NETWORK INTERCHANGE, INNOVATION, AND ENTRY TOOLS TO DRIVE PARTICIPATION AND GROWTH

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1 NETWORK INTERCHANGE, INNOVATION, AND ENTRY TOOLS TO DRIVE PARTICIPATION AND GROWTH June 15, 2011 Tim Attinger Managing Director, MPD

2 Interchange Mechanisms in Platform Markets 2 Adoption and growth of, and innovation in, platform businesses requires an interchange mechanism that attracts participants to the platform and stimulates activity by shifting value/cost between them Interchange: Flexible and market-driven interchange mechanisms are necessary to the growth of payments network businesses Entrants and Innovators: New payments entrants and new players in most platform businesses use market-driven interchange mechanisms to stimulate adoption and growth Competitive Dynamics: In network competition, payments networks use interchange to compete for issuer and merchant product adoption Incumbent Advantages: Interchange fee regulation naturally disadvantages new entrants because they lose the flexibility in payments network pricing that 1) is necessary to drive adoption, and 2) their competitors enjoyed in building their networks

3 Network Business Fundamentals for Growth 3 Maximize the value of the network business by driving incremental participants and activity to the payments network Network 1) Attract Participants: Penetrate new stakeholder segments by identifying and serving needs uniquely (ex: special rates / services for a new acceptance segment) 2) Drive Interactions: Deliver product, service, channel innovation to drive access to network and enable more interactions between stakeholders (ex: prepaid load networks) 3) Add Value to Each Interaction: Innovate services and value in the network "cloud" to drive value to interactions between network participants, therefore driving transactions that underpin those interactions (ex: marketing information applications)

4 The Role of Interchange in Network Growth 4 Flexible market-driven interchange structures are key to the three major drivers of network innovation and growth Attract Participants: Interchange mechanisms must have the flexibility to attract participants, particularly those with multiple market options Drive Interactions: Products and services that facilitate interactions among participants need the ability to constantly re-balance value exchange between participants to maximize the output of the system Add Value: Exchange mechanisms must also have flexibility to fund enhancements to value exchange and the provision of incremental services (ex: fraud management services such as chip+pin and NFC) that increase the core value of the network system as it evolves

5 New Entrants Focus on Attracting Participants 5 New platform business entrants use market-driven interchange mechanisms to attract participants to both sides of the platform and the consumer usually plays for free Business BOKU Description Global mobile payments start-up supporting direct-carrier billing Over 200 carriers and 10Ks of merchants in 65 countries Primarily digital goods and gaming currency Participant Strategy and IF Consumers: recruited through carriers Merchants: signed direct and through partners Interchange: 25-70% of ticket from merchant ; consumer is free Open Table Tempo (formerly DebitMan) Online/mobile restaurant reservation system Restaurant buys & installs management software Consumer registers and makes online reservation Retailer loyalty program and payment management network Retailer loyalty card tied to consumer bank account Retailers issue their card and accept others Consumers: recruited through online search Merchants: signed directly and through partners Interchange: $1 per reservation paid from merchant for every reservation made through the system; consumer is free Consumers: recruited by issuing merchant Merchants: direct sales and sign on to platform when bringing consumers Interchange: ~7 cents/txn (Pre-Durbin) paid from issuing merchant to acceptor; free to consumer

6 Interchange as Competitive Lever US Premium Credit 6 American Express entry in competition for bank issuance of premium credit, followed by Discover, induced premium interchange increase responses from Visa and MasterCard as systems output grew ILLUSTRATIVE Visa MA Amex Discover Standard Premium New Standard New Premium

7 Interchange as Competitive Lever US Debit 7 Over the past decade PIN and Signature debit programs both used interchange to accomplish different business ends: Signature lowering rates over time to expand merchant acceptance, with PIN raising rates to recruit greater issuer participation ILLUSTRATIVE Signature PIN Average Cards Merchants Transactions System Growth

8 Rate Regulations May Disadvantage New Entrants 8 The effect of suppressing interchange in a marketplace will be to rob new entrants of the flexible exchange mechanisms of which the market leaders availed themselves to build their current positions, Attract Participants: If rates are artificially low, a new entrant loses flexibility in the mechanism used by incumbents to build their positions Drive Interactions: Once a payments network has established acceptance and issuance, as well as growing economic activity in the system, flexible interchange mechanisms provide for product and service portfolio diversity and interchange balancing / bundling by product segment Add Value to Interactions: Regulating interchange to low levels impairs the ability a new network entrant to innovate in network services that increase in value with scale (risk, reporting, loyalty, security, value-added platforms, etc), and robs the entrant of the interchange flexibility necessary to drive their adoption

9 Thank You