Preparing for the Post-Check Future
The volume of paper checks, the fuel for many processors and hardware vendors, is dwindling fast as consumers switch to electronic payments. Can paper-dependent companies wean themselves from the check before it’s too late?
Jim Daly
Americans still write more than 20 billion paper checks a year, and those payment instruments keep hundreds if not thousands of companies in business. Processors, software developers, and vendors of check-reading hardware all owe their existence to the muchmaligned paper check. But decades of predictions about a paperless society, while widely off the mark in many respects, are finally coming at least partially true in the financial realm. As credit, debit, and prepaid cards, along with even newer payment forms, find increasing consumer favor, the volume of checks is now falling fast enough that companies whose business models depend on the paper may have precious little time to hammer out new strategies. U.S. volume peaked in 1995 at 49.6 billion checks, according to a December 2006 report from TowerGroup Inc., an independently run research firm owned by MasterCard Inc. Since then, volume has fallen fast, and the rate of decline is accelerating. Citing Federal Reserve data, the report noted, “paid check volumes declined at an average rate of 3.3% per year between 1995 and 2000 and then at 4.3% per annum between 2000 and 2003.” It’s getting even worse if you’re a paper aficionado. Needham, Mass.-based TowerGroup predicts volume will fall to 17.9 billion checks in 2009 from an estimated 22.1 billion this year (chart, page 32). If TowerGroup’s forecast is on the mark, the annualized rate of decline would be 9% from 2000. Debit cards are leading the growth race, with a nine-year compounded annual growth rate of 23.2% followed by the automated clearing house at 16.9% and credit cards, 8.4%. No one predicts the written check will disappear, but the rapid fall in volume is driving up unit costs—the expense for moving, processing, and otherwise handling each check. TowerGroup notes the Fed increased check-processing prices 5% to 6% for paper shortly before its report came out, though imaging prices declined. Eventually, many vendors may conclude that processing paper checks or making devices that read them no longer justifies the return. “Those that provide check reader/sorters shouldn’t count on a lot of new business going forward,” says Nancy Atkinson, senior analyst at Boston-based Aite Group LLC, a technology research firm.
Killing Trees
The Federal Reserve announced in June that it plans to have just four regional centers providing paper check-processing services by March 2011. Since the Fed system began restructuring its processing operations in 2003, it has already cut the number of offices providing full paper check-processing and settlement services from 45 to 22. Banks, too, are scaling back on their check infrastructure. Forms of electronic payment that depend on checks, though prospering now, face decline and extinction along with the paper that makes them possible. These include ACH consumer-payment codes—ARC, TEL, WEB, POP and the new back-office conversion, or BOC—that convert the documents to electronic form. Then there is the Check Clearing Act for the 21st Century (Check 21), the 2004 law that confers legal status on paper printouts of check images but also encourages image exchange. While these new check variants enjoy high transaction growth rates today, experts predict they will peak, perhaps in just a few years. “The next several years are going to keep all of us busy, [but] at some point the fun’s going to end,” says Robert Meara, senior analyst at Boston-based research firm Celent LLC. Many companies most closely identified with the paper check are rushing to diversify while they still have a chance. “Everyone who’s in the check business today is looking at what’s happening … as a finite opportunity,” says Thomas Kettell, strategic business manager of emerging markets for Long Beach, Calif.-based printer manufacturer and scanner marketer Epson America Inc., a unit of Japan’s Seiko Epson Corp. “We believe there is tremendous opportunity in e-check, but it is finite.” Consider Shoreview, Minn.-based Deluxe Corp., formerly known as Deluxe Check Printers, a fitting name for the nation’s largest such printer. As recently as 2003, Deluxe drew nearly 90% of its revenues from checks and related products, but three years later that figure was down to about 64% (chart). Deluxe is now targeting small businesses with business checks, all manner of forms, and other printed products as major growth areas.
Even leading payment processor First Data Corp.’s TeleCheck service, whose bread-and-butter franchise is check verification and guarantee at the point of sale, is moving on. “TeleCheck is going to become less of a paper-check company,” says company president Brian Mooney. And into which markets are these check-based companies moving? While Deluxe is leveraging its printing heritage, the choices for processors and hardware vendors are myriad, though fraught with the possibility of confronting experienced incumbents when they tread on new turf. Nonetheless, check processors do have a strong suit: experience in converting paper to electronic formats. “Basically, what these vendors need to do is look where there is still a lot of paper out there,” says Aite’s Atkinson. “We’re still killing lots of trees in this country.”
The trees are being used by hospitals and doctors’ offices to produce medical forms, and by utilities and countless other business to produce bills and invoices. This mass of paper presents vast opportunities for electronic payments, especially recurring payments, and imaging services. Companies in the check-processing space also are looking at payment-security services.
‘Next Horizon’
Some, such as San Francisco-based specialty processor BankServ, formally BServ Inc., even are finding profitable niches in checks— business checks, that is. “We very much stay away from consumer check applications,” says BankServ president and chief executive David Kvederis, adding that his firm decided back in 2000 to pursue a strictly business-to-business course. Regarding the processing of retailers’ consumer checks, he says, “The handwriting’s on the wall. We just saw no future in it.” Kvederis is perfectly happy to deal with paper-based business checks, for now at least, because volumes are stable. “Depending on whose statistics you want to believe, they might even be going up a little,” he says. The main reason, however, is that the paper check is what Kvederis sees as “a means to an end,” the end being more electronic payments. With its main focus on Check 21 and related applications such as its DepositNow remote deposit capture service, BankServ’s transaction volume is exploding. Kvederis expects his firm to handle 5 million Check 21 transactions this year and “probably 25 million” in 2008. Indeed, remote deposit capture, in which businesses scan checks for electronic deposit on their premises, represents a natural market for processors looking for new growth markets (“Why Remote Capture Looks Super,” April). “Remote deposit capture is not only appealing for small businesses, but it also is appealing for large companies,” says Aite’s Atkinson. The boom in ACH and Check 21 transactions is providing a windfall for manufacturers that produce scanners that can image a check and read its magnetic ink character recognition (MICR) line, buying those firms time to transition into a less paper-dominated future. “Our volume of check-reading products continues to increase year over year, month over month,” says John Arato, vice president and business unit manager of retail products for MagTek Inc., a Carson, Calif.-based hardware maker. And Mosinee, Wis.-based Wausau Financial Systems Inc., a leading provider of lockbox software and services, is still processing “a ton” of paper, according to Patrick M. Brzezinski, vice president of remittance solutions. In part because of its recent acquisition of Omaha-based Data Management Products Inc., Wausau is handling about 3 billion paper checks a year. With DMP under its wing, Wausau claims it has 40% of the total remittance market, with such major providers as U.S. Bancorp, First Data’s Remitco, Regulus Group LLC, and The Bank of New York Mellon Corp. all using its software. Payment processors and vendors preparing for the post-check world are applying their expertise with retailers and other card- and check-accepting merchants to seemingly logical adjacent markets. One such market frequently mentioned by payments executives is health care, an approximately $2 trillion sector partially penetrated by cards when consumers pay their co-pays or access health-savings accounts, but still dominated by paper checks from insurance companies and government. “The health-care market as far as payments is still a manual process,” says Kettell, who says Epson is “looking at” the market. Besides Epson, Panini North America, a leading provider of check scanners for banks, also is eyeing the medical sector, though Michael Pratt, chief marketing officer, is guarded with the details. “We are extending our reach in terms of our payment solutions to related markets like … health care,” he says. The Dayton, Ohio-based company, a subsidiary of Turino, Italy-based Panini S.p.A., has a
number of what Pratt calls “next-horizon solutions” in the pipeline, products under development from research that originated last year with interviews from banks and technology companies.
Eyeing Bill Payment
In September, Monett, Mo.-based bank processor Jack Henry & Associates Inc. announced a pact with HealthEquity Inc., an administrator of health-savings accounts, under which Jack Henry will make HealthEquity services available to employees and consumer customers of its 8,700 financial-institution clients. The two partners see revenue opportunities from the projected growth of HSAs, into which consumers park tax-free funds from their paychecks to pay for current, qualified medical expenses and save for future such expenses. Though HSAs were created by Congress in 2003, only 3.2 million individuals have established such accounts and have invested more than $1 billion since 2004. But the U.S. Treasury Department projects more than 14 million HSAs representing 40 million to 45 million people will be opened by 2010, according to a Jack Henry news release. Researcher Atkinson also notes that Cincinnati-based Fifth Third Bancorp, owner of the big merchant processor Fifth Third Processing Solutions, is looking to establish itself as a major business-services provider to the medical sector. In a May presentation to analysts, Fifth Third executives said health care would become a “core competency” of the bank, with services to include such things as imaging of explanation-of-benefits documents. These so-called EOBs list who is responsible for paying what share of each medical service incurred by the consumer and are one of the most paper-intensive parts of health care.
According to Atkinson, similar opportunities await banks and processors with paper shipping notices, other logistics documents, and purchase orders. “There is an opportunity to move toward electronifying those documents as well,” she says. Some of these opportunities involve vast amounts of strictly B2B transactions. Minneapolis-based U.S. Bancorp, like Fifth Third a major merchant acquirer and consumer card issuer and ATM owner but also a leading commercial card issuer, last year bought Schneider Payment Services, a division of Green Bay, Wis.-based trucking firm Schneider National Inc. The acquisition added $7 billion in payments to U.S. Bank’s PowerTrack freight-payments portfolio. Another natural market is recurring payments, such as the monthly utility and loan bills consumers pay. Top outsourcers in this market include CheckFree Corp., Metavante Corp., Online Resources Corp., and Fiserv Inc. (which is acquiring CheckFree), but others are looking to move in or expand their footholds. One is Electronic Clearing House Inc., a Camarillo, Calif.-based merchant processor and purveyor of the Visa POS Check Service that authorizes and electronically settles check payments using the VisaNet network. Checks represent about 20% of ECHO’s business, says Chuck Harris, chief executive and chief operating officer, but much the company’s growth is coming from recurring and Internet payments. ECHO is working with its merchant clients to convert as many paper payments to card or e-check transactions as possible. “We do see near-term opportunity in the back office … where there are recurring payments, government payments, areas where consumers for whatever reason still use check products,” Harris says. Kris Winckler, ECHO’s senior vice president of strategy and marketing, notes that consumers still want to use their demand-deposit accounts even if they don’t write checks. “It doesn’t have to start with the raw material of a check,” he says.
Too Late?
Other specialty processors are looking for life beyond the paper check by going after recurring and other check-based payments to churches and non-profit groups. One is Minnetonka, Minn.-based Vanco Services LLC. Vanco’s annualized volume is $60 million, and 90% of that is recurring, says president and chief manager Jeanne Spencer Rose. Vanco’s merchant base of 15,000 includes 8,500 churches that are converting what used to be mostly cash and check donations to credit and debit cards, she says. “That moves them away from the check and the lockbox,” she says. “Eventually they too are looking for a more efficient way.” Jack Henry is “ramping up bill pay,” according to Stacey Zengel, general manager of imaging solutions. The company also is exploring mobile payments, though Zengel won’t divulge details. And still another route to a paperless future is transaction security, especially when it comes to demand-deposit accounts. Here, too, some well-established players dominate, including Fair Isaac Co., TeleCheck, eFunds Corp. with its Scan check-verification product, and Fidelity National Information Services Inc., the firm that bought check and card processor Certegy Inc. last year and acquired eFunds in September. That isn’t stopping a hardware company such as MagTek from going after the security market with new or enhanced services.
About a year ago, MagTek unveiled Magensa LLC, a service bureau with a suite of authentication and related services. MagTek assures clients its services meet the Payment Card Industry data-security standards (PCI) intended to thwart database breaches and other card-related fraud schemes. “Right now there is a very big demand for PCI-compliant products,” says MagTek’s Arato. Even companies that already have big check-verification and other risk-assessment services, including Houston-based TeleCheck and ECHO with its National Check Network database of positive and negative check information, are trying to figure out new ways to leverage those files. TeleCheck’s Mooney says his firm’s transition away from paper and into a more electronic future includes conversion services such as its Electronic Check Acceptance product that offers ACH and other routing alternatives, and also funds collection and settlement. But more risk-assessment services are part of the plan, too. Mooney, who wouldn’t give details, acknowledges TeleCheck
could be bumping heads with some tough competitors. Yet TeleCheck, like MagTek, sees the growing demand for more security services as worth the risk. “The ultimate goal is to reduce payment-system fraud,” Mooney says. “Nobody wins when there’s fraud in the system.” Processors and vendors are likely to be most successful if they pursue new markets based on carefully assessed demand rather than offering new products just because they fear the loss of business from declining check volume. Time may be getting short. “If you’re starting to make that preparation now, it’s too late,” says Wausau Financial’s Brzezinski.