The Alternative-Payments Threat

Red Gillen
January 21, 2009 | COMMENTS

Safer, faster, and cheaper are the benefits of electronic payment methods over traditional ones, especially credit and debit cards. The Internet has already made “safer, faster, cheaper” (or at least faster and cheaper) just a series of commodities.

From established players such as PayPal and Google to lesser-known entities such as eBillMe and Bill2Phone, nearly all alternative-payment players offer personal data security, online shopping convenience, and merchant pricing that are significant improvements over payment-card functionality. As a result, alternative-payment players run the risk of becoming indistinguishable from one another.

Some of these players, however, are working to differentiate themselves through their ability to induce payments. In other words, the players that are likely to pose the greatest disruptive threat to cards and card issuers are those that evolve beyond simply enabling payments and actually creating a lift in sales.

Rather than languishing on an online merchant's check-out page, the players poised to dominate will promote a purchase at an earlier stage in the buyer's decision-making process--in search engines, on product listing pages, or even in product descriptions. At each point of this decision-making process, successful alternative players will induce purchases in a number of ways.

• By raising buyers' awareness that they can use an alternative payment method to purchase a product.
• By offering discounts on purchases made with that alternative method.
• By offering advantageous financing terms (“90 days same as cash”) for a particular purchase.
• Through loyalty/reward programs.

Market-changing alternative payment players can work with merchants to tailor any of these inducements at the product or even the individual buyer level. This ability cannot easily be matched by the payment card industry. And it exposes a lingering threat posed by alternative payments--that merchants will increasingly promote these payment methods over cards.

If these alternatives are cheaper than cards and create a bigger sales lift at the same time, it would make sense for merchants to promote them. The growing number of mainstream merchants that accept alternative payments attests to this.

It's important to note that from the perspective of payment card brands (Visa, MasterCard, American Express, Discover) and their issuing financial institutions, some alternative payment players such as PayPal and Amazon Payments are actually helpful. The cards are a fund-source option, and alternative-payment spending volume is attributed to the cards.

The alternative players, however, take on more of a competitive role as fund sources switch from cards to direct debits from deposit accounts (as is currently the case for about 50% of PayPal users), thus stealing revenue from cards.

Given that sourcing funds directly from deposit accounts lowers merchants' costs (and ultimately their pricing), e-commerce sites will increasingly use promotions to encourage buyers to make the switch away from using traditional credit and debit cards.

Other alternative players are extra competitive from the perspective of financial institutions and card brands. These players cut cards completely out of online payments by sourcing funds from a combination of deposit account direct debits, transactional credit, and revolving lines of credit--all across a rapidly expanding merchant base.

So, is there a future for traditional credit and debit cards? These cards enjoy nearly universal acceptance both online and in the brick-and-mortar world. This is a feature that has taken decades to build, and it won't soon be rivaled by alternative payment players.

Card revenue lost to alternative payments' direct-debit and transactional-credit features already amounts to hundreds of millions of dollars. To counter this loss in volume and revenue, financial institutions and card brands need to encourage the continued use of cards as the source of funds with alternative payment players.

To encourage card use within alternative setups, bonus loyalty/reward programs could be an effective tool. Though such programs would likely be expensive, losing card volume to deposit account direct debits and transactional credit might cost more. At some level, card industry players will have to come up with ways to offer the same kind of purchase-inducing approaches that are now being pioneered by their alternative-payment competitors.

With or without cards as the funding source, alternative payment providers will continue to gobble up retail e-commerce purchase volume. The spoils will go to those players that understand their role is no longer to allow shoppers to pay for a purchase. Instead, these players will realize that their role is to make shoppers want to pay.

Red Gillen is a senior analyst at Boston-based Celent.