Leave Us Alone, We're Innovating!

Last week I was asked to give my thoughts on what the market obstacles are to payments innovation and what if anything the government should do about this.  The occasion was an excellent conference put on by the Kansas City Federal Reserve Bank.

The premise of the question seemed to be that it’s been hard to get mobile payments, NFC, and other things off the ground. Maybe there’s a problem there and we need to government to knock some heads together or show the way.  After noodling on this subject for about 2.3 nanoseconds I concluded that entrepreneurs should post sign to Gov: Stay Out.

I made three points.

  • We are going through one of the most intense periods of innovation in payments—really anything that surrounds the exchange of value between consumers and merchants—that we’ve ever had.
  • But a lot of things that people call innovation wouldn’t actually make consumers and merchants better off. Often they don’t solve a real problem. They can’t and shouldn’t get traction in the market.
  • Decentralized markets are pretty efficient at discovering the optimal path of innovation in the payments industry. And the government doesn’t have a great track record when it comes to payments innovation.

Creative Destruction

We’re in a period of creative destruction. We see this in a number of ways.

  • A lot new technologies and business models are being introduced. For example, LevelUp is a mobile payments system that is tying payments to sophisticated loyalty programs.
  • A lot of this innovation is blurring the lines between online and offline commerce.   That’s Pay by Square.
  • Much of this innovation is coming from major players outside the traditional industry. That includes Google, Facebook, Intuit, and Groupon.
  • Venture capital is poring into payments.  Just about every day some VC is handing out several million to a payments-related startup.
  • The big guys are acquiring innovative players. For example Visa bought Fundamo, a mobile payments platform for lesser developed countries.
  • Just about everyone in the payments industry and in adjacent ecosystems is focused on innovation.  Just take a look at Amex which has a whole business unit run focused on this.
  • All the traditional players are very worried. Just listen to their nervous chatter about PayPal’s entry into offline payments.  And they should be nervous because a lot of the innovation is commoditizing the networks and issuers.

There are several reasons why we’re going through this “inflection point” of creative destruction.

  • The spread of mobile devices: 100 million smart phones in the US as of January 2012. My guess from looking at the data on the demographics of people with smart phones is that they account for a majority of spending. They are high spending people under the age of 45.
  • The development of sophisticated software platforms on mobile devices and in the cloud that empower entrepreneurs around to engage in payments innovation.  Think iPhone, PayPal X, and IPCommerce.
  • The rise of data analytics. Many of these new schemes like Square and LevelUp are using data in creative ways to provide value to merchants and consumers.

Innovation doesn’t always lead to good products.

Just because something is an innovation, or called one, doesn’t mean that it can or should succeed in the marketplace.  Entrepreneurs talk about their innovations like parents talk about their kids.

There are some serious obstacles to market adoption.

The most important one is that payments currently work really, really, well. You swipe your card or click online and it all happens in a second. Merchants get paid. Everyone knows how to do it.  A lot of the mobile phone solution that have been devised fail because they are just too complicated.

The next most important one is the chicken and egg problem.  Many of these innovations can succeed only if they get merchant and consumers to agree.  That’s usually a hard business problem. But its especially hard if the innovation doesn’t make merchants and consumers better off.

Third, there are massive amounts of sunk costs tied up in payments. From the rails, to the processing software platforms, to the physical point of sale equipment, to all the learning that clerks and consumers have done.  That leads to massive inertia. It is true that a lot of the payments system is a rickety Rube Goldberg contraption tied together with rubber bands, paper clips, and shoelaces.  A lot of it could be replaced with better stuff.  But it all works, so why spend good money changing it?

Entrepreneurs encounter many market obstacles. But a market obstacle isn’t the same thing as a market failure (the name of the problem that economists agree we might think about fixing). Many seemingly great ideas won’t get traction because at the end of the day they don’t generate enough incremental benefits relative to the incremental costs.  That’s been the problem with the adoption of NFC.  Waving cards at the point of sale sounded great to a lot of senior execs and payments pundits.  Visa and MasterCard led banks to issue millions of cards and kept telling merchants they better take them because it was inevitable. Unfortunately, contactless didn’t save consumers much if any time and forced them to change their behavior. It also required merchants to invest in changes in their physical point of sale without any evidence that it would save consumers money.

Of course, it wasn’t inevitable after all. Most of the successful mobile payment apps are using QR Codes. NFC may take hold eventually because the market is ready for it, not because central planners wish it to be so.

Just because things that sound cool don’t take off policymakers, and academics, should avoid the knee-jerk reaction to claim there’s a market failure.  It is probably consumers and merchants speaking loudly that it isn’t so cool after all.

Government: Please, Go Stay Away

When it comes to guiding payment innovation what should the government be doing? The short answer is stay out of the way especially while the market is trying to figure things out.

First, there’s no evidence there are market failures in the adoption of payments innovation. A market failure would be a situation in which an innovation that increases net social value doesn’t get adopted in the marketplace.  No one has articulated a compelling case for why that is likely to happen.

Second, there’s no reason to believe that the government could identify markets failures with any degree of accuracy.  Even people who are deeply knowledge about payments aren’t very good at predicting what consumers and merchants really want.  Just look at the mass hysteria over NFC. The very smart and knowledgeable people at MasterCard and Visa weren’t very good at predicting market adoption. Some regulator in Washington, DC is going to do better.  Its important to emphasize that anyone who supports government intervention has to show not only that the government can identify problems but they can also solve those problems, not create unintended consequences from solving those problems that actually make things worse, and don’t make things worse by also fixing problems that weren’t.

Third, governments don’t have a particularly good record when it comes to payments innovation. Let’s give credit where credit is due though. A government created the fundamental innovation in payments: the creation of metallic money three millennia ago.  But what have they done for us since I say tongue slightly in cheek?

Indeed, as soon as they had gotten people to use government minted coins governments figured out how to use this innovation to tax people. They started depreciating the content in the coin so that the government could buy things with coins that were really worth less.  (This is known as seignorage.  Some governments did this with such abandon that people didn’t want to use the currency. Smart governments, like believe it or not the Greeks back then, managed to keep the depreciation low enough that no one really noticed.)

Then there has been the whole check debacle in the United States.  Anyone who has tried to get into B2B payments knows how we are still living with a massively inefficient system as a result of the Fed’s subsidizing the check system during much of the 20th century.   Even with the movement to electronic checks we’re almost certainly losing large swaths of the rain forest and contributing to global warming as a result.  (Some people at the Fed will tell you they saved the country from a massively inefficient private sector check system, in the late 19th and early 20th century, where checks circled the country for weeks in order to avoid the bank fees.  That’s actually bunk as my paper on the early history of checking showed a few years ago.).


There is a lot of chatter in the government (and at various Federal Reserve Banks) about the payments industry and how various policies could “help things out” or even improve on what the card networks do.  The industry isn’t perfect and there are certainly areas where government regulations are needed.  Guiding innovation and helping supposed entrepreneurs overcome market obstacles isn’t one of them.



The How We Shop Report, a PYMNTS collaboration with PayPal, aims to understand how consumers of all ages and incomes are shifting to shopping and paying online in the midst of the COVID-19 pandemic. Our research builds on a series of studies conducted since March, surveying more than 16,000 consumers on how their shopping habits and payments preferences are changing as the crisis continues. This report focuses on our latest survey of 2,163 respondents and examines how their increased appetite for online commerce and digital touchless methods, such as QR codes, contactless cards and digital wallets, is poised to shape the post-pandemic economy.

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