Opinion & Analysis: The Great Mobile Alliance

Steve Mott

Banks and merchants aren’t natural enemies—they’re only set at odds by the distortions created by the current payments system. In fact, most banks and retailers have much to gain, and little to lose, by working together on a new system built on mobile payments and marketing.

(Editor’s note: This article is the first part of a two-part piece examining the natural complementarity of banks and merchants in payments and the impact their collaboration could have on trends in mobile payments and marketing. Look for part two in the September issue).

The tortured relations between banks and merchants over payments issues reach a new nadir just about every week these days. But just when it seems things could get even worse, there are signs that the quest to harness mobile technology to improve the way people transact might provide a pathway for healing these wounds.

Some of these longstanding combatants realize that, working together, they—and perhaps only they—have the opportunity to constructively monetize product data collectible from mobile transactions. And the economic value from this breakthrough is likely to trump everything that has come before it.

To be sure, the payments closet is filling up fast with a lot of new skeletons these days.

Massive lawsuits combating interchange are moving to completion after years in the courtroom. The Department of Justice is investigating Visa Inc. once again for use of market power. Nobody’s happy with the way the Federal Reserve interpreted the Durbin Amendment.

And new battles have broken out between the card networks and retailers over the lack of meaningful improvements in security offered by introductory near-field communication (NFC) and EMV chip card programs—for which the merchants are expected to pay the bulk of the costs.

Trillion-Dollar Upside

All the while, the U.S. payments system continues to slog along in the backwaters of outmoded plastic card technology. Banks are accused of resisting investment in full-scale chip-based technology that will reduce endemic fraud and attendant inefficiencies in payment processing. Merchants are blamed for clinging to old terminals and performing lax vigilance on this aging system.

And a growing array of observers in the nation’s capital are expressing their concern (if not embarrassment), and are beginning to turn their attention to whether and how to guide the widely expected transformation of the payments system to a new, mobile-based form factor that no longer funds criminal and terrorist organizations through rampant fraud.

Regulatory and legislative scrutiny of the emerging mobile payments paradigm is also being fueled by the entry of deep-pocketed new players (Google Inc., Isis, PayPal Inc., etc.) which are also seeking to cash in on the mobile-marketing largesse.

Concerns over the security of transactional data and the ability of consumers to ensure the privacy protections they expect are looming as another huge issue in the politics of payments to come.

So the table stakes for the course of the payments system are large, and growing bigger every day. Mobile-wallet offerings (Google, PayPal, Visa, Isis, and—last month—MasterCard Inc.) that house existing payment types are just the ante.

The real bets of these and other prospective market entrants are on who will control and monetize the unprecedented, rich, and voluminous data that mobile payments, offers, and experiences can now generate.

A few examples illustrate this mobile mother lode that’s now on the table.

The revenue upside for banks and merchants from the mobile-marketing transformation could be a trillion dollars or more—if the first generation of wallet providers doesn’t lay claim to it first.

But merchants have made it clear that fixing the payment system, and establishing security and privacy for control and use of mobile data, has to happen before they ever consider sharing stock-keeping unit/product data with anyone, least of all, the various middlemen that are trying to insinuate themselves between the buyers and sellers hoping to transact more efficiently with mobile.

What’s less well-understood in today’s rapidly evolving mobile marketplace is that, on an individual basis, all but the largest banks appear restive about a payments marketplace where the vast proportion of plastic card benefits accrue to a handful of institutions.

A growing number of these banks have as much to benefit from a mobile transformation of the way people transact as many retailers:

– The rich will get richer. About  90% of credit card transactions are done by a half dozen big banks, including online transactions; that concentration won’t change in mobile transacting unless smaller banks find a way curry favor with merchants, which will control mobile-payment adoption;

– Enlightened use of debit “cards.” About 60% of debit card transactions are done by less than 20 bigger banks, and online transactions are dominated by the big signature-debit card banks; this constitutes a better opportunity for smaller banks to consider enlightened new value propositions for both merchants and consumers in the mobile venue—such as more innovative use of the automated clearing house network;

– Signature-debit cards are untenable now. Post-Durbin, most banks view signature-based debit cards—even at ceiling rates elevated by the Fed in the wake of ferocious bank lobbying (led by Visa)—as no longer profitable: sig-debit card costs are an estimated 21cents per transaction, versus a Fed-surveyed 24 cents average interchange rate for non-exempt banks (those with more than $10 billion in assets); nearly every bank would be better off supporting other payments for mobile, including merchant-friendly options or low-cost ACH options from their mobile banking sites or even PayPal options—if they can get a piece of the revenue without all the risk and costs of sig-debit;

– The shift to more profitable PIN debit. PIN-debit costs, which are an estimated 8 cents to 10 cents per transaction, are a better option for banks post-Durbin, but historic banking-industry resistance to putting PIN-debit solutions online have put that option out of reach for remote transacting—until now, with options for mobile emerging quickly;

– Swapping out card rewards for mobile offers. Reduced debit card profitability has inclined many banks to curtail rewards programs, which generally didn’t differentiate bank programs any way; tailoring mobile-marketing promotions with merchants that deliver more individualized benefits to share customers appear to be a much better proposition for all parties trying to drive consumer loyalty;

– Making PCI go away. The ever-expanding but increasingly futile effort of the Payment Card Industry data-security standard to contain data breaches and resulting mag-stripe fraud is now becoming onerous for banks as well as merchants; nearly every bank is tired of the costs of mag-stripe fraud and its impact on customers, and a growing number of financial institutions are looking for more chip-based security (e.g., full encryption of account credentials, one-time-use tokenization, use of PINs, etc.) than the card networks are offering;

– Avoiding endless issuing fees.  Since the IPOs of Visa and MasterCard, smaller issuers are experiencing an increasing array of new fees for doing mostly the same things that have been done in the past, but don’t get those fees rebated the way the bigger bank members do; use of other, less avaricious networks for mobile transactions looks better every day;

– Getting a fair share of mobile-marketing largesse. And banks are just as interested in the mobile-marketing upside as retailers and all the third-party providers are, and just as concerned about data security and consumer-privacy protections; in today’s marketplace, Visa and MasterCard will corner that opportunity for themselves—if Google doesn’t beat them to it!

As a consequence, a growing number of financial institutions are exploring ways they might be able to get off the customary Visa and MasterCard plastic card rails. They’re looking at how to put together (or participate in) alternative networks that offer fair compensation for the work (e.g., real risk management) that they actually do—without having one entity (i.e., card networks) make all the rules and set all the rates in a one-sided way.

Giant Sumo Wrestlers

In this all-important regard, these banks are aligning more closely with most merchants. 

Which leads to the key question of what banks and merchants can do together that they can’t do themselves. The answer lies mostly in how consumers view the potential for banks and merchants working together. Several important truths exist about consumer relationships when they’re trying to transact:

– Nearly all consumers are both customers of a bank (or credit union) and a merchant; in contrast, they are not really customers of Visa or Google or the processor or the POS terminal provider or even—for mobile purchases—the handset maker or carrier;

– Banks have great data on how payment accounts are used, who the consumer is, what financial resources they possess, what risk they pose, and how, where, and with what merchants purchases are made—but just on those payment accounts that they issue and hold;

– Merchants frequently know the consumer, and a lot about the transaction session (location, time of day, products purchased, arrays of payment accounts used), but only for purchases made with that specific merchant;

– Combined, banks and merchants know a lot about the transaction event, the consumer’s behavior, and the likelihood that the purchase is legitimate—a boon to risk management and a ready fix for card-not-present risk (where banks and merchants operate independently, with merchants holding the bulk of the liability unilaterally);

– Add in mobile-session data—the handset ID, carrier, location, and phone number—and mobile transactions have the potential to be safer than any other type of transaction (assuming device access is reasonably protected);

– Integrating data flows over time, banks and merchants also can know a lot about what products a given consumer buys and buys repeatedly, and can infer and deduce a lot about the consumer’s life events, providing a marketer’s dream of lifestyle data;

– Working together, banks and merchants can develop an approximation of a consumer’s wallet-share;

– Consumers tend to trust both their individual banks and the merchants they know, so if they agree to relax privacy protections with anyone, who better than banks and merchants working together?

– Using collective information and mobile data to prove the action-response juxtaposed against a personal purchasing history and behavior set gives a bank-merchant combination an unprecedented offering for product placers.

With limited exceptions card networks and their big-bank members have historically squared off against the biggest, most recalcitrant of merchants like giant sumo wrestlers in a winner-take-all contest, leaving lesser, smaller players from both sides with no path forward.

Fresh Beginning

But that battle of the titans has been classically counter-productive, and might well have run its course in payments history. Although small banks and credit unions squandered their opportunity to vie for transaction-volume growth by caving in to big-bank interests in the Durbin debate, there is increasing realization that their survival depends on how they participate in the mobile transformation.

Ditto for smaller merchants, which must find a way to be tooled-up and viable on mobile devices and transactional platforms.

The trick is how to get individual banks and merchants talking and working together out of the shadow of the Visas and Wal-Marts of the world.

Mobile offers a fresh beginning, but collective action in the early going by the existing payments players already threatens to cripple the uplifting opportunity offered by technology that lets buyers and sellers become intimate with each other.

In part two, we’ll examine five challenges banks and merchants must overcome to get started working together and to make sure their collaboration delivers an economic proposition superior to the one offered by today’s albatross-like payments system.