The payment landscape: Why so complex?

You go to your favorite retailer or more likely your favorite online retailer, buy the item of choice and check out using a credit (or debit) card. From the time you swipe, dip, wave your card/phone or hit the ‘submit’ button on your phone/browser to the time you see the magical "transaction approved" message do you know (or care to know) what happens in those intervening seconds? Well, the other day when my precocious wife (who is an expert in her own field and always seems to have the right answers) asked me that question, I tried my best to explain! But my answer (which was more of a disjointed ramble) left her unsatisfied. Suffice to say, spurred by a bruised ego and some healthy spousal rivalry, I took it upon myself to 'demystify' the payment ecosystem for myself (and her) and along the way stumbled into some interesting questions and observations.

First things first. Let’s create a simplistic view with the help of the graphic below (courtesy google images) of the current payment ecosystem and call out the key players in the game.

1. The Consumer: The cardholder like you and me who makes the purchase online or offline using the card.
2. The Merchant: The provider of the goods or services: physical or online.
3. PoS/ISO/Payment Gateways: Massively oversimplifying here--but essentially the ‘front-end’ that is used to accept the card information. Think of Verifone, NCR etc in the physical world and Stripe or Square in online. 
4. Payment processor or Payment Service Provider: They take the information passed from the gateways and process the data--essentially validating basic card info and passing that onto the merchant banks (also known as acquirers). Worldpay (formerly Vantiv and soon to be FIS), Fiserv, TSYS etc are the leaders in this space.
5. Merchant Banks or Acquirers: These are the banks that provide services to the merchants by processing and settling card transactions with an issuer on behalf of the merchant. e.g. Chase, Wells Fargo, BofA etc
6. Card Networks: Visa, Mastercard, American Express, Discover. They provide the ‘rails’ and the ‘rules’ between the merchant bank and the issuer bank. Amex and Discover are slightly unique in that they also act as issuers.
7. Issuer: Bank or financial institution that issues credit card to the consumers - e.g. Capital One :-)

The way the various entities make money is by taking a ‘fee’ paid by the merchant (usually in the range of 2.5%-3% of the transaction) and splitting it up through the value chain with the issuer getting the lion's share (around 2%-2.5%). When put in context with the billions of card transactions worth trillions of dollars, you quickly realize how lucrative this space is!

So what’s the first thing that strikes you when you see the above ecosystem? If you are like me--the sheer number of intermediaries! Now some of them definitely add value (after all, I can’t imagine thousands of Banks trying to establish a relationship with each other and with millions of merchants) However, this space also reminds me a bit of the travel/vacation booking industry or even the taxi industry years ago--too many ‘middle-persons’ and I bet I am not the only one asking this question. Unless you have been living under a rock, anyone who is someone in the Financial Services industry has heard about the two big acquisitions-- Fiserv acquiring First Data and FIS promptly following suit by scooping up Worldpay (formerly Vantiv). While both these acquisitions are more complementary and within the payment processing space, I would venture to guess there could be some disruptions on either ends of the payment processing value chain -- gateways/ISOs on one side and merchant banks on the other.

Some of these payment processors already have a complex suite of offerings and work closely with banks to offer a whole bunch of products including platforms for some core banking activities. I would not be surprised if they try and make a play for the ‘acquirers cut’ of the share by either providing merchant services (if they can get the appropriate licenses on their own) or by partnering with another bank and 'riding on its license'.

On the other end of the payment processors are the Gateways--they are the interface to the customers and some would say control the customer experience either in a physical store or online. This is also the area that is least regulated and where the most innovation is happening at the moment-- Stripe or Square anyone? Below is a great graphic (courtesy google images) that beautifully demonstrates how this part of the ecosystem has rapidly evolved and the term ‘PoS’ has taken a whole new meaning with the Cloud Based PoS architecture pioneered by the likes of Stripe and Square.

These mega mergers should provide the combined entities the economies of scale (and a diverse set of talent pool) to start making more disruptions (and further consolidations) in the gateways space. Looking at the data and the trends, my prediction is that's where the bulk of the innovations will happen in the near term. Then there is the question of completely disrupting the entire ecosystem using the Wechat, Alipay or Paytm model (will dig into them deeper in a separate blog). However, what allowed Wechat, Alipay, Paytm etc to flourish in Asia was the general lack of an established e-payment infrastructure and the 'rules' that govern them, combined with a unique set of geo-political factors. My guess is that the US and other developed western economies with a mature and established payment ecosystem have less of an incentive for a complete overhaul. That said, I am a payments neophyte and curious to hear from the experts--What’s your ‘trendometer’ telling you? Is there another mega-merger on the horizon? Is Square or Stripe up for grabs? Will we see a Wechat like disrupt-er completely overhauling the payment ecosystem and making lives of customers and more importantly merchants much easier? Leave me your thoughts here or @ddas1992