European Payment Service Providers: A Race to Market
Emerging infrastructure standards, such as SWIFTNet and EMV, payment solutions, such as EBA Step 2 and VisaDirect, and both ‘e’ (electronic) and ‘m’ (mobile) channels are all forcing payments players to face up to some key questions relating to their business strategy in the years to come.
In order to remain competitive, European banks are being forced to make strategic decisions about where and how they will operate within the different ‘value webs’ currently emerging across the landscape. The rise of more customer-centric payments systems are forcing banks to re-examine their payment value propositions in light of both changes to market infrastructures and the increased competitive threat posed by fast-moving new entrants. The time would appear ripe for the creation of a payment utilities model, designed to allow banks to share costs, minimize risks, and better utilize funds that would have previously been sunk into payments infrastructure purchases. Yet, the evidence shows that very few utility models thus far have managed to gain significant traction in this market. While this track record has not impressed the payments market to date, there are signs that the situation is changing and that the reality of a successful utility is starting to materialize.
Historically, the payments market has been characterized by high levels of competitive concentration, with a small number of large banks dominating domestic payments processing and clearing businesses. These structures have traditionally been locally based. Many existing national payment systems, while often efficient at a domestic level, are fragmented and fail to satisfy EU commission requirements for SEPA. The array of institutions through which payments must currently pass has also been a barrier to efficiency in this market. These institutions face a trade-off between processing volume and unit pricing, with higher unit costs often resulting from the variety of mechanisms in place.
Consequently, the demand for a shared payments business service provider (BSP) platform, with sufficient scale to obtain efficient cost parameters, has emerged. These emerging models are creating a market for outsourcing and driving financial institutions to invest in innovative, revenue generating new ventures. These BSPs offer full service capabilities, delivering both business processes and technology services to third parties and are run by people with experience in operating the business. Such platforms would require the cooperation and collaboration of a number of nationally dominant players, working in concert toward a common goal. To date, franchise conflict, substantial implementation costs, and a number of social challenges, particularly in continental Europe, have all proved to be substantial barriers and thus far the cost of these have outweighed the benefits of large-scale bank collaboration in the payments space.
Some banks have dipped their toes into the BSP waters, but genuine success stories are few and far between. In fact, a review of past BSP ventures reveal a results spectrum ranging from underperforming attempts like European Transaction Bank (ETB), Finforce, and Arcordia, through to partial success stories like Proponix. Additionally, there are a few emerging ventures where the verdict is still unclear. BSPs that have failed to build the necessary momentum for market success have essentially not succeeded in attracting the large number of client banks required for such a scale-driven business model. In fact, they have never achieved the market credibility needed to build a critical mass of participant transaction volume. The Proponix venture has enjoyed some momentum, but challenges around market pricing have prevented it from developing into a full-blown success story. These mixed market results have led to persistent resistance to the emergence of genuine BSPs.
In our experience, this resistance is usually driven by a fear among potential players that BSP initiatives might actually bring about more harm than benefit. The reasons and barriers for this are multiple. Firstly, many banks still consider their technology and operations capabilities as valuable sources of competitive differentiation. In the battle for market share they are reticent to let go of what are believed to be core assets by turning to BSPs as an alternative. These organizations have failed to recognize that in many cases proprietary infrastructure is not core to their business, as it does not sufficiently differentiate their offerings. If anything, this somewhat antiquated mindset is increasingly becoming a competitive albatross. In our view, the persistence of financial institutions to remain infrastructure owners is neither realistic nor viable, especially for small players. We continue to advocate the point of view that, regardless of governance structure, the customer franchise business, product innovation and delivery, and infrastructure provision will need to be unbundled as the payments landscape evolves in the years to come.
Secondly, banks have not yet overcome their reticence to work collaboratively with competitors when it comes to outsourcing non-core activities. Many players are concerned about the loss of management control and ownership over outsourced activities. However, alternatives exist to the simple customer/provider model and these allow more flexibility in terms of governance and control. Indeed the governance model of a BSP can offer a co-owned or co-sourced service, and as such can allow many providers to operate in an environment of cooperation. These governance options provide a viable alternative to any dominant-player centered models.
Thirdly, despite increasing cost pressures, the traditional financial incentive to explore and develop alternative payment governance structures has simply not been sufficient to induce wholesale banks to begin the transformation process. More recently, banks have come to recognize and appreciate that the costs associated with owning all the business ‘bundles’ described above are suboptimal for all but the largest providers. Indeed, organizations are struggling to cope with the overwhelming maintenance and development costs required to keep up with industry changes, such as CLS, T+1, Basel II, and the EU pricing directive, to name but a few. There are many examples of payments businesses where maintenance and support of existing infrastructure exceeds 80 per cent of the available IT budget. Banks are slowly coming to digest these cost implications.
Finally, banks fear that the risks to quality and control that are involved might outweigh the benefits of outsourcing. They are afraid to delegate services that could impact customer satisfaction, that SLAs in themselves will not ensure quality and that they will lack the weight to influence decisions and manage the new interface as required. They are afraid that the nature of BSP itself will impact quality and customer satisfaction. Lack of exit options from the outsourcing model once the decision has been made magnifies these fears.
The lingering resistance to BSPs is based on traditional banking perspectives on the dynamics of competitive markets. However, it is the very nature of these dynamics that have undergone significant change in recent years, particularly in the European payments market. This change has been driven by regulators with an increasingly European and customer protection outlook, challenging the historical balance between regulation, competition, and cooperation that has developed in each national market. As such, the change in regulatory stance will force banks to re-think their payments models, and consequently how they compete and cooperate. This, combined with emerging standards, new technologies, and increased competition will drive banks to increasingly question the value of keeping payment processing capabilities in-house. The emergence of infrastructures that undermine the value of traditional correspondent relationships and, for the smaller providers, the inability to follow their competitors to low-cost offshore environments, will compound these arguments. As such, the relationships between traditional competitors are evolving towards more collaborative footings when appropriate. The old market paradigms are slowly fading away as value propositions are being redefined around customers, cost pressures are mounting, and issues around quality standards of external partners are being redefined.
Against this backdrop, we see the emergence of three payment BSP models in the not too distant horizon. The common theme across all three of these models is customer-centricity, and if implemented correctly they will have the potential to liberate a dimension of value beyond cost benefits and equity participation. Accelerated top-line revenue growth constitutes a third dimension of value, and is a direct outcome of the marked increase in quality that will characterize winning BSP models of the future. Higher quality standards will translate into higher degrees of customer loyalty, and ultimately customer-spend, which will be achieved through improved specialization and managerial focus.
Bank-centric model (FI in-sourcing): Many banks are acknowledging the benefits of focusing on scale through centralization, shared services, and efficiency service offerings. We see this in the current market with both Citibank and ABN Amro augmenting their respective payments service delivery to large corporate customers by creating utilities, access portals, and support for exchange and marketplaces. Deutsche Bank is also leading the development of full-service distribution channels, leveraging their strong retail and wholesale client bases, as well as their ability to meet the demands for unified services across products and markets. These strategies are allowing banks to solidify their market positions as payments systems become increasingly interconnected.
Joint venture model: Market forces are challenging the traditional payment system continuum. Non-traditional providers are challenging incumbent systems and payment markets are increasingly responsive to payment provider models that combine the strengths of world-class banks with global solutions and technology providers. The partial success of AMS’s Proponix offering is a testament to this fact. The success of iPSL – the UK-based joint venture between Unisys, Barclay’s, Lloyds TSB, and HSBC, which seeks to create efficiencies and cost reductions by managing routine business functions – is yet another example. iPSL now handles nearly 70 per cent of all checks processed in the UK and is truly transforming business operations, all of which demonstrates that a number of banks can collaborate successfully with a large technology partner.
Infrastructure-centric model: The emergence of new payment infrastructure platform players – EBA Step 2/3, VisaDirect, and domestic players with international ambitions – is demonstrating a trend toward making payments both more regionally oriented and customer focused. Market initiatives seeking to drive common messaging standards – IBAN & BIC, MT103, RosettaNet, and TWIST – are becoming more prevalent, driving automation, and allowing infrastructure providers to get closer to the end customer. Additionally, many incumbents are increasingly enhancing their market propositions to offer value-added services, both advisory and processing.
Newly established business strategies are shifting banks from ‘infrastructure compliance’ to ‘business enhancement’ and driving the realignment of bank operating models to support this transformation. Higher service levels and cost savings are being achieved through cohesive sourcing strategies that support a bank’s operating model through the utilization of outsourcing and off-shoring. The framework for success thus lies in developing the case for a BSP solution that demonstrates substantial long-term benefit while simultaneously being viable in the short- to medium-term. The benefit must outweigh the implementation complexity and any related down side from social and system upheaval.
Thus, beyond a compelling financial model, non-captive BSPs should additionally be designed from the outset to price ‘at market’ rather than be a cost-transfer mechanism for incumbent institutions, have a governance and consequently pricing structure that support open and ubiquitous usage, and from the outset have credibility in terms of capabilities and longevity.
Even with these criteria fully satisfied there is a final hurdle. The complexity of providing a payment BSP lies in the complexity of the broader service proposition. While the underlying payment processes are commodity processes, the customer service layer and supporting transaction conditions can create significant complexity. This complexity is, however, at the heart of what customers value and therefore formulates an important dimension on which banks can differentiate themselves from their competitors. BSP providers must be able to either handle these complexities or allow their customer banks to handle them in more efficient ways.
The dynamics of the payments market in Europe are evolving at increasingly rapid rates. Customer, competitive, technical, and regulatory pressures are forcing payment providers to re-examine the basis on which they design and ultimately deliver customer propositions. Traditional forms of governance and structure are being replaced with innovative arrangements, often involving either competitors turned collaborators or non-traditional payments players, or even both. Standing still and watching these developments from the sidelines can no longer be a viable strategy for European payments providers. Understanding the nature of the changing game and positioning for success on the basis of a disaggregated value-chain has for many become the only feasible means for long-term survival in the European payments space.
This article is reprinted with permission from the Capco Institute, publishers of the “Journal of Financial Transformation”.