The challenge of digital micropayments in Mexico

In a recent post in the Celent Banking Blog entitled The Mobile RDC Cost-savings Myth, Bob Meara discusses the mirage of costs savings for banking thinking of introducing mobile payments alongside a well developed mulch-channel network. His argument is spot on, the cost of the transaction might be lower but there are also maintenance issues to be considered, activity cost in banking is the stuff of Alice in Wonderland and more important, potential savings might be small when considering that many have already been realized.

At the other side of the spectrum, however, are micro-finance institutions working in developing countries such as Mexico. So far many they have relied on staff as the main distribution channel. Mobile payments offer the possibilities of foregoing legacy investments and jumping the queue, sort to speak.

logo-Guatemala

Thanks to a travel and subsistence grant from FUNDEF,with Gustavo del Angel and Enrique Cardenas, we have started to map the evolution of payment systems in Mexico. While on site, I was lucky to be invited to a field visit to see first hand operations from Banco Compartamos, a Mexican microfinance institution.

The day started early (kicking off at 0630 hrs) to travel in group to the nearby city of Cuernavaca. The sherpa for the day was Enrique Majos, Banco Compartamos CEO, together with his IT and PR directors. We were joined by two other directors at the site. These visits are a regular thing for Compartamos’ directors.

I was introduced to all the local staff members and took part in the daily debrief (a pilot scheme in which all team leaders report on their activities for the day and any issues from the previous day). All “colleagues” set off on to meet with their customers groups – along the lines of Gramin, Compartamos lends small amounts to individuals (chiefly self-employed women), who are part of co-sponsor groups.

During the meeting individuals bring their weekly repayment and make sure everyone has met their commitment. The “colleague” role is to inquire on the nature and state of the indiviudual’s business while also looking for cross selling opportunities. An “expert colleague” will establish good rapport with all/most the members of the group. If appropriate he/she will also hand deliver a certified cheque for any new loan.

Virtually all individuals will bring their weekly repayment in cash. The leader of the meeting will keep track (through a basic ledger and updating individual pass books manually). At the end of the meeting all repayments are then taken to be deposited in a nearby retail bank branch.

Repayment (cash is collected within the white box) - also evident on the table (Compartamos' staff in their distinctive pink shirts)

Repayment: cash is collected within the white box and is also evident on the table (Compartamos’ staff in their distinctive pink shirts)

Hence, Compartamos’ staff do not handle cash. Yet Compartamos has to rely on larger banks and a network of correspondents (such as a chain of convenience stores) to collect deposits and distribute loans. Most of these, in turn, will charge individual depositors onerous fees to provide their service. Like many other microfinance, the distribution channel is challenging growth and diversification.

Mobile payments are not the solution at present. For one, the service is highly unreliable outside of big cities and in some of the regions where Compartamos operates, there is no network cover at all. Second and most important, individuals who borrow from Compartamos work in a cash economy. Their business (such as market stalls, beauty products, or seasonal goods) is carried out in cash. Few have access to the Internet or a smart phone (yet all have a mobile).

A mobile branch (i.e. on the back of a bus or minivan) could provide some relief provided it is not a target of highjacking or highway robbery. The volume of individual business is not enough to justify deploying ATMs (let alone self-replenishing machines) in the most remote areas while other financial intermediaries discourage their use of ATM through punitive fees. The time is perhaps ripe for Compartamos and other microfinance come together in the deployment.

Cashless at the Royal Mint

A recent item in the BBC News website on the Royal Mint (below), found the apparent controversy that where money is actually made (well coins really), employees are not allowed to use them to purchase their food during lunch. This in turn let to a invitation to discuss the pros and cons of the cashless society.

Article: Made of money: The Royal Mint where cash is banned http://www.bbc.co.uk/news/business-23327926

Video: Is there a cashless society? Jon Sopel Interviews Bernardo Bátiz-Lazo (Global – @BBCNews) http://t.co/rBDHkNbU9e (6 min)

Back on track

Well it seems teaching is over and the Autumn term was too much for Dave and I to keep feeding this blog.

We also had a very interesting and thought provoking meeting at UC Irvine entitled “Payment Technologies: Past, Present and Future” (read an excellent summary by Irving Wladawsky-Berger&lt) and I also had a couple of presentations at industry conferences (I am serialising the summaries underCurrent issues in payments within the Light Blue Touchpaper blog).

So rather than boast about our travels, I wanted to restart our thoughts on cashlessness through a provocation and with the help of an apparently unrelated article that caught my attention. Entitled “How Memes Are Orchestrated by the Man“, Kevin Ashton of The Atlantic, tells a very detailed and well documented story of how commercial interest rather than a new Internet culture that which propelled the Harlem Shuffle to stardom. Interestingly, it says the meme died in February, but I still find big references to it, chief among them this one in the Mexican football classic a couple of days ago – and my football blind, eldest son immediately knew what this was about.

But what is relevant to this forum is the following extract:

Google regards clicks and views as a “currency,” and take pains to get the numbers right, but unlike most other mass media, its figures are not verified by anyone who does not profit from higher numbers.

and goes on to conclude

The technology may have changed, but the money still flows the same way: to creators of contracts not creators of content.

And that got me thinking of Jon Matonis and other supporters of cryptocurrencies (see for instance Bitcoin Prevents Monetary Tyranny) or mobile wallets for that matter. Why? Because more often than not, the proponents of digital payments are focusing their discussion on content and are naive of institutional change.

Myths and realities of the cashless society

People *think* that technology moves fast and culture moves slowly. I mean, the Rolling Stones are still one of the world’s most popular bands, right? But that’s not always true. If you look at futurists’ takes from the middle of the last century, their biggest misses were not just technological (jetpacks instead of iPhones) but cultural .. [such as failing to] anticipate the rise of the natural and organic food movements. Alexis C. Madrigal – The Atlantic

A panel named as above took place at the European Business History Association annual conference (#ebha2012) in Paris (August 30th to 1st September, 2012). The panel was chaired by Carles Maixe (@carlesmaixe) from University of La Coruña (Spain), who introduced the audience to the authors as well as the idea behind this blog/forum. A common theme was looking at the practical implications of delivering on the idea of a cashless society by not for profit deposit taking financial institutions.

The panel was composed of:

The comments by Mark Billings (Exeter, UK) and the discussion that ensued included contributions from of Patrice Beaubeau (Paris Ouest Nanterre, France), Steve Toms (Leeds, UK), Chris Colvin (Queens Belfast, UK) and Osamu Uda (Nihon, Japan), among others. Points raised included (included, in no particular order):

  • This panel and indeed a good attendance, reflects a growing literature and interest to look at the impact of technology in financial services from an historical perspective, which is challenged to provide a true comparative history of automation (rather than individual case studies sitting side by side).
  • For the foreseable future we are likely to talk about “the less cash society” (see recent article in Gadget Lab — www.wired.com about generalise mobile payments needed at least another 10 years).
  • There is a need to look at the impact of cashless (and indeed deeper analysis of ATMs) into bank employees and banking practices.
  • Provide a comprehensive survey of how the idea of a cashless society has been dealt with, at least conceptually (including contributions to economics, social costs of different payments, anthropology, etc).
  • It is still not clear the importance of differences in the institutional setting to promote financial inclusion and aid (or hamper) a cashless society.
  • The 1960s sees the birth of the modern monetary economy, which in large part is based on applications of computer technology.
  • The discussion on the cashless society (and particularly contemporary narratives) tends to emphasise the artifacts (such as mobile phones or chips) as opposed to what is money and its economic and social uses.

The discussion continued during the evening (see photo below). An idea here emerged following last week’s post on transparency, as it was considered that surcharges on cash withdrawals were similar to a regressive tax: a fixed value regardless of amount withdrawn is more punitive on lower income individuals as the total payment of surcharging fees is a greater proportion of their income than for high-income individuals. An empirical issue is which of the two groups observes greater frequency of withdrawals and keeps a higher balance of cash and coins. Gustavo del Angel baptised this effect as “feeding the gander”, in a loose symil to the large tubes commonly used in the creation of fois gra, replicating the payments pipeline giving no option but to “eat” the surcharge.

(L 2 R): Gustavo del Angel, Carles Maixé-Altés and Bernardo Bátiz-Lazo, Paris (Sep, 2012)

Transparent Pricing of Payment Services?

Bernardo recently sent me a link to a blog post that advocated for transparent pricing of payment services. The post is a bit of a rant about unnecessarily high interchange fees, which is the fee the merchant’s bank pays to the card-issuing bank for a credit or debit card transaction. These fees are set by the system as a whole, and they naturally set the floor for what a merchant pays to accept credit or debit cards. The trouble, the author argues, is that these fees are much higher than they need to be, and because consumers are generally unaware of these fees, they continue to use the most expensive, least efficient payment instruments, ultimately resulting in higher prices for goods and services.

The solution, the author contends, is to make these fees transparent and visible to the consumer. The author reasons that if the fees charged by the payment networks are passed on explicitly to consumers, they will naturally choose less expensive payment instruments, and probably exert pressure on the payment networks to lower their fees across the board.

VISA and Mastercard have traditionally prohibited such surcharges via their merchant agreements, but various lawsuits might soon give merchants in the USA the right to pass on their merchant discounts more explicitly (merchants in Australia and New Zealand have been able to do this for a while now). Although very focused merchants such as gasoline stations are allowed to offer a “discount” for cash transactions, they are not allowed to impose any kind of “surcharge” for transactions involving cards. In real terms, these are just two different ways of looking at the same thing, but the card networks, which have always been very savvy at marketing, know that consumers don’t see these as equivalent. A “discount” is a reward, something you might want to take advantage of, but not something that will really hurt you if you pass it up; a “surcharge” is a penalty, something you should do everything you can to avoid.

Psychologists refer to this phenomenon as “loss aversion,” noting that most people are motivated more by the threat of a potential loss than the promise of a potential gain, even if the net result is the same. Thus, if you were offered a discount to pay in cash, you might take advantage of it, but wouldn’t be as motivated to do so as you would if you were told that you would have to pay a surcharge if you wanted to use your credit card. Theoretically, a surcharge would motivate more people to choose less expensive payment instruments, forcing the card networks to lower their fees.

All of this sounds great in theory, but the trouble is that surcharges would be only one of many considerations that ultimately influences a consumer’s choice of payment instruments. Human beings are complex creatures; we are motivated not only by prices, but also by convenience, the status something might afford us, the extrinsic rewards it might provide us, the desire to be treated fairly and with respect, and expectations formed by years of prior experience.

Imagine if the next time you went to the grocery store, you were told at the checkout that you could pay one of four different amounts depending on which kind of payment instrument you used. Would you be happy that transaction pricing was finally transparent, or would you just be confused and angry that you had to pay 3-4% more because you wanted to use your air miles credit card? If you are reading this blog, you are probably already more aware of these issues than others, so imagine how someone who has no idea these fees even exist would feel.

Historically, consumers have tended to react very negatively to this kind of unbundling and pass-through of fees, especially when they’ve been conditioned for many years to assume that the service should be provided for free. For example, when most of the airlines in the USA started charging for checked bags a few years ago, consumers responded with outrage, and tried to carry on enormous bags, delaying boarding, which made everyone even more frustrated. In Seattle (my hometown), the city council just passed a law requiring stores to charge their customer 5 cents for a paper bag; the intent was to incentivize consumers to bring reusable bags for environmental reasons, but it has resulted mostly in anger towards the city council.

Although these kinds of moves are intended to draw consumer’s attention to the real costs of providing a good or service, they instead tend to focus consumer’s dissatisfaction and anger towards the organizations imposing the change. This provides a good opportunity for competitors to jump in and steal customers, as Southwest Airlines is attempting to do with their “bags fly free” policy.

Banks in the USA have been playing this game of chicken for many years with regards to checking and debit/ATM card fees. Traditionally, American banks have offered checking, ATM, and debit card services for free in order to lure more and more consumer deposits. These services, of course, have real costs that are not being passed on transparently to consumers. At various points in history, a few banks have tried to unbundle these costs and pass them on explicitly to their customers, but they have almost always reversed their course in response to customer backlash. The most recent example was Bank of America’s attempt to impose a $5 fee to use their debit cards; after a large number of customers left the bank, they were forced to abandon their plans.

My point is that imposing surcharges might not achieve the results the blog author expects. As opposed to directing attention and indignation to the card networks and their interchange fee, it may instead direct that anger towards the merchants themselves, especially if their competition starts advertising a “no surcharges” policy. In that scenario, consumers may see the surcharge as something capriciously imposed by the merchant, and not something that is being passed on from the card networks.

The larger question here, however, is how we should think about transaction pricing in general. How much “should” it cost to process an electronic transaction, and how much of that should be paid by the merchant vs the consumer? That depends in many ways on what you think a payment card network like VISA or MasterCard actually is. Are they like public utilities, whose fees should closely resemble their underlying costs, or are they for-profit businesses, whose fees should be set according to market conditions? Many people seem to think of them as the former, but the card networks are neither structured nor financed as public utilities, and they certainly don’t think of themselves as such.

But we are now heading into another, very complicated topic, so I will leave that to another post. For now, what do you think about the idea of making card transaction pricing transparent via surcharges? Do you live in a country where this is already happening, and if so, what has been the general reaction?

Bye-bye, wallets

This week’s Time magazine runs a special report on “10 ways your phone is changing the world”. As you would expect one of the topics is Can a Phone Replace Your Wallet?, in which the author, Harry McCraken (@harrymccracken), attempts to live one whole week without cash while purchasing solely using Square and Google Wallet. This experiment was perhaps inspired by a recent attempt by Michael Fitzpatrick (@fitzp) to explore how near field communication transformed travel in Japan. Yet for all the success in Tokyo (or Hong Kong for that matter) to integrate transport and micro-payments, McCraken’s was not impressed by his experience in San Francisco:

I managed to make it through seven days without cheating, unless mooching off my wife. But there are enough glitches – at one point Google Wallet stopped working altogether – that I was glad to get my wallet back.

This attempt to enforce a single a single payment method echos Visa’s failure at the recent London Olympic venues – where there were only eight ATMs to service thousands of visitors (see further Cashless at the Olympics).

A second article on the same topic is: What Is Driving Africa’s Banking Boom. This one deals with the tried and tested discussion of cross boder payments and using mobiles as delivery channel for bank diversification. In this regard it was interesting to see, in the printed edition of the special report by Time, the result of their worldwide survey. In it, “receive payments” ranks 14th as a response to “Do you use your mobile device to perform each of the following tasks at least a few times a week?”. “Receive payments” was “least used” in the USA (5%) but most used in India (31%). They don’t disclose all of their results, but it would have been interesting to know the same data for “make payments”.

Note – In that survey, “make/receive” a phone call was “least used” in the UK (83%) and “most used” in South Korea and India (98%).

Starbucks and Square

Last week, Starbucks made the announcement that they have decided to invest in the San Francisco payments company Square, and will soon allow customers in their US stores to pay with Square’s mobile payment application “Pay with Square.” This was a great vote of confidence for Square, but a somewhat surprising move for Starbucks.

Square is a really interesting company. It was founded by Jack Dorsey (of Twitter fame) in order to help small merchants accept payment cards. Square removed the friction for small merchants by doing three things: they radically simplified the merchant sign-up process; they offered consistent, transparent, and reasonably affordable pricing; and they enabled just about anyone with a smartphone to accept cards by creating a little magstripe reader and application that communicates with their servers over the phone’s data connection.

I first became aware of Square at my local farmers’ market; the guy who sells handmade pasta pulled out his iPhone, swiped my card through a little square-shaped device plugged into the headphone jack, and handed me the phone to sign my name. Since it was a farmers’ market, the merchant had no phone line or power source, but he didn’t need either; the card was read by Square’s app on his phone, which then communicated to Square’s servers over the mobile phone network. As I walked off with my purchase, I received a receipt for the charge via email. It was unbelievably cool. It felt like the future of cashless payments.

Since then, I have run across several other mobile phone-based payment systems that work in similar ways, but Square has continued to expand their offerings into a set of coordinated products. They now offer a point of sale (POS) app for the iPad, which is probably more than adequate for a small merchant, and a related “Pay with Square” application for consumers. Pay with Square is like a digital wallet, in that consumers can register their credit or debit card account, along with a picture and name, and then make charges against their card at any Square merchant.

Instead of using Near Field Communication (NFC) like Google Wallet, Square relies on the GPS functionality built into most smartphones. When a Pay with Square consumer enters a Square merchant, the consumer app knows this by virtue of its current GPS coordinates. The consumer is then asked if he or she would like to “open a tab” with the merchant, and if so, the consumer app notifies the merchant’s terminal via Square’s servers. The merchant can then tap the customer’s picture and name to initiate a new transaction. Square likes to point out that using a picture and name makes the transaction more “personal,” but the real advantage, at least for the time being, is that the consumer doesn’t need an NFC-enabled phone (only about 1% of phones sold today are NFC-enabled). Pretty much any smartphone with a GPS will do.

Pay with Square also seems to skip the signature step, which raises some interesting questions. When you sign a traditional transaction slip, you are legally authorizing the merchant to charge your account. The card networks have relaxed this requirement for transactions under certain amounts at certain high-volume/low-risk merchants, but it is unclear to me if Pay with Square transactions are also subject to these same rules, or if they have negotiated a general suspension of the signature requirement with the card networks. If the latter, this introduces a sticky issue with regards to fraud and transaction disputes. If you dispute a transaction, the merchant is required to produce a copy of the signed receipt, but if there is no signed receipt, Square will have to provide some kind of evidence that you, and not someone who stole your phone, authorized the transaction. The merchant can verify your picture and name, but what stops the thief from updating the picture before making fraudulent purchases? Perhaps Square uses picture analysis algorithms to detect significant changes to the registered picture, triggering a review?

By capturing both the consumer and the merchant, Square is also able to do some interesting things related to loyalty programs. Merchants can establish various schemes, such as every 10th coffee is free, and Square does all the work of tracking the purchase history and notifying the consumer and merchant when various goals have been met. Think of all those little punch cards you carry around in your wallet today, and how those could just become automatic and seamless in the future.

I would suspect that Square, being founded by the former CEO of Twitter, is also thinking about tapping into the social networks of their customers, though I haven’t seen any announcements related to that yet. For example, Square could easily send you offers to your favorite merchants and let you forward those to friends on your various social networks. Or they could notice that you and some of your friends often frequent the same restaurant or bar, and extend an offer to your entire group.

Of course, the real chore facing Square right now is expanding their merchant and consumer network, which is why the Starbuck’s announcement is so important to them. More than anything, Square needs visibility, and soon every customer who walks into a Starbuck’s store will see their name and hear about their products.

The Starbuck’s announcement also helps to legitimize the very idea of mobile payments, and will most likely help to increase adoption of schemes like Square. Historically, consumers have always had troubles developing trust in new payment systems, and are typically unwilling to use something that seems “experimental” or “cutting-edge” when it comes to their money. But one of the ways in which consumers establish trust more easily is if some business or organization they already trust introduces them to the new system. Think of when you meet a new person via a trusted friend; if you trust your friend and your friend trusts the new person, its becomes much easier for you to trust that new person as well. It works the same way with organizations and systems; if you trust the organization, and the organization vouches for the system, you tend to feel less apprehensive about giving it a try.

One thing is certain though: it will take quite a while for mobile payment systems like Square to displace cash and plastic cards. In fact, the use of cash in the United States and the UK seems to have increased during the recent recession, and the use of credit and debit cards continues to increase as well. The idea of using your mobile phone instead of a pastic card is still a bit too “exotic” for most people over 30, and it will likely take a generation before it becomes commonplace and normalized.