McKinsey on Payments

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					 Number 4                                                                      April 2009

McKinsey on Payments

Foreword                                                                                 1
Global perspective on payments: The McKinsey Global Payments Map                         3
McKinsey’s Global Payments Map offers a new comparative framework for under-
standing consumer and corporate payments preferences around the world, enhancing
banks’ ability to match product innovations with local market opportunities.
The changing European payments landscape: Crucial trends to 2013                        13
The payments business generated profits of €60 billion for European banks
in 2007, accounting for a quarter of total banking revenues and more than
15 percent of banking profits. Given the value at stake, the importance of examining
how the payments landscape will evolve over the next five years is beyond doubt.
U.S. payments: Pockets of growth despite a slowdown                                     20
The U.S. payments business faces significant challenges, but even under our most
pessimistic scenario, we expect industry revenues will grow over the next five years.
Innovative and well-positioned payments providers will gain competitive advantage
by exploiting opportunities created in a dramatically changing market.
Payments strategies and opportunities for postal operators around the world             26
Although postal operators have traditionally played an important role in payments,
strong forces are reshaping industry dynamics and profitability. To defend their pay-
ments franchise, postal operators must act quickly. If they do so, they may even be
able to leverage payments as the foundation of an exciting new growth strategy.
Mobile payments: Ringing louder                                                         34
Mobile communication devices have become substantially more popular and sophisti-
cated as consumers have become remarkably comfortable with their use. Such changes
could herald new growth for and a reshaping of the mobile payments industry.
U.S. healthcare payments: Remedies for an ailing system                                 40
As American consumers shoulder more of the burden of healthcare costs, new
models are needed to facilitate payment flows, combat growing bad debt, and improve
efficiency across the value chain.
34                McKinsey on Payments                               April 2009

                  Mobile payments: Ringing louder
                  As mobile communication devices grow more prevalent and sophisticated,
                  and as consumers gain comfort in their everyday use, it is time for a fresh
                  look at how mobile payments could impact the payments industry.

Monica Adractas   In downtown Tokyo, a manager leaving his           Japan remains the leader in mobile payments
Yran Dias         office at day’s end stops for sushi at a nearby    implementation (Exhibit 1). Tokyo-based
                  convenience store, and then catches a train        Sony, for example, developed a microchip
Yves Enkels
                  for home. He pays for the snack and train          that when included in cards and handsets en-
Diogo Rau         fare with a quick wave of his smartphone           ables them to exchange transaction data with
Hiroko Sasaki     over each merchant’s point-of-sale (POS) ter-      POS terminals without direct contact. Today,
                  minal. Gone is the need to fumble for cash,        60 million Japanese use the Edy card (named
                  wait for change, sign transaction slips, or        for the euro, dollar and yen) and similar
                  linger in long lines. Japan’s penchant for the     chip-bearing cards. Sony also worked with
                  latest gadgets, digital technology, and auto-      Japan’s leading telecommunications provider,
                  mated vending has clearly helped drive its         NTT DoCoMo, to create a payments net-
                  rapid acceptance of mobile payments, but           work and introduce chip-bearing mobile
                  progress is also occurring in Europe, South        phones: consumers make everyday purchases
                  America, the U.S., and elsewhere.                  with a simple wave of their handsets over
                                                                     specially equipped POS terminals. About 20
                  Advancing globally                                 million Japanese now use such phones, and
                  What has changed since mobile payments             the technology is now emerging in South
                  emerged a decade ago? Three significant            Korea, as well.
                  trends suggest it is time to reassess this grow-   In Europe, uncertainty about conversion to a
                  ing corner of the payments landscape. First,       Single Euro Payments Area may hinder mo-
                  mobile phones have become ubiquitous in            bile payments growth, but progress has oc-
                  markets worldwide. Second, mobile device           curred nonetheless. Here, as in Japan,
                  owners can now use them to make secure             transportation provided the spark for mobile
                  transactions. And third, consumers have            payments development. Early efforts capital-
                  grown comfortable with using mobile devices        ized on the popularity of text messaging to
                  for more than simple communications. These         create applications such as those for paying
                  and related trends are unfolding in unique         parking fees. Transit applications still domi-
                  ways that vary by market and geography.            nate the region, but mobile payments players
                                      Mobile payments                                                                                        35

Exhibit 1                             Profiles of m-payments platforms in Japan
Mobile payments
                                       Provider          NFC payment        Number of holders*              Number of accepting merchants*
enjoy broad                                              platform           Millions                        Thousands
in Japan                               bitWallet

                                                                                                    7.8           74

                                       NTT DoCoMo

                                                                                                  7.07                                320

                                       East Japan
                                       Railway Company
                                                                                  1.05                          34.3
      * As of April/May 2008
Source: Credit Industry Whitepaper,
        ePayment 2006, IR release

                                      are exploring more retail-friendly, mi-             Google, Apple, and a medley of smaller play-
                                      crochip-based applications with several trials      ers have started to appear in this arena.
                                      now under way. Notably, consumer payment            Despite limited progress overall, the mo-
                                      preferences vary significantly among Euro-          bile payments concept remains appealing.
                                      pean countries, which could present further         While mobile banking focuses on transac-
                                      challenges for mobile payments.                     tions between consumers and their banks,
                                      Turning to South America, we note ad-               mobile payments centers on transactions
                                      vances occurring in several markets – often         between consumers and merchants, or
                                      with diverse approaches. Brazilian financial        other consumers (see “Mobile payments
                                      institutions are testing new business models,       and mobile banking” on page 36). The
                                      including a mobile device that can function         mobile payments value proposition bene-
                                      as an inexpensive POS terminal for small            fits both parties to the transaction. Con-
                                      and mobile business operators. And wireless         sumers gain increased convenience,
                                      telecommunications leader Oi threatens to           transaction speed, targeted offers, and cus-
                                      sidestep financial institutions by offering a       tomized loyalty programs. Merchants can
                                      full range of services, from merchant to con-       profit from new opportunities to increase
                                      sumer. Meanwhile, Visa is partnering with           sales, retain customers, reduce cash-han-
                                      Banco do Brasil to offer the bank’s cus-            dling cost, and improve checkout produc-
                                      tomers mobile payment services via any              tivity. Quick-service restaurants can even
                                      Brazilian mobile provider.                          reduce staffing needs by enabling mobile
                                      In the United States, often considered a lead-      devices to link with order-taking kiosks.
                                      ing innovation hub, mobile payments have
                                      made less headway. Some financial institu-          Contending technologies
                                      tions, phone companies and technology de-           Two dissimilar technologies have emerged
                                      velopers are, however, jointly testing a variety    as leaders in mobile payments, each with
                                      of mobile payment approaches. Meanwhile,            distinct benefits and limitations: the short
36   McKinsey on Payments                                    April 2009

     message system (SMS) and near field com-                NFC, by contrast, requires a microprocessor
     munication (NFC). Other technologies, in-               with an integral close-range antenna (such
     cluding some that use mobile phones’ Web                as the earlier-mentioned Sony version) that
     browsers, Bluetooth, or downloaded soft-                is included in mobile devices or cards. Such
     ware, have also emerged. They are similar               devices can transmit transaction data when
     to SMS-based approaches in not requiring                passed near appropriately equipped POS
     special hardware.                                       terminals that provide energy through mag-
     Found widely in Europe, SMS-based pay-                  netic induction so the microprocessors re-
     ment systems use the text-messaging pro-                quire no other power source and have a
     tocol to exchange purchase data via brief               long life. Passwords can be required for
     instructions transmitted to payment                     high-value transactions. NFC transactions
     providers, which promptly clear and settle              can clear via traditional credit networks, or
     the respective transactions. SMS users can              be processed via closed networks. Deploy-
     securely pay merchants and others, make                 ment requires that merchants have NFC-
     deposits, or send remittances. Because any              ready terminals and consumers have cards
     phone capable of text messaging can be                  or devices with NFC microprocessors (or
     used to make SMS-based payments, low                    handsets with NFC-enabled SIM or data
     cost and ease of deployment are strong                  storage cards). Unlike the basic memory
     SMS advantages. However, users must                     chips some devices use, microprocessors en-
     correctly complete multiple data entry                  able more sophisticated data exchanges and
     steps that can sometimes be frustrating                 processing, as well as stronger authentica-
     and time-consuming. Beyond Europe,                      tion. Speed, accuracy and simplicity in pur-
     SMS has been successfully deployed in the               chasing are NFC’s compelling attributes.
     Philippines, Kenya, South Africa, and sim-              Security must be a vital concern, whatever
     ilar economies where telecom infrastruc-                the technology. In the U.S., Boston’s public
     ture and inexpensive, readily available                 transit system introduced the Charlie Card,
     mobile phones help compensate for bank                  a stored-value card, in 2006. Recently, stu-
     branch scarcity.                                        dents from the nearby Massachusetts Insti-

       Mobile payments and mobile banking
        People sometimes use the terms mobile banking and mobile payments interchangeably, which may
        cause confusion. The accompanying article discusses the development of mobile payments, which
        may be defined as the use of handheld electronic devices to pay for goods and services at the point
        of purchase. Mobile payments offers increased speed and convenience in everyday purchases and
        micropayments, such as those for parking and public transportation.

        Mobile banking, by contrast, involves using mobile devices to gain access to financial services, pri-
        marily for banking and investing. Bill paying is often a mobile banking feature, but does not occur in
        real time so is not considered a form of mobile payment. Telephone banking, ATMs, and mobile
        phones helped pave the way for growing mobile banking acceptance. We expect that consumers will
        become increasingly comfortable in using mobile devices to make transfers, bill payments and other
        types of bank transactions, and that this in turn will facilitate growth in mobile payments.
                              Mobile payments                                                                                            37

                              tute of Technology hacked the card’s tech-             ments could readily accommodate transac-
                              nology, revealing its low encryption level.            tion volumes of €185 billion in Europe and
                              Such problems can rapidly undermine con-               $200 billion in the United States. These vol-
                              sumer confidence and cause substantial set-            umes represent low-value transactions, such
                              backs, especially during the critical launch           as parking, transit fares and fast food pur-
                              phase of new products. Security must there-            chases. But low-value transactions could be
                              fore remain a paramount concern.                       just a stepping stone to the greater rewards
                                                                                     of the medium-value transaction segment,
                                                                                     which includes groceries and other retail
         Mobile payments can provide                                                 items, restaurant meals, and sporting and
                                                                                     entertainment events.
 fresh opportunities for entering or more deeply                                     The nature of markets and opportunities
      penetrating market segments and for                                            naturally varies by industry. Banks could, for
                                                                                     example, introduce chip-embedded cards as
          bolstering customer loyalty.                                               product-line extensions that deliver customer
                                                                                     convenience while reinforcing brand loyalty.
                                                                                     Banks could also offer virtual wallets – ap-
                              Assessing markets and opportunities                    plications added to smart phones that enable
                              Today, most mobile payment transactions                account- and card-linked POS payments.
                              are for digital commerce purchases, such as            Card companies, too, are recognizing the po-
                              ringtones, games, music and other software             tential of chip-bearing cards as evidenced by
                              items that reside on phones. Digital com-              the cards’ broad acceptance in some key mar-
                              merce constitutes a market of approximately            kets. These companies are continuing their
                              $10 billion in the U.S. and €16 billion in Eu-         efforts to advance the technology, enhance
                              rope. The potential for mobile payments is             security, and reduce deployment costs. No-
                              much greater, however, in conventional re-             tably, while mobile phone service providers
                              tail. Our research suggests that mobile pay-           control the distribution of the handsets, they

Mobile payments in developing markets
The Philippines offers an excellent example of the appeal of mobile payments in developing economies. Here, where much of the popu-
lation lacks sufficient financial resources to justify bank accounts, mobile payments provides an affordable alternative. SMART Commu-
nications – the nation’s leading provider of wireless services with 35 million subscribers – collaborated with Banco De Oro and
MasterCard to launch SMART Money in 2001. SMART Money effectively provides stored-value accounts that owners manage via their
mobile phones or debit cards. The accounts, which are actually coupled to underlying accounts held by Banco De Oro, accept a broad
range of transactions, including bill payments, cash transfers, POS transactions and airtime purchases.

SMART Load, the platform’s most popular application, enables prepaid reloading of accounts with limited sums – generally about 10
percent of average daily wages for low-end consumers. The company completes 8 million to 10 million transactions daily. A major
SMART Load benefit versus prepaid voucher services is its cost savings of approximately U.S. $5.6 million quarterly. SMART Padala, an-
other popular SMART Money application, enables international cash remittances via SMS texting, so funds are available immediately.
This application is highly popular among migrant Filipino workers.

By 2008, SMART Money achieved 20 percent market penetration, substantially exceeding analysts’ projections. As SMART’s experience
illustrates, aptly designed mobile payments offerings present lucrative entry opportunities even in developing economies.
38                                      McKinsey on Payments                                  April 2009

 Exhibit 2                              Distribution of payment methods at point-of-sale in the U.S.
 High cash use                          Percent of transactions, 2006
 presents opportunity
 for mobile payments                       Cash           Transit system    81                                                         8   10
 in many segments                          Check                                                                               1

                                           Credit card    Fast food         79                                                     7       13
                                           Debit and                                                                       1
                                           prepaid card
                                                          Theaters          74                                             10              15
                                                          Movies            41                                  30                 27
                                                          Drug store        34                      12          22                 32

                                                          Gas station/
                                                          C-store           31                             35                      32
                                                          Grocery store     28                 15          18                      39

                                                          Discount store/
                                                          Warehouse club    27                15           26                      32

 Source: Dove’s 2005/2006 Study of                        Department
                                                          store             18       11                    42                      29
         Consumer Payment Preferences

                                        have limited appetite to act like banks for           ample room for more sophisticated pay-
                                        their consumers. Therefore, cross-industry            ment forms in many retail segments where
                                        partnerships could be a logical competitive           cash still dominates (Exhibit 2). In devel-
                                        strategy that financial institutions should be        oped markets, for example, micropayments
                                        alert for and weigh carefully.                        for public transit, small business purchases
                                                                                              and routine healthcare offer high-volume
                                        Creating a flexible mobile strategy                   opportunities. And many markets, no mat-
                                        It is important that prospective mobile-              ter how advanced, have significant un-
                                        payments players develop strategic plans              banked and migrant segments that are yet
                                        to address the potential opportunities and            untapped (see “Mobile payments in devel-
                                        threats mobile payments might well pres-              oping markets” on page 37).
                                        ent – even if change is not imminent.                 Any market can present significant hurdles
                                        Early involvement could be crucial to                 to entry. In mobile payments, the need to
                                        forging the partnerships and alliances that           grow consumer and merchant participation
                                        successful strategy implementation re-                rapidly and simultaneously are certainly ob-
                                        quires. And because mobile payments                   vious hurdles. While consumers are hesitant
                                        technology can change rapidly, flexibility            to acquire new devices that few merchants
                                        should be a high priority.                            will accept, merchants are reluctant to in-
                                        Mobile payments can provide fresh oppor-              vest in technology that consumers might not
                                        tunities for entering or more deeply pene-            adopt. Timing is similarly difficult. Al-
                                        trating market segments and for bolstering            though the trade-offs involved in being the
                                        customer loyalty. Research shows there is             first to market are well understood, they are
                  Mobile payments                                                                                         39

                  complicated here by the potential emergence       phones themselves, consumers, companies
                  and acceptance of even newer technologies.        and investors are enticed to enter markets
                  Mobile payments entrants must also decide         that promise ever-increasing convenience
                  whether to create their own closed system or      for consumers and profit for providers.
                  join an open system with an established card                           ***
                  network. Japan Railways (JR) developed a          While the future of mobile payments may be
                  closed system for its Suica stored-value fare     somewhat unclear, recent advances in key
                                                                    markets tell us now is the time for prospec-
                                                                    tive entrants to reexamine the threats and
       While the future of mobile payments                          opportunities on their doorsteps. Consumers
                                                                    seem ready – even eager – to enjoy the many
  may be somewhat unclear, recent advances                          conveniences smart cards and phones offer,
                                                                    including mobile payments. And, unlike ear-
      in key markets tell us now is the time                        lier efforts, many of the underlying technolo-
      for prospective entrants to reexamine                         gies have now been tested and shown
                                                                    effective under diverse scenarios in markets
the threats and opportunities on their doorsteps.                   around the globe. Given these substantial
                                                                    advances on both the consumer and technol-
                                                                    ogy fronts in mobile payments, the pace of
                  card, later extending its application to scores   market development and corporate alliances
                  of vendors throughout its enormous station-       could soon increase dramatically.
                  retail complexes, as well as to bus, taxi, and
                  other non-JR transit providers. New tech-
                                                                    Monica Adractas is a consultant, and Diogo Rau is
                  nologies, as well as the devices and systems
                                                                    an associate principal, both in the San Francisco office;
                  they depend on, inevitably present both           Yran Dias is a consultant in the São Paulo office,
                  risks and rewards for early market entrants.      Yves Enkels is an associate principal in the Brussels
                  From photography to computers to mobile           office; and Hiroko Sasaki is an associate principal in
                                                                    the Tokyo office.

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