Payment Myths

Five Payments Myths Debunked BY Kenneth Kerr and Leon Majors

The payments industry has more than its share of urban legends that require re-examination.

| SYNOPSIS | With all the rapid changes in the payments industry in recent years, particularly the shift from paper-based to electronic transactions, numerous assumptions have become accepted as truth, despite the lack of underlying facts, according to consultants at Phoenix Payment Systems Practice. Many of these payments "myths" derive from directional shifts that are then extrapolated into all-encompassing paradigm shifts, the authors say, citing five strongly-held beliefs: that cash will disappear in 10 years and paper checks in five; that banks will spend $15 billion on remote capture; that mobile payments is ready for mass adoption; and that unbanked populations are homogenous and can be served that way. The dictionary defines myth as a fictitious or imaginary story or a false belief? The payments industry harbors more than a few of these myths, which are presumed to be true and are often reinforced with glib statements that seldom receive significant argument or debate. In payments, myths may develop from directional shifts in payment usage—from paper-based to electronic transactions, for example—which are then presumed to carry forward to a near allencompassing end-point of either total mass adoption of the newer technology or complete elimination of the older one. Alternatively, several technologies, which may in fact be competing with one another, will all be projected as winners in the marketplace. Let’s call a time out on propagating myths and consider this principle: in modern times, we have never successfully terminated a payment system; we just keep adding more. For example, the industry has spent billions of dollars building and expanding card-based payment systems. Yet, we may now supplement that system for business customers with inexpensive check scanners from Radio Shack. Below is our selection of five of the most egregious myths in payments. Our goal in describing them is to encourage readers to scrutinize more carefully some widely held assumptions. As the old Chinese proverb says, Before you drink the water, know the source. A modern paraphrase might be: Before you buy the hype, understand the information that generated it.? 1 - Cash Will Disappear in 10 Years; All Hail the Cashless Society! An ever increasing shift to electronic payments of all types has led to the notion that it will inevitably lead to a cashless society, and some predictions of this eventuality are for the not-too-distant future. For example, last year, an executive at one of the card associations predicted that cash handling costs would exceed card processing costs by 2012, causing merchants to surcharge for cash transactions, which would help precipitate the end of cash. Under this scenario, the movement to a truly cashless society would be brought about by the population’s continuing selection of electronic payment methods over cash, by merchant non-acceptance of cash and, finally, by government edict/decision. It is true that cash usage as a percentage of all spending methods has declined over the past several

decades, now accounting for just one-fourth of payments at grocery stores. However, the number of cash transactions in the U.S. did not fall below 100 billion until 2005. A significant portion of the expected decline in cash usage has already occurred and cash transaction volume levels should remain high as long as governments choose to continue to issue and circulate currency. It’s also true that cash has already disappeared for certain types of transactions. Car rental companies and airlines, for example, have largely stopped accepting cash as a form of payment. Cash is still accepted at tollbooths, but contactless electronic payments have significantly reduced cash payments because they are more convenient to consumers—shorter wait times, no need to have currency on hand, etc. Debit card usage has grown steadily over the past decade for many types of transactions, replacing cash as well as check and credit card transactions. Cash, however, continues to hold favor for many types of transactions and for particular segments of society. Cash is viewed by many consumers as the most convenient form of payment for most low-dollar transactions. And despite the general movement toward electronic bill payments, walkup bill payment centers continue to hold their share of total bill payment volumes. For example, 15% of utility customers continue to pay their bills through walkup centers, with cash accounting for about half of these payments. In many ways, cash is the most versatile and easily exchanged method of payment, particularly for interpersonal and small-dollar business transactions. Its use is also, of course, largely anonymous and untraceable. For this reason, cash usage has natural opponents who are concerned about money laundering, tax evasion and most types of criminal activity. However, any governmental move to totally eliminate cash will be countered on many fronts. Its elimination will be viewed as discriminatory, since it is the primary form of payment used by many low-income, immigrant and ethnic group segments. Many other citizens will oppose its elimination for reasons of privacy, personal freedom and, simply, tradition. While some merchants have eliminated cash as a payment option for logistical reasons, most merchants are loath to remove any payment option that customers still want to use. Cash usage will continue to fall as a share of total payment volumes, but the drop going forward will be marginal and non-threatening to its longevity as a form of payment. It is also interesting to remember that in 2007 there were still hundreds of thousands of person-to-person transactions involving physical gold and silver bullion and that bartering remains alive and well. 2 - The Checkless Society is Near; Checks Will Disappear in Five Years “Give me a break” is the phrase that comes to mind as a response to this prediction, which has been repeated every year since about 1979. The only myth in the financial sphere that comes close to this one in longevity is the one stating that “smart” chip cards in the U.S. are three to five years away from massmarket adoption. Similar to the prediction of the end of cash, rumors of the demise of the check have been premature. Checks have declined, but still account for over 30 billion annual transactions. It’s unlikely that the banking industry will take a unified action to stop issuing checks to its customers, particularly with the emergence of several new check processing methods. However, it’s easier to imagine that checks will go away in favor of other bank payment methods than to think of cash falling out of the payment stream as a form of payment. It is at least feasible that checks can go away, although we believe that there is a generational bias toward paper that will be eliminated in the long term only by the deaths of the users.

Also, the business sector remains heavily check-dependent. Until recently, there had been a slight shift from checks to payment cards, but the emergence of remote deposit capture (RDC) may reverse that. Just imagine that a decade of card marketing strategies and investments for the small business segments is undone by a $1,000 scanner and a copy of QuickBooks! The National Association of Check Printers will not be making plans for their going-out-of-business party as long as they continue to hear about the banking industry’s plans to spend billions on new check processing methods. 3 - RDC: Banks and Their Customers Will Spend $15 Billion Extending Obsolescence Speaking of which... RDC itself encapsulates a little myth and a little hype. Take the idea that the industry will spend $15 billion over the next decade on this technology that simply helps prolong the life of the paper check. While no one actually states that $15 billion will be spent, that is the total industry investment needed to match common adoption predictions if you count the roughly 20 million potentially upgradeable endpoints at point-of-service (POS) and back-office business locations. This money will be spent on scanners, retail back office infrastructure and bank hardware, software, telecommunications equipment and services. True: there are several hundred thousand businesses looking for a better solution for check acceptance, a solution that makes it easier, safer and more efficient to process checks. Banks have done a wonderful job in communicating the availability of these services, based on both image and the Automated Clearing House (ACH). The problem (or devil), as usual, is in the details. RDC, like other services, needs to be part of a package of services, with a clearly defined and proven benefit message to customers. It needs to be better, faster and cheaper (at least two out of those three) than existing solutions. Services also must be offered within the existing risk and compliance standards of the bank. Not every customer will qualify and not every customer will generate volume worth doing. We have interviewed hundreds of banks who are offering or planning to offer RDC that have not considered its impact on service standards, clearing times, deposit window times, costs and other critical factors. Banks need to determine and clearly articulate enhanced benefits across these factors to get customers to buy. Most companies will not switch because the tech vendor sold the service as “cool;” the service must make business sense and the service packages must meet specific customer needs. Some businesses need and have an easier business case for ACH conversion, either POP or back-office conversion (BOC). Does your bank offer both? Do you offer clear business cases for one over the other? Will you offer ATM image deposit for the customers who don’t need or can’t qualify because of their financial/risk profile to scan their own transactions? Do you even provide ATM access to business customers? Many banks are offering or planning “me-too” solutions without real consideration of strategic implications. Does your institution target segments that will be solid long-term users of these services? Services for retailers are likely to be the first to be commoditized and controlled by existing providers of other merchant services. Bank customers who are primarily in the business-to-business space may be more logical targets, but they were the same targets listening to your message to use credit and debit cards for these same transactions.

There are significant segment-based opportunities. The question is, have you targeted your marketing message to reach them? The industry must be selective in how these services are packaged and marketed. Specific services must be deployed to meet the particular needs of identified customer segments. If remote capture is truly a mass-market service, it will evolve to become part of a merchant services platform. If it is a niche service, it should be marketed only to customers who are a long-term strategic fit for the financial institution. If you can’t answer why you are offering it, or provide a real value statement for your customers and justify your investment in real terms, you’re just participating in a fad. 4 - Mobile Banking and Payments: If You Build It, They Will Come Throughout 2007, new mobile banking and payment applications were brought to market on a regular basis by banks and mobile carriers. While some providers have very modest expectations for adoption, the general notion being promoted is that a mass market of consumers now wants anytime mobile access across financial applications. It’s true that an early-adopting customer segment, which will tend to be young and already mobile-savvy, does exist. This segment fits the description of the anytime, anywhere customer. Their numbers are in the millions and do represent an opportunity for providers. However, they are a very small segment of the overall customer base. Many solutions targeted in this space are really designed to only reach the upper end of this segment. It’s easier and cleaner to target segments that are “almost” like mass-market customers. As was learned from many failed efforts during the early part of the past decade to build new and seemingly inevitable payment systems, adoption requires far more than simply building the rails to move transactions. While consumers will use mobile devices to bank and make payments at some point in the future, financial providers and others involved in the process, such as carriers, need to understand how many, how quickly and which customers will adopt various applications. Significant barriers, including security concerns, will keep mass-market consumers on the sidelines for years to come. The early adopters will sign up for some services because they are attracted by the features and benefits they provide—and to some extent by the “cool factor” that comes with being the first to use a new technology. The mass market, however, is driven to adopt when a strong compelling need justifies adding a new process to their lives, one that replaces or adds to an existing process. The business case for most mobile applications should be built with the assumption that only a small, but possibly important, segment of customers will sign up in the short term. Applications need to include features and benefits that are geared toward the early adopters, rather than to the mass market. Determining who the early adopters are by each mobile application, and more importantly, what features they desire, is critical to each product launch. Getting beyond the early adopters will require that mobile offerings provide compelling features and benefits that go beyond the processes used today. For the mass market, offerings must be faster, less expensive or more convenient to the point that people are willing to change their behavior. A significant commitment of marketing resources will be critical to reach and promote the applications to these customers. Marketing also needs to allay security fears and demonstrate the real benefits to using the new applications. The experience with online bill payment is instructive in demonstrating the role of marketing in promoting adoption of new financial applications. Credit card and telecommunications companies strongly promoted electronic payments and achieved strong adoption rates. By contrast,

utilities built the application but did little to promote it so their customers responded with slow adoption rates. Some banks may only want to offer mobile offerings to stay competitive and will not care if adoption rates are low. Services may be free and generate no revenue so, in the case of mobile banking, this will be just one more channel for banks to manage. However, for payment applications that can generate revenue and for which adoption is critical, providers that use a simple “build it and they will come” strategy will likely be disappointed if they do not understand the needs of their primary target segments and do not apply the appropriate level of marketing to draw customers. 5 - Unbanked People are Homogeneous and Can Be Served That Way There’s much talk in the industry about serving the unbanked or under-banked population. The problem is that many assume this consists of one homogenous population segment. It is true that most people in the unbanked segment can be considered low-income, although there are some very wealthy people who don’t use banks. But the similarities end there. Providers that can successfully coordinate a package of services across 23 million households speaking 60 primary languages, in three levels of acculturation and 22 primary geographic clusters, will quickly tell you how homogenous they think the unbanked really are. There are many unique challenges in marketing financial services to the unbanked, including the fact that there are millions of such unbanked consumers, even some with legal residence status, who will not use any product that requires identification. There is no single package of services that will work for all or even a majority of unbanked segments. No individual financial institution has the geographic or product set footprint to reach these markets on a national basis. Financial institutions need to partner with other financial institutions or non-bank players to meet the needs of these market segments. Instead, unbanked and under-banked consumers, just like other customers, need a dedicated package of services that meet a variety of financial needs. They are willing and used to paying fees for services, but they will not overpay, except as a last resort. We have seen many product concepts that originated as single-shot attempts to pick a single product and charge premium pricing. This approach typically fails. One of the more attractive segments among the unbanked consists of people who are accumulating wealth and who believe they have a chance to pull themselves out of their current circumstances. This segment needs a focused set of products built to meet their growing needs. Providing unchanged traditional banking services and ATMs in Spanish and other languages is not the answer. Mr. Kerr is vice president, retail payment strategies, and Mr. Majors is president with Rhinebeck, N.Y.-based Phoenix Payments Systems Practice. Banking Strategies: January/February 2008 Issue 84,Issue #1