An Industry in Flux: Anything Can Happen

  Imagine Microsoft Visa Corp. How about Google MasterCard Inc.? Picture the next big thing in payments, with everyone's mobile phone a well-stocked wallet of cards and ACH-payment options. No, those corporate names do not exist any more than the flying cars science fiction once predicted would be common by now. And cell phones used for payments? Well, there are some efforts under way to bring that potential to fruition on a large scale. Indeed, there were some big changes and incremental shifts this year that have set up intriguing possibilities for the payments industry in 2007 and beyond. How will MasterCard going public this year and Visa's announcement that it plans to do the same affect the outcome of the consolidated merchant lawsuit over interchange? Will merchants turn more to ACH networks as alternatives to the card networks? Top payments industry analysts peer into their crystal balls for some educated guesses on the trends likely to emerge.
  IPOS AND INTERCHANGE
  The metamorphoses of MasterCard this year and Visa perhaps in 2007 from being card associations to publicly owned corporations represent the biggest change to the card industry in decades.
  "In 2007 and the next few years, banks will be feeling their way around those new dynamics," says David Evans, founder of consultancy Market Platform Dynamics and the author of the book Paying with Plastic. "The new, publicly owned card systems will be finding their ways around the tension between having to deliver results to shareholders and dealing with banks as, in effect, customers."
  For now, everyone is trying to "cover their bases," Evans says. Anything can happen, from banks aligning with different card networks to large banks starting their own networks, he says.
  Greater disclosure of card-acceptance rules and interchange rates are natural extensions of the reorganizations and of increasing merchant pressure on networks, says Auriemma Consulting Group analyst Megan Bramlette.
  Merchants such as Wal-Mart Stores Inc. will continue to fight for lower costs to accept card payments by trying to form their own banks. And card networks that are more independent of bank issuers may give retailers more bargaining power over bank issuers.
  But Evans says merchants should not necessarily bank on network reorganizations leading to lower interchange fees. "I don't think merchants will see relief through the (MasterCard and Visa) IPOs," he says. "As American Express has done historically, they have all the incentive in the world to increase those fees."
  The consolidated merchant lawsuit against banks and networks for alleged interchange collusion will continue to be a huge variable in the market values of Visa and MasterCard as private companies in the next few years. But such uncertainty does not necessarily preclude another corporation with very deep pockets from acquiring one of the networks, according to Evans. "When you start thinking about global players like Google, GE and so forth, doing an $8 billion transaction isn't that difficult," he says. Such a buyer would have had to pony up a bit more than that as of mid-November, when MasterCard Inc.'s value had risen to $12.7 billion.
  Celent analyst Ariana-Michele Moore says in a recent report that she does not expect government intervention in the interchange fight in 2007. But she believes merchant ire ultimately will push down fees.
  "These lawsuits are likely to be more of a nuisance than a true threat, and even merchants who threaten not to accept cards are likely to fold to consumer pressure to accept them," Moore writes. "However, the debate has created a rift between merchants and banks and has sparked interest in the merchant community to find ways to circumvent the card issue."
  Moore expects some merchants to employ any of three alternative payment methods that route transactions over the automated clearinghouse network: PayByTouch, which is supported by finger biometrics; Fastlane, which uses driver's licenses to initiate payments; and Debitman, which operates its own PIN-debit network. But she does not expect such alternatives to achieve wide adoption by merchants in the near term.
  DEBIT AND PREPAID
  Though Visa and MasterCard might not like to admit it, some of the biggest competition at the point of sale will involve consumer choice of debit versus credit cards.
  Indeed, analysts predict another big year for debit on a variety of fronts.
  "In 2006, the number of debit card transactions exceeded the number of credit card transactions for the first time," notes Dove Consulting Group analyst Tony Hayes. "The lines will further diverge in 2007 as debit erodes check and cash payments." Hayes projects that signature- and PIN-debit volumes both will grow by 20% next year from 2006 totals.
  Analysts expect merchants to continue to encourage that trend. "As 2007 progresses, I would not be surprised to see retailers begin offering small discounts or other incentives to encourage additional debit card usage," Bramlette says.
  Signature- and PIN-debit also will duke it out at points of sale as merchants keep steering consumers to enter their PINs for cheaper interchange, analysts agree.
  Issuers will use debit and prepaid cards to encroach on cash and checks, pursuing customers with thin or less-than-stellar credit histories, notes David Poe, CEO and managing director of Edgar, Dunn & Co. "There's some real opportunity to move those payment forms to electronic payment forms such as prepaid and debit," he says. "There's a recognition that a third of Americans are below where the historical targeting of credit cards has been, but there are prepaid cards and debit cards that can be much more focused on those segments."
  Whether as general-use credit card replacements or as gift cards, open-loop, network-branded prepaid cards proliferated in 2005 to 45.7 million cards, more than double the 21 million cards circulating in 2004, according to Mercator analyst Tim Sloane. He notes in a recent report that even that jump is a slow-down from the heady 91.6% growth rate of 2003 to 2004.
  Sloane predicts big growth ahead for network-branded gift cards, to $7.5 billion in 2009 from $1.3 billion in 2005. Payroll, insurance and government use of prepaid cards also will show healthy growth, he writes.
  LOYALTY AND REWARDS
  Many analysts predict less largess in bank credit card rewards programs, as the profitability of this marketing tool is starting to lose steam.
  "I would not be surprised to see the generosity of some value propositions actually decrease," Bramlette says. "In the wild market share grab that we saw in the rewards space, less attention was placed on the profitability of these account types. As these accounts mature, issuers may be forced to trim back their offerings in an effort to boost these products' declining profit margins."
  Indeed, American Express announced in August that it would remake its rewards program, raising annual fees for some cards and dropping double-point rewards for most everyday purchases to single points.
  But Bramlette and other experts expect to see more rewards migrating to debit cards. "A growing number of banks will use debit rewards as the foundation for a broader bankwide loyalty program," says Hayes.
  More banks will use "relationship rewards" to lure customers into multiple accounts. Those with mortgages through the bank could receive lower credit card interest rates, for example. "It's pretty nascent right now with only a few banks trying it," Poe says, citing Bank of America and Citibank as leaders in offering such rewards. "But more banks are getting into it."
  Both merchants and bankers will turn to increasingly sophisticated and detailed customer databases to offer customers the perfect bait for additional business, experts note.
  "On the banking side, that's becoming extremely important," says George Albright, chairman of Speer & Associates Inc. "As I track all these transactions, I really have a view of what the customer wants to do day in and day out: paying bills, what transactions [they] use, when they will roll over balances, when they will not, which retailers he uses."
  ONLINE PAYMENTS
  Internet payment tools such as PayPal and Bill Me Later will continue to compete head to head online with bank cards, analysts agree.
  Moore notes in a recent report that 55% of U.S. households now have computers with Internet access, and the average person logs on for more than two hours each day. She predicts online retail, travel and auction payment volume will reach $340.9 billion by 2009, up from $208.5 billion in 2005.
  Card issuers will continue to fight for online payments, too, as Internet shopping increases as the younger generations age, analysts say. The top issuers will continue to beef up online security tools while attempting to keep those tools from slowing online transactions.
  "We're going to see banks introducing more-convenient and more-secure ways to use their products over the Internet," Poe says.
  One way banks will make their own cards easier to use on the Internet is by letting their own accountholders use their credit and debit cards to pay bills through their online banking Web sites, Aite Group analyst Gwenn B?zard predicts. Now that more billers are allowing card payments, "banks are simply catching up on the trend now that more consumers and billers have gotten used to using cards to settle bills," he says.
  EMERGING TECHNOLOGIES
  2007 will be "the year of contactless" as MasterCard and Visa provide financial backing for more financial institutions to issue contactless cards to their customers, Hayes predicts.
  Other analysts agree. According to Moore, issuers had distributed more than 13 million contactless cards and key fobs in the U.S. by early 2006. She predicts that number to grow to 20 million by the end of this year. Poe predicts "significant growth" in contactless in 2007 as networks and issuers work to push acceptance of the technology to more merchants and new sectors, such as parking garages and mass transit.
  Which brings the discussion to mobile-phone payments. Some major U.S. pilots of phones embedded with near-field communication (NFC) chips brighten the forecast for mobile phones as payment tools in coming years. But analyst optimism about mobile payments is varied.
  "We'll see some successful pilots, and more banks will start to roll [mobile-phone payments] out to a larger group," says Jane Yao, managing director of benchmarking and survey research for the American Bankers Association. "Particularly as everybody has cell phones, to make it a payment tool will make more sense."
  Most analysts look ahead five to 10 years for mobile phones as consumer payment wallets to start to gain payment traction. "There's still a lot of hype," B?zard says. "Even contactless is barely emerging in terms of volume."
  Though Evans agrees that both contactless and mobile phone payments have a lot of ground to cover, he sees today's contactless expansion leading to NFC-chip-embedded mobile phones as the ultimate future of payments in the U.S. and abroad.
  "The world is ultimately going to end up with contactless on mobile phone-type devices," he says. "That's the end game for some point in the future."
  FRAUD
  The dark cloud of potential security breaches will continue to follow the payments industry. Card networks will crack the whip on noncompliant network users. And vendors will keep pitching their latest products to help fight the bad guys.
  Gartner security guru Avivah Litan expects overall fraud will start to decline in 2008 as card networks punish retailers who store magnetic stripe card data. Litan expects Visa's fines for violating the Payment Card Industry fraud-security standard alone to top $6.5 million in 2007, up from about $4.7 million on 2006.
  Security weaknesses of contactless RFID cards will continue to be exposed, Litan predicts. "This will force card issuers and vendors to scramble and increase the security on their cards," she says.
  But Hayes says the industry will continue to improve payment security. "Neural networks and real-time transaction authorization scoring will become more widely utilized and more effective at mitigating risk," he says.
  Litan agrees that innovations in 2007 will move security forward. Watch for "the beginnings" of next-generation mag-stripe cards in the U.S., which will make counterfeiting cards tougher and transactions more secure, she says.
  Though talk of chip-and-PIN's destiny in the U.S. will continue, Litan does not expect U.S. adoption of the smart card standard being used in Europe for at least another seven years. Evans does not believe it ever will arrive in the U.S.
  As thieves find greater security at bank, processor and merchant levels, "they try to get the funds through the consumers rather than the institutions," Yao says.
  Yao says she expects a greater push for biometric authentication tools in 2007, as traditional passwords seem less effective in countering savvy criminals. And banks will continue to try to educate consumers to be less susceptible to giving up their secret information to the wrong e-mailers and callers, she says.
  To let our analysts off the hook a bit, predictions are merely educated guesses, and past years have thrown the payments industry some curve balls no one saw coming. But one thing is certain: Major shifts in the payments industry this year have made 2007 an intriguing year about which to venture guesses.
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