Cash was king, who’s next?

“The king is dead, long live the king”

Cash/cards are dead, long live mobile payments. Many commentators have declared that cash and credit cards are on their way out. The future is in mobile payments. Five years from now, many of us may not even carry wallets, they say.

So should I start buying up wallets given that they may be a collector’s item soon? A Business Insider report paints an interesting picture. It estimates that cash use will decline at a CAGR of approximately -1% in the future, while in-store mobile payments will grow at a CAGR of 154%. How will that happen, you may ask? Well, commerce is going mobile. And who likes pulling out their credit card to pay on their mobile? I certainly don’t. The screen is small, typing 16+ digits is not fun. And you are not always purchasing from retailers that have your information stored under a sign-in. Once I start using an online payments service, I will start doing it in-store, particularly if the merchant allows/encourages me to do so. The next thing you know, the only thing I need to pay in-store is my smartphone. There is merit to this argument. After all, online payments giant Paypal processed $180bn in transactions last year. And only 30% was on eBay!

And so the story goes. But the jury is out on whether consumers will jump in to pay with their mobile. Is it really much more convenient to pay with your phone in store when you can just swipe your card? How much time does it really save you? And perhaps most importantly, does it feel secure?

Enter Apple. CEO Tim Cook doesn’t just want to play your music and send your texts; he wants to be your wallet. Apple Pay could be a game-changer in the world of mobile payments. The reason is that because Apple is trying its best to make it as secure as possible. First, iPhone6 allows you access only after a fingerprint match. A “secure element” in the device also encrypts your account numbers so that they can be stored safely. Apple Pay itself uses a technology called NFC – Near Field Communication. The technology uses low power signals to communicate with a reader that is a few inches away. The cool part is that the iPhone will communicate with the reader in code. So unlike a typical credit card transaction where your card number is fully visible and available, Apple Pay will send a secret code to the reader. The reader will unlock this secret code and then communicate with your bank to get authorization for funds. So even if your phone was hacked, all the hackers will get is unintelligible code, not your actual bank account/credit card number. Sounds good, no?

But cards are fighting back. If its speed you want, they have a product for you. This summer in London, I often paid for my lunch with “contact-less payment” using my debit card. I would just wave my card in the general vicinity of a reader and lunch was mine. No pins or signatures required. As we discussed in class, consumers have incentives to use credit cards, such as rewards, cash-back, etc. If Apple Pay means I have to pay for my flights, then forget it. Apple will probably have to do more to win in this space. They will certainly need to get partners on their side and understand the motivations for consumers to use certain payment methods.

Not to mention that Tim Cook still has to convince merchants to adopt the reader. This is the real question. Will merchants want to invest in the reader? Many small merchants in the US already have Square, which lets them use the traditional credit/debit card in a mobile fashion. Larger merchants may want their own barcode-enabled system – Starbucks is an incredible success story in this space. In a recent earnings call, the CEO mentioned that in 2013, 11% of Starbuck’s US and Canada transactions were done through the mobile app. Users are reported to find the app very engaging. An app with an in-built payment system could be a great way for a brand to directly engage with the customer. The Starbucks app connects to your credit/debit card or PayPal account. It remains to be seen if large global brands will want to give up direct engagement for Apple Pay.

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But the gauntlet has been thrown. PayPal seems to be nervous. Apple Pay is credited with eBay’s recent decision to spin off PayPal. Their first response was to take a cheap shot. They ran an ad reminding consumers that Apple was recently a part of a massive data breach that involved naked pictures of celebrities being hacked and released on the internet. Want your naked pictures on the internet? No? Then don’t use Apple Pay.

But they will have to try harder than that. Apple has grand ambitions to convert 600m ITunes account holders to Apple Pay. Some good-old fear-mongering probably won’t do the trick. Many will be watching this space with great interest. I know I will. Maybe Google will learn a lesson or two and bring back a new and improved Google Wallet?

P.S. PayPal is also trying make moves into the global remittances market. Every year, immigrants send $542bn in remittances home. PayPal is angling to get a piece of that market. You can now use PayPal in Nigeria and South Africa, for instance. Personally, I would like to see companies like Apple and Google make an effort to create products for consumers in emerging markets. Companies like Mpesa have done amazing work to help the global unbanked access financial services like never before. With their collective knack for innovation and engineering prowess, Apple and Google could have a meaningful impact in this space. I suppose at this point its more important for me to have a marginally better smartphone every few years.

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The international money transfer industry is about to be re-disrupted but the jury as to which innovation will disrupt it is still out there. Not long ago (in the early 2000’s) Xoom disrupted the industry by creating a platform to send money online, removing the large costs of operation derived from having a network of physical locations to collect the money to be sent. In the past year we have seen two new types of startups emerge in the international money transfer industry that aim to disrupt this industry once again.

One of the models is peer to peer. This model is designed to avoid incurring one of the largest costs of money transfer which is sending money across international borders.  The way it works is that once a customer sets an order to send money abroad the company finds someone that wishes to send money the other way around. By doing this they can transfer the money without it actually moving across the border because they just do a local transfer (e.g. someone sending from the US to Europe and another one sending from Europe to the US get paired up so that the money sent doesn’t leave Europe nor the US). Another key advantage to this model is that since the company doesn’t hold foreign currency they don’t need to manage its risk and therefore are able to offer a better foreign exchange rate.

Of course, getting this model off the ground will not be easy since one big challenge with this model is building a large enough network so that every time a user wants to send money the company can find a counterparty to complete the transaction.  Some of the most important players using this model are TransferWise and CurrencyFair.

The second model that has been launched is the one that uses bitcoin as the tool to send remittances abroad. An example in this sector is Bitpesa which sends money to Kenya using Bitcoin and allows users to withdraw the money through mobile banking platforms already pretty popular in Kenya or the recipient’s bank account. The way it works is that customers buy bitcoin through one of the available bitcoin vendors, they send Bitcoin to Bitpesa and then Bitpesa delivers it in Kenyan Shillings. Since bitcoin is a virtual currency that can travel internationally without any additional charges there are large savings to be created in the remittance market. However bitcoin has not yet taken off and there are two key things holding back its adoption: first the regulation that will continue being imposed on it and second the large volatility that it still has which makes exchanging fiat money for bitcoin a highly risky activity by itself.

Because of this it would seem that the peer to peer model should be adopted much more quickly causing it to be the clear winner, right? Well in this case I think that the two innovations will coexist but eventually bitcoin will end up being the main technology to send remittances.

The reason is that while peer to peer is a great idea and the technology is already out there working there is one huge flaw in it which is that for it to work there needs to be a balance in the amount of money transferred between countries and unfortunately the majority of remittances are sent between countries that are not balanced. Take for example the US to Mexico market. Mexico is one of the largest recipients of remittances (about 25 billion USD are sent every year from the US to Mexico); however Mexican immigrants can’t use a peer to peer service because there are very few people sending money from Mexico to the US. This is the case for other key markets such as India and the Philippines.

For this reason I think that the peer to peer services will be interesting players for some markets but will not end up being the dominant technology and they will only survive until bitcoin takes off (by reducing its volatility and getting through regulatory hurdles). Once bitcoin takes off and uses its scale to provide even larger savings than the ones offered by peer to peer models maybe we’ll see bitcoin emerge as the winner. For now nothing is set in stone.

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Online Payment Platforms for the Poor – Cutting the Cost of International Remittance

Imagine a world where you can login to your PayPal account and send money to your cousin’s mobile phone in rural Haiti for 1% and the transaction will occur instantaneously.  Imagine a world where when you forgot to pay for dinner last time you dinned with your friends in Nairobi, you login to your M-Pesa mobile money application and send $40 for free as you walk down Mount Auburn Street in Cambridge.  Your friend gets the money 5 seconds later, goes into the local kiosk, gets the $40 in Kenyan Shillings, and pays for her groceries with that money 10 minutes later.  Do these scenarios seem too far-fetched?  I think not.

Let’s start out with some quick statistics to get a sense of the international remittance market.  According to the World Bank at the end of 2010, there are 215 million people living outside their countries of origin.  Remittances account for 2 percent of GDP for all developing countries, and 6 percent of GDP for low-income countries.  In total in 2010, remittances sent home by those living abroad to developing countries were $325 billion, three times the size of official development assistance.

Now let’s do some quick math to calculate the cost of these transactions.  In Haiti for example, the sender of money will pay on average 6-10% the total transfer amount.  This is on the high side, so let us say that on average across the world senders pay 5%.  This means that in total in 2010, senders paid more than $16bn to transfer money back home.  This is equivalent to approximately 15% of official development assistance that is being lost in transaction fees, or rather paid to banks.  One has to ask why?  Why would we take $16bn away from the poorest people in the world?  There has to be a better way.  This is where online payment platforms can help.

Let us use Haiti as a perfect example of a country that cannot afford these transaction costs.  According to the World Bank, Haiti receives $1.5 billion in annual international remittances, a sum is equivalent to half the national income.  This translates into $120m in transaction fees assuming an 8% average fee.  That translates to an expense of $12 to each person in Haiti in a country where the GDP per capita is $1,200, or 1% of the average person’s annual income.  The percentage is actually much higher as a few extraordinarily wealthy Haitians are skewing the GDP per capital number.

Why are these fees so high?  Traditionally, there are two key players in the remittance service business:

1.  Banks: Offer transfer products or partnering with a money transfer operator.

2.  Money Transfer Operators and their Agents: A non-deposit taking payment service provider that involves a payment per transfer.  The agents distribute the money to the end receiver and capture the sent money from the sender.

The problem for these channels is that the documentation requirements to meet regulatory obligations make small transactions expensive for the banks, MTOs, and clients.  That is why the 5-10% fees are charged.

So what do we need to decrease transaction fees?  The answer is first to develop a functioning mobile money platform.  The mobile banking world has made revolutionary improvements to efficiencies in client documentation and low transaction costs.  Essentially, it has cut the cost out of the money supply chain to provide a low enough cost banking system to meet the needs of the world’s poor.

Digicel, the largest telecom operator in Haiti, launched TchoTcho mobile money platform in April 2011.  As of the end of October, they have 110,000 mobile wallet users with more than 1 million transactions per month.  What makes TchoTcho mobile possible with low fees is the ability to register clients using smart phones and thus eliminating much of the paper trail traditionally required when registering customers for a traditional bank account.

To facilitate the mobile money market, Digicel has had to create a network of low cost agents across Haiti to handle cash in / cash out transactions.  These agents are primarily local kiosks, grocery stores, and gas stations.  Many can also handle proper client registration documentation at a fraction of the cost of traditional banks.  They take a photo of the customer using a smart phone, enter their personal details, and send the information to Digicel’s headquarters.  To simplify this concept, they have created an official banking structure for the unbanked that does not require separate bank employees and the incredible amount of paperwork.  So the question becomes, can we use the mobile banking network as a structure to decrease the cost of international remittances?  The answer to this question is mixed, but I am optimistic.  It may not be possible yet in Haiti, but it now exists in other parts of the world.

In October 2011, Digicel launched Digicel Mobile Money which allows senders in New Zealand and Australia to send money online to recipients’ phones in Fiji, Somoa, and Tonga.  It takes less than 5 minutes and costs a flat fee of $2.40.  This is 1/5th the cost of the transactions in Haiti for a $200 remittance payment. Since Digicel has digitalized Know Your Client documents, it is able to provide documentation for the regulatory requirements easily and electronically.  It just electronically matches the sender and receiver and sends the transaction information to the central banks.  No people involved.  No banks involved.  Digicel handles the cash flow.  It minimizes the amount of remittances people will withdraw from the agent network by giving recipients the option to transfer cash to mobile minutes or to conduct other mobile payment transactions.

Time is needed to fully develop these agent networks to a point where they can handle the size of the international remittance market.  If it happened all at once obviously the grocery stores and kiosks would not have the cash on-hand to give to the receivers of remittances.  Time is also needed to further develop the online payment platforms in the developed world to better mesh with the regulatory system in the US and in the developing countries.  But in time, these payment systems could change how money flows around the world.  It would also save the poor $16bn a year.

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