september-2012-navigator

Safeway’s decision to IPO a minority stake of Blackhawk Network is yet another milestone in the evolution of the prepaid industry given its unique distribution role in the broader value chain. Green Dot and NetSpend serve as bell weathers for the market value of program managers in the prepaid value... More

Figure 1 is the September Payments Industry Stock Price Tracker. The chart measures current stock prices and market caps (as of September 28th, 2012) as well as movement over the last 30 days, and year-to-date. Most companies across the payments value chain experienced a strong September after mixed results in... More

September 2012

Payments Industry Stock Price Tracker

1 of 9 © 2012 First Annapolis Consulting, Inc.September 2012 Navigator

It has been two years since Green Dot and NetSpend went public after establishing themselves as early leaders in general purpose reloadable (GPR) prepaid with unique distribution advantages. Today, both companies are still leaders in a prepaid market that is increasingly competitive. As such, we take a quick look at trends and developments at Green Dot and NetSpend as well as the implications for the prepaid market. Performance TrendsWhile the stocks of both companies have given investors pause, both Green Dot and NetSpend have continued to deliver meaningful revenue, generating $467 MM and $306 MM, respectively, in 2011. As... More

Revisiting Prepaid in the Context of Green Dot and NetSpend

Published by First Annapolis Consulting, Inc.

Navigator

Amidst Regulation, Unbanked Population GrowsThe FDIC recently released its 2011 report from the second National Survey of Unbanked and Underbanked Households. Based on its survey of over 45,000 households, the FDIC found that the percentage of households that are unbanked has increased roughly 0.6% since 2009. These research findings are consistent with First Annapolis’... More

Historically, debit card reward programs were employed by issuers to increase penetration, activation, and usage of debit cards among DDA customers. However, the enactment of the Durbin Amendment dramatically changed debit economics and prompted issuers to reevaluate their debit product and deposit account offerings. In an effort to control cost... More

Finalized in 1999, the Prompt Payment rule was designed to ensure that federal agencies pay vendors in a timely manner. The rule, enacted due to the increased use of electronic payments in the government and the private sector, assesses interest charges against agencies that are late on their vendor payments... More

The Prompt Payment Rule & Federal Agency Commercial Card Programs

Many aspects of the card payments business have remained relatively unchanged for twenty years. Sure we saw the migration to EMV, the emergence and growth of e-commerce, and the integration of loyalty and branding partners, each a significant evolution, but the business of issuing a consumer card or processing a... More

Planning for Disruptive Change is an Imperative in the Payments Industry

Blackhawk IPO and the Value of Prepaid Distribution

First Annapolis Fall Industry Events

Oct. 4 Commercial Payments International London Joel Van Arsdale

Oct. 8 BAI Retail Delivery D.C. Lee Manfred

Oct. 15 ABA Annual Convention San Diego Josh Gilbert

Oct. 22 Money 2020 Expo Las Vegas Lee Manfred

Oct. 23 Chicago Fed Payments Chicago Paul Grill

Nov. 7 FFIEC Payment Systems Risk Conference Arlington Ray Carter

Nov. 8 Commercial Payments International Chicago Frank Martien

Nov. 27 Co-Brand Partnerships Conference San Diego David

Woynerowski

Debit Card Rewards – Not Quite Dead Yet

Apple’s iPhone 5 debuted September 21st after several months of fanfare and, as usual, rumors that this might be the iteration that includes NFC technology for payments. These theories were refuted in the days leading up to CEO Tim Cook’s keynote address at the fall media event on September 12th... More

Apple’s Actions Spur Mobile Payments Speculation, Present Opportunities


Source: Company SEC Filings and Investor Presentations

Green Dot NetSpend

2009 2010 2011 2012 Q2

2009-2011

CAGR 2009 2010 2011 2012

Q2

2009-2011

CAGR Operating Revenue $258.50 $363.90 $467.40 $136.70 34% Operating

Revenue $225.00 $275.40 $306.30 $85.30 17%

Operating Margin 26.90% 19.00% 17.90% 13.80% n/a Operating

Margin 15.90% 15.00% 18.70% 20.40% n/a

Net Income $40.60 $42.20 $51.50 $11.90 13% Net Income $18.20 $22.70 $33.20 $10.20 35%# of Active GPR Cards 2.7 3.4 4.2 4.4 25% # of Active

GPR Cards 1.9 2.1 2.1 2.2 5%

Gross Card Volume ($B)

$5.80 $10.40 $16.10 $4.00 67%Gross Card Volume ($B)

$7.60 $9.80 $11.20 $3.00 21%

Figure 1: Key Metrics of Green Dot and NetSpend2009-2012 (Millions, unless noted)

Revisiting Prepaid in the Context of Green Dot and NetSpendBy Nirnay Sinha

It has been two years since Green Dot and NetSpend went public after establishing themselves as early leaders in general purpose reloadable (GPR) prepaid with unique distribution advantages. Today, both companies are still leaders in a prepaid market that is increasingly competitive. As such, we take a quick look at trends and developments at Green Dot and NetSpend as well as the implications for the prepaid market.

Performance Trends

While the stocks of both companies have given investors pause, both Green Dot and NetSpend have continued to deliver meaningful revenue, generating $467 MM and $306 MM, respectively, in 2011. As indicated in the table below, Green Dot has delivered strong growth in revenue, active cards, and gross purchase volume. However, Green Dot’s operating margins have gradually declined year over year in light of continued pricing pressure as well as increased revenue share payments to distribution partners. Nonetheless, Green Dot generated over $3,800 in purchase volume and $111 in revenue per active card during 2011, increasing from $3,000 volume per card and $107 revenue in 2010. To date, Green Dot has relied on a retail distribution model highlighted by its partnership with Wal-Mart, as well as partnerships with Walgreens, CVS, Rite-Aid and others.

NetSpend, in contrast, has shown steady growth in operating revenue and gross card volume while increasing operating margins. Specifically, net income has improved by 35% from 2009 to 2011, largely driven by the growing number of customers that use direct deposit to reload their cards. NetSpend generated $5,300 in purchase volume and $145 in revenue per active card in 2011, compared to $4,700 and $131 respectively in 2010. It has been a leader in ‘meeting the underbanked consumer where they are’ and earns 60% of its revenue through alternative financial service partnerships with check cashers, payday lenders, and tax providers. The largest of these alternative services partnerships is with ACE Cash Express. In addition, NetSpend has diversified its card distribution approach through partnerships with Experian, Creditcards.com, BET Network and others.

Potential Challenges to Industry Incumbents

Retail banks have historically been skittish on establishing a broad presence in the prepaid market, but the Durbin Amendment has expanded their interest as a means to replace a portion of lost debit card revenue. BB&T and Regions

were amongst the first large banks to offer a GPR prepaid card and have since been joined by several others including the highly publicized product launch of “Liquid” by Chase. While it is too early to judge the latest prepaid efforts of banks, their actions alone will put pressure on pricing and other areas such as distribution/customer access. As an example, Chase’s new “Liquid” product poses a significant threat given the reach, deep pockets, and marketing muscle of Chase. Chase recently completed piloting the program and is in the process of rolling the Liquid card out across its network of 5,500 branches and 17,500 ATM locations. Coupling its physical network with its Smartphone remote deposit capabilities, Chase Liquid has the potential to provide greater access to customers for both deposits and withdrawals avoiding reload and ATM fees in the process.

Incumbents in the prepaid market will need to adapt to other threats brought upon by increased competition. American Express has invested heavily in its prepaid product suite and secured several attractive distribution arrangements. Prepaid is highly strategic to American Express as an entry product and brand building vehicle to new customer classes notably the younger demographic. Taking note of the Walmart Money Card strategy, Kroger and U.S. Bank are partners with the potential for a powerful “one-two punch” given the reach of Kroger’s distribution and the strength of the U.S. Bank franchise. The grocery channel is the most attractive channel for closed-loop gift cards and is well-positioned for open-loop success given the foot traffic and frequency of visit dynamics.

Finally, the prepaid market is not immune to the regulatory scrutiny sweeping the financial services industry. The Consumer Financial Protection Bureau recently announced an “advanced notice of proposed rulemaking”, and is seeking input on a range of topics including cardholder terms and fee structures. The implications on the industry are yet to be determined, but prepaid will certainly face more regulatory scrutiny than it has in the past if for no other reason than its growth.

Longer Term Stakeholder Implications

Irrespective of their recent stock market challenges, Green Dot and NetSpend have advantages in prepaid that others have yet to replicate and that may be the real wake up call for the industry given the number of niche specialists in the segment. To state the obvious, both Green Dot and NetSpend have built franchises that generate hundreds of millions of dollars in revenue. Behind that revenue is scale, distribution, and insights into customer and product behaviors

that are extremely valuable and unique in the prepaid space. Both companies have made investments to diversify their businesses in different ways. Green Dot built a reload network, acquired Bonneville Bank (renamed Green Dot Bank) and Loopt, [a mobile services platform] while NetSpend diversified into payroll cards several years ago with the Skylight Financial transaction. Both companies are top of mind when others are seeking partnerships for program management.

You would be hard pressed to identify a market segment that was any hotter than prepaid in recent years. Venture capital and private equity investment was rampant; buyers were routinely rebuffed by potential sellers; start-ups were prevalent across the value chain; thousands attend conferences far and wide; use cases seemed like an endless stream of growth and international

markets were icing on the cake. We are still bullish on prepaid as a product, but would not be the least bit surprised if there was a shake-out in the market. Payments businesses are scale-based with a long track record of consolidation over time across the value chain. While there is a spotlight on the stock market performance of Green Dot and NetSpend, the bigger story may be the implications for many other industry stakeholders as it relates to their ability to achieve scale, deliver shareholder returns, and address a new set of industry challenges.

For more information, please contact Nirnay Sinha, [email protected]; John Grund, [email protected]; or Josh Gilbert, [email protected]


Blackhawk IPO and the Value of Prepaid DistributionBy John Grund

Safeway’s decision to IPO a minority stake of Blackhawk Network is yet another milestone in the evolution of the prepaid industry given its unique distribution role in the broader value chain. Green Dot and NetSpend serve as bell weathers for the market value of program managers in the prepaid value chain, but the importance of distribution is evident in their respective business models. However, the two largest distribution players – Incomm and Blackhawk – are privately/closely held (although Warburg Pincus recently made a minority investment in Incomm) and among the most interesting companies in prepaid. It is important to note that both Incomm and Blackhawk are more than pure play distribution entities given the technology, products/services, and platforms resident in each company. That being said, both enjoy highly advantaged positions in the prepaid value chain given the dynamics of distribution and as an affiliate of Safeway, Blackhawk is particularly unique in that regard.

Any IPO (or investment in the case of Incomm/Warburg Pincus) is fundamentally a story about future growth which begs the question on the direction of third party distribution. Will consumers adopt mobile in a way that shifts card acquisition from physical distribution in any meaningful way? Will Blackhawk and Incomm be major players in the mobile wallet space and be able to transfer their strengths in physical distribution to the digital space? Can physical distribution be leveraged in ways beyond prepaid to open up entirely new growth vectors? Is the runway for international growth robust? Will entirely new third party distribution models emerge with the likes of Facebook, Groupon, Amazon, etc.? Can a retailer-led initiative such as MCX (Merchant Customer Exchange) eventually be a platform for gift card distribution? Will some combination of forces drive distribution margins down over time? The market will be the ultimate judge, but to date, distribution-based business

Founded/Launched • Launched in 2001 as a division of Safeway, Inc.

Distribution Reach • 72,000 retail outlets• Over 90% of store locations of the Top 50 grocers in North America

Geographic Markets Served • Offices in the United States, Australia, Canada, France, Mexico and the United Kingdom• Operates in 17 countries with plans to enter China and Brazil

Channels

• Retail Stores• Online (www.giftcardmall.com)• Mobile (www.gowallet.com) • International• B2B

Core Products/Service

• Closed-Loop Card Distribution• Open-Loop Card Distribution• Program Management• Financial Services• Secondary Prepaid Market Platform (Recent Acquisition)• Telecom Products• Digital Content

Sample Branded Offerings• PayPower: Open-Loop Visa Prepaid Card• GoWallet: Online and Mobile Digital Wallet• REloadit Network: Reload Prepaid Cards

Financial Metrics• 2011 Operating Revenue $752M (+30%)• 2011 Pre-tax Income: $62M (+64%)• 2011 Adjusted EBITDA: $78M (+30%)

Figure 1: Blackhawk at a Glance

Source: Goldman Sachs 2012 Global Retailing Conference, company websites and press releases, and Safeway 2011 Annual Report


Debit Card Rewards – Not Quite Dead YetBy Emma Causey and Stephen Dye

Historically, debit card reward programs were employed by issuers to increase penetration, activation, and usage of debit cards among DDA customers. However, the enactment of the Durbin Amendment dramatically changed debit economics and prompted issuers to reevaluate their debit product and deposit account offerings. In an effort to control cost, many eliminated debit rewards programs. This is observable by comparing the number of debit rewards programs in the market before and after the enactment of the Durbin Amendment. In 2009, 52 of the Top 100 debit issuers offered a rewards program. Today, only 37 maintain such programs.

The elimination of rewards programs between 2009 and 2012 was not evenly distributed across debit issuers. As demonstrated below, issuers regulated by the Durbin Amendment dropped rewards programs with greater frequency.

The rise in rewards programs among exempt institutions suggests smaller debit issuers may have positioned themselves for the post-Durbin fallout by either retaining existing rewards programs or initiating new programs designed to capture customer migration away from larger banks. There is now almost an even split of rewards programs between regulated and exempt issuers.

Of the 37 existing rewards programs, 22 are points-based, 12 are cash-back programs, and 3 are miles-based. Additionally, seven issuers offer discount programs such as Visa Discounts and MasterCard Marketplace; however, these were not considered traditional debit reward programs for this study.

Though many of the recent reward program investments were made by smaller issuers, 19 of the 37 active rewards programs are offered by institutions regulated by the Durbin Amendment (>$10 billion in assets). The affordability of these programs may be the direct result of fee structure changes and minimum balance requirements implemented in the period following the passage of the Durbin Amendment. Only 15 of the debit rewards programs currently in market are associated with free checking accounts (i.e., no minimum balance requirements or card usage commitments). Several issuers have restructured reward-eligible accounts and added fees and/or balance/usage requirements. PNC, for example, offers a no-fee account without rewards alongside a more robust account with rewards and associated fees.

Despite the elimination of programs over the past several years, predictions proclaiming the death of debit rewards appear to be premature. Durbin-exempt issuers are increasingly viewing rewards as an opportunity to differentiate their products while some regulated financial institutions continue to find value in offering debit rewards. This dynamic will be interesting to observe over the coming months as issuers of all sizes continue to fine tune their debit strategies in a post-Durbin world.

For more information, please contact Emma Causey, Senior Analyst specializing in Deposit Access, [email protected]; or Stephen Dye, Analyst specializing in Deposit Access, [email protected]

Assets 2009 2012 Change % Change

>$10B 37 19 -18 -49%<$10B 15 18 3 20%Total 52 37 -15 -29%

Source: First Annapolis Consulting research and analysis


Figure 1: Debit Rewards Programs across Regulated and Exempt Issuers

Figure 2: Prevalence of Debit Rewards Programs by Type

models have been resilient and impressive. According to management, Blackhawk generated $62 million in pre-tax income for 2011, a 64% increase over the previous year, and even stronger metrics are anticipated for this year.

Safeway’s decision to take Blackhawk public is a classic case of unlocking value given the P/E differential between a grocer and a high growth, high margin company with low capital intensity. Blackhawk has an enviable market share with over 72,000 distribution locations and drove just under $7 billion in load value in 2011. Blackhawk has a commanding share of grocery distribution and, ironically, has successfully established relationships with direct competitors of Safeway. The reach of its distribution network and share of the grocery channel allowed Blackhawk to secure certain relationships on an exclusive basis at attractive margins. Over the course of time, the cost of and debate over third party distribution is always high on retailer agendas

given their thin margins and different views on incremental sales but to many it is a cost of doing business unless and until the market changes.

While overall market conditions have improved for IPOs in general, Green Dot’s recent earnings miss and lowered guidance have given pause to investors that have been riding the wave of prepaid. That said, Blackhawk has a unique model with large-scale distribution, access to millions of customers a day in foot traffic, a self-managed line of open-loop prepaid products, and distribution arrangements with market leaders across verticals. In our view, distribution remains the most defensible link in the prepaid value chain as even the best products cannot overcome weak distribution.

For more information, please contact John Grund, Partner specializing in Credit Card Issuing, [email protected]

By Josh Gilbert and Emma Causey

The FDIC recently released its 2011 report from the second National Survey of Unbanked and Underbanked Households. Based on its survey of over 45,000 households, the FDIC found that the percentage of households that are unbanked has increased roughly 0.6% since 2009.

These research findings are consistent with First Annapolis’ analysis of the retail banking market after the final Durbin Amendment rules were published. At that time we predicted that 1.7% of debit customers would eventually leave the formal banking system over the next five years as a result of regulation-induced account re-pricing. More specifically, our analysis suggested that FIs subject to debit interchange regulation would need to add or increase account fees while increasing minimum balance requirements. Given that these factors are frequent deterrents to opening and maintaining a bank account, it is not surprising that the unbanked population is on the rise. We expect the unbanked percentage to steadily increase over the coming years as financial institutions continue to re-price deposit accounts in response to the low interest rate environment and regulatory pressures on historical revenue sources.

Amidst Regulation, Unbanked Population Grows

Figure 1: Percent of U.S. Households that are Unbanked

Source: FDIC National Survey of Unbanked and Underbanked Households, 2009 and 2011

For more information, please contact Josh Gilbert, Principal specializing in Deposit Access, [email protected]; or Emma Causey, Senior Analyst specializing in Deposit Access, [email protected]


The Prompt Payment Rule & Federal Agency Commercial Card ProgramsBy Brian Rutland

Finalized in 1999, the Prompt Payment rule was designed to ensure that federal agencies pay vendors in a timely manner. The rule, enacted due to the increased use of electronic payments in the government and the private sector, assesses interest charges against agencies that are late on their vendor payments. The rule also provides federal agencies with guidance on when to make payments for their government commercial purchasing card.

By comparing the early payment rebate escalators offered by commercial card program providers with the government’s Current Value of Funds (CVF) rate, federal agencies can maximize their theoretical savings. The CVF rate is the simple interest rate charged on overdue federal government receivables. In summary, if the early payment rebate escalator offered by the card provider is greater than the cost of funds based on the CVF rate, agencies should pay as early as possible. If the rebate escalator is less than the cost of funds, agencies should wait until the payment due date to make the payment.

Suppose a provider offers 0.015% (i.e., 1.5 basis points) more in rebate on spend per day of earlier payment, and the CVF rate is 6% – meaning the government earns 1.67 basis points [(6% / 360 days in a year) * 100] for each day it delays paying the card provider. In this scenario, and according to the Prompt Payment rule, the agency should wait until the payment due date to

pay in order to allow the government to continue to earn higher interest on its funds. Assuming $10,000 in debt owed and a maximum early pay rebate offering of 1.06% from the provider, a federal agency could save $61 by waiting until the last possible day to pay, as opposed to just $56 by paying early. This is further illustrated in Figure 1 below.

Agencies have access to an online rebate spreadsheet that automatically calculates the savings to help determine when they should pay. Savings can be calculated by entering the amount of money owed to the card provider, the maximum rebate, and the daily rebate offered by the provider into the spreadsheet. Providers who want to be paid faster have the option to increase their rebate escalator based on average payment days to just above the CVF rate, which is calculated quarterly and is only adjusted if it changes by two percentage points from the prior quarter.

Payment date analysis can be beneficial to both government agencies and card providers. Government agencies can maximize savings by paying at the right time; and providers who want to be paid faster can impact payment timings via days payment rebate escalators.

For more information, please contact Brian Rutland, Analyst specializing in commercial payments, [email protected]

Figure 1: Prompt Payment Rule Calculation Example

Equation$ Rebate [$10,000*(1.06% – 0.015%*(30 – days to pay))]

$ Cost of Borrowing (6%*$10,000)*(days remaining to pay/360)

Days Remaining to Pay 0 15 30

$ Rebate $61.00 $83.50 $106.00$ Cost of Borrowing $00.00 $25.00 $50.00

Net Savings $61.00 $58.50 $56.00

Source: United States Department of the Treasury, http://www.fms.treas.gov/prompt/rebate.html and http://www.fms.treas.gov/cvfr/index.html


Planning for Disruptive Change is an Imperative in the Payments IndustryBy Marco Mazzonetto and Joel Van Arsdale

“It is not the strongest species that survives. It is the one that is the most adaptable to change” Charles Darwin.

Many aspects of the card payments business have remained relatively unchanged for twenty years. Sure we saw the migration to EMV, the emergence and growth of e-commerce, and the integration of loyalty and branding partners, each a significant evolution, but the business of issuing a consumer card or processing a payment for a merchant in a POS environment looks relatively similar to what it did in 1990. The same will not be said about the next twenty years, or even the next decade. The innovators dilemma, a theory developed by Clayton M. Christensen, states that incumbent businesses can be destroyed by disruptive innovations because these disruptions tend to be low-end or small in scale at their inception (therefore uninteresting to incumbents), but in the long-run, they come to represent entirely new orders of business allowing new entrants to overtake incumbents. There are a number of disruptive forces at work in consumer electronic payments and it behooves all payment services providers, both consumer and merchant facing, to both understand and have a plan to adapt to them.

E-commerce is hardly new, but its impacts as a force of disruption have become more readily apparent in recent years. In the U.K. this year, the majority of all card payments will be card-not-present transactions (with the majority of these being e-commerce) and effectively all of the card growth is now coming from e-commerce. PayPal has clearly been among the pack of innovators which have used the e-commerce disruption to steal market share and to establish a strong competitive position. PayPal’s success arose primarily because the company exploited a series of niches ignored by incumbents. First among these was U.S. P2P payments (which PayPal positioned for with a simple and easy digital solution while incumbent banks rested with yesterday’s solution – checks); second was payment acceptance services for micro-businesses (which legacy bank providers considered too risky); third was security concerns related to card e-payments in various markets and customer

segments (in Europe in particular), and fourth was cross-border e-commerce (again, mostly for small business). In each of these four cases, the incumbents failed to recognize that this market niche was significant and attractive in the long run, or they simply failed to prioritize action. PayPal, with an arguably basic and simple solution, has built several billion dollars of shareholder value by exploiting these opportunities created by the disruption of the internet and e-commerce.

More recently, Square (and others emulating Square), has taken a solution which some incumbents deemed unsafe or unnecessary and created a company worth several billion dollars. Square’s value proposition is to use a standard smart phone to enable card payment acceptance, with the process and service merchandising surrounding the technology representing some of the greatest innovation. Incumbents in payment acceptance viewed micro-merchants as too risky or of too little value to pursue, when in fact, it is a sizable customer segment, but one which requires a different way of marketing and operating.

Finally, M-Pesa in Kenya and other Sub-Sahara African markets has used simple, mobile text-based services to penetrate deeply a segment of unbanked customers which traditional banks struggled to serve. Sixteen percent of the Sub-Sahara African population now uses mobile money transfers. African banks have fought back against this disruption, with some success, primarily using politics and regulation to position themselves in the mobile money value chain (arguably hindering the development of simple and elegant solutions in the process). Specifics aside, the M-Pesa example reinforces that engaging in traditional banking in many parts of the world is simply not appropriate relative to customer needs, and that it is the non-traditional, the disruptive competitors that are most likely to innovate and thrive.

As shown in Figure 1, mobile phone technologies are just one among many potential forces of disruption at work in the marketplace. Completely different generational behaviors, cloud-based technologies, and new market entrants, among others, are all forces re-shaping the payments marketplace and

Macro-Category Examples of Disruption Forces

Socio-Economic Disruptions • Gen C is quick to adapt to new technologies, digital inclusiveness• Drive for financial inclusion among the unbanked (but not necessarily by banks)

Disruptions At POS Level

• ePOS (integrated systems) gain POS market share, stand-alone payment terminals fade • NFC POS becomes mainstream • Authentication technologies evolve beyond PIN and signature (towards device recognition, biometrics, etc.)• Card volumes shift from card present to card not present• Merchants demand an integrated, multi-channel payment service

Mobile Technology Disruptions

• Mobile technologies (devices + apps) change the way in which consumers and merchants engage in commerce generally, payments follow

• Mobile wallets change the consumer payments landscape and who owns the customer• Consumer mobile devices (smart phones, iPads) become POS acceptance devices and a gateway into merchants

Open and Cloud Based Technology Disruptions

• POS environment increasingly “thin” and cloud based, not local• Payment schemes and service providers “open” up their platforms to attract developers and service providers (a

clear scale advantage)• Mobile phone operating systems become standard for POS devices

New Market Entrants • Google, Apple, Amazon, Facebook, and other new entrants enter the payments marketplace with new business models

Regulatory Disruptions • PCI changes the operating role of merchants in payments• SEPA, PSD and similar regulatory regimes reduce barriers to entry

Figure 1: Forces of Disruption in the Payment Industry



creating risk for incumbent product and service providers.

Today’s incumbent payment product and service providers must be prepared for change. This task is made difficult by traditional ways in which companies plan for the future and by the underlying curse of the innovators dilemma. Most companies have strong annual and medium-term planning processes, but these processes generally fail to consider longer-term disruptions. The traditional approach to strategic planning consists of setting goals, developing a strategy, planning for major investments, and developing budgets on a one to three year basis. This planning considers incremental changes in market conditions (macro-environment, major changes to competition, foreseen losses of customers, etc.) but it rarely considers disruptive change and long-term positioning. Management teams also too often lack the incentive to look beyond their own business unit, product, or customer segment. Unfortunately, with traditional planning, companies are naturally reactive (and typically late) to disruptive change when it happens, rather than taking advantage of the openings created by it.

Scenario-based planning focused on disruptive forces helps management take into account a more dynamic and longer-term view of market conditions and how to optimize the positioning of the company in the long-term. This type of planning process forces management outside of their daily duties and comfort zones to think about a future world which is uncertain and dramatically changed. Beyond just thinking about the future more distant and different, a scenario-planning based approach helps to engrain a degree of awareness and flexibility into a company’s strategy which traditional budgeting and strategic planning do not. Even if the scenarios envisioned never come to pass, management benefits from the creative experience and new ways of thinking about the business.

First Annapolis has developed a three-phased approach to assist our clients with scenario-based strategic planning:

1. In the first phase, we work with management to brainstorm and to organize the management team’s thinking on forces of change. What is changing or could change that would dramatically impact our business? We then work with management to understand the nature of each of these forces – is it hype? Is it reality? How will it impact us? Etc.

2. In the second phase, the objective is to further understand, prioritize and

focus the planning by developing disruption scenarios. Forces of change typically do not act in isolation and the scariest scenarios typically involve several forces acting in concert to disrupt a marketplace. For example, it’s not just the release of the Google Wallet that could be disruptive; it’s the combination of changing consumer usage patterns, integration of services with mobile devices, and creation of new services and business models on top of a Google Wallet that could prove disruptive to payment service providers. At the culmination of this second phase of planning, management has a short-list of scenarios which focuses on those which are most disruptive.

3. In the final phase of planning, we work with management to develop strategic responses to the disruptive scenarios. This involves first diagnosing the impact (financial impacts, geographic impacts, customer segments, etc.) and the probability of such an outcome (along with key drivers of this probability). Secondly, we help management to develop an improved sense of awareness about how and when disruptions are developing (for example, you will know the scenario is potentially real when consumer adoption hits __% and when Visa and MasterCard do XYZ). Lastly, management should develop strategic responses to each disruptive scenario outlining an executive level strategic roadmap (what new acquisitions, products, partnerships etc. will position the company to minimize the damage or to take advantage of the disruption?).

Figure 2 is a highly simplified example of a disruptive scenario that could have been predicted and planned for five years ago. This is an over-simplified example, but hopefully the point is clear. Strong, forward thinking scenario based planning can be a strong tool for positioning a company for long-term success and to prevent major disruptions to current business models.

The payment industry is set for material change in the next decade and visionary leaders should ensure that their organizations are prepared for tomorrow’s disruptions. Scenario planning for market disruption can be an effective tool for positioning a company for future success.

For more information, please contact Marco Mazzonetto, Manager specializing in Merchant Acquiring and European initiatives, [email protected]; or Joel Van Arsdale, Partner specializing in Merchant Acquiring and European initiatives, [email protected]

Figure 2: Simplified Example of a Disruptive Scenario

Current Position• Company is a leading U.S. mid-market acquirer (30% market share)• Company uses direct sales as their primary sales channel• 20% of revenue arises from terminal and terminal based services

Disruptive Scenario (simplified)

• Merchants migrate from stand-alone terminals to ePOS systems• ePOS developers (i.e., VARs) integrate into payments• Open and cloud-based ePOS systems accelerate these shifts (lowering ePOS costs, and easing the path to

payments integration)• Acquirers which respond slowly to the VAR channel lose market share

Impact Given Status Quo Response• 4% loss in market share• 20% reduction in terminal and terminal VAS revenues• Flat profit growth

Scenario Planned Response

• Develop an open front-end (simple APIs, etc.) into the platform which allows VARs to easily integrate• Develop a commercial structure for using VARs as distribution partners• Develop a roster of reporting and other value-added services designed to integrate effectively and easily in

an ePOS environmentSource: First Annapolis Consulting research and analysis


By James Watts and Dara Khan

Apple’s iPhone 5 debuted September 21st after several months of fanfare and, as usual, rumors that this might be the iteration that includes NFC technology for payments. These theories were refuted in the days leading up to CEO Tim Cook’s keynote address at the fall media event on September 12th. The speculation on whether Apple will enter the increasingly crowded mobile payments space is fueled by a number of activities. These include:

1. PassBook, which digitally stores tickets, loyalty and gift cards;

2. EasyPay, a self-checkout tool;

3. Express Checkout, which enables online purchases with in-store pickup;

4. NFC patents filed by Apple, and;

5. Mobile security acquisitions

Apple’s long-term intentions are still unclear. Retailers, issuers, the card networks, and other payments players can benefit from understanding Apple’s capabilities and evaluating how best to incorporate similar features into new and existing offerings.

Merchants can learn from how Apple uses mobile commerce to facilitate process improvement. PassBook is one example. It can help merchants reduce friction related to boarding, check-in, or going into various applications to access mobile payments or marketing. This includes airlines and other travel entities that support mobile ticketing and retailers that scan QR codes for gift cards, loyalty cards, and coupons. PassBook can be used to improve convenience by allowing merchants to utilize time and proximity features to simplify mobile payments or check-in. For example, loaded payments cards or airline tickets can appear on the lock screen of the phone when nearby a store or before a flight begins boarding, respectively. Balances, points, and other data can also be presented and updated in real-time. Target, Starbucks, United Airlines, and MLB.com are already integrated, and other merchants are expected to support their payments, ticketing, and marketing products in PassBook.

Apple utilizes EasyPay and Express Checkout to enable quicker transactions using the payments credentials customers already have linked to their iTunes accounts in stores. Similar technology can be utilized by other merchants. Some already enable online or remote mobile purchases with pickup in-store,

Apple Actions Spur Mobile Payments Speculation, Present Opportunities

but self-checkout is less common. Issuers and retailers could position their co-brand and private label cards as the default payment method in similar self-enabled checkout tools. These services could also be integrated with merchant or issuer-developed wallets already in the market. As the holiday shopping season approaches, merchants that expect to offer a mobile point of sale (POS) solution for line-busting should consider whether a self-checkout option for their customer base makes sense, and how they can integrate the functionality into their existing mobile apps.

Several of Apple’s submitted patents are now publically available. Though the iPhone does not have NFC, the patents make clear that the technology is top-of-mind for the company. These documents envision NFC being used to redeem offers and interact with products in stores. The patents also hint at P2P and top-up capabilities, functions commonly associated with mobile prepaid. Apple has other mobile payments-related technologies in the works. Earlier this year, Apple acquired mobile security developer Authentec for $356 million. The company specializes in fingerprint scanning and has several patents related to mobile payments authentication. These capabilities could help solve for any outstanding security concerns surrounding a future mobile payments play.

Regardless of how Apple’s approach to mobile payments unfolds, its history suggests it is a fast-follower and will wait to develop a product that is tailored to meet customer needs. The mobile payments, wallet, and marketing landscapes are complex and consumers are not currently adopting solutions in large numbers. Whether the company is successful will be a function of whether Apple can successfully deploy its existing assets such as its user base and control over the mobile experience, create a better solution for payments, marketing, and shopping tools, all while offering customers a compelling enough value proposition to adopt.

For now, retailers and issuers should consider not only short term opportunities to gain early adopters, but also what long-term implications may be for existing payment and marketing practices. Mobile presents several opportunities for merchants to capitalize on in the near-term. Following what innovators like Apple and the other new entrants into the payments space are doing can help retailers and issuers improve existing processes in the near-term. Early adopters may be in the best position to reap benefits as mobile payments develop. Creating convenience for customers before competitors and developing more sophisticated merchandising and marketing strategies will be key to success.

For more information, please contact James Watts, Senior Consultant specializing in Credit Card Issuing, [email protected]; or Dara Khan, Associate specializing in Emerging Payments and Credit Card Issuing, [email protected]

Figure 1: Apple Mobile Payments and Marketing Applications

Source: Apple


By Collin Bauer

Figure 1 is the September Payments Industry Stock Price Tracker. The chart measures current stock prices and market caps (as of September 28th, 2012) as well as movement over the last 30 days, and year-to-date. Most companies across the payments value chain experienced a strong September after mixed results in August and have maintained an average YTD increase of over 25% relative to the broader market’s 13% gain thus far in 2012.

In summary:

The issuing sector continued to see significant gains in September, edging up 6% on average this month with positive results for nearly every issuer tracked. Gains were felt throughout the sector earlier this month on the heels of increased certainty surrounding European financial markets. The ECB laid out a bond-buying program to give countries extra time to sort out financial matters, while also decreasing the near-term risk of a European breakup. Bank of America and Citi posted double-digit gains this month behind the news, but currently all have ‘hold’ recommendations from analysts. In September, Bank of America joined Discover on the list of issuers who have realized gains of over 50% since January. Discover’s stock hit record highs this past month after the announcement of a new partnership with PayPal, whose recent strong performance has spurred investor confidence.

The processor / acquirer sector posted mixed results in September. Global Payments’ stock price leveled-out this month, despite being down 13% on the year partly driven by a data breach in March that resulted in the compromise of nearly 1.5 million card accounts. Fiserv was the biggest gainer in the processor / acquirer sector over the last 30 days after announcing recent partnerships with Oak Bank and MidFlorida CU. Conversely, Vantiv’s stock price dropped 4% in September with the loss likely attributed to the expiration of its IPO lockup towards the end of the month.

The networks also posted big gains in September; in aggregate, the sector was up 6% from 30 days ago. Visa and MasterCard prices rose earlier this month on the heels of a $7 billion settlement over swipe fees. Network revenue growth is forecast to slow through the end of the year due to uncertainty in global consumer spending.

Payments Industry Stock Price Tracker

Figure 1: Monthly Average Stock Price Tracker

Companies Sep. 28, 2012 30 Day Δ YTD Δ Current Market

Cap ($Billions)Acquirers/ Processors

TSYS $23.70 3% 19% $4.51 Fiserv $74.03 6% 26% $9.96 FIS $31.22 -1% 17% $9.57 Global Payments $41.83 1% -13% $3.43 Heartland $31.68 4% 30% $1.25 Vantiv $21.55 -4% N/A $2.91

Average - 1% 16% -Issuers

American Express $56.86 -1% 18% $66.09 Bank of America $8.83 11% 52% $98.66 Capital One $57.01 1% 30% $33.45 JPMorgan Chase $40.48 9% 16% $155.08 Citi $32.72 12% 15% $98.21Discover $39.73 3% 64% $19.66 U.S. Bank $34.30 4% 24% $64.49 FleetCor $44.80 4% 47% $3.69Wright Express $69.72 8% 28% $2.67

Average - 6% 33% -Networks

MasterCard $454.8 6% 23% $56.31 Visa $134.61 6% 31% $89.64

Average - 6% 27% -Market Index

S&P 500 $1,440.67 2% 13% -Source: Yahoo Finance, First Annapolis Consulting research and analysis

Founded in 1991, First Annapolis is a specialized advisory firm focused on electronic payments. Our market coverage is international in scope with a primary focus on North America, Latin America, and Europe. First Annapolis is headquartered in the Baltimore / Washington, D.C. corridor and Europe is served through our office in Amsterdam. In total, we have over 70 professionals across our practice areas giving us one of the largest and strongest advisory teams focused exclusively on electronic payments.

Card IssuingDeposit Access Payments StrategyMerchant AcquiringRetailer ServicesMobile Commerce Alternative PaymentsCommercial Payments

Practice AreasManagement Consulting

Partnership FinanceStrategic SourcingPortfolio ManagementStrategy Development / ImplementationLoyalty Program SupportCommercial Risk Compliance

M&A Advisory ServicesEnd-to-End Transaction SupportValuationsFairness OpinionsDiligence / Negotiation Support

Services

For more information, please contact Collin Bauer, Analyst specializing in Credit Card Issuing, [email protected]

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