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A Tail of Payment: one, two, ...

posted Jun 30, 2011, 4:13 AM by Konstantyn Spasokukotskiy   [ updated Jul 1, 2011, 2:37 PM ]
Mobile payment is becoming hot, shiny, new hype thing. There are different mobile payment approaches. There are approaches to make sense of the approaches. Here I add my spices to the soup. This article builds upon two methods. First, the historical perspective. Second, the utilitarian perspective. To be sure, none of them is sufficient in predicting what's next. But a superposition of the methods as well as data that you already know may give a clearer crystal ball view.

A brief history of modern payment

There was a time when cash was the predominant payment method. Let's call it payment 1.0.

Advancing industrial (engineering) revolution demanded new ownership form for capital stock - corporations. Huge sums of capital were required to pull the industrial thing off. At the time industrial assets were too expensive to be purchased and owned by sole individuals. The ideas of collectivism quickly won over. In fact, collectivism was so powerful in the real economy terms that by inertia gave birth to socialistic notions. For example it had been a driving force behind French Revolution. The revolution may had been an overshot, but the corporations as a collective ownership of production means became the worldwide standard.

Collective ownership and high production output brought two problems: 1. big sums of money, 2. unwillingness of management to be accountable. Big money were bulky, hard to store, hard to transport, hard to defend. Management didn't want to risk life for ensuring money storage and financial transactions. Banks came to the rescue. Noncash (cashless) payment: warrants, checks and transfers as we know them, had become strong during the time. Everybody won. Managers got rid off a substantial risk. Banks could grow rich by collecting fees for handling real money, while practicing fractional reserve and clearing houses. The payment 2.0 was conceptualized.

Noncash payment in it's infancy had the potential to advance our society only up to the 1.5 level. The cashless operations were at first reserved to business entities and few affluent people. A significant portion of economy ran cash. Consumers didn't have enough incentives to go cashless. Banking inevitably introduces additional business processes to transactions. Individuals didn't want to pay the price. For a while banks were not interested in winning consumers over. Big sums were processed for the industry. It provided good return to effort ratio. Penny pinching personal banking wasn't very attractive.

Over time individual craftsmen, small farmers and traders went out of business. Consumption goods are almost entirely produced and distributed on industrial scale since the second half of the twentieth century. The cushion that separated cash and noncash operations had gone. Banks have become direct intermediary between individuals and businesses. Cash flow doesn't bypass banks any more. Banks are forced to handle cash from consumers. Handling cash is hard and expensive. Banks got a reason to think anew. Consumers still didn't want to assume the noncash burden - no avail.

The first attack was a frontal assault - forcing personal checks upon consumers for retail payments. Noncash payment had been sold to many businesses. For example, many government entities don't take cash. Households have only other choice - money order - that is overall more expensive than maintaining a checking account. This effort to engage banking effectively converted nonconsumption into nominal customer base, but de-facto cash changed hands wherever possible.

The second attack exploited a more sophisticated back-door plan and thus has been more successful. Electronic payments provide convenience to consumers while shift most of the transaction costs to businesses. Particularly debit card can be seen as checks progeny. Since 2006 debit card use has grown 14.8% - more than any other payment method. Finally, the amount of cash and cash-like resources dwindles as electronic payment is being adopted.

Noteworthy, it wasn't the debit card that broke the ice. A more convenient "check" handling wasn't the decisive feature that motivated consumers to acquire new payment habits avoiding cash. Among the deal-breakers were: too much transaction transparency; lack of convenient facility to exchange funds between neighbors, who live back in the woods; etc. The gains of electronic payment were balanced by losses.

The success of debit card rides on the back of electronic credit card. An easy, no-smile, immediate access to money was the killer application. In the early 1980's reckless lending was enabled by new monetary policy. It attracted swarms of consumers. Credit effectively sponsored learning and switching costs. Consumers adopted noncash everyday payment as requirement for getting easy money. Payment by credit cards is in decline today (2006-2009 payments by credit card reduced -0.2%). An exuberance paved the way to electronic era.

The utilitarian analysis

If history is any guide, mobile payment is just a flavor of electronic noncash payment.

The overall economic potential equals the inefficiency costs that still remain in the system. The costs can be estimated. An extrapolation of historical value that was released by moving from payment 1.0 to 1.5, then to 1.X can provide the scale of upgrade from 1.X to 2.0. It is fathomable that another 3.0 horizon could present itself after we reach 2.0 milestone. But for now, 2.0 milestone alone seems to be an adventurous task. Even if 1.X - 2.0 upgrade doesn't sound like a great deal, it really is larger than prior developments. The significant metric here is value release/year. Speedy value release is due to a multiplicity of factors that favor rapid adoption of noncash payment. A compressed time scale makes little shifts high paced and substantial.

The most important question for technologists is "who's horse to bet on?" There are three principles to consider:
1. mobile payment is a new trick to bridge old capability gap. That means old motivations and reasoning persist. The main adoption drivers would be: ease of use for consumers and low transaction costs for banks.
2. consumers do not adopt new payment technologies unless advantages are overwhelming. A winning solution has to minimize adoption burden and attach benefits that originate outside of banking ecosystem. The later means that
3. technology perks matter. Technology availability and costs/function will determine which payment system wins. It is not to expect that payment industry will be costs-efficient by sponsoring proper technology. Vice versa, technology will sponsor establishment of successful payment methods.
It seems that physical availability of technological infrastructure would be one of the determining factors. Technologies like near field communication (NFC) are relatively easy to use but will never ever be prevalent. A scenario: two people shake hands in a desert and exchange funds - will take very long time to occur with NFC. It requires active, integrated into the circuitry NFC chip that is available in all phones.

At the same time simple second-hand phones are already ubiquitous in many corners of the World. Technologies that don't rely on hardware capabilities have timing advantage. A modified voucher-like system -that doesn't have any hardware anchor- would have good chance winning the race. Unfortunately none of the contemporary systems lives up to the task. Be it lack of direction, too much greed or else, great applicability and thus potential availability aren't supported by the ease of use and low costs. An opportunity, once, twice, ...