Digital Disruption and the Payments Industry

“If you don’t disrupt yourself someone else will.” These words, ringing true for bank and non-bank organizations, came to light in a keynote by Peter Diamandis, CEO of Singularity University and Chairman of the XPrize’s challenge.

The keynote, highlighted in our recent blog, D is for Disruption and Payments Innovation, covered three topics pertinent to the payments industry—dematerialized, demonetized, and democratized—that highlight where industries are heading. These points were addressed further in our blog, 4 reasons the digitization of payments is imminent, which showed the death of checks, the rise of mobile payments, the evolution of the procurement professional, and the rise of customer experience as drivers to digitized payments.

Consumer-Focused Innovations Changing an Industry

While consumer-driven innovations are shaping much of the payments revolution, another factor underscoring payments innovation is the proliferation of new technology (Fintech) in the payments world—driving established incumbents to adapt or die. A recent McKinsey article, aptly titled, How the Payments Industry Is Being Disrupted, took a deeper look into driving factors behind payments innovation revolution, noting that global payments revenue is expected to grow by 6 percent annually for the next five years and highlighting the following drivers:

Nonbank digital entrants will transform the customer experience, reshaping the payments and broader financial-services landscape
The modernization of the domestic payment infrastructure
Current cross-border inefficiencies are opening doors for new players
The implications of digitalization in retail banking are causing a ripple effect for transaction bankers

As this answers how the industry as a whole is being affected, another McKinsey article highlights how incumbents can address the changes to the industry and capitalize before they are, in the words of Diamandis, “disrupted.”

The article, An Incumbent’s Guide to the Digital Disruption, took a look at disruption across industries, for example, Norwegian newspaper group Schibsted’s decision to move its main profit driver—classifieds—online; noting other disruptors like Airbnb, Uber, Netflix, and more.

The S-Curve of Disruption

There are multiple points in the disruption of industries, each with challenges, barriers, and opportunities for incumbents to address. The S-Curve of disruption, displayed by McKinsey, demonstrates how an incumbent must act in the four stages of digital disruption:

Disruption is Detectable (Faint signals with a lot of noise)
- Incumbent Move: Acuity, recognizing signals among the noise and acting, often requiring the incumbent to challenge its own “story.”
- Barrier: Myopia, or nearsightedness, to the coming disruption.
- Example: In 1999, Norwegian media company Schibsted realized that the newspaper industry relied too heavily on classified ads, and became convinced that “The Internet is made for classifieds, and classifieds are made for the Internet.” Prior to the industry’s disruption, the company took strides to shift its focus to becoming an online classifieds company, and has grown since.
Disruption is Clear (Emergence of a validated model)
- Incumbent Move: The core technological and economic drivers have been validated, and established companies need to commit to nurturing new initiatives so that they can establish footholds in the new sphere.
- Barrier: Avoidance of Pain. The industry disruption is there, but the impact is not big enough to dampen earnings momentum of established players. Incumbents are often reluctant to suffer short-term pain for long-term success.
- Example: In 2011, Netflix relied heavily on DVD-by mail, with streaming only being a small part of its revenue stream. When the company shifted to a streaming-first focus, its share price dropped by 80 percent. For larger companies, this means the shift of a product line to fit into the long-term company success.
Disruption is Inevitable (Critical mass of adoption achieved)
- Incumbent Move: Acceleration. By now, the future is pounding on the door. The new model has proved superior to the old, at least for some critical mass of adopters, and the industry is in motion toward it.
- Barrier: Inertia. According to McKinsey, this is the hardest stage for an incumbent to navigate, as declining performance results in tightening budgets and less focus on innovation, moving spending to maintain legacy business while killing any momentum the organization has in order to embrace disruption. Incumbents must embark on an “unremitting reallocation of resources from the old to the new model, and show a willingness to run new businesses differently from the old ones.”
- Example: In 2005, German media company and former “digital laggard” Axel Springer realized that disruption was inevitable and jumped into action, acquiring 67 digital properties and launching 90 new initiatives by 2013. Today, digital media contributes 70 percent of Axel Springer’s earnings.
Disruption is the New Normal (At Scale and Mature)
- Incumbent Move: At this point, the reality is that the industry has fundamentally changed. Incumbents realize that earnings are caving in and they are no longer in a position to take market share.
- Barrier: The industry has already become the haves and the have nots, and incumbents who failed to adapt were left out. The challenge, of course, is to find where an incumbent can fit in, and recognize which problem it can solve in the new industry.

Fintech’s Disruption in Payments

At this point, the way payments are made has coasted into stage three, the inevitable transformation. Driven by increased access to technology, the 2009 financial crisis, a changing regulatory environment, new consumer preferences, and a thriving competitive landscape, payments will continually evolve.

A study by Deloitte found that the biggest driver behind payments disruption is convenience for businesses and consumers, followed by tailored services and a push toward lower and lower costs.

All of this leaves established players three choices—done independently or in some combination, summed up by Payments Cards and Mobile: Copy, cooperate, or buy in order to meet up with higher expectations and increased competition.

“Being disrupted is never a comfortable experience, but those that can see the potential of positive engagement with their disruptors and have the drive to make it work in their favor stand to establish huge competitive advantages.”

With new Fintech startups reaching 4,000, and venture capital investment reaching $19 billion USD in 2015, according to Moody’s, several forces could tip the scales or accelerate the transformation of the payments industry.

Some of these forces include greater movement toward open data, a regulatory environment that could change the rules of engagement, the introduction of a ‘killer app,’ or the entrance of established technology companies into the Fintech space.

Future-Proofing

To address the challenges ahead for incumbents, a whitepaper by BNY Mellon recommends the following:

Developing and publishing an internal “road map” outlining how to identify and respond to market threats and opportunities,
Identifying opportunities to strengthen business through proactive innovation (e.g., redeploying consumer payments infrastructure for corporate payments),
Meeting and engaging with nimble fintech startups within the digital payments sector to gain knowledge and better understanding of potential developments in the payments space, through events such as innovation slams with fintech companies, clients, and internal stakeholders. Dialogue and involvement with the fintech world can be an ideal way for banks to explore and gain direct exposure to the technology innovation scene,
Conducting ongoing research to keep abreast of fintech-driven changes within the sector. Whilst the complex nature of wholesale and corporate payments markets means major change is unlikely to happen in the short-term (12-18 months), banks need to be sufficiently forward- looking to ably respond to market changes in the medium-term (18 months to four years). Banks are not known for their agility, and early warnings will ensure they are able to choose the most appropriate strategy (partnership, acquisition, product development, etc.),
Ensuring key staff are educated on developments, threats, and opportunities in the payments business. Digital currencies and the blockchain in particular have the potential to significantly shake up payments, and vigilance in this area is necessary to ensure banks are not caught “on the back foot” and remain relevant, prepared, and proactive,
Developing an innovation programme in partnership with IT, enabling the prototype of new initiatives to be tested in a “safe to fail” environment,
Optimising information and data already available. Patterns and trends in client preferences and behavior can be identified and analysed (due to enhanced technology and transparency capabilities) to not only offer far better client service, but to generate real added-value to both banks and their clients.

Conclusion

With payments continuing to evolve, it has never been a better time to be a user of payments services. More competition catering to the direct needs of the companies and users has built an environment that helps each select what matters most. Learn about the evolution of payments, and stay on the cutting edge of payments evolution by following WEX on LinkedIn, and learn more using the resources below.

Digital Disruption and the Payments Industry