Can Payments Technology Change the World?

Can payments change the world for the better? Is it making a difference in a positive way? Bruce Parker joked that he has often tried to convince people that the industry backdrop of The Office was supposed to be “payments”, but they couldn’t get the rights so they went with “paper” instead. Payments has a deserved reputation for being boring. You could debate if it’s any more interesting than selling paper. But another, not-so-boring way to look at it is that Dee Hock – the founder of Visa – has done more to get access to clean water than any other human. Of course Dee Hock has never done anything to directly deliver clean water. He’s never made a speech or delivered an initiative. But if you analyse the economic impact of the idea behind Visa – banks collaborating to make payments smoother – that collaboration has reduced payments friction in the global economy to the tune of 50 basis points for 50 years. If you look at various countries, the more they adopt the Visa model, the more their economic output grows. Those 50 basis points translates to trillions and trillions of dollars in economic growth all over the world. If you think about how easy it is to go to another country and use your credit card, and it just works, you see just how well this principle of collaboration works. 

“More people have more efficient ways of earning a living and spending their money because of [the Visa model].” – Bruce Parker

Raising the Boats

Chris challenged this idea of universal growth by making the point that the “benefit of these advancements are uneven.” Some countries are further along because they are able to take advantage of this model but others are not. So these payment systems are great and they reduce friction but they also leave people behind. For example, a shop may take contactless payments, but they might not accept cash, which alienates some customers that don’t have access to that technology.

Bruce responded that it’s not an argument for cash, and the card model may not even be the answer. But we would all be better off if we can implement something such that it would be possible for everyone to use it. If somebody has a means by which they can participate in the payments side of the economy directly, easily, and with the lowest possible level of friction, Bruce doesn’t see how that’s bad. We want more people to participate so it’s not whether or not we should criticize cards, necessarily. It’s more about how we can increase participation.

Bruce goes on to talk about computer innovation as an analogy. Everybody thought the computer market was completely saturated in the 1990s, then laptops came along and created a whole new replacement cycle – Bruce refers to this as “disruptive change.” But when we got to the smartphone era, and now you have everything in this one device, that is when we democratized it. And now, virtually everyone in the world owns one. So the democratization of these mechanisms and making them accessible becomes itself a goal.

Visa and Mastercard are the desktop in this analogy and this industry is working its way toward a lightweight “smartphone” model that anybody can use. So we haven’t had that rising tide event yet, but it seems to be headed in that direction.

Taking a look at China’s eComm, logistics and business success, Alipay, Alibaba, and Ant Group represent an unbelievable shift toward that new future. It’s easy in the U.S. to miss how ubiquitous Alipay is throughout the economies where it’s dominant. It’s not kind of dominant. It puts the market share of someone like a Visa to shame and touches everything. And the reason for that is they’ve solved for democratization and, ironically, it had everything to do with mobile devices and QR codes, specifically.

What makes payments so hard?

A big part of what makes payments difficult comes back to what makes Dee Hock so gifted and the work he did so powerful. Payments requires collaboration, not only with the things that are bought and sold, but with how we agree to hand the money over. 

Let’s use shoes as an example. When you purchase shoes from the merchant, there are going to be some assumptions about the payments experience. Today, you type in a Visa card number and you’re giving that payment detail to the merchant. The merchant hands it off to their partnering processor (ex Worldpay). Worldpay then hands it off to Visa. Visa hands it off to the issuing bank (ex Bank of America). BofA has a payment authorization system, sometimes called a switch, that figures out if the account has enough money and then authorizes the transaction. That authorization comes back from BofA, through Visa, through Worldpay, back to the retailer and you get that confirmation message that the shoes are on their way. The agreement we’re talking about is that the authorization means that there is a hold – ie your credit line has been reduced or your bank balance has been reduced. But the money hasn’t gone anywhere and won’t go anywhere until the shoes are shipped, at which point the retailer will go back to Visa and request the money. BofA sends the money through the Visa network to the bank the merchant signed up for with Worldpay; the acquiring bank. The merchant then asks the acquiring bank to send that money into their corporate checking account (ex Wells Fargo). At this point the merchant has gotten the money for the shoes.

So it’s over and everybody can breathe a sigh of relief, right? Well, it’s not over because you are unhappy with one of the pairs of shoes so you’re going to return them for a refund. For you, it’s as simple as shipping the shoes back. But the merchant has to go back through Worldpay, back through Visa, back to BofA to let them know that some of the money will be going back to your Visa card. That whole second sequence of events is a different set of collaborations. And that ability to return products is fundamental to why people buy things online. You are much more likely to push the BUY button if you know there’s a RETURN button somewhere. Zappos built a huge franchise around this idea of giving the customer delight – if you don’t like anything about these shoes, that’s no problem because they know the card association rules mean that they can process that refund, you get your money back, you can have a level of comfort, and it goes on

If we think about disputes and chargeback, we think about settlement, we think about cost of funds, we think about extensions of credit, there are so many points of collaboration between the banks, technology providers, processors, and merchants that are going on behind the scenes just to make the purchaser a little bit more comfortable that if there’s a problem, it will get taken care of. And that’s what makes payments so hard: it’s not figuring out how to move money when everything goes right, but how to do everything else.

“All happy payments are happy in the exact same way. But all sad payments are sad in their own way.” – Bruce “Tolstoy” Parker

Challenges to Payments Technology

According to Chris, designing the process is easy compared to getting all these people to adopt that process in the same way.Bruce agrees and compares it to the internet: the internet isn’t a thing, it’s an idea. It comprises a set of technologies and agreements and collaboration. People don’t think about the fact that if they’re sitting in Dallas ordering shoes from Zappos in Las Vegas, somebody somewhere is paying for connectivity between these two places. There are a lot of agreements that go into making that connectivity possible, of which people aren’t aware. Occasionally, something like Net Neutrality comes along and those agreements become part of the public conversation, but by-and-large, the internet is just the internet.

Payments works almost exactly the same way. The issue is who gets to set the rules. The major participants such as the big banks know what’s at stake. They know there are not just winners and losers decided in the process, but that the losing can be existential and the winning can be take-all. So they are sensitive about what they are agreeing to, which makes the stakes higher for getting that collaboration to work.

The final piece of the puzzle is figuring out how to overcome the technical challenge. In the same way that the internet has to deal with building the infrastructure – the various parts of delivering the internet – delivering payments services is a very technical task. It boils down to bits running on computers and networks. It’s not just the difficulty of getting people to agree from a business or governance perspective. It’s also figuring out how to communicate on this basis on which you’ve just agreed. There have been a number of cases where people come up with ideas that never take off. It becomes a distraction for a long time because everybody is trying to figure out how to solve technology problems that, ultimately, nobody adopts.

Payments has the additional challenge of fraud because fraud exists wherever money exists. The fraudsters are out there, they’re constantly probing, they’re super smart, and they’re trying to get away with it. The system won’t work if you don’t take that into account and defend yourself against it. Customers need to be able to trust that their card number or other personal information won’t end up on the dark web.

Where is the Most Exciting Innovation Happening?

It’s the confluence, says Bruce. It’s where all these things are headed to an intersection in the very near future that gives an opportunity for more tectonic shift. In general, the pace of change in payments has been pretty slow. Between 2000 and 2010, the biggest event that happened was the introduction of EMV chips we have in all of our cards. By contrast, in the last 10 years, there are more things happening in more places around Open Banking and APIs. The Federal Reserve and Clearinghouse have been pushing Real Time Payments (or Faster Payments). People have these devices and they’re interacting differently, even in physical stores, from a digital perspective. Banks in the EU have been required to open up and provide API access. At the same time, there are several collaborative initiatives around this idea of turning multi-day transactions into a transaction you can see is completed in a matter of seconds. There’s nothing else to do. So this is really interesting, according to Bruce, but not necessarily for the obvious reason.

Yes, going faster is better. But going faster doesn’t necessarily reduce friction. You still have to figure out how to return that pair of shoes and the challenge only gets harder when you do everything faster. What is exciting is that there’s an opportunity for collaboration that could potentially happen outside the banking community. Visa, Mastercard, etc were bank sourced: they were created by/for/with banks who collaborated with each other. When you let the payment information or bank information or account information be free, then the innovation can occur outside the banks, so potentially some of these problems can be solved in a unique way and possibly in a much lighter and more democratized way.

There’s a lot to figure out, but things will get more and more interesting over the next five years, says Bruce. Today, about 60% of U.S. bank accounts are accessible through an API. In the next five years, that will go up to 98% through this Real Time Payments mechanism. Because there is no Visa or Mastercard involved, it will create an opportunity for people to rethink how it all works. Visa and Mastercard have missed the boat on pricing (aka interchange). They have been sued endlessly because that price doesn’t adjust with the market or with scale. Walmart is the loudest complainant because they’re the biggest of the biggest and Visa/MC/etc won’t give them a discount. So while card companies represent a collaboration within the banking industry, they are not a collaboration with merchants. This means pricing happened outside the view of the customer, which isn’t great. So there’s an opportunity for a lot of change: some of it is business, some of it is technology, and as much or more of it is experience. When people can pull up to a fuel/charging station in a car, the pumps turn on, petrol/electrons are exchanged, and infrastructure just knows how to keep things moving without requiring punching buttons on devices or swiping pieces of plastic; those are experience issues. We’ve seen so many of them change during this crisis. The experience had to change. That is the big driver that pushes the technology and business side of things and puts us in a very interesting place, not 10 years from now, not 20 years from now, but 5 years from now. Things are really happening.

Is it possible to achieve collaboration nirvana?

Collaboration tends to favor one party over another – cards are bank centric. But is there some kind of association model that would treat all parties equally? The short answer is “not really.” It’s something we are working through technologically and culturally. 

If you look at Facebook, the user “purchases” the use of the service by giving away their data. Facebook sells that data to businesses who try to sell something back to Facebook users. There is only one entity who is funding the system and that is the advertisers.

In the same way, you have banks who are serving consumers. On one side of the network you have the customer’s bank. On the other side you have the merchant’s bank. But there is an imbalance in the signaling mechanism between them. The reason comes down to competition and ease of substitutes. If it were easy to substitute something besides Visa or MC, that would be one thing. But given that after almost 50 years, Mastercard is still a distance 2nd to Visa, you see that it’s been fixed since the beginning – the initial conditions of the system determined what the outcome would be and it’s not really changeable. There are structural design issues on how the associations were put together that prevent balance. So there’s always going to be an imbalance, but at some point there will be a different balance.

Take substitutions: let’s say you’re a service provider that wants to use Real Time Payments to handle customer subscriptions. You’re not so concerned with refunds because you can just give your customer an extra month free instead. So where will you see Real Time Payments explode? Probably not in retail sales, due to the issue of refunds. Will you see it in subscriptions? Absolutely.

Modo’s point of view is that making all of this successful requires payments orchestration – you have to start keeping track of who owes what to whom. In that subscription model, Real Time Payments works. That’s just one piece of the puzzle. You could also have a refund or a credit that’s applied. You need to start keeping track of these ledgers as they’re interacting between several participants. That’s what we think is really important.

Everybody is really excited about blockchain, which just replaces all these other ledgers with a new one. But it doesn’t solve the problem of getting all these different systems to work together – the banking system, the card system, and everything in between. The problem to solve is knowing where the money is at any particular point during the transaction. Instead of assuming Visa has defined some rules, what if, instead, we make up the rules as we go along or as new technology such as Real Time Payments becomes available? What if Walmart has the ability to say “I, Walmart, am going to fund all deals around refunds myself. You, the customer, have a relationship with Walmart. We’re going to take care of you.” Then moving that money in a real-time fashion is all you need. All the dispute management, refund processing, management of cash and settlement, the things Visa and Mastercard do, is no longer needed. Walmart can do more themselves more efficiently and cheaply, which is what Walmart does.

Are associations wrong? No. In the same way that some people still use desktop computers, consumers will continue to use cards. We can have collaborative interactions amongst parties, but it has to be driven by standards or agreements or technology conventions that make all of this interoperable.

“We’re going to see standards emerge that really are about solving this problem of collaboration and don’t try to do quite so much as what the original models did.” – Bruce Parker

Where does Modo fit in all of this?

Modo wrangles the complexity around how various entities interact. Every bank wants to be different. Every merchant wants to be different. Everybody wants to have a different experience that they may or may not control and they want to be able to handle this in a secure way without reinventing the wheel. Modo’s mission statement is “Reducing friction in payments so we can do the most good for the most people.” There are a couple of cool things that promote that ability. The market calls it payments orchestration, which solves the problem of how do you conduct movements of value in a very broad sense across several parties.