The Next Upheaval in the US Payment Systems (1995)

An $84 billion industry is at stake The first wave of new technology saw banks lose the credit card business A second wave may benefit companies that control the gateways to electronic payments Consumer checks are safe for now Despite the fanfare ushering in new payment technologies such as e-cash, smart cards, and credit card transactions on the Internet, the economic significance of the payments industry and the structural changes it is experiencing are seldom fully appreciated. Few even view payment products and services as an industry. But $84 billion a year is generated by the US payments system (Exhibit 1) - equivalent to 40 percent of the total revenues earned by commercial banks, savings and loans, and credit unions in America today. Almost $33 billion is earned by intermediaries such as banks, credit card processors, and payment networks from the fees paid by consumers and businesses to make their transactions. The remaining $51 billion comes from the interest earned on customers' balances. Traditional financial institutions and payment processors still control 99.9 percent of these revenues. Yet the explosive growth of technology and the arrival, of nonbank entrants are bound to erode this dominance with the shift to electronic payments, rendering much of today's costly banking infrastructure obsolete. Surprisingly, senior executives at financial institutions have been slow to grasp the importance of the changes that lie ahead, perhaps because they still view the industry in a piecemeal fashion rather than applying the integrated business perspective brought to retail banking or brokerage. Rare is the banker who thinks of trying to increase his or her share of all the revenues and profits being captured by the various intermediaries from the moment the consumer pays at the checkout until the funds are transferred into the retailer's account. When banks ruled the payments system, this narrow outlook might not have mattered: as long as a bank held your checking account, it controlled all payment revenues. But now, a range of communication, network processing, and software companies with competitive cost structures and a different business mentality have caught the scent of opportunity and are circling to attack. In some areas, such as credit card processing and card issuance, these entrants have already made a killing. In others, such as check intermediary revenues, the battles are yet to begin. Though it is impossible to predict their outcome, it is clear they will be fought on five different fronts: consumer credit cards; processing revenues anti payment networks; check revenues; business payments; and employee payroll transactions [ILLUSTRATION FOR EXHIBIT 2 OMITTED]. All US payment institutions will need to think about how - or indeed whether - to compete in each of these areas of the industry. Within this article, that industry is defined as the transactions, instruments, networks, and players that facilitate the delivery of commerce to consumers, businesses, and governments. Excluded are cash transactions of less than $2 and payments related to equity and debt securities and international commerce. Consumer credit cards Consumer credit cards are the most mature and pervasive form of electronic payment. Their conversion from a paper based to an electronic product has had an enormous impact on the structure of the payments industry, and may offer lessons for other sectors of the business. Consumer credit cards account for almost half of the total US payments industry, with $43 billion collected by a broad range of banks, card issuers, and merchant acquirers (the banks that sign up merchants to accept credit cards). Although much of this revenue comes from interest on card balances, $16 billion derives from the interchange fees charged to merchants and the fees paid by consumers (Exhibit 3). [TABULAR DATA FOR EXHIBIT 3 OMITTED] Credit cards have been one of the fastest-growing businesses within financial services. …