabling Real Time Processing and build there services to be delivered on Mobile and in Apps, still have the ability to provide the kind of value that merchants are actually looking for. In the end the Payments company that will come out on top, are able to process transactions and use those payments as the stepping stone to develop additional services that will augment transactions, as well as inform, support or help merchants to manage those payments.

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