Oh, Duh! Payments' Most Obvious (Yet Overlooked) Best Practice
by David Evans
Sometimes it helps to be reminded of the stunningly obvious. You know, like if you want to lose weight, why not just eat less and exercise more? My favorite business example is don’t compete where there’s lots of competition. Blue Ocean Strategy became an enormous business best seller by making that “oh, duh” point.
So here goes: payments innovators need to provide significant additional value to consumers and merchants if they want to have a snowball’s chance in hell of success.
Now, I’d be embarrassed to offer such trite advice if it didn’t seem like every time I turn around there’s another multi-million dollar wad of cash gone up in flames.
Tempo is the latest one of these.
(Related Interview: Tempo CEO Opens Up about Decision to Shut Down after Durbin)
This payments network started seven years ago under the name DebitMan. It provided a decoupled debit card that merchants could offer to customers who could then use this card at other merchants that accepted DebitMan. It didn’t have anything that was any better than existing cards. In fact, it was worse since it ran over the ACH rails, couldn’t offer many places for consumers to use their cards and didn’t bring any extra sales to merchants. It was a business built almost entirely on the proposition that merchants will flock to a cheaper card as a result of their outrage over interchange fees. A grand total of seven merchants did a turtle stampede over the last seven years, bringing with them a piddling 100,000 customers.
Don’t get me wrong, building a business based on being cheaper can be very smart. Hey, look at the gazillions Wal-Mart has made. In fact, an entrepreneur would make a fortune if she could really build a payment card business that was a lot cheaper than the incumbents and offered as much value. But Tempo staked its future on what I call the “interchange fallacy”: merchants don’t like paying interchange fees, and therefore, they will favor a payment method that offers lower fees.
The fallacy is that merchants mainly care about whether accepting a payment method is going to drive additional sales (and therefore additional contributions to margins) and that depends largely on how many consumers want to pay with that card. All else equal, merchants would love lower interchange fees. The trick is making an alternative anywhere close to equal with successful payments networks and the tens – if not hundreds of millions – of customers they bring with them. So, that means solving the chicken-and-egg problem of getting enough merchants and consumers on board quickly. That can only happen if the payment system can provide a lot of value consumers and merchants can’t get elsewhere – PayPal did that online – or already comes to the party with lots of merchants or consumers—Discover had a boatload of consumers from its Sears’ owner.
Instead, Tempo seemed to have thought that it could be successful by undercutting the merchant fees by the existing networks. There were just two problems. (Related Commentary: Tempo, Take 2: Lessons the Payments Sector Can Learn From)
The first we’ve just hit: if you aren’t creating a lot of extra value, you don’t have any way to get both merchants and consumers on board. Lower prices to one side just isn’t enough. The second is that betting a business on a price advantage on one side of a two-sided business has long, maybe infinitely long, odds. Tempo’s founders should have thought about the possibility that interchange fee regulation would wipe out their advantage (between the merchant class action and the bills in Congress, it wasn’t exactly a secret that interchange fees might be forced down, and people like me were sounding the warning). Perhaps more importantly, they should have wondered what would have happened if they had become successful: chances are the very efficient payment networks would have dropped their interchange fees and shifted more of the costs to the consumers.
Tempo wouldn’t be all that remarkable if it was just some doe-eyed entrepreneur chasing his dream. But this was a company that had serious VC backing and smart management. Nor would it be worth mentioning if it was just the exception among startups. I’m beginning to think it’s the rule. The original ISIS business model was based on cutting merchant fees, Revolution Money’s grand ambition to be a payment network was too, and of course, there’s the PayByTouch debacle. Then, there are a bunch of entrepreneurs who shall remain unnamed but who just don’t seem to recognize that they need to create lots of value for merchants and consumers to get them to change their current way of doing things.
OpenTable, on the other hand, provides a great example of how to innovate in a platform business. It provides a lot of insights for what I think the payments networks and issuers need to be thinking about post-Durbin: figuring out ways to provide a lot of value of merchants, and in particular, driving additional sales and profits.
OpenTable identified a major point of friction in the fine dining restaurant business. Restaurants had a problem managing their reservations and tables. Handling them manually was a pain. Screwing up reservations cost money, because someone who made a reservation that the restaurant didn’t record would probably not come back. Consumers had an even bigger problem. To find a reservation, they had to get the restaurant’s number, call, probably go on hold and then talk to a person – not to mention know about the restaurant in the first place. It was a time suck and even more so on a busy night when you had to call several places to find a seat.
OpenTable entered the market by selling restaurants reservation-management systems. They eventually got enough restaurants on board their platform that they started an online consumer reservation system. The restaurants paid for the reservation system and then $1 for every person who made a reservation through their system. For a $50 meal, the restaurant would pay $2 or 4%, which makes interchange fees and merchant discounts look cheap. AmEx recently did a deal with OpenTable, where members can use their reward points on a prepaid card that they can use to pay at OpenTable restaurants.
This is the sort of innovation that the payments industry needs now – solutions to big frictions that really help merchants and ones that they are willing to pay for, and that consumers value, too. (Ironically, some restaurants are making the same complaints about OpenTable as they made against the card industry. That’s a column for another day.) It may be that some of the “gee-whiz” things that we’re hearing about in payments will provide these solutions. You know, NFC-enabled mobile phones with slick applications that will send consumers on shopping sprees down the aisles while at the same time managing their bank accounts, getting dinner going and walking the dog.
The recent success of OpenTable and companies like Groupon suggests that there’s still lots of money to be made using the existing building blocks that don’t depend on particular technologies or even new ones. OpenTable is built from pretty much off the shelf software components, and Groupon is sending e-mails. Wow. Of course, a lot of creativity and hard technical work went into creating these slick platforms, but my point is that these companies were based on identifying a problem (a major friction), a business model for making money from solving that problem and building solutions with off-the-shelf technologies for solving those problems.
So, at the risk of ending with another trite sentiment, payments intrapreneurs and entrepreneurs should pay close attention to how non-payment companies (today) are solving problems for merchants and creating value. These companies are doing something else that is worth paying attention to: commoditizing the payment transaction. Their value is really on the value created and these days, it ain’t paying for the check or the coupon. It’s driving business to merchants and monetizing the value that set of activities generates. And, it’s that kind of stunningly obviously mantra that is worth thinking hard about.
David S. Evans is an economist and a business advisor to payment companies around the world. His recent work has focused on helping companies create, ignite and profit from payments innovation. He is the originator of the Innovation Ignition Framework®, a tool provides a systematic way for companies to evaluate and implement innovative ideas and achieve critical mass. David is the Founder of Market Platform Dynamics. Read More