India has leapfrogged its way in technology adoption, beginning with the penetration of smart phones and most recently digital payments. Digital payments in India is going through rapid evolution and is being steered by government regulators and banks. This makes the growth of digital payments in India very different compared to the US and China, where banks and government agencies stayed mostly away.
A quarter into 2017, it is clear that digital payments in India is not going to be the same.
The role of the intermediary is over. Revenue from MDR will disappear in the next 2 years; offline digital payments will be disrupted as POS devices will make way to mobile payments; and data will be the new profitability.
First, a quick peek into the history. Digital payments grew as card schemes (Visa, Mastercard, Amex, RuPay, Union Pay, etc.) worked to create a standard for enabling consumers to pay using their credit/debit cards across different businesses – online and offline. This led to the design of what is known as the “Card Present” (offline payments using a POS machine) and “Card Not Present” (online payments using a payment gateway) payment methods. Both these payment methods have multiple banking and technology stakeholders with the card schemes laying the working principles and resolving deadlocks. A consequence was the associated cost of a transaction – the more the stakeholders, the more you shell out for the service. Businesses did not have a choice, and either absorbed the cost (sometimes up to 200 basis points) or passed it on to the consumers (as was seen in some local retailers and utility companies).
This no longer works well in India for the following reasons:
- In a low margin and hyper-competitive market like India, 200 basis points is often a good enough reason to not use a technology, especially when cash payments are readily accepted and the ATM network is well built. If there was a way to execute the transactions ‘directly’ without running it through the interchanges, the cost of a transaction would fall.
- India is a 2FA market, meaning that the risk is passed on completely to the card issuer. The acquiring bank’s risk is often limited to an issue in service delivery – which again is limited to online transactions. There is very little value you get in return to a high interchange fee.
- The credit economy in India is still in its infancy and credit cards account for a mere 4% of overall cards issued – as a result, debit cards dominate digital transactions. Transaction fees for debit cards are regulated by the government to a maximum of 100 basis points, thereby limiting the revenue potential for payment providers. Unlike markets like US, where companies like Stripe and Paypal operate around 300 basis points across all cards, India doesn’t give this advantage to PSPs.
- Indian banks and government bodies, like NPCI, have been at the fronts of the digital payments battle. Unlike the US, where the banks and government saw the digital payments growth from the sidelines, India is a different market altogether. With the introduction of platforms like UPI, the focus is to ride on the penetration of mobile devices and eliminate the intermediary from the payment flow.
The future of digital payments in India is bright, but will look dramatically different.
- Banks, riding on public rails like UPI and Aadhaar, will drive digital payments through their mobile apps. Money transfer will no longer need an intermediary or an aggregator, thereby allowing the unit economics to support micro-transactions.
- Offline digital payments will be disrupted as mobile devices and banking apps will disrupt traditional POS devices. Larger banks that have a legacy of POS acquiring will struggle to cannibalize their revenues from POS and painfully transition to the world of mobile payments. The new age banks will lead this change and will not even bother entering the POS business. This change will be slow, but will eventually be a reality in another two years.
- As MDR revenue vaporizes, payment aggregators will turn to data for profitability and try to become FinTech players. Leading consumer players (think Amazon, Flipkart, PayTM) and the upcoming banks & financial services institutions (Equitas, Bajaj Fin Serv, IndusInd, …) are already moving strong in this space and have a significant edge on either data and/or access to capital. Current PSPs have neither advantage and will collapse under this competition, eventually getting assimilated by global omnichannel payment players (Ingenico’s acquisition of EBS and Techprocess), banks, or large consumer/e-commerce companies.
Digital payments in India is a large opportunity and has been pegged to be around $500B by 2020 [ref. BCG-Google Report]. The winner of this, however, may not be the traditional PSP, as we know it.