Guest bloggers Anupam Majumdar and Arnab Sinha from our European payments strategy team provide perspective on dissecting the changing revenue fundamentals of European payments.
Some European payments pundits believe that payment transaction fees are racing towards zero, compelling payment services providers to make money from data to survive in the long run. They are not alone in their thinking. Nearly three-fourths of the European banks we surveyed recently agree that payments are becoming free; 69 percent believe payments are already free or will be so over the next 12 months.
While this might be applicable for the oversupplied bank payments space, payments transaction economics across other segments are still generally healthy. We observe that the more commoditized and oversupplied a market segment becomes, the greater the pressure on transaction economics, and at the same time, specialized segments which are undersupplied continue to demonstrate healthy transaction economics. And although data monetization is still at a relatively early stage of evolution, traditional value-added services are outgrowing core processing revenues and revenue diversification is key to outperforming market fundamentals.
Not all payments segments are created equal
There are wildly different transaction economics within payments business segments, as shown in Figure 1. Bank payments and card processing, which are somewhat more commoditized and subject to pressure from large clients, show weaker revenue yield and growth than alternative (and more differentiated) payments or FX/remittance.
Figure 1. EU average revenue per transaction (€)
Transaction economics are closely linked to the payments service’s supply, demand and relative value creation. SEPA bank payments are simple, effectively commoditized and mostly undifferentiated among bank providers. Therefore, the average revenue per transaction earned by banks is low and under significant price pressure (declining at 25 percent per annum). In SEPA payments, pricing is often cost-based with both prices and costs declining rapidly. Online alternative payments, on the other hand, are value-based. They drive incremental sales for merchants, resulting in revenue of about €1.80 per transaction and more than 20x revenue on SEPA bank payments. Retail business models which serve many customers (such as PSPs servicing SME merchants) also tend to exhibit less price pressure than wholesale business models (such as service bureau processing).
Pricing pressure is a reality in payments. While prices almost always go down, it does not mean the transaction profitability fundamentals are poor. As long as scale economies (for example, growth in costs per transaction) outpace pricing pressure (such as revenue per transaction), EBITDA outcomes capture the benefit of transaction growth (Figure 2). Price pressure leads to revenue growth that lags transaction growth (though still positive). However, costs are declining at an even greater rate, which leads to increases in EBITDA per transaction in sync with overall transaction growth.
Figure 2. Economics of payments’ pricing pressure
Clearly, scale economies matter. They drive EBITDA margin expansion and, thus, scale to accelerate shareholder returns. Within our sample, large payment providers (>€250 million of revenue) experienced 10 percent year-over-year EBITDA margin growth from 2015 to 2017, compared to three percent for small providers.
Along with scale, scope of service also matters. Based on our analysis, value-added services (such as fraud management or FX services) are increasingly important drivers of revenue and growth. For e-commerce PSPs, value-added services beyond core processing and collecting now account for 39 percent of revenue and these services are growing at 20 percent per annum relative to five percent growth among core revenues.
Fraud management is a good example of a data-driven service. Other forms of data monetization, such as offer presentment and redemption, are far less developed. The potential for data monetization remains strong, but will evolve over the long term with services more closely aligned to core processing, while other data monetization services progress more slowly from concept to revenue generation.
In summary, payments are far from being fully commoditized. As we discussed here, there are specific payment types that are in over supply and where the economics have led to commoditization. Whereas, most payments that are priced on value and are not over supplied continue to show good economics with room for further value creation. We do expect in the coming days, the value from such payments will at one hand continue to come from core value-added services, such as FX and fraud management, while also maturing from emerging areas, such as data monetization and analytics.
A very insightful article. And although it is true that there is an increasing pressure on direct revenues in terms of payment fees, the value that core transaction banking brings to the Banks in terms of stability and cost of funds is becoming more clear in an increasingly unstable market with regulations like basel4 putting more pressure on banks.
It is ironical that payment services are in abundant supply who are already over served. But at the same time, services are not available to a large body of prospective customers. They are still waiting to be included to the financial system. If inclusion is mandated like CSR, some balancing can happen including reasonable pricing