MPD Innovation in Payments

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Igniting Innovation in Payments


How Software Development Platforms Will Drive Innovation and Transform Payments

The use of software platforms to drive innovation and transform industries has exploded since the 2006 publication of my book Invisible Engines , written with MPD Chairman and MIT Professor and former Sloan School Dean Richard Schmalensee and MPD Principal and Harvard Business School Professor, Andrei Hagiu. Around the globe, these “invisible engines” are ushering in a new era of technological change based on software.

The Apple iPhone has shaken the mobile phone industry worldwide, in part by creating a massive applications business built on the phone’s operating system. Firefox has revolutionized the browser industry by encouraging developers to write add-ons and, in doing so, toppled Microsoft’s Internet Explorer from dominance in many countries. Facebook has created a powerful social networking platform by opening itself up to developers. Amazon started a cloud-computing platform that enables entrepreneurs to access its vast software code, hardware and global communication systems over the Internet.




Invisible engines are based on software code. Software programs are written in various languages. Working by themselves or with other programs they tell hardware – from the pixels on your iPhone to the chip on your desktop to the communication devices providing your internet connection – what to do. They are the brains behind everything from the card reader in which you swipe your debit card, to your social network page where you visit friends, to the complex trading decisions at hedge funds, to your favorite word processing package.

Software programs can become platforms that support other software programs when code that is written to perform a particular task is made available to other software programs so the writer does not have to write that code again. That is what Windows does. It contains many little bundles of code that help developers write their own programs. Microsoft provides a link to that code—called Application Programming Interface (API)—that allows developers to link into the Windows code. Some businesses make their service available by providing an API. For example, YouTube provided an easy-to-use API for people to include access to videos on their social network pages.

By making APIs available, the owners of software programs are letting others use their intellectual property, the results of their hard work writing code. They can benefit from doing this if others decide to write valuable applications that work with their software platform. More people are likely to use a platform if there are more attractive applications that work with it. For example, many users decided to switch from Internet Explorer to Firefox because there were add-ons for Firefox that did things that were not available with Internet Explorer such as support for XHTML – a popular programming language for webpage developers. Software platform providers do not have to make their code available for free though. Developers that sell their applications through the iPhone app store give a portion of their revenue (about 30 percent as of the end of 2009) to Apple.

Invisible engines are catalysts that use a multi-sided platform business model. They ultimately create value by making it easier—lowering the transactions cost—to get several different groups, whose members value each other, together. In the physical world, a shopping mall is a two-sided platform that helps bring shoppers and merchants together.

Software platforms generate value by reducing the cost to developers of writing applications for consumers and providing a common place for users and developers to get together. Facebook for example provides a place, not only for friends to get together, but also a place for friends to find applications that can help them and applications to find users that can benefit from them. Facebook helps developers do this and thereby creates value for its community and ultimately itself.




The iPhone provides a potent illustration of the invisible engines/catalyst business model. By the end of 2009 there were more than 100,000 applications available for the iPhone. These applications have been downloaded more than 3 billion times since Apple opened its iPhone store in July 2008. Apple’s success has shaken up the mobile phone industry in many countries around the world. It has unleashed tens of thousands of entrepreneurs and created a multi-billion dollar application industry for mobile devices. Here is how an invisible engine helped make this.

Inside the iPhone there is a computer chip on which is stored the software code that does all the magic that has been behind the success of this smart phone. That software code is usually called the operating system for the iPhone. Apple could have decided to keep that code entirely to itself and focus on making the iPhone a self-contained device that only did things that Apple wanted it to do; it would have had a “closed software platform”. Instead, in a smart move, it decided to make that operating system a software platform that could support third-party applications. That meant it had to create APIs which would enable outsiders to link into the iPhone’s operating system. These APIs give developers access to blocks of code that manipulate various aspects of the iPhone. Apple then provided a “software developer kit” (SDK) to help programmers develop applications using the iPhone’s APIs and put together a web site to provide other resources for developers.

An important set of business dynamics starts when such an operating system is opened up and thereby becomes an “open software platform” that can support developers. Apple initially provided more than enough applications and features on the iPhone to persuade many people to get one. By opening up its operating system it then started a virtuous circle. Entrepreneurs and hobbyists saw the opportunity to write interesting applications that could use the features of the iPhone, including its large touch screen and connectivity. The iPhone users soon found that they could download applications that made their phones even more useful than they were when they first bought them. More people started buying iPhones because of the increasingly valuable applications. As the number of iPhone users increased, developers had even more incentives to write applications.

Apple has not taken this process for granted. Like most other successful platforms it has stoked the fires. It developed a marketplace–an online shopping mall–to help developers make their applications available to iPhone users and earn revenues from them. Apple is responsible for collecting money from iPhone users and then gives the developers about 70% share of the revenue. Users have benefitted from having effectively a single location to search for applications. Developers have benefited because Apple has reduced the transactions costs of selling and has assembled an audience of users.

Apple has obviously made enormous profits and seen the market value of the firm increase because of the success of the iPhone and its application store. iPhone users have done very well also as a result of the tens of thousands of applications they can choose from, some of which enable them to do things that were not possible before. New markets have opened for entrepreneurs that use the iPhone, and some of them are earning significant profits or obtaining fame. By bringing developers and users together the iPhone has served as a catalyst which has created value—and profit—out of thin air. Others have followed suit. The most significant follower is Google, which has introduced the Android software platform for mobile phones, has stimulated hardware makers to introduce phones using this platform, and has worked hard at persuading developers to write applications for its store. (Microsoft has been trying to be the open software platform for mobile for many years but has thus far failed to catch on.)

Apple’s experience with the iPhone shows the power of the invisible engine model. As we will see software platforms can drive payments innovation and revolutionize the payments business.




The invisible engine model followed by Apple’s iPhone has helped power the information technology industry for about three decades. Apple itself was one of the pioneers in encouraging developers to write applications for its desktop operating system. It invented the “software evangelist”. Microsoft, though, was the maestro catalyst. Its Windows software platform attracted thousands of software developers and hundreds of millions of users. As a result it has been the durable center of a vast desktop-computer based ecosystem since at least the launch of Windows 3.0 in 1990. My book, with Andrei Hagiu and Richard Schmalensee, Invisible Engines tells the story of how software platforms have transformed industries including computers, video games, and handheld devices and then accelerated innovation. It then examines the forces behind the various business models that have been adopted in these industries. Many software platforms have decided not to charge developers while others have. Some have decided to vertically integrate into hardware while others have remained pure platforms.

The development of the internet and the spread of high-speed broadband throughout the world provided have resulted in a new age of software platforms. Several of the major web businesses have turned themselves into platforms. The heart and soul of any web business does not reside in a server farm somewhere or in its buildings—it lies in the thousands and thousands of lines of software code that enable people to see and interact with web pages. Once written these software programs can be opened up to others by exposing APIs that enable developers to use portions of that code to interact the web properties.

Facebook has allowed developers to write applications that work inside its social network. As a result developers can write games, such as Farmville, that people on Facebook can play or online shopping and advertising programs such as those developed by FreeCause for raising money for charities. By the end of 2009 there were more than 500,000 (yes, really) applications running on Facebook. This five-year old site has also developed a program called Facebook Connect. Developers can write applications that through APIs made available by Facebook enable users of those applications to pull their Facebook identity, friends and privacy to other websites. As of the end of 2009 there were more than 6000 developers working on Facebook Connect applications. These applications make Facebook more valuable to its users, and the greater number of users makes Facebook more valuable to developers. Although it has made slow progress, the expectation is that Facebook will make money by selling, in some fashion, access to the eyeballs drawn to Facebook and these applications to advertisers.

Amazon is one of several companies that are competing to create a general purpose software platform that can be accessed over the internet. Such platforms are said to reside “in the cloud” (more on this below) because they are off in the distance as opposed to on the user’s desktop or other client computer. The idea is to develop a set of services that application developers can use. These include software services that allow developers to use the code rather than writing their own. But they also involve access to the vast server farms and communication networks around the globe. Amazon’s Web Services plays to this company’s strength in selling products over the internet. It provides special services to developers who are writing programs to help merchants operate virtual stores and receive payment.

Invisible engines are beginning to disrupt the payments business both online and offline. This industry is at the heart of commerce and makes it possible for businesses and people to exchange value around the world. By definition it involves essentially all the money in the world. If invisible engines start driving innovation in this industry they could have an enormous impact on consumers and businesses who transact with each other.




When we speak of “payments in the cloud” we are using the term in a broader sense than it is usually used in the information technology world.

Cloud computing simply refers to accessing software and hardware over the internet. In a sense we’ve all been doing that since the commercial internet started 15 years or so ago. Just consider search. Google stores massive amounts of data on web pages on server farms and updates these data regularly. It has devised complex and sophisticated software that searches those web pages for information. We obtain access to that software and hardware using just our browsers (and possibly some code that is stored on our computers if we have installed a toolbar).

As the web economy has grown, more businesses have started offering services that reside in the cloud. To take a few examples, Flickr helps consumers store and manage your photos in the cloud; provides customer relationship management software in the cloud. Google Docs helps consumers and enterprises do word processing, spreadsheets, and other applications in the cloud and Microsoft’s soon to be released Office 10 will do so as well.

Several things have happened that have led to cloud computing becoming the next big thing.

(1) Accessing things over the internet has become much faster and more reliable in many parts of the world as a result of the spread of broadband.

(2) Software development has moved from local devices to the internet so there are more languages, tools, and code to leverage.

(3) There’s been a lot of progress in developing inexpensive, efficient, and massively large computer systems. Of necessity Google and other companies had to figure these kinds of things out.

(4) The companies that have invested in massive and scalable server farms have realized that they can sell others access to it. Many of the obvious suspects have gotten into offering cloud-based services including Amazon, Google, IBM, and Microsoft.

Cloud computing is also associated with a change in the traditional business model. Consumers and enterprises typically bought (technically they licensed, but usually in perpetuity) software packages which they installed on their computers. Expanding information-technology resources meant front capital expenditures for hardware and software. In contrast, cloud computing is usually sold in bite sizes under what is known as the “software as a service” model. In fact it is even better than that. In a typical situation consumers and enterprises are paying monthly or annual fees to obtain access to hardware including storage as well as software.

Amazon Merchant Services provides a good example of what cloud computing is all about and one that is relevant for the payments industry. Suppose you are a retailer who wants to start selling over the internet. If you wanted to stay on earth, you would hire someone to build an e-commerce site for you, line up someone to host it, and get a processor to enable you to take payment cards on line. If you wanted to go to the clouds, you could rely on the software that Amazon has created for quickly building a store on line, have them host it at one of their server farms, and use their payments system.

Amazon Merchant Services also illustrates how cloud computing has resulting in innovation moving to the cloud. Amazon has developed a payment services product that relies on the payment systems back down on the ground. They connect to one or more processors that in turn connect to the rest of the payments system. Amazon’s innovative product stays in the cloud where everyone down on earth can connect to it. PayPal, Apple, and other companies are also engaging in this sort of innovation in the cloud. A later entry will discuss them in more detail.

Cloud computing also unleashes innovation from hardware. For most of its history the payments business has been tied to devices that pretty much have the software hard wired in. Maybe the supplier of the hardware could modify the software but the merchant really couldn’t nor could other players in the ecosystem. And since these devices were closed systems a clever entrepreneur couldn’t develop applications that could provide extra value to the merchant or to members of the payments value-chain. That’s can and will change. Software will come down to the devices from the cloud and APIs will enable entrepreneur/developers to add value.

There are other opportunities for moving innovation off the ground in payments that don’t necessarily involve using internet connections to software residing on remote hardware. At the moment the payments system consists of a number of highly secure private networks that companies can plug into. A point of sale terminal at a retailer plugs into several private networks. It does that by connecting to a switch which then routes transactions across the debit or credit rails to the relevant clearing and settlement system and so forth. One doesn’t have to rely on the internet necessarily to move innovation off the ground. Companies could provide remote services over private networks.

One way to do this would involve developing a software platform that enables third parties to write applications that would work with the payments system. That could happen in a couple of ways.

(1) The major processors currently operate software platforms that provide services to banks. They could potentially open up portions of these platforms to developers to build applications that use some of the features and functionality of these platforms. The same is true for networks. Obviously, there are security issues that would have to be dealt with to ensure the safety and integrity of the platforms.

(2) A third party could build an uber-software platform that sits on top of all of the various software programs that lie on the payment rails. That uber-software platform would connect into these software programs. Then developers could plug into the uber-software platform to write applications. In both of these cases it becomes possible for innovation to take place outside of the software and hardware that currently comprises the payments systems. The resulting innovative applications then also sit outside.

When we talk about payments in the cloud for the rest of this series we will use this term to refer to the development of applications that sit outside of the traditional payments system and link to the traditional payments system through APIs on software programs that sit somewhere on the rails of the traditional system.

One thing is for sure in my view: innovation in payments will move to the cloud and anything who wants to be a player will need to be there as well or work with someone or is.




I’ve explored how invisible engines drive innovation and transform industries. I’m now going to explain how they will do that in the payments industry. This entry explains why the payments industry needs a catalyst to ignite innovation.

There is an intricate set of systems and enormous group of businesses that are involved in payments. They range from the companies that print paper checks, to ones that make the point-of-sale terminals where you swipe your debit card, to banks that operate depository accounts, to clearing and settlement networks. At the beginning of 2010 this industry involves many different computer systems, each with a software program, that have been through brute force forced to interoperate with each other. Consider what happens when you swipe your card. The terminal sends your card information along with details of the transaction to a switch. That switch, which may be operated by a variety of payment players, has a software program that decides what to do with the transaction. It will send it on to a merchant processor that will keep track of the details of the transaction and act as an intermediary with a clearing and settlement system which will contact the bank processor that acts on behalf of the bank that issued the card or possibly the bank itself. Many software programs running on numerous pieces of computer hardware are involved in the various steps in the process.

What we have just described is one “rail” in the payments system—the one for credit cards. While this may vary by country, in the United States there other rails for debit cards, paper checks, electronic funds transfer, and other “tender” types. Now suppose that you are an entrepreneur who has come up with a great idea that involves incorporating payments into your application. This innovation could be something as simple as a software program that helps small businesses accept payment in multiple ways and integrate these payments into basic accounting software. To succeed, you would have to integrate your application into the many software platforms that are used for the many tender types taken by businesses. That is such a daunting task—one involving substantial money and time not to mention the cooperation of the other businesses that handle payments—that you might well give up.

This is a perfect problem for a catalyst to solve. Massive transactions costs make it hard for payments entrepreneurs and payments users to get together. A software platform—perhaps in the cloud– can lower those costs by investing in linking to the multitude of software programs that handle various elements of payments. By exposing APIs, this software platform then makes it possible for entrepreneurs to quickly integrate into most relevant aspects of the payments business. Such a software platform is analogous to Windows which among other things enables software applications to work with the multitude of device drivers that work various hardware peripherals such as computer hardware, printers, and cameras.

A great deal of innovation can be unleashed once these APIs are exposed. Entrepreneurs won’t need to replace hardware at the point of sale; they will just need to develop applications that work with platforms that connect to the hardware. They will be able to achieve massive distribution quickly thereby making it easier to ignite their businesses. With that they will be able to obtain scale more quickly and lower costs. It will be possible to roll out innovations to many channels simultaneously by porting apps between different platforms or using APIs for platforms to connect to multiple channels.

In the next section I will describe a platform that sits on top on the rails I’ve just described and helps developers of new payments businesses access the messy plumbing of the payments system right down to the point-of-sale devices at retailers. Then I will describe how PayPal has created a software development platform for online transactions. These platforms help developers of applications, say for the iPhone, easily integrate payments. And finally I will explain how the traditional card networks will play in this new world in which innovation, and value-added services, are driven by invisible engines Should the card networks create their own open software platforms or focus on just running the rails?

Innovation in payments will, in my view, be driven over the next decade by software platforms that facilitate a vast ecosystem of applications. And there’s going to be competition over who provides the best APIs (and underlying code) to support applications. One of the things we’ve learned about software platforms is that they have huge network effects. The platform that gets more applications and users will get even more applications and users. That doesn’t mean that only one software platform will survive because each could differentiate itself by catering to different needs of developers. But it does mean that it is unlikely that more than a handful of payment platforms will survive. The race is on.




There’s no Steve Jobs strutting on the stage, massive consumer buzz, or slick television ads about how there’s an app just for you. But there are some things you’ve probably heard about and a soon-to-be known Denver based company, IPCommerce, is the invisible engine that’s powering them.

You might have seen the television advertisements for American Express OPEN. They’ve launched AcceptPay which they tout as “an online invoicing and payment solution that can help business owners improve cash flow at a time when customers are taking a longer time to pay.” Amex’s solution is based on a software application developed by PaySimple and a small-business service built around this application. A small business can easily accept multiple tender types online and offline after installing this application and signing up for the service. For the reasons discussed above, developing an application like this is incredibly complicated because it needs to work with multiple payments rails and comply with lots of security rules.

If PaySimple had to do all of that work itself, on top of developing easy-to-use software for small businesses with a greater user interface, it would still be a powerpoint deck gathering dust in a VCs office. Fortunately, PaySimple was able to use APIs which linked into IP Commerce’s software platform, that provided all of the code and connections needed by link into the payments plumbing. Through the miracle of the division of labor, PaySimple got to focus on what it could do best—develop an innovative solution for small business—and offload a lot of dirty work to a specialist. As a result, American Express got access to a technology that would have taken it a long time and a ton of money to develop on its own—so much so that the AcceptPay innovation probably never would have launched without something like IP Commerce.

The APIs that IP Commerce makes available are enabling many entrepreneurs to develop payments-related applications far more quickly and cheaply than they could have done on their own or through other solutions. Square—the new smart-phone enabled payments system for small merchants and their consumers—is powered in part by the IP Commerce invisible engine. So is BrainTree Payment Solutions, a gateway and value add provider of online payment solutions. . A new e-commerce application that relies on IP Commerce’s APIs, getta , that just launched on MySpace. Getta uses the power of social networks to encourage group buying—the buyers get volume discounts and the merchants get sales.

IPCommerce has made these applications—and more like them—possible by spending years doing the dirty work of creating code that links into the multitude of discrete and non-interoperable software programs that ultimately run the payment systems. This tedious work is what many successful software platforms do. There’s nothing glamorous about Windows 7 or Snow Leopard. These software platform—that we don’t really think much about, except when they crash—are based on millions of lines of code that do all the nasty business of computing—from telling the chip to move 1s and 0s around, to working the pixels on your screen, to connecting to your home wireless system. IP Commerce has spent the last 4 years and many millions of dollars writing the code that’s needed to get a lot of the mundane but complicated tasks that need to be done to work with each of the several tender types that are used in the US.

IP Commerce’s work isn’t done. While it covers much of the payments business through which most of the dollars flow it doesn’t have 100% coverage yet. And it is going to need to keep up with ever changing software systems. Moreover, like all software platforms, its value will ultimately come from spawning numerous applications that rely on it. But it has done a lot of the tedious but important work of developing a cloud based platform that sits on top of the payments system and it has a rapidly growing stable of applications that have shown its power.

IP Commerce has the prospect of creating the same sort of powerful network effects that Windows has (which isn’t to say they are necessarily the next Microsoft—that franchise is tough to beat!). These come in two ways. First, IP Commerce’s platform will become more valuable to the participants in the payments ecosystem (such as processors and device makers) the more applications there are there are that drive volume through these points. Likewise it will become more valuable to developers of payments applications as even more of the payments system standardizes on this platform. Second, some of the applications that are being built on IPCommerce—like some of those built on Windows—have there own APIs and are creating there own ecosystems. These applications can work more easily together as a result of relying on the same platform.

Don’t look, of course, for tens of thousands of applications coming out of garages over the next year. Creating “applications” in payments is a lot harder than it sounds. The success of the iPhone has made us think about applications as software programs that do cool things like help you find friends nearby or learn Mandarin. In payments, the software application is usually just one piece of a business model. Developing successful business models in payments—no matter how good the software application is—is extremely difficult. There’s everything from glacial inertia to chicken and egg problems to solve.

Despite these challenges it is likely that cloud based platforms such as that provided by IP Commerce will become the one of the main drivers of innovation in payments in the coming years. These platforms drastically lower the cost of creating businesses that need to connect to the payments plumbing to create value. They are likely to therefore unleash a vast amount of entrepreneurial energy devoted to discovering ways to provide value to businesses, consumers, and governments that transact with each other. PaySimple, Square, Getta, BrainTree Payment Solutions, TIO Networks, SoftTouch, and over 100 other applications, are early indications of what’s to come.




When it comes to using invisible engines to drive innovation and transform industries, PayPal is the first out of the gate in the payments industry and well ahead of the traditional players. This online payments giant claims that “PayPal X is the first and only global payments platform open to third-party developers. Our new set of APIs will offer unlimited possibilities for [developers] to easily monetize your ideas, by providing security and connectivity to the world’s financial systems.” This isn’t the usual hype—whizbangthing.ppt—that we get from payments providers trying to stake a claim. Six months after announcing its open platform more than 25,000 applications have been written to it and a vibrant developer community is are cranking out more apps as you read this.

Here’s what PayPal has done.

To begin with it turned PayPal into an open platform that provides a rich set of services to developers. It rolled out a new set of APIs that developers can use to build PayPal’s payment services into their applications. Now, in addition to sending and receiving money for P2P and B2B transactions, developers can make parallel and chain payments, pre-approve with PIN-authorization, integrate PayPal into the merchant’s order and account flow, pay attention to the context in which the merchant is interacting with the consumer, integrate ACH, pre-populate a PayPal account application for customers who don’t have one, and many other things. These APIs link to code in PayPal’s Adaptive Payments Platform that do the work for the developer.

Like every successful platform play, Pay Pal created a set of tools that help developers use these APIs. Just go to PayPal X Developer Network and you will see that PayPal has provided the standard “software developer kit” (sdk). Then it has provided a set of sample applications that give developers some guidance on what to do. PayPal X also have a “sandbox” where developers can test out their applications to debug them and make sure they work.

Taking a cue from the Invisible Engine strategy that Andrei Hagiu, Dick Schmalensee and I described in our book, PayPal put on a develop conference as soon as it opened its new platform. Over 1500 came to the November 3-4 conference in San Francisco. PayPal also offered prizes for the best applications. The winner of the $50k prize was Rentalic which helps people rent their stuff to other people. It has been described as a mashup of eBay and Craigslist. Here’s how it works. Joe lists her lawnmower on Sue offers to rent it for a fee they agree on. Joe uses PayPal to verify they can pay the deposit for it. Sue gets a secret code. After meeting Joe and making sure that she’s getting a working lawnmower she gives Joe the secret code.
PayPal has been trying to get people excited about the iPad. On April 16th, 2010, it held a developer bootcamp in San Jose that was focused just on using PayPal X for iPad apps. It got 300 participants. Naveed Anwar, who is the head of Pay Pal X and seemingly its chief evangelists, talks about PayPal X and the IPad, and shows some clips of the developers beavering away on apps, in the Pay Pal X IPad Developer Camp video on YouTube.

PayPal is also rolling out its own applications but even here it is allowing developers to build value-added services on top of them. Most significantly, PayPal just rolled out the PayPal IPhone Bump which makes it possible for people to transfer money to each other using their iPhones. (Now, personally, on this one I’m a bit skeptical. The video provides a great example of overhyped P2P. Maybe there’s a market for P2P, especially for small B to P transactions, but it isn’t likely to be splitting meal bills which seems to be the favorite example of the P2P optimists, or charging a friend for a slice of my pizza as featured on the video.)

With PayPal is ignited a new global payments platform very quickly. Here’s the virtuous circle:
• They’ve started with rolling out a series of services that are available through APIs.
• They’ve poured money into encouraging developers to write applications by providing prizes and putting together a VC network.
• They’ve provided these developers with tools and soon a place where develops, like the iPhone Store, will be able to sell their applications.
• This has led to the rapid growth of applications, the growth of a developer community, and more buzz that will drive more developers to PayPalX.
• They’ve started building alliances with companies like Facebook, Microsoft, IBM, and Salesforce. That’s the start of building out a potentially huge ecosystem.

It is remarkable how quickly PayPal has ignited its open platform strategy.

What does this mean for the traditional payment networks? For one it puts further distance between PayPal’s online dominance and the traditional networks. PayPal conquered eBay, has made great strides in moving its payment services off eBay, and is now creating a potentially enormous ecosystem of online applications. This is coming at a time when the distinction between online and offline will soon end. For example, the iPad with wiFi at the point-of-sale is online and can compete with traditional hardware and private connections. PayPal and the traditional networks have had an uneasy relationship for the last decade. PayPal drives an enormous volume of card transactions but everyone knows that they have strong financial incentives to move transactions to ACH and that in any event PayPal—not a card network and not a bank—owns the online customer relationship.

For another, it means that the traditional networks are far behind their alternative payment system rival in seizing the most important opportunity of the coming decade: creating an open platform for development payments applications. First movers such as PayPal aren’t necessarily the category winner—and in fact often get leapfrogged by those who bide their times. That said, PayPal—like Apple in the smart mobile space—is rapidly generating network effects and creating an increasing number of applications that will make it hard to beat.

Finally, PayPal’s seemingly flawless execution of its open platform strategy makes one wonder whether the traditional card networks have the genes to compete in this very Web 3.0 kind of world. PayPal has its roots as a software application that lived within one of the great internet companies. It wasn’t that long ago that the traditional card networks mainly used mainframes running Cobol. If the card networks can’t pull it off though they could be to payments what the mobile carriers are to mobile communications.




The traditional card networks are great at what they do and they’ve only gotten better over time. Transactions occur lickety-split over their networks. They provide valuable services to merchants and cardholders directly or through their bank partners. They have healthy market capitalizations—almost $180 billion for American Express,Discover, MasterCard and Visa combined (as of the end of April 2010). The old associations have made money faster than investors expected when they first IPO’d. Equity in MasterCard—the first of them to go public—sells for almost 5 times the June 2006 IPO price.

The card networks all recognize that their future lies in innovation. Hardly a day goes by without one of them (or several of them) announcing a new initiative somewhere in the world—from mobile to contactless to e-commerce. Indeed, it is the market’s faith that these companies will seize the incredible opportunities for shifting transactions from paper to electronic methods that feeds the multiples they command (more than 30 for Visa at the end of April 2010).

It is unclear at this point, however, whether the card networks understand how open software payments platforms will radically change the payments business in the next decade. They may have lots of plans in the works, may be behaving stealthily, just waiting to pounce on the first movers in their own sweet time. Or they may be unsure of what’s happening, what to do, and how to do it—they may be deer in the headlights of nimble rivals who aren’t saddled with old code and pre-web says of doing things.

In fact, the card networks have three stark choices: spur innovation with an open platform, innovate with a closed platform, or just stick to running the rails.


  • Open software platform strategy. They could use an invisible-engine strategy by building an open software platform on top of their existing networks and promoting the creation of applications that use services based on their rails. They would expose APIs to third party developers that would provide services. They would thereby compete for the attention of application developers with PayPal X, Amazon Merchant Services,IPCommerce, and whoever else tries to build a platform layer.



  • Closed software platform strategy. They could try to develop value added services themselves in competition with third-party application developers writing for competing platforms, or partner with other firms to develop value-added services that rely on their network. With a closed strategy they would not provide APIs that third-party developers generally could access.



  • Just run the rails strategy. They could focus on making money from transactions that go over their rails and focus on running those rails as efficiently as possible. They could leave operating software platforms and fostering third-party applications to other companies. They would benefit from the success of these companies who would drive more transactions over their rails.


Each of these strategies poses risks. To evaluate them it is important to agree on three premises concerning how the payments world will evolve over the next decade regardless of what the networks do.

First, over time the distinction between the online and offline world in payments will vanish. Fast internet connections will become ubiquitous. Almost every device we interact with will have a connection. Those devices will access web-based software which will provide an increasing array of services.

We have already seen this happening. When the commercial internet started only a few computers were connected. Over time virtually all computers had internet connectivity. Then mobile phones started being connected. It is widely expected that most phones in industrialized countries will be internet-enabled in not too long. The third screen—the television—is next. Other devices are in the queue. Automobile manufacturers, for example, are incorporating internet capabilities in their cars and providing software platforms for applications. Importantly, for our purposes, point-of-sale devices will become internet-enabled and rely on services provided by web-based software. That will include everything from card terminals to cash registers.

This means that the neat distinction of today between online transactions that you do with your computer (or increasingly, the mobile phone) over the internet, and offline transactions where you walk into a brick-and-mortar store without touching the internet, will disappear. The internet will become like the electric power grid—something that almost every device is plugged into. The corollary is that it will be meaningless to talk about internet-payment providers, such as PayPal, as if they were an interesting group of foreigners. The alternative payment providers will be at the physical point of sale because the physical point of sale will be connected to the web.

Second, most devices even at the point of sale will rely on software, probably residing in the cloud, that provide valuable services. At the moment, most point-of-sale devices rely on software that either resides on the device or on servers that are accessed over a corporate intranet. Devices usually rely on a dedicated software solution. Once devices can obtain easy access to the internet it will prove more efficient to move software to the internet as well. Device makers may do this on their own to obtain greater control over software—including their choice of vendor and the ability to provide easy updates over the lifecycle of their equipment. Merchants may demand this as well because cloud-based software will provide them greater flexibility.

Innovation for the point-of-sale will move out to the cloud or will at least become un-tethered with the particular point-of-sale device. Internet-connected computers made it extremely easy for software developers to distribute products to businesses and people via a download. That, of course, led to an increasingly vibrant application community. Internet-connected point of sale devices will do the same. The mere availability of the direct link to the point-of-sale devices will ignite a developer community.

Third, there’s going to be limited room for software payments platforms. Several software payments platforms will succeed in becoming the “go-to” places where developers who want to incorporated payments and related functionality into their products and services. But it is doubtful that there’s going to be room for more than two or three.

Software platforms are driven by indirect network effects. The more applications that are written for them, the more customers (businesses and consumers in this case) will want to use them; and the more customers there are for the applications for a platform the more other developers will want to write more applications. The main reason this virtuous circle doesn’t lead to a monopoly platform is that different platforms can specialize in providing different services—product differentiation can offset indirect network effects. The other limiting factor is that software developers will port their applications to a few platforms but not many. They will go for the two or three platforms that have the largest reach assuming they are technically on par.

For payments, it is doubtful that the four card networks plus several alternative payments providers plus others will all succeed in operating software payments platforms. This point has, as we will see, has huge implications for the risks faced by the networks in choosing a strategy.

With these premises in place, it is easy to see the risks and opportunities that the card networks face during the new age of invisible engines.

Let’s start with the stick-to-your knitting strategy of focusing on just running the rails. That would involve future value-added services moving to third-parties. The software payments platforms would support ecosystems of application developers that would incorporate payments functionality into their applications. (Just to be clear, these applications could be software programs that support substantial businesses. That’s the vision for Square for example.) The applications businesses would earn revenue from their customers and the software platforms would earn license fees (and perhaps revenue cuts) from the applications business.

The card networks could charge for access to their rails. They would benefit from more applications generating more transactions over their networks. The risk is two-fold. On the one hand the software platforms and applications suck up a lot of the value that’s available from using the rails. The card rails could try to get a piece of the action but that brings us to the other hand: the software platforms, and perhaps other players, could try to disintermediate the rails altogether. In fact, one would expect that PayPal will squeeze card fees down. They are already moving transactions over to cheaper-for-them ACH. Their ability to do so will eventually put downward pressure on transaction fees for the card networks (not to mention interchange fees if those survive the current regulatory and legal onslaughts). The card networks could try to be like the cable companies and squeeze a lot from everyone who tries to use their rails. That has worked, although it is getting ugly, in cable because there isn’t much competition. It is unlikely to work in payments where there are multiple sets of payments rails and lot of opportunities (see PayPal above) to shift transactions in response to cost differences.

The card networks could also take the middle way. They could embrace the idea of creating applications that use their network services but do that themselves, but more aggressively than they have in the past and with a clear eye on what’s being built on the open platforms, or enlist business partners to that with them. This has several advantages. For one, it allows them to keep tight control over what’s built on their networks, make sure it is consistent with their overall business objectives, tightly integrate the applications, and prevent applications that could degrade the performance or reputation of their networks. For another, it allows them to make money from the applications directly rather than limiting themselves to access and transactions fees. They will own customer relationships and data as well. The chief disadvantage of the closed-platform approach is that it does not generate the sorts of indirect network effects that have powered the growth of the iPhone and seem to be working well so far for PayPal. The networks would have to hope that they make up in quality of apps what they lose in quantities.

Finally, the card networks could adopt an invisible engine strategy. That would generally involve creating a software layer above their networks, developing features for that layer that use their rails and provide other services as well, and making these features available through APIs. Following the PayPal X approach they would need to evangelize their platforms and provide developers with the tools and encouragement to create successful applications. There is a huge upside potential here. They could, as I’ve described throughout this series, become the centre of a ecosystem of applications that would drive value back to the centre and in doing create barriers for rivals. See Windows.

Like most things in life that have major payoffs, there are at least two related and significant risks: First, it is highly unlikely that all four of the card networks could succeed in establishing successful software payments platforms. One could easily imagine that only 2-3 platforms emerge and that at least one of those is one of the alternative payments providers. That would mean that if all four networks tried 2-3 of them would probably fail. Second, there can be a wide gulf between aspiration and ability as every little boy who wants to play pro-ball soon finds out. The card networks have much experience developing sophisticated software systems and communications platforms. So it isn’t like a car company wanting to get into the software platform business. But the card networks have evolved slowly from mainframe based companies and don’t, at least obviously, have demonstrated skills in doing internet-related development work. They may lack the genetic matter to go up against PayPal or other companies that were born in the internet world. Thus, the card networks could make significant investments of financial and reputational capital in trying to become one of the software payments platforms and fail in succeeding.

The rise of invisible engines in payments therefore presents significant opportunities and risks for the traditional card networks. One or more of them could distance themselves from their rivals by becoming one of the surviving software payments platforms with a robust set of applications driving traffic. Those that don’t develop a successful platform could find themselves as service providers to much more interesting and robust businesses. It is beginning to look like this is the way the mobile communications business could evolve—with the iPhone, the Android, and perhaps another software development platform driving applications and the carriers settling for charging for carrying traffic.

The traditional card networks are clearly trying to navigate what to do. Visa’s acquisition of CyberSource for $2 billion may be an important step in its developing an open software platform. CyberSource is the e-commerce engine for about 300,000 merchants. It mainly helps these firms with key back office tasks—risk and fraud most importantly, call centers, and then processing. Combined with other technology it could help Visa challenge PayPal X. American Express’s acquisition of Revolution Money for $300 million is another example. Revolution Money has a payment platform based on internet technology. It could also provide some useful building blocks for a larger efforts.

The decisions these networks make on how to proceed, and how to meet the Pay Pal X challenge, will determine the course of payments over the next decade.




Innovation has happened slowly in the payments industry. The experience with the introduction of contactless at the point-of-sale in the United States illustrates why. Merchants had to install new equipment to accept contactless cards. Many haven’t wanted to do that without evidence that consumers want to use the card. But there hasn’t been a groundswell of demand from consumers because there are few places to use the cards or really compelling reasons to use it. It is hard to ignite innovations in payments because it is costly to change current systems and because it is difficult to solve the chicken-and-egg problem of getting multiple stakeholders in the ecosystem on board.

Cloud-based software platforms may change that very quickly. Innovation will take place through the creation of software-enabled businesses that access the payments rails through software development platforms that live in the cloud. These innovations will be pushed through the broader payments ecosystem through the internet.

Whether Square succeeds or not as a business it points the way to how this will happen. It is based on a software application that relies on two software development platforms—IPCommerce’s payments software development platform and Apple’s iPhone software development platform. It connects to merchants through an internet-connected device—the iPhone, iPad, or other smart mobile technology. It connects to processors through an internet connection that takes it to IPCommerce’s software platform in the cloud. And it connects to consumers through email that traverses the internet.

Rentalic—the winner of PayPal X’s first application competition—may also succeed or fail but again points the way. An entrepreneur comes up with an idea for bringing buyers and sellers together (in this case renters and rentees) and needs a way to deal with complex payments (in this case handling the security deposit). She goes to a payments software platform in the cloud for these services. PayPal X enables Rentalic to connect buyers and sellers and ultimately to multiple payment rails.

Rentalic and Square demonstrate why the pace of innovation is likely to increase rapidly in payments and highlight the opportunities. Innovation will pick up because the cost of getting new ideas that require payments solutions is declining rapidly as a result of these software platforms. The opportunities are enormous—one only has to look at what Apple has accomplished with its Applications Store and glance at how quickly PayPal X has attracted developers and new applications.

The “applications” also highlight the risks facing the traditional card networks if they fall behind. Both Rentalic and Square involve physical transactions—the bread and butter of the card networks. Rentalic is mainly about renting physical items where the buyer and seller will actually meet in person probably. Square is about transactions at physical points of sale. That’s the future. One or more of the card networks may figure out how to create an open software development platform and get a virtuous circle going around an “applications store”. Some card networks may find themselves on the sidelines and watch a huge amount of value being sucked towards the cloud.

Invisible engines will drive innovation and transform the payments industry. Some incumbents will win, and some will lose, as this disruption unfolds over the next decade. But there’s no doubt in my mind the entrepreneurs, consumers, retailers, and other stakeholders in the payments ecosystem will benefit tremendously.


Market Platform Dynamics helps companies find, develop and monetize innovation. We do this by leveraging the experts, expertise and ecosystem that we have assembled over several decades of working with the most innovative platforms in the payments, mobile, technology, online and digital media sectors, worldwide. This work is guided by MPD’s Innovation Platform® – a set of proven tools and rigorous frameworks that create ignition strategies that drive growth and profit.

For more information on Igniting Innovation in Payments, contact and visit to see “what’s next” in payments worldwide