Cutting Checks: Challenges and Choices for the Adoption of B2B Electronic Payments

Transcription

1 Cutting Checks: Challenges and Choices for the Adoption of B2B Electronic Payments Mark J. Cotteleer Marquette University Christopher A. Cotteleer Andrew W. Prochnow Charter Consulting, Inc. September 2005 ACM, This is the author's version of the work. It is posted here by permission of ACM for your personal use. Not for redistribution. The definitive version is forthcoming by ACM Charter Consulting, Inc.

2 Introduction Changes in the business-to-business (B2B) payments marketplace continue to attract executives attention. Increases in electronic payments, decreasing paper check volumes, and new legislation in the field have been the main indicators of this change. Businesses are beginning to realize the need to add new payment options to a process that has traditionally been dominated by paper checks, wire transfers, and automated clearinghouse (ACH) transactions. What started as a consumer push toward electronic payments has influenced new thinking in the B2B market. Financial institutions and businesses must closely monitor this trend because current product offerings fall short of changing expectations. For banks, ignoring market demands may result in disenfranchised customers, decreasing revenues, and falling profits. For businesses, failure to adopt new payment options may result in lost value. The future of electronic banking depends on the development and adoption of new technologies. The promise has been that banking leaders will continue to offer new delivery methods [11]. This promise is being realized in the area of electronic B2B payments. The purpose of this article is to discuss current issues confronting the B2B electronic payments industry and to investigate the key technologies that will shape the future of B2B transactions. Electronic Payments Overview For decades, paper checks have served as the keystone settlement method for financial transactions in the U.S. market. However, evolving technologies have created new possibilities within the payments supply chain. To date, the fastest growing sector of the electronic bill payment market has been business-to-consumer (B2C) transactions. For instance, 2003 marked the first year that the majority (53%) of in-store consumer payments were conducted electronically. Similarly, from 2001 to 2003, automatic electronic payments and online bill payments increased from 17% of the consumer bill payment mix to 29% [3]. Businesses have been less aggressive in their adoption of electronic payments. As of 2001, 86 percent of B2B payments were still executed using paper checks with the remaining 14 percent using a variety of electronic payment options (See Figure 1) [9]. 2

3 Figure 1: B2B Payment Methods (2001) EDI 2% Cards 1% Other 1% ACH 10% Checks 86% ACH Checks EDI Cards Other Industry research on electronic payment trends suggests a near-term increase in B2B electronic payment volume [5]. The rational behind this payment transformation lies with improvements in their cost, timeliness, and reporting accuracy relative to paper checks. The 2004 passage of the Check Clearing for the 21 st Century Act ( Check 21 ) is indicative of changing mindsets regarding electronic payments. Check 21 legalized the substitute check, a check printed from an electronic image of the original check. This legislation allows financial institutions to process payments more efficiently because electronic check images can now be transported over the internet. Although Check 21 technologies may serve as a minor process enhancement, they still rely on manual intervention and do not provide savings to the extent of true electronic payment processes. True electronic payment systems continue to evolve as an attractive solution because they allow bundling of payments with related transaction data, along with easy integration with Accounting and Enterprise Resources Planning (ERP) information systems. This means that businesses expend fewer resources processing payments, reconciling payments with invoices, and entering information into databases. According to a study conducted by the National Automated Clearing House Association (NACHA), companies pay anywhere from $2 to $5 to create and deliver a single paper-based invoice. Another $10 is spent on the other side of the transaction for processing and payment [4]. Estimates suggest that a typical large business, sending approximately 792,000 invoices per year, can save nearly $5 million annually by eliminating costs related to processing paper payments 3

4 [10]. In the face of these potential savings, business executives are starting to recognize the value of moving to an electronic payment solution [12]. The result is that approximately 61 percent of all B2B payments are forecast to be conducted electronically by the year 2010 (see Figure 2) [5]. Figure 2: Projected Growth in B2B Electronic Payments ( ) B2B Transactions (billions) Year electronic payments check payments B2B Electronic Payment Adoption Challenges and Dimensions of Value Four challenges confront firms that are interested in adopting electronic payment processes: (1) Systems Integration; (2) Absence of Remittance Standards (3) Security; and (4) Uncertainty in the Business Value Proposition. In addition, candidate technologies must be considered in light of their ability to deliver value in multiple dimensions. Systems Integration The most significant barrier to the adoption of electronic payments is a lack of integration across the many systems needed to support such a process [1]. B2B payments involve up to five distinct entities: The buyer purchases goods and services The buyer s financial institution provides banking services to the buyer The supplier provides goods and services The supplier s financial institution provides banking services to the supplier The Federal Reserve or other check clearing entity facilitates the check sorting process The top of Figure 3 depicts the traditional B2B check clearing process in which a buyer writes a check that subsequently flows through the supplier, the supplier s bank, the Federal Reserve 4

5 (or other check clearing entity), the buyer s bank, and finally back to the buyer. This process is supported by human interventions throughout the supply chain, including manual entry of check amounts and associated transaction data. Figure 3: Life Cycle of a B2B Payment Paper-Based Payment Environment Stage 1 Stage 2 Stage 3 Buyer Business Supplier Business Supplier Bank 1. Receives Invoice from Supplier 2. Writes and ships check to Supplier 3. Manually enters data into ERP system Stage 4 1. Deposits check in Supplier Bank 2. Reconciles payment with invoice 3. Manually enters data in ERP system Stage 5 1. Credits Supplier bank account 2. Ships check to Federal Reserve or other check clearing entity Stage 6 Check Clearing Entity 1. Sorts Checks 2. Forwards check to Buyer Bank Electronic Payment Environment Buyer Bank 1. Debits Buyer bank account 2. Forwards processed check to Buyer Buyer Business 1. Manually enters data into ERP system Continuous Exchange of Funds and Information Buyer Business 1. Sends purchase order electronically 2. Receives invoice electronically 3. Sends payment electronically on desired date 4. Transaction information is automatically uploaded and stored in local systems 5. Status of payments and cash position are transparent E-Payment Provider 1. Provides secure payment environment 2. Automatically transfers funds between accounts Supplier Business 1. Sends invoice electronically 2. Receives payment and remittance data together for improved reconciliation 3. Transaction data is automatically uploaded and stored in local systems 4. Status of payments can be viewed for improved cash management ability 5. Receivables may be financed 5

6 Shifting payment processes to an electronic format requires infrastructure to route payments and related information through an integrated network. This poses a significant adoption challenge because users of the payment supply chain possess varied levels of technological sophistication. Creating uniformity in electronic payment infrastructure further complicated by the fact that Federal Reserve infrastructure standards apply to Fed products but not products that fall outside the Fed s domain. Therefore, building the infrastructure necessary to securely and reliably transmit electronic payments and related transaction information between a large group of diverse users remains a considerable obstacle. However, the result of an improved payment network, as shown in the bottom of Figure 3, is a streamlined process supporting the continuous exchange of information and funds. Remittance Standards Complicating the challenges associated with systems integration is a lack of minimum standards pertaining to electronic payment data. Although the Federal Reserve has long promulgated standards to guide the type and format of information associated with paper- and ACH-based payments, invoices and receipts, such guidelines do not currently exist in the world of electronic payments. Consequently, different types of electronic payment systems have evolved that support varying levels of transaction information. These include: Level 1 which incorporates standard purchase information including merchant name, transaction amount, and date; Level 2 which adds summary level detail including point of sale codes, sales tax amounts, and accounting codes; and Level 3 which further incorporates line item purchase detail including sales quantities, product codes, product descriptions, and shipping data. Early adopters of electronic payment technologies have complained that inconsistencies in remittance standards have resulted, in some cases, in the corruption of important remittance data, including invoice numbers and other information [8]. As electronic payments become more widely accepted, niche players in the electronic payment industry must converge to facilitate efficient networks. This is because electronic payment users want information formatted so that it can be processed straight through to internal systems. Recently, the Clearing House Payments Company released a plan to help catalyze standards convergence. Collaborating with bank owners and payment technology vendors, the company took the traditional EDI 820 file the standard EDI payment file format and trimmed it down to ten essential fields. In the past, EDI 820 files included hundreds of fields, creating problems for 6

7 some trading partners if senders used too many or too few fields. The simplified electronic payments network (EPN) 820 format was approved by the Standards Institute and is broadly accepted by industry participants. This coordinated effort, or one like it, should hasten the acceptance of electronic payment systems [12]. Security Security issues have also delayed the adoption of electronic B2B payments. Since B2B transactions involve multiple parties, they flow across diverse technology architectures. Each party in an electronic transaction is, therefore, subject to the security procedures of other members in their financial supply chain. Arguably, paper-based payments are subject to similar security challenges. However, these challenges are well understood and have long been accounted for. An added complication with electronic payments is that they are potentially subject to a larger pool of anonymous attacks. Consequently, existing security tools such as encryption technology may need supplementation by third-party vendors that protect information as it passes across diverse networks. Transforming business confidence in B2B electronic payments might be achieved by building B2B payment solutions into electronic financial networks that already operate with a high degree of security. Value Proposition Uncertainty Electronic payment networks (like other networks) are subject to network externalities. This means that the value of participation is contingent on the size of the network itself (i.e., the greater the number of participants in the network, the more valuable the network is to each participant). Given that electronic payment networks are still evolving, it has been difficult for potential participants to estimate the value of joining, and therefore to assess the appropriate level and speed of investment. Investment decisions in this context are influenced by firms perceptions of the likelihood of agreement on aforementioned issues related to standards and integration [7]. The value proposition of electronic payment networks is further clouded by firms realization that connecting represents just a portion of the total cost. After the initial capital investment, firms must invest significant resources in training employees to use the system. Furthermore, banks and businesses cannot simply abandon old check processing infrastructure because not all B2B transactions will immediately migrate to electronic payments. Faced with this situation, 7

8 firms have an incentive to wait for others to go first, watching as others build the value of the network prior to joining, or waiting to join until they are compelled to do so by competition or regulation [7]. Value Dimensions In addition to surmounting key adoption challenges, firms must also consider electronic payment technologies in light of their ability to deliver across multiple dimensions of value. A clear understanding of the value drivers of electronic payments can enable firms to better address challenges to electronic payment adoption. In 2004, Charter Consulting surveyed businesses across multiple industries and ranked ten attributes based on their perceived value to B2B electronic payment users [2]. In order of importance, they include: 1. Offering direct savings over paper-based check processing direct cost per transaction decreases for electronic payments as compared to paper payments 2. Facilitating reconciliation and dispute management finding and retrieving data is simplified under an electronic payment system 3. Providing global coverage payments can be sent and received outside the US market 4. Improving control over payment timing and cash flow payment is initiated and sent at the precise time the company intends 5. Increasing visibility of cash requirements payees can see scheduled payments and anticipate cash flow 6. Reducing fraud and credit loss potential payments are sent over a secure and reliable global network 7. Possessing remittance data supports Level III remittance data 8. Offering low implementation costs the up-front investment is minor for all users and costs are clearly defined 9. Integrating data and payment information payments are bundled with transaction data for simplified integration into account systems 10. Offering a flexible fee schedule transaction fees are negotiable Electronic Payment Technology Options Three electronic payment technologies currently offer the promise of simultaneously addressing key adoption challenges, accelerating B2B electronic payment adoption, and delivering across multiple value dimensions. These include: (1) ACH-based bank proprietary electronic payment platforms; (2) Enhanced purchasing card technology; and (3) Open network systems. For businesses, these technology platforms offer potential saving and streamlined processes that have long been promised from revolutionary payment systems. Financial institutions will find that 8

9 providing these electronic payment options to business customers can strengthen their product portfolio, present an opportunity to expand relationships with existing customers, and attract new customers who seek electronic payment efficiencies. Table 1 summarizes each alternative s ability to deliver value. The following discussion will expand upon these abilities and the ways in which these technologies address key adoption challenges. Table 1: Electronic Payment Technologies and Associated Business Value Attributes ACH-Based Proprietary Bank Platforms ACH-based transactions have existed in one form or another since the early 1970s (e.g., for direct deposit of employee salaries). Bank proprietary systems are electronic payment solutions built upon the ACH network. In recent years, banks have invested heavily in developing software packages that have improved the functionality of business-to-business ACH transactions. These systems now combine financial processing and electronic data warehousing capabilities into one comprehensive service. Buyers and suppliers send complete trade information (including contracts, pricing, orders, receipts, and invoices) to bank systems which is then stored in a document available to both parties. These platforms provide comprehensive electronic bill payment and presentment from the beginning to the end of the payment cycle. From a value attribute comparison standpoint, ACH-based products meet many of the requirements identified by B2B transaction participants. The strength of these attributes is the foundation of ACH s historical popularity in facilitating small, recurring financial transactions between businesses and consumers. 9

10 Nevertheless, the desired characteristics that are missing from the ACH-based platforms indicate why the product has been less successful in the B2B electronic payments market. One particularly troublesome issue is the moderate to high implementation costs of ACH-based platforms, particularly for small and medium-size businesses. This factor contributes to systems integration problems. Another significant challenge facing ACH-based solutions is that they rely on bilateral, closed networks. This means that firms have to share sensitive financial information, which in turn increases the fraud risk. Global coverage is also a concern with this product, as ACH systems have been built for domestic use. Despite these limitations, bank proprietary solutions are well suited for large corporations and government agencies that conduct low to medium value, recurring payments within the U.S. This suitability is summarized in Table 2. Table 2: Optimal Electronic Payment Application Enhanced Purchasing Cards Enhanced purchasing cards (p-cards), such as MasterCard s e-p3, are electronic payment solutions that offer management services for business-to-business purchasing, presentment, and payment. This electronic payment strategy results from collaboration between outside software vendors and existing purchasing card issuers to provide businesses with customized end-to-end electronic commerce. P-card solutions allow buyers and sellers to collaborate within a single environment, streamline payment processes, and use the purchasing card for payment. Businesses can transmit orders electronically, view the status of orders and invoices online, control the initiation of payments, and integrate data into existing financial systems. Enhanced p-cards share many of the positive characteristics of a desirable electronic payments network. Enhanced p-cards are typically web-based and relatively easy to integrate with legacy software and hardware environments. This greatly reduces the cost and complexity of implementation. 10

11 Another p-card benefit is a reduction in fraud and credit loss potential, due to enhanced settlement processes. P-card transactions settle through an online Credit Gateway that allows institutions to exchange encrypted information for authorization purposes. This system provides a secure environment for payments because sensitive account information is not directly exchanged, and transactions are easily traceable and challenged when disputes arise. One significant disadvantage of enhanced purchasing cards is that interchange fees typically still apply. This means that suppliers may be averse to accepting the enhanced p-card for medium to large-value transactions because fees will increase at a considerable rate. Given these benefits and limitations, the enhanced p-card represents a good avenue for current users of purchasing cards and prospective electronic payment orientated businesses that conduct low-value, non-recurring transactions (see Table 2). Open Network Systems Open network systems, like Visa s Visa Commerce platform, are rules-based electronic payment systems that utilize open, secure and global settlement networks to process buyerinitiated payments. Open networks are designed to interface directly with front-end procurement and accounts payable systems to provide both buyers and suppliers with a seamless and integrated corporate payment solution. Open networks also enable buyers to initiate and settle payments based on specific pre-established terms with suppliers. Unlike enhanced purchasing card and ACH-based platforms, open networks employ a flexible fee schedule, allowing for a minimization of fees for high-dollar transactions. In addition, open network solutions may be easier to integrate with legacy environments. Visa Commerce, for example, was specifically designed to easily integrate with existing procurement applications, regardless of the level of sophistication. This means that financial institutions, buyers, and suppliers, who want to utilize an open network, can do so with a minimal up-front investment. Finally, open networks like Visa Commerce offer global coverage, a major consideration for most moderate to large firms. Open network payments appear to be best suited for medium to largevalue, multiple-invoice directed payments, as they circumvent interchange fees and support robust transaction data. 11

12 Summary The volume of electronic payment activity has risen steadily since 1979 [6]. Leading this trend has been consumers willingness to submit payments electronically. Increasingly, businesses have sought to improve their understanding of the value of adopting electronic payment systems. Studies have begun to illustrate in greater detail the specific value afforded to businesses by adopting electronic payment systems (for example, see [4]). Along these lines, recently introduced products possess attributes that will help overcome past obstacles, such as systems integration, remittance standards, security, and an uncertain value proposition. These challenges will be overcome through the introduction of technologies that can be implemented by a greater number of entities (lower up-front investment costs), possess improved data capabilities (permitting varying degrees of data remittance), and are built upon existing networks (more certain value proposition). At this time, it is important for both financial institutions and businesses to evaluate their electronic payment product portfolio. This analysis should be coordinated and compared against organizational needs and goals. Financial institutions that offer an appropriate electronic payment product mix can expect to enhance existing client relationships, attract new clients, increase revenues, and decrease both costs and the risk of fraud. Businesses that identify and adopt clear electronic payment strategies will realize streamlined business processes and significant bottom-line savings. Those seeking to implement electronic payment technologies should consider not only emerging technology options, but also evolving payment needs. Although ACH, enhanced P-cards, and open networks have different characteristics, it is important to realize that a firm may choose to utilize a combination of these technologies. The long-term goals of an organization, from both a business and process perspective, should be analyzed and agreed upon before a new payment regime is implemented. Surely, the future of B2B payments resides in an electronic format; the question is who will realize the benefits of electronic payments adoption? 12

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