By Natasha Roy, Himadri Sikhar Pramanik and Manish Kirtania, TCS
With digitization assuming significant thrust today, where is the micropayments industry headed? In this article on the evolution of micropayments, we look at the various factors that affect (and, sometimes, impede) mass adoption.
The evolution of micropayments has been characterized by the cyclical emergence and collapse of different generations as presented in Exhibit 1. The first generation of micropayment systems were initiated in the early 1990s – with the entry of top brands (IBM and Compaq), premier institutions (Carnegie Mellon University and W3C) as well as tech startups such as DigiCash and CyberCash. However, these initial systems suffered from limited scalability and lack of customer trust. Thus, by end of the decade, most of these systems went bankrupt or were terminated. For example, IBM did not operationalize its micropayments platform, while DigiCash and CyberCash filed for bankruptcy.
The next generation emerged around 2000-2001 with significant advances in user interface and scalability. However, these systems had to deal with increased competition and regulatory oversight. Some of the niche players that were unable to adapt, were shelved or sold out – triggering the second wave of collapse in the history of micropayments.
A prominent example is PayStone – a Canadian provider, who closed its online micropayments business in 2009 due to non-compliance with regulatory directives.
Meanwhile, in 2006-07, the industry witnessed a set of unique disruptive market forces – including shifts in consumer mindset, government policies, technological breakthroughs and business innovations. They created a dynamic ecosystem with expansion in channels and applications and cross-industry participants. We have presented the evolution of this ecosystem in Exhibit 2.
A majority of incumbent providers managed to survive the new market conditions. However, the fundamental challenges of interoperability and high fixed costs remain unaddressed till today: Over the last decade, a large variety of micropayment providers have emerged, resulting in a multitude of payment systems and standards.
While some central governments are working towards nationwide, interoperable platforms (such as the CEPAS in Singapore), there have been very few initiatives towards industry-wide standardization. This has resulted in a fragmented market, with limited compatibility among competing providers.
Moreover, the industry also suffers from prohibitively high fixed overhead costs. While top market players are experimenting with innovative techniques, these initiatives are yet to gain scale. For example, Apple introduced back-end aggregation to distribute fixed cost over a large number of transactions, while PayPal developed a new pricing model with low fixed costs exclusively for micropayments.
This demonstrated that the universality of micropayments may not be addressed completely in the near future. The next generation of micropayments, Gen 3.0, when it arrives will have to address the pressing challenges of interoperability and cost management. However, given the new wave of market innovation and government participation, we could say that a sub-generation Gen 2.5 for micropayments that originated in 2006-07 continues till date. This Gen 2.5 is distinctly different from Gen 2.0, but the change is not significant enough for us to believe that Gen 3.0 of micropayments has arrived.
While the different generations for micropayments evolved from a continuous interaction between regulatory directives, market forces and technology drivers, Gen 2.5 is notable on multiple counts as illustrated above (shown in Exhibit 2):
Various national governments are legislating to promote and encourage the growth of micropayments. The Payments Council in UK will bring in regulation to allow mobile numbers as proxy for bank accounts. Similarly in Kenya, the government has directed mWallet providers to develop open systems to ensure interoperability. CEPAS, a nationwide system for micropayments in Singapore, is a shining example of the impact of government endorsement on the health and success of micropayments.
The emergence of customer loyalty schemes has created the need for micropayments in the retail space. The increasing universality of mobile devices and social media are other related drivers. Starbucks realized the significance of these emerging trends and benefitted from its multiple initiatives. In 2012, it partnered with Square and started accepting digital micropayments from its customers using Square’s mobile app. Moreover, in Oct 2013, it launched “Tweet-a-Coffee” campaign to leverage social media-based, Peer-to-Peer payments. The campaign was highly popular, triggering purchases worth USD 180,000 for two months. More importantly, the success of this USD 5 gift card shows that loyalty programs will be a key driver for digital micropayments in future.
Some retailers are also leveraging these trends to boost sales volume. For instance, UK-based, fast-food retailer, Greggs had been battling a shrinking topline since 2012. To counter this, it started developing a digital loyalty app based on PayPal technology, allowing transactions of GBP 50 or less. This app was launched in Feb 2014.
The widespread popularity of mobile payments and digital wallet solutions have offered a low-cost alternative platform for the growth of micropayments. In the next few years, NFC-enabled contactless payments will open up newer use cases for micropayments such as in public transport and points of transaction. Similarly, cloud-based mobile payments promise to bring forth a massive reduction in operational costs.
Adoption of Micropayments
User adoption has been affected by 3 factors: motivating user adoption, barriers to adoption and hygiene factors (with the absence of hygiene factors causing user dissatisfaction).
User Adoption of Micropayments:
These factors have been presented in Exhibit 3 as ‘Challenges to User Adoption’, ‘Motivation Factors for User Adoption’ and ‘Hygiene Factors for User Adoption’. Exhibit 3 depicts the evolutionary stages of micropayments vertically, starting from Gen 1.0 and moving up to Gen 2.5.
Sudden technological innovations and systematic efforts from industry participants convert individual factors from one type to another – redefining customer experience across generations.
Based on our observations, there are two kinds of cross-factor transitions:
- Challenges arising from one generation transforming into Motivation Factors of the next generation: Challenges which are addressed partially or by a small set of providers, become motivation factors for consumers. For instance, latency was a major challenge in the first generation. In the second generation, this was addressed by some of the providers using offline validation, which has proven to be a significant attraction for customers.
- Motivation Factors of one generation transmuting into Hygiene Factors of the next generation: When premium and innovative, first-of-a-kind features offered in selected systems/markets are replicated on a large scale in the subsequent generation, they constitute hygiene factors, becoming a part of basic consumer expectations from the service. Technological breakthroughs are major contributors in this process. For instance, in the second generation, user convenience was a motivation factor – simple, web-based interfaces increased the adoption of micropayment systems.
Subsequently, the birth of digital wallet and mobile payments redefined user convenience, making this a hygiene factor. Unless triggered by specific market conditions and collective industry efforts, these factors continue to move in the same category across generations.
- Motivation Factors: When premium features offered by certain providers cannot be provided on a large scale, such factors continue to motivate user adoption. For instance, even in generation 2.5, providers that use low-latency systems and make use of cloud-based operations (for lower cost), are able to differentiate themselves in the market.
- Hygiene Factors: Even when fundamental hygiene factors are addressed differently across generations, they remain a part of basic service expectations in the consumer mind space. For example, user control is one of the basic expectations from micropayment systems. Users should be able to monitor the status of their account (current balance and pending payments) and track the duration of fund transfer.
The industry is still unable to address prohibitive fixed transaction costs in comparison with transaction value.
Gen 2.5 – Why Should Banks Enter the Micropayments Space?
Till date, banks have been mostly wary of launching a full-fledged micropayments product – owing to smaller market size, prohibitive costs and regulatory oversight. However, at present, the market offers a huge opportunity in terms of market growth as well as the underlying demand for innovation.
Market Size and Growth:
The total value of the European micropayments market stood at EUR 6 Billion in 2011. Furthermore, under the aegis of the European Payments Council (EPC), the market is expected to grow to EUR 15 Billion by 2015. On the other hand, micropayments (transactions values <USD 25) in USA stood at nearly USD 2 Trillion in 2005 while online micropayments, a sub-segment of this market, were pegged at USD 7 Billion in 2009.
More than for their market size, micropayments are critical because of the demand for innovation to circumvent cost disadvantages that cannot be addressed by conventional payment systems. This demand is three-pronged and comes from:
- Consumers: High fixed transaction costs associated with micropayments prove to be a significant hindrance. Even though providers use aggregation techniques at present, these do not fit a one-time purchase. They are also inconvenient in cases where the customer has to pay upfront for the products/services. The emergence of mobile and social-media based payments is also driving consumer demand for real-time low-value transactions.
- Business: Merchants are battling against existing market fragmentation. The micropayments industry is characterized by a large number and variety of providers, each controlling a small part of the market. Buy side customers can use any of these micropayment providers. Few providers allow interoperability among themselves. For instance, Facebook Credits incorporated PayPal payments to increase user adoption in 2010. Later, it also adopted PayPal’s micropayments service launched for digital goods. However, the alliance was short-lived, with Facebook eventually phasing out its digital payments platform. Facebook today is preparing to join the mobile payments race again with its own payments system.Thus, merchants have to tie-up with a large number of operators to ensure payment acceptance for a substantial volume of customers. In Singapore, the government recognized this challenge towards universality of micropayments and developed CEPAS 2.0, a standard to allow interoperability of different payment schemes. Globally, the emergence of digital currency exchangers, which provide interoperability among different digital currencies, is a move towards addressing this fragmentation.
- Government: Public institutions across the globe are taking active interest in the micropayments industry. There are regional nuances in their underlying objectives though. However, all these objectives favor a greater adoption of micropayment systems. For example, the European Payments Council (EPC) is driving the acceptance of digital payments and micropayments to circumvent the complex, highly expensive cash generation process.
On the other hand, in emerging markets, micropayment systems offer a powerful means to achieve financial inclusion. The success of M-PESA in Kenya is a case in point.
Market Dynamics – Role of Banks vis-à-vis Other Market Participants:
Banks: In those markets where we see a regulatory push towards micropayments and payments innovation, top-notch banks have successfully launched micropayment services. For example, Barclays launched Pingit – a mobile app that allows person-to-person (P2P) payments of minimum GBP 1. However, as is evident in this case, the approach has been indirect, leveraging popular consumer trends such as P2P (person-to-person) payments and social media payments. Moreover, most of these initiatives have been launched in relatively mature markets such as the UK and The Netherlands.
Beyond these few instances, banks haven’t participated in micropayments. The industry has been dominated mostly by non-banking participants. The first generation was driven by technology start-ups and venture capitalists. Generations 2 and 2.5 have produced a wider spectrum of players.
Digital Payment Providers:
In the second generation, digital payment processors such as PayPal, Allopass and Square came into existence. They have been instrumental in the creation of new services and in introducing pricing innovation, such as transaction tier pricing in the market.
The advent of mobile payments was another major development for micropayments. The popularity and widespread adoption of mobile devices helped mobile operators in gaining market traction. This wide customer base helped in spreading infrastructure costs, while the absence of specific regulations helped maintain profitability. In some of the emerging markets, such as Africa, telecom providers are playing a pivotal role in reaching out to the unbanked population and thereby helping increase GDP and lower transaction costs.
The rapid adoption of mobile payments also prompted other market players, such as the digital payment providers, to leverage mobile as part of their digital channel mix for micropayments.
Apple forayed into the market of micropayments primarily to support its products. Nevertheless, the revenue-sharing model with the app seller was an instant success, driving the adoption of micropayments. Google, Amazon and Microsoft are the technology players of mark in this space.
Social Networking Providers:
The consumer-led proliferation of social media and the rise of social gaming paved the way for two important trends – commercialization of content exchanged over social networks and peer-to-peer payments on social media. These trends in turn created a unique opportunity for micropayments in social media. To exploit this market, some social networking providers started partnered with third-party payment providers, such as Twitter’s alliance with Twitpay, Twollars and Flattr. Others explored the opportunity to launch virtual payment currencies and platforms, such as Facebook Credit (2011). This market segment is still evolving, with Facebook switching back to real-world currencies and Twitter dropping some of its partners.
Traditional Payment Processors:
Payment intermediaries such as Visa have made a late entry into the market – primarily because the overall market size is much smaller compared to macro-payments. The high cost associated with card-based systems caused another hindrance. However, gradually these providers launched the digital wallet and micropayment services. For e.g. Visa launched Payclick in 2010 and American Express launched Serve in 2011.
To sum up, the inability of banks to respond in the near future can prevent them from playing a dominant role in micropayments in the future. Moreover, banks will lose out on a huge opportunity to reposition themselves.
Preventing Erosion of the Banking Value Chain:
With the advent of digital payments, banks are competing head-on with digital payment and technology providers (such as PayPal and Google) as well as communication service providers. These players are constantly innovating to create new combinations of digital financial services – e.g. the debit card from Google Wallet and the Smartphone-based credit card reader launched by Square Inc.
In some cases, non-banking payment providers are part of the communication loop linking merchants, payer and banks (e.g. PayPal), while in others, they are offering payment portals, bypassing banks altogether. M-Pesa in Kenya is an example of a mobile network operator (MNO) providing a cheaper and more efficient alternative to banks for financial inclusion.
The end result is that multiple competitors are eating up parts of the banking value chain and banks face the risk of being reduced to the limited role of offering basic transactional features. Given the huge interest of governments across the world, the micropayments market will play a significant role in defining payment systems of the future.
Diversifying Revenue Pipeline: Banks are exploring alternative means of revenue generation and micropayments offer multiple opportunities for this. Even without direct market participation, banks can rely on their existing infrastructure such as channels, IT applications, among others, and earn revenue by leasing them to participants from other industries. By linking bank accounts with micropayment offerings, banks can offer an end-to-end payments solution, broadening their transaction base.
Marketing and Restoring Market Reputation: In recent times, the reputation of banks has suffered due to multiple litigations and regulatory fines. Customer trust is also at an all-time low. In this situation, by actively participating in the micropayments market, and helping various governments in establishing financial inclusion, banks can regain consumer confidence and recover some of their lost reputation. However, the specific nature of bank participation will depend upon the evolution of micropayments and the course of action taken by market participants and regulators.
Guidance: What Banks Can do in Response to the Evolving Scenario of Micropayments?
The market for micropayments continues to evolve differently across regions. However, based on the development of the payments industry and specific market events in the past, we envision three probabilistic scenario for the global micropayments industry, which are:-
- Scenario 1: Consortium Rules resulting in the adoption of a unified micropayment standard and set of instruments throughout the globe. Alternatively, we see the emergence of a global Micropayment Exchange, with interoperability among multiple systems / currencies.
- Scenario 2 – Regional Rules causing the emergence of nationwide and regional standards for micropayments, alongside strong regulatory governance.
- Scenario 3 – Enterprise Rules creating a lack of a consensus across nations or regions, which can in turn hinder interoperability, leading to market fragmentation and the emergence of closed ecosystems.
Exhibit 4 provides a visual summary of these future scenarios: Collaboration at a global level is expected to drive a worldwide micropayment consortium. Alternatively, governance by regional/ national regulatory authorities will result in regional clusters of micropayment systems. In the absence of any such collaborative efforts, the market of micropayments will mostly likely be dominated by individual enterprises from various industries. The Exhibit 5 is a representative micropayment ecosystem with buyers and sellers interacting with multiple cross-industry players, including technology vendors, retailers and financial service providers.
In order to win banks will have to chart out a strategy and take up specific actions to penetrate the micropayments space. In Exhibit 5, we illustrate each of the scenarios with present-day cases and recommendations for positioning.