By Scott Loftesness, Glenbrook Partners 

Though most of us are professionally involved in the electronic payments industry, let’s get personal for a moment. When you think about the payments you make as a consumer every day, have recent innovations in payments actually affected you and your behavior?

Here are a few examples of recent payments innovations that might jog your memory:

• No signature required on purchases at restaurants, convenience stores and the like, using your existing magnetic stripe-based credit card
• Payment using a new contactless card where you didn’t even need to remove the plastic card from your wallet
• Making FastPass or EZ-Pass toll (and now parking) payments, without cards and without stopping
• Buying from a small online merchant where you paid with PayPal instead of providing your card details to the merchant
• Paying your utility bill online with your rewards-based credit card knowing for sure that the utility company had received it while you earned your rewards
  

Did new technologies, new business models, or some combination thereof enable these innovations — or did they develop in some other way? Were the innovations truly “good” in the sense that they delighted customers — or, as some critics say about our industry, were they “bad” in the sense that they may grow revenue but not customer value?

And what about those “bad innova­tions?” Here are some examples of business model innovations that many in the industry have embraced only to come under serious regulatory and legislative scrutiny:

• Have you ever missed a payment due date and been subject to a hefty late fee?
• Have you paid for a cup of coffee with your debit card only to be charged an overdraft fee?
• Were the terms on your revolving credit card ever changed significantly as a result  of a late utility bill payment?
  

All of these examples were certainly revenue innovations for the financial institutions involved — but would consumers consider these true innovations?

How Does Innovation Happen?

When we think of innovation, it connotes the image of a positive contribution — making something better. Given that payments-related innovations often involve two-sided markets with multiple stakeholders, the perception of real innovation is very much in the eye of the beholder.

Importantly, innovation is not invention — it’s a lot harder. At the end of the day, the best ideas and inventions need superb execution to become real-world innovations.

Sometimes, innovation happens within a large, established company that’s a leader in its field. Leading companies pay very close attention to the needs of their best customers and constantly strive to innovate in order to enhance the value they deliver. This category of “sustaining innovation” tends to evolve naturally from the customer relationships but typically yields smaller improvements in value. Most established companies are very good at this kind of innovation. The examples at the beginning of this article mostly include sustaining innovations introduced by industry incumbents — the lone exception being PayPal for eCommerce payments.

Much more often, however, truly disruptive innovation comes from the periphery, and not by the established “incumbents.” The nature of disruptive innovation — finding a non-obvious yet relatively simple improvement to the needs of the unserved or the overserved — seems to be sparked by smart outsiders. Outsiders have an advantage over those actually practicing in the field who, perhaps all too well, respond primarily to the needs of their best customers. Outside their peripheral vision may be opportunities for the new entrants to serve today’s non-consumers or the overserved (including those over-paying for services).

PayPal is a near perfect example of a truly disruptive innovator that took advantage of the incumbents’ focus elsewhere, leaving open a whole segment of unserved merchants that had previously been ignored. PayPal’s successes have been especially painful to incumbents that built their initial progress by serving the needs of small merchants.

Some large institutions try hard to sustain a culture of innovation. Bank of America’s Center for Future Banking, for example, launched a five-year effort in March 2008 in conjunction with MIT’s Media Lab to serve as an “innovation engine that will seek to transform the ways banking will be conducted in a world of rapidly changing social, economic and information landscapes.” The card companies and major processors also invest heavily in innovation strategies — almost exclusively focused on their largest and best current customers.

In the current economic crisis, most innovation initiatives in large companies are feeling the pinch. Companies are shedding what they perceive as non-essential expenses to meet quarterly financial pressures. Yet, these companies remain critical to innovation. For the most part, solutions won’t come from the next new gadget or clever software, though such innovations will help. Instead, they must plug into a larger network of change shaped by economics, regulation and policy.

Distributing Innovation

One of the special challenges in the world of electronic payments is that All of these examples were certainly revenue innovations for the financial institutions involved — but would consumers consider these true innovations?

How Does Innovation Happen?

When we think of innovation, it connotes the image of a positive contribution — making something better. Given that payments-related innovations often involve two-sided markets with multiple stakeholders, the perception of real innovation is very much in the eye of the beholder.

Importantly, innovation is not invention — it’s a lot harder. At the end of the day, the best ideas and inventions need superb execution to become real-world innovations.

Sometimes, innovation happens within a large, established company that’s a leader in its field. Leading companies pay very close attention to the needs of their best customers and constantly strive to innovate in order to enhance the value they deliver. This category of “sustaining innovation” tends to evolve naturally from the customer relationships but typically yields smaller improvements in value. Most established companies are very good at this kind of innovation. The examples at the beginning of this article mostly include sustaining innovations introduced by industry incumbents — the lone exception being PayPal for eCommerce payments.

Much more often, however, truly disruptive innovation comes from the periphery, and not by the established “incumbents.” The nature of disruptive innovation — finding a non-obvious yet relatively simple improvement to the needs of the unserved or the overserved — seems to be sparked by smart outsiders. Outsiders have an advantage over those actually practicing in the field who, perhaps all too well, respond primarily to the needs of their best customers. Outside their peripheral vision may be opportunities for the new entrants to serve today’s non-consumers or the overserved (including those over-paying for services).

PayPal is a near perfect example of a truly disruptive innovator that took advantage of the incumbents’ focus elsewhere, leaving open a whole segment of unserved merchants that had previously been ignored. PayPal’s successes have been especially painful to incumbents that built their initial progress by serving the needs of small merchants.

Some large institutions try hard to sustain a culture of innovation. Bank of America’s Center for Future Banking, for example, launched a five-year effort in March 2008 in conjunction with MIT’s Media Lab to serve as an “innovation engine that will seek to transform the ways banking will be conducted in a world of rapidly changing social, economic and information landscapes.” The card companies and major processors also invest heavily in innovation strategies — almost exclusively focused on their largest and best current customers.

In the current economic crisis, most innovation initiatives in large companies are feeling the pinch. Companies are shedding what they perceive as non-essential expenses to meet quarterly financial pressures. Yet, these companies remain critical to innovation. For the most part, solutions won’t come from the next new gadget or clever software, though such innovations will help. Instead, they must plug into a larger network of change shaped by economics, regulation and policy.

Distributing Innovation

One of the special challenges in the world of electronic payments is that executing on a potential innovation often requires the cooperation of a group of stakeholders who need to collaborate in some fashion to enable success.

Banks in the United States are primarily distributors of very similar products, with much of the innovation happening around distribution rather than the manufacturing of financial products.

Indeed, in the case of card products in particular, the card brand companies (Visa, MasterCard and more recently, American Express and Discover) have done the “heavy lifting” of product development. They then make their products available to their client financial institutions, which lightly customize and take them to market in the institution’s own proprietary fashion. The need for underlying processor support by many financial institutions is another factor that must be considered in enabling meaningful product differentiation.

Bill Me Later (BML) is another prime example of a disruptive entrant to the card companies, and certainly worth exploring. Started by several former credit card executives, BML initially focused on distribution innovation to change the fundamental business model of a credit card issuer. Its founders realized it was possible to skip the traditional mass mailing model and instead solicit new credit customers directly at the time of purchase — effectively using the merchant as their distribution partner in reaching potential new customers.

Subsequently, BML innovated again very successfully with a product uniquely suited to its newly secured distribution relationships. This innovation went back to the early days of department store credit financing — offering promotional financing such as 90–days same­as-cash offers to consumers. BML’s product innovation leveraged their unique, proprietary online connection to eCommerce retailers to enable the retailer to propose real-time promotional financing offers to consumers shopping online. This product innovation helped drive the top line sales revenue of merchants, and the word spread fast through the merchant community about BML’s ability to help provide them with that magic word: lift.

What Doesn’t Work?

A recent example of a commercial failure in consumer payments is Pay by Touch, a San Francisco-based venture focused on enabling consumers to make payments using fingerprint biometrics. Although the company successfully raised significant private equity financing, it failed to attract enough merchant and consumer interest to succeed. It is likely that this approach was simply too disruptive, requiring too much change on the part of both merchants (such as point-of­sale upgrades) and consumers (as part of a new behavior shift).

Futurists often note that first-time failures like Pay by Touch should never be written off because they tend to resurface when you least expect to see them again. Might we see biometric-based payments again in our future?

Consumer Payments Today

Electronic consumer payments today are relatively simple, especially for consumers. Merchants, on the other hand, have to deal with the difficulties of operating rules, cost structures, and the like. Some merchants can’t get acceptance because of their lack of credit history and the inability of acquirers to underwrite them.

What larger merchants want, of course, are increased sales and electronic payments to help deliver those results. They want to accept whichever products their customers want to use to pay — including PayPal if their customers find more convenience and security. Other innova­tions (such as Bill Me Later) that further extend one-time credit to consumers help further drive merchant sales. The reality, of course, is that each new type of payment adds acceptance friction to the merchant’s back office operations — and the lift from any new payment type is weighed against the cost to offer it.

Key Themes in Emerging Payments

Glenbrook Partners provides a payments innovation monitoring service that helps our clients follow new offerings and new entrants of increasing interest to them. Each month, we distill down the most interesting new developments and significant trends — especially potentially disruptive ones — and provide a report of our findings. This “innovation radar” service shares information about the most interesting and potentially most important innovations emerging in the payments market. It also serves as an important adjunct to in-house capabilities for tracking competition and trends.

Here’s a brief look at a few of our current themes:

• A contest is under way for access to the funds in consumer checking accounts — through the traditional check and debit card approaches by banks versus the ACH-based disruptive approaches of PayPal, decoupled debit cards and others.
• Web 2.0 technologies are enabling independent third parties to act on behalf of consumers to better analyze their spending habits and patterns and to help them make better choices and, in the process, save money.
• The ability of the mobile smartphone handset to provide a richly interactive user experience any time, anywhere will fundamentally change consumer behavior with respect to financial products in addition to enabling new on-the­go merchant acceptance locations as well.
  

Especially when budgets are tight and innovative efforts have been significantly curtailed, it’s important to keep one eye on the radar for the potentially disruptive innovations that could change your business. Science fiction writer William Gibson said, “The future is here. It’s just not evenly distributed yet.” What’s your process for ensuring your organization is not surprised by the future that may indeed already be here?

About the Author

Scott Loftesness has more than 30 years of experience in information technology, as a technologist, senior executive, board member, venture investor, consultant, advisor and mentor. He is currently focusing his work at Glenbrook Partners on payments innovation, mobile payments, social media and Web 2.0 in banking and financial services. In addition to his work at Glenbrook as a consultant, Scott is responsible for the company’s online Web services that serve payments professionals.