Cards vs cash: Big boys vs the little guys
By Anwar Jumabhoy & Srikrishna Vadrevu April 5, 2016
- There will be room for only a few players in both the card and cash business
- Banks are closed on weekends and public holidays, the new players are 24/7
SEARS, Roebuck & Co was the first retailer to issue private label cards, way before banks were interested.
It was a ‘chicken-and-egg’ business since you needed enough merchants to accept the cards, and enough card-holders to use it for the merchants to accept and pay the cost.
That’s the reason why Bank of America in 1958 launched the BankAmericard in Fresno, California which had a population of about 250,000.
With an unsolicited mail drop of 60,000 cards to residents – 45% of whom had a relationship with the bank – it was able to bring the merchants on board.
What it found was that small retailers were relieved to move the credit burden they were holding to Bank of America, as it also meant relieving them of the need to manage, track, and send monthly statements for the large number of very small receivables.
This is an important point that is still relevant today, something that Square – founded by Jack Dorsey (also founder of Twitter) in 2009 – understands well … but more on that later!
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Incidentally, Sears sold its retail card business in 2003 to Citibank for US$3 billion in cash (plus a further US$3 billion in invested capital). At the time, it was the eighth largest bank in the United States with 59 million accounts.
The initial stage did not go well for BankAmericard users nor the bank, as credit controls were weak and fraud was widespread – 22% of accounts were delinquent.
Systems were brought in, and other banks signed up to be issuers in what became a franchise network. By 1970, ownership was actually vested with a consortium of issuing banks.
Visa was born in 1976. MasterCard was created in 1966 in a more orderly manner by other banks, which formed the Interbank Card Association.
Both Visa and MasterCard provide an interconnect platform between the issuing bank (which provides the card to the holder) and the acquiring bank (which provides the terminal and online facility to accept payment).
It’s a thin-margin business if ever there was one. Depending on the type of card, system, volume, etc., the issuing bank takes 1%, the acquiring bank 0.3%, and Visa-MasterCard get the thinnest slice, of about 0.1%. The merchant (retailer) typically pays 1.5% excluding other charges and fees.
Small percentages, but huge volumes: According to The Nilson Report, “American Express, Diners Club, JCB, MasterCard, UnionPay, and Visa brand cards generated 168.56 billion transactions at merchants in 2013.”
Visa, which had the lion’s share of the card market (debit and credit cards) in 2015, did pretty well – revenue was US$13.88 billion and net profit was US$6.328 billion.
Its percentage take from each transaction has actually shrunk over the years, but volume has exploded, and that means there really is no ‘meat’ for a new player to put together a global merchant credit-based network.
What about the unbanked?
Since the unbanked don’t have credit cards, they use cash or make a direct bank transfer.
In this instance, there is no need for the verification, security, chargeback and other support services from the Visa-MasterCard network, saving the merchants the 1.5% fee.
They do, however, lose out on the marketing initiatives that card companies and acquiring banks run regularly to expose the merchant base to new customers.
But small merchants do have other and better marketing options with digital campaigns and ‘Groupon’-type promotions.
There are alternatives to cash transfers like M-Pesa, the Swahili mobile wallet that is widely used in Kenya and Tanzania.
With this system, you only need a mobile phone number to hold, transfer or receive money, allowing users to sidestep the entire banking system – no need for an account, a bank branch, ATM or credit card.
Sounds amazing, but adoption has been slow, possibly due to cultural reasons. M-Pesa is only now expanding into South Africa, Afghanistan, India and other countries, but for small transfers, the fees for cash withdrawal can add up.
In Malaysia, Tranglo Sdn Bhd, founded by Sia Hui Yong, offers crossborder airtime transfers across 100 countries, and it is aggressively expanding its remittance business.
When asked why the new focus in business direction, Sia replied, “For us, it is a natural progression –airtime transfers, and now to money transfers.
“We have a huge network of service locations, especially in the South-East Asian region, where we first launched money transfers,” he added.
Asian-based startups need to overcome registration issues with each country, as each country regulator and cellular operator imposes its own conditions, restrictions, and ‘know your customer’ (KYC) standards.
KYC demands the recipient of the funds know the depositor and its source of funds, and was established to reduce the transfer of ill-gotten gains and money-laundering.
The lack of uniform regulations and unique interpretations by each country is a major hurdle that needs to be overcome if we are to see a major pan-Asian player emerge.
Internationally, there are already several large players, which tend to be dominant in their home markets.
TransferWise, an Estonian company based in the United Kingdom, operates on a peer-to-peer basis and by matching transfers across countries, can avoid the banking system.
Neat, right? Utilising technology, it expanded to the Indian hawala system. In this transaction, money is transferred across borders without an actual remittance, using a trust-based swap system.
The way the system works is simple: You go to an agent in India, pass him Indian rupees, he gives you a code number and a collection point in the recipient country.
With that information, your contact in the receiving country can almost immediately receive the cash in local currency.
This system built on trust has worked well, but the ‘no questions asked’ philosophy is now under pressure from regulators seeking to enforce KYC standards.
Companies providing remittance services need to either manage the foreign exchange (forex) transaction internally, or with a banking partner in an MVNO (mobile virtual network operator) type arrangement.
The latter essentially buys ‘wholesale’ and sells ‘retail,’ a fragile business frame given the pervasiveness of technology platforms and information.
XE Trade, the go-to-place to check exchange rates, offers money transfers, as does a bunch of other companies: CurrencyFair (Ireland); WorldRemit (United Kingdom), which raised more than US$140 million in venture capital funding; Azimo (United Kingdom, with an African focus offering free, instant transfers); OrbitRemit (New Zealand); Euronet (Nasdaq-listed), etc.
Although it’s quite a crowded space, there will be others as volumes are huge, perhaps larger than the card business.
The remittance business
According to World Bank data, international migrants hit an all-time high in 2015, with 250 million migrants remitting US$601 billion back to their home countries. Out of that, developing countries accounted for US$441 billion.
The top three origination countries in 2014 were the United States (US$56 billion), Saudi Arabia (US$37 billion), and Russia (US$33 billion).
The largest receiving countries were India (US$72 billion), China (US$64 billion) and the Philippines (US$30 billion).
The economic turmoil resulting from falling oil price and changes in exchange rates will affect both labour and remittance numbers in 2016.
Old vs new players
Interestingly, Western Union – which was built on the back of the telegraph infrastructure in the United States – has been offering money transfers (wires) since 1871. MoneyGram was founded in Dallas in 1940, and Ria was founded in New York in 1987 and acquired by Euronet in 2006.
All three companies started by charging exorbitant fees, but stayed relevant by adopting new technologies, lowering their fees, and making key acquisitions.
PayPal also offers a remittance service, through Dwolla Inc, that is linked to a bank account, sidestepping the Visa-MasterCard network.
All these businesses require the ‘network effect’ to grow – enough people need to accept and use the system for it to become ubiquitous.
Square has built its own ecosystem: Square Register (point-of-sale), Square Cash (money transfer), Square Payroll (payroll), and Square Capital (loans). This is in addition to accepting card-based payments.
According to CrunchBase, prior to its November 2015 initial public offering, Square had raised US$590.5 million in venture capital funds.
And unlike Visa-MasterCard, Square has actually raised its processing fee, which was initially 1.5%, to 2.75% currently, which it says is “lower than alternatives.”
Since it offers convenience, no setup fee, and caters to small business owners (90% of its customers), the difference in percentage fees is not significant. Like BankAmericard in 1958, Square is addressing the pain points of retailers.
Another interesting startup is Stripe, founded in 2010 by Irish bothers John and Patrick Collison who had a novel proposition for small retailers (or as we say, a powerful business frame).
Stripe hosts the card transaction, so merchants don’t need to worry about compliance – all information is stored in Stripe’s vault, which the merchant has access to.
To get the business going, Stripe has raised US$280 million. Visa-MasterCard must be supportive as they will get their thin slice.
However, Square and Stripe could end up as threats since they have built-in flexibility for other payment ‘forms,’ including bitcoins.
And in Malaysia …
In 2015, Euronet acquired local company IME (M) Sdn Bhd. IME had 71 branches in Malaysia and 500 employees. Euronet was founded in 1994, specialising in ATM deployment and management, but has since expanded into mobile airtime and money transfers.
Telenor Group, Digi.Com’s controlling shareholder, in November 2015 made an offer to acquire Prabhu Money Transfer, which is 100% owned by a Nepali-based company, subject to Bank Negara approval.
Merchantrade Asia was founded by Ramasamy Veeran in 1996 and started by operating the now-forgotten ‘overseas calling booths’ and selling IDD calling cards to migrant workers – a fiercely competitive commodity business with no customer loyalty.
In 2007, it was the first to get an MVNO licence, in collaboration with Celcom. Other companies, including Tune Talk, emerged and margins in this business eventually also shrank, but Merchantrade has attracted investment from Sumitomo Corporation and Celcom, raising about RM50 million. [RM1 = US$0.25 at current rates]
With regard to Merchantrade’s transition, Ramasamy said, “We had the customer in hand and were effectively a low-cost channel – first for IDD cards, then prepaid mobile cards – but we could see this business coming to an end.”
Like the true entrepreneur he is, Ramasamy (pic above) decided to go into the money remittance business. Merchantrade now offers online transfers to complement the 320 agent locations that give it a 48% share of the retail market.
The growth of the retail market indicates that demand has extended beyond the migrant population, and to the general population and small business owners who used to go to banks.
Banks are closed on weekends and public holidays. Why not find a service provider that operates seven days a week?
Malaysia’s Money Services Business Act 2011 provides a uniform and dedicated regulatory framework for money-changing, remittances, and wholesale banking.
This clarity has led to a growth in the number of licensed MSBs (money services businesses) and improved the image of the industry.
It has also brought new competition for the banks as smaller companies and white-collar workers can now shop around for better rates.
But the capital requirements are huge and this explains why Merchantrade is only one of six wholesale licensed businesses, including two global companies: Travelex and UAE Exchange.
Are our companies ready for the big game?
There will be room for only a few players in both the card and cash business. Companies need to be adequately funded and get their business frame right, for what will be a bruising fight.
Anwar Jumabhoy & Srikrishna Vadrevu are passionate about bringing entrepreneurship into large companies through the adoption of the ‘nine entrepreneurisms’ which they have identified. Their book, Beyond Corporate Entrepreneurship, is due to be released in 2016. #9entrepreneurisms
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