As more consumers and merchants shift to digital payment methods, established processors are challenged by newer entrants that integrate across multiple channels and use artificial intelligence to enhance their services.
Incumbent processors have steadily updated the legacy platforms that they created decades ago. These platforms have been integrated with technology acquired through mergers with other processors, and retrofitted to offer online and digital payments. According to Jim Cho, head of U.S. commercial at London-based Checkout.com, 80% of processing in the U.S. occurs on these legacy platforms.
Historically, banks have partnered with large processors such as Milwaukee, Wisconsin-based Fiserv to process card payments on behalf of merchants. The bank owns the merchant account, but the processor provides the payments services. Several banks such as Bank of America, Citigroup and JPMorgan Chase have their own processing businesses.
When cardholders pay either online or in a store, the processor routes the transaction via the card network to their issuer for approval or denial. The network relays the decision to the processor, which transmits it to the merchant. If the payment is approved, the issuer places a hold on the card and settles the amount owed to the merchant's bank via the network, which reimburses the merchant minus a fee.
With the addition of fraud detection systems at every stage, a transaction passes through many complex connections. To keep up with the growing volume of payments on their networks, processors need massive infrastructure updates, said Max Neukirchen, head of payments and commerce solutions at J.P. Morgan Payments.
Nonbank processors
The new breed of processors that emerged in the e-commerce age such as Checkout.com, San Francisco-based Stripe and San Jose-based PayPal were designed to work well in e-commerce and digital environments. They use application programming interfaces and cloud-hosted software to integrate more easily with online-only merchants. Their products are designed to be more customizable and scalable than decades-old systems.
"Fintechs have won market share from legacy processors by providing merchants with turnkey access to a wide suite of software capabilities through connections that are quick to implement and address consumer needs for fast and transparent payments services," said Vineeth Subramanyam, head of Spring by Citi at Citi Services. "Some of these capabilities are built on top of core foundational services provided by banks and payment networks."
The pandemic, which led to a massive surge in e-commerce as people couldn't visit stores (or were loathe to pay in cash when they could), was a key driver for technology investments, and enabled digital-only processors to gain market share at the expense of legacy providers, said Aaron McPherson, principal at Boston-based AFM Consulting.
"Digital-native processors integrate more easily into merchants' websites and have more robust developer support and cost advantages," McPherson said. "However, these players face disruption as cloud services such as Amazon Web Services make it easier for startups to enter the processing market. Startups can establish processing services very quickly and get the necessary computing power by renting it from cloud providers instead of building their own data center."
The competition between incumbents and new entrants is providing merchants with an overwhelming amount of choice in processing, according to Alex Ferguson, product manager at Omaha, Nebraska-based consultancy TSG.
"Instead of selling simply on price, now more than ever, processors' sales staff must be informed not only of what technology and value-adds exist in the market, but how that technology fits each merchant," he said.
AI-enhanced merchant services
Processors are using AI to better serve merchants. For example, payments orchestration uses AI to determine the most efficient route for each payment. It has the potential to disrupt incumbents as it frees merchants from being tied to just one processor. Orchestration providers such as Boston-based Bluesnap and Durham, North Carolina-based Spreedly route transactions on behalf of merchant clients to the fastest, most secure and least expensive channel possible.
Checkout.com and London-based Worldpay use orchestration to boost acceptance rates and optimize costs for their customers.
"Payment declines lead to cart abandonment and are a big issue for e-commerce merchants," said Nabil Manji, Worldpay's senior vice president of payouts and financial partnerships. A successful transaction can depend on what network the payment is being routed through and which bank issued the card, he said.
"Orchestration puts pressure on processors for price and product, as they lose the barrier preventing merchants changing to another processor," said Don Apgar, director of merchant payments at Pleasanton, California-based Javelin Strategy & Research.
Another way in which processors differentiate themselves is by leveraging AI to mine their proprietary data and provide merchants with customized insights and benchmarks.
"Processors should use AI for customer insights, for example allowing merchants to use natural language to query data sets instead of using point-and-click to create reports," said Forrester Research principal analyst Lily Varon.
"Consumers expect to see relevant ads from merchants," said Frank Keller, executive vice president of PayPal's large enterprise and merchant platform. "The dilemma with personalized commerce is that if merchants predict what you want, it's frightening, but if they don't, it's annoying."
In the case of merchants who offer many different payment methods, personalization means knowing which methods their customers regularly use and which are appropriate to offer them, Keller said.
"Most customers only use one or two payment methods, so merchants need to know which these are," he said. "Transaction context is also important. For example, offering [buy now/pay later] for low-value purchases makes no sense."
