Because the payments industry, like countless industries before it, is being disrupted – and commoditized – by the internet. Intermediaries are being cut out. Margins are being depressed. And transaction fees are being converted to loss leaders.
How is that possible?
Because we’ve hit an inflection point. Today, money is little more than “bits of light assembled in secure packets” (to quote a mentor) and issued by fiat. I value $1 because you value $1 and we trust each other because that dollar is backed by the “full faith and credit” of some government somewhere.*
Money stopped taking the form of gold bullion decades ago. Its modern form more closely resembles an email, SMS or WhatsApp message. Likewise, a payment is now little more than a secure communication that updates a ledger somewhere. That’s why startups like Dwolla are able to build their own payment networks on the cheap (relatively speaking). It’s also why Google added a send money option to Gmail and why Facebook poached David Marcus from PayPal to run their messaging strategy.
Okay, but how does that affect traditional players?
Securing a communication and updating a ledger isn’t that difficult, so entering the payments industry isn’t as daunting as it used to be. As new players enter the arena, their first task is to differentiate themselves from the competition, which can take the form of lower fees, faster access to funds, better user experience, customer relationship management, access to finance, etc.
Most players enter the market by competing on price (see Amazon Local Register vs. Square). In turn, existing players respond by upping their service quality, increasing their service options, or lowering their prices (some don’t respond at all, but this isn’t a viable long-term strategy). This continues until the players reach some sort of market equilibrium, which increasingly results in a free or at-cost transaction fee.
Some new entrants launch their businesses assuming a 0% transaction fee from day one. Take LevelUp, for instance, which calls for “interchange zero” in the United States. LevelUp’s bet is that it can make more money on transaction data than it can on transaction fees, so it removed transaction fees entirely for eligible merchants. If you accepted Visa via Wells Fargo for 2-3% per transaction and LevelUp offered to let you accept Visa for 0%, what would you do?
Fair enough, but how do any of these companies survive?
That’s precisely the question, and it’s why your friend at the party had to whisper. The industry may be at an inflection point, but it’s not entirely sure where it’s going. One direction, which we’ll discuss in a subsequent post, is what we like to call the “lending layer” – a financial services layer that sits on top of the payment rails. But that’s only one of many – and I do mean many – potential directions.
The answer may be uncertain, but the question filling board rooms from London to Lagos is: What do we do once transaction revenue disappears? How do we survive?
– Ben Lyon (@bmlyon)
* Or because we’ve verified it against some public ledger.
UPDATE – September 12th, 2014 – As a clarification to the above, LevelUp has offered select merchants a 0% transaction fee in the past, but normally charges 1.95% today. For the purposes of this piece, Airtel Money in Kenya (internal P2P transfers) and Square Cash in the US are likely better examples.