Changingpaymentmechanism inretail 20140113

Changing Payment Mechanism in Retail

Aparna Gole Ashish Banka

January 2014

Contents Executive Summary ................................................................................................................................... 3 I. Evolution of Payment Mechanism ......................................................................................................... 4 II. Types of Payment Mechanism Used in Retail Industry......................................................................... 5 A. Cash ................................................................................................................................................ 6 B. Non-Cash ........................................................................................................................................ 6 1. Cards ........................................................................................................................................ 7 2. Others / Alternative Payment options ..................................................................................... 8 III. Alternative Payment Mechanism......................................................................................................... 10 A. Mobile Payment ............................................................................................................................. 10 1. Using mobile apps and mobile browsers ................................................................................. 10 2. Interactive Voice Response System (IVR) and SMS based transactional payments ................ 10 3. Direct operator billing .............................................................................................................. 10 B. Contactless Payment (RFID based NFC system) ............................................................................. 11 C. Digital Wallet .................................................................................................................................. 11 IV. Conclusion............................................................................................................................................ 13

Table of Figures Infographic 1: Timeline – Payment Mechanism Evolution ....................................................................... 4 Infographic 2: Types of Payments Used in Retail Industry ....................................................................... 5 Infographic 3: Cash Vs Non-Cash Transaction .......................................................................................... 6 Infographic 4: Cashless Payments Mix by Geography (%, 2011) .............................................................. 7 Infographic 5: Retail Channel Revenue Mix .............................................................................................. 8

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Executive Summary

66%

Consumer payment by value done without cash in 2011

79%

Cashless payment done using cards in the US in 2011

23%

Non-store retail sales (particularly from e-commerce and m-commerce) expected in 2017

Digital payment is gaining traction – and more so with the backdrop of retail sales channel also going digital in the form of e-commerce and m-commerce. The payments industry is also experiencing significant change amid consumer demand for better payment methods. Technological advancement in payment systems provides retailers with an opportunity to better serve its consumers and also reduce costs related to payments.

This report summarizes the changes in the payment systems in the retail industry over the years and what is in store in the coming future.

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I. Evolution of Payment Mechanism Humans have always felt the need to trade or exchange goods and services from each other. In the earlier days, this was facilitated by bartering: exchanging of goods (food, apparel, tools, weapons or services) which had some value. The importance was more on ‘need’ and less on ‘valuation’.

With development of civilization, humans began giving more importance to valuation. This led towards standardization of money. The first form of standardized money was in the form of ‘cattle’.

Then cowrie shells were introduced which were used mainly in Asia Pacific region and then began the era of metal coins, paper notes, cheques, cards and more modern electronic payments. A brief journey of different types of payment systems used is as depicted below: Infographic 1: Timeline –Evolution of Payment Mechanism 9000 – 6000 BC Use of Cattle as form of Money

1,200 BC

1,000 BC

Use of Cowrie Shells as form of Money

The First Metal Money and Coins

17th Century

12th Century

Cheques Introduced

Bill of Exchange Introduced

18th Century Printed Currency Notes and Printed Cheques Introduced

Early 2000s

9th Century First occurance of Paper Notes

The Birth of Modern Silver Coins in Sardis, Ancient Lydia Outside of China

1960s

1970s

Credit Card Introduced

Magnetic Stripes Card Introduced

2000s

Cards with Chip & Pin Introduced

600 BC

1990s

Different types of Electronic Payment Systems introduced (like PayPal etc.)

1980s

Online Banking Launched

Debit Card Introduced

Late 2000s

Early 2010s

Early 2010s

Contactless Payment Introduced

Mobile Phones used for Payments

Cashless Payments systems gaining popularity - Digital Wallet, NFC etc.

Source: Secondary Research; Sutherland Analysis

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II. Types of Payment Mechanism Used in Retail Industry The evolution of organized retail industry dates back to the 19th century when many departmental stores (like Macy’s, Bloomingdale’s etc.) started their operations. Cash was the key mode of payment. With introduction of guaranteed cheques and it gaining popularity amongst consumers, retailers started accepting it as a mode of payment. Over the period, cards became common and credit and debit cards alongwith a smattering of travellers’ cheques and prepaid currency cards are the new forms of payment alongwith the plain old cash and currency.

“Up until the 1960s we really only had two ways to pay – cash or cheque, but improving technology and changing lifestyles have seen a steady stream of innovations since. Nowadays we take for granted the extra choice offered by credit and debit cards, electronic payments, online shopping and banking.”

– Adrian Kamellard, CEO, Payments Council (UK)

Broadly, the payment systems currently adapted by the retail industry can be summarized as below: Infographic 2: Types of Payments Currently Used by Retail Industry Credit Card

Cash

Debit Card

Gift / Prepaid Card

Payment in Retail Cards

Non-Cash

Cheques

Other (Newer & Expanding) Electronic Payment (E-Pay) Mobile Payment (M-Pay) Source: Secondary Research; Sutherland Analysis

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A. Cash The world may be transitioning towards becoming cashless, but cash is still the king in retail transactions. While cash sales as a percentage of total sales are declining, it stills accounts for the largest part of the total value transacted. Cash transaction is easy to carry out and provides settlement on the spot, making it safest and therefore the dominant mode of retail payments - by businesses as well as customers.

“Surveys, including the European Commission's recent EU-wide Eurobarometer, consistently show that the public still have a strong preference for cash, and with good reason. Stateunderwritten cash is universally acceptable, requires no technological infrastructure and provides instant settlement. Furthermore cash is simple to control and monitor: an important factor for all of us who are concerned by the growing indebtedness of UK citizens.”

– Mike Bowen, UK Spokesman, European Security Transport Association (ESTA)

Infographic 3: Cash Vs Non-Cash Transaction

Consumer Payments - By Volume (c.2.6 Tn Transactions, 2011)

Consumer Payments - By Value (c.USD 63 Bn, 2011)

34%

Cash

66%

c.85% of all consumer transactions are done using cash which translates into 34% of consumer payment value

Non-Cash

15%

85%

Cash

Non-Cash

Source: MasterCard Advisors analysis, BIS CPSS, McKinsey Global Payments Map, World Bank Statistics

As seen above, c.85% of transaction volume was handled by cash, which indicates that customers prefer cash payments for smaller cart value. As such, cash is expected to remain a favourite payment method for years to come for small shopping baskets.

B. Non-Cash Cheque was the first type of cashless payment used by the industry for decades before the advent of cards and more recently electronic and mobile payments. The innovations in electronic payment systems have led to the invention and usage of many different types of payment mechanisms. The emergence and meteoric rise of online shopping has also contributed towards development of cashless payment mechanisms.

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Infographic 4: Cashless Payments Mix by Geography (%, 2011) 79% 65%

69% 50%

41% 28% 18% 9%

Card

11%

North America

10%

3% Cheques

Europe

17%

Others

Mature APAC

Emerging Asia

Source: World Payments Report 2013

Cards (debit card / credit card / prepaid card) remain the most popular form of cashless payment.

Cheques are seen losing sheen while other forms of electronic payments are gaining popularity on back of increasing internet broadband and smart-phone penetration.

1. Cards a. Credit card Credit cards are the most widely accepted electronic payment scheme in the world and more popular amongst different forms of card payment. Acceptance at wide variety of merchants across the globe is an important factor that makes credit cards a popular payment instrument – especially amongst the travelling consumers who want to carry less cash due to the risks involved.

Apart from the benefits of being cashless, loyalty programs and rewards associated with the cards and the fact that customers get ‘credit’ for few days (not to mention the EMI and roll-overs if the outstanding dues are not paid on time) ensures that they remain popular choice of payment.

“By their nature, the value of cash transactions tends to be lower than the value of card transactions. If customers pay by card, they are less constrained by the amount of cash they may happen to have with them, and they may choose to spend more.”

– The Foundation, a Retailer-Focused Management Consultancy based out of London (UK)

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b. Debit card Linked to customers’ accounts, debit cards were mainly used to withdraw cash from the ATMs. Debit cards were introduced and issued with an intention to reduce the workload of bank tellers and reduce costs associated with customers’ bank visit. Over the years, changing technology enabled the usage of these ‘ATM cards’ as a ‘Debit cards’ in order to make cashless payments at merchant outlets. In addition, as every bank that that has adopted new technology can issue debit card to all its account holders, there are more people with debit cards as compared to people with credit cards.

However, the fact that customers need to have money in their accounts that could be debited whenever the card is swiped has limited its usage - as many a times a customer may not be having sufficient funds in his / her account but may be desiring to make a purchase. This is where the credit card comes handy. c. Prepaid cards Prepaid cards are generally of two types: ‘Open Loop’ and ‘Closed Loop’. Open loop cards can be used at many/ all outlets (eg: Travel card pre-loaded with money) whereas closed loop cards are generally issued and accepted at the same point (eg: gift card of a merchant outlet). They are newer payment options as compared with credit/debit cards and are still gaining acceptance in terms of usage. These cards are preloaded with money and do not require customers to have a bank account.

All a customer has to do, is buy a prepaid card, load it with money and the card is ready to be used.

2. Others / Alternative Payment options The increasing role of Internet in today’s world is changing the lives of consumers. This has led to retailers moving into virtual spheres to get an additional channel of sales. Growing popularity of e-commerce and m-commerce is a key reason for popularity of other / alternative payment options.

New technology initiatives are changing the payment method from plastic cards to digital devices.

Infographic 5: Retail Channel Revenue Mix

10%

3% 1% 7%

90%

2011

Brick & Mortar

3% 4% 12%

2% 19%

7%

81%

77%

2015E

2017E

E-Commerce

23%

15%

M-Commerce

Although other channels of retail are expected to gain traction, stores are expected to remain a dominant channel accounting for almost three-quarters of retail sales (c.76.5%) in 2017

Others

Source: Gartner

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‘Electronic Payment’ (E-pay) and ‘Mobile-Payment’ (M-pay) are payment mechanisms that allow transactions to take place. Unlike cash and cards, they are not an alternative channel of payment but rather facilitator of payments that uses cash, cards and bank accounts and facilitates payment between two parties (mostly consumer to business).

E-pay is defined as digital payments that are made over the internet for e-commerce activities whereas M-pay is defined as a form of payment where the mobile phone is used as a payment method (mostly in stores). E-pay and M-pay are gaining popularity across the globe due to the ease of making the payment anytime.

Let us discuss the technology driven payment options which are either already in use or are on verge of usage in the next section.

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III. Alternative Payment Mechanism A. Mobile Payment The technological evolution of mobile phones has already rendered some of the everyday technologies useless and this evolution is now eyeing the payments market. Mobile payment, or M-pay, refers to government regulated payment services performed from a phone.

“I am convinced that the future of money will be mobile. In the past, payment innovations may have been ‘pushed’ to a largely indifferent market but, in the future, I know they will be ‘pulled’ by a hugely eager and enthusiastic market.”

– Peter Ayliffe, President and CEO, Visa Europe Some of the broad ways a customer can transfer money or pay for goods and services from a mobile phone are as discussed below: 1. Using mobile apps and mobile browsers Working on the same principle as online payment, a consumer can make a payment using mobile phone by browsing the webpage or by downloading the mobile application of the retailer with built-in payment option. The consumer can then make the payment by using credit/debit card or net-banking or any other option provided by the retailer.

Example: most commonly used by the retailers as a payment option who provide m-commerce platform for shopping 2. Interactive Voice Response System (IVR) and SMS based transactional payments Consumers can also make a payment using mobile phones by entering credit/debit card or net-banking details over the automatic IVR system and/or by sending SMS. Many retailers and service providers are providing consumers with IVR system to complete their purchase of goods or services. Consumers can also make payment by sending SMS text message to complete the payment.

Example: a consumer making a purchase over a phone call can be directed to an IVR system to make a secure payment as the person on the other side of the call cannot know details of the payment 3. Direct operator billing This method uses telecom operator as a channel of payment. Here, all the payment done through a mobile phone is charged to the phone bill. Smart-phones are not necessarily needed for this type of

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payment to take place as payment instructions can be given by SMS or by using USSD (Unstructured Supplementary Service Data).

Example: a consumer buying ringtones, games or other digital contents which are billed to his mobile phone number. Services like Airtel money wherein a consumer pre-loads his mobile number with money (through cash or credit cards) and later pays for many services like DTH bills, transfer money to other numbers, utility bill payments etc. using USSD or SMS. boxPAY (available in 70+ countries) is another example where a user’s purchases are charged to their mobile phone bills Apart from these, M-pay can also be done using NFC tech and digital wallet, as discussed in separately.

B. Contactless Payment (RFID based NFC system) Widely used in credit cards and more recently in mobile phones, the contactless technology enables consumer to make a payment by waving their contactless device over a reader at the point of sale.

Major retailers across the globe are integrating contactless readers with point-of-sale (POS) systems to accept contactless payment.

Contactless payment system uses radio-frequency identification (RFID) technology to enable ‘Near Field Communication’ (NFC) for making secure payments. As there is no need to swipe the card/device, the security risk related to ‘cloning’ of card/device is eliminated.

Also, as the card/device does not leave a consumers’ hand, other risks (like misplacing of card etc.) are also eliminated. All the leading major payment services companies (American Express, MasterCard, and Visa) have contactless payment initiatives.

Transport systems and low-value convenience goods (such as vending machines, phone booths and snack bars) are currently the main markets for card based RFID payments system whereas mobile phones are majorly used for higher value transaction at retail outlet.

Google Wallet is a type of ’digital wallet’ (explained below) which can also enable NFC backed contactless payment between a mobile phone and a NFC reader at POS. Although NFC technology is around for more than a decade, it has not really found traction due to the limited interest of retailers to install readers at POS and reluctance of mobile vendors to introduce NFC enabled handsets in the market until a very recent past. However, with consumers becoming more aware of the technology, with vendors introducing more NFC enabled handsets and with retailers integrating the readers at POS, NFC may finally become a success in coming years.

C. Digital Wallet Digital wallet, also known as electronic wallet (or e-wallet), is a system that stores consumers’ various/multiple payment information details (credit card, internet banking, digital coupons etc.)

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and enables encrypted payment (online or in stores). Digital wallet eliminates the need to carry the physical wallet and hence provides consumers with a safer payment options. A digital wallet not only enables paying at home (online payment) but also enables payments on the go through NFC enabled system (eg.

Google wallet and Isis Mobile wallet) or login based system (eg.

Paypal and Amazon Payments). Facebook Payment is also a type of digital wallet which allows users to make a payment for purchase of product/services which was shown as an advertisement on Facebook page provided the seller opts for this payment option.

However, more than payment transactions, some of the other usages (like storing coupons, movie tickets, airline boarding pass etc.) which can be used via NFC enabled phones (eg. Apple’s Passbook on iPhone) are making digital wallet more popular. This growing popularity of digital wallet is expected to drive payment based usage in coming years.

“If you look at payments innovation, such as the credit card in the '50s and the ATM in the '80s, we really haven't seen much change. But, digital wallets will be as big an innovation as credit cards and ATMs, and it is evolving really quickly and will not be in the form factor that we see today...We have moved into the first stage [of payments innovation], which is the digital wallet, but it is very early, because to be quite frank, the consumer isn't crying out for a digital wallet. Cash and coins work really well and have done so for thousands of years.”

– Adrian Christie, Spokesperson, PayPal and eBay – Australia

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IV. Conclusion Payment systems are the basics for conducting all economic activities. Through the ages, there have been tremendous change in the way payments used to take place. However, last few decades have seen dramatic changes in payment system due to technological evolution; and needless to say, coming few years will also see many new innovations.

Digital payments is fast gaining acceptance and it has the potential to become major source of payments in coming years. However, it is unlikely that usage of cash and cheques will fade. They are expected to be in the mainstream for years to come.

“The successful businesses, the game-changers, all have one thing in common: they are customer centric and data-driven.”

– Peter Ayliffe, President and CEO, Visa Europe Sensing vast opportunity in revenue from the payment system and to make system more robust, retailers have started coming up with their own payment systems (eg. Paypal from eBay and Amazon Payments). Integrated system not only provides extra layer of security but also provides these retailers with even more consumer data which can be used for predictive analytics. Hence, it makes sense if more and more retailers join the payments bandwagon.

With advancement in technology, stricter government regulations and increased consumer expectation amid increasing adaption of technology, the market will require more advanced, secure and efficient payment systems. The evolution of payment systems is finally a never ending process!

“By 2020 and certainly by 2025, electronic payments will have matured to be even more secure and easy to use, available to everyone, pretty much everywhere, almost all the time. But even in the 2025 period, in spite of a range of electronic currencies, and electronic ways of paying, coins and banknotes will still be in common use.”

– Dr Ian Pearson, Lead Futurologist, Futurizon

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