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Next in Tech | Episode 46: Payments evolution in digital

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Listen: Next in Tech | Episode 46: Payments evolution in digital

The payment part of digital engagement has evolved from a technology best left to specialists, to something that’s a critical part of customer engagement. Principal research analyst Jordan McKee joins host Eric Hanselman to look at how payment technology and functionality is being integrated into software platforms that are extending to financial services offerings to increase revenue opportunities. They’re leveraging market adjacencies to deepen customer ties and provide better insights.

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Eric Hanselman

Welcome to Next in Tech, an S&P Global Market Intelligence podcast where the world of emerging tech lives. I'm your host, Eric Hanselman, Principal Research Analyst for the 451 Research arm of S&P Global Market Intelligence. And today, we'll be discussing digital payments with principal research analyst, Jordan McKee, also part of our 451 gang. Jordan, welcome to the podcast.

Jordan McKee

Eric, thanks for having me.

Eric Hanselman

So with the holidays around us, payment technologies are really top of mind. But this is an area that you've been following. What do you see as changing in payments?

Jordan McKee

Yes, it's a good question. And certainly, no shortage of change in the payments industry. But if I were to take a step back, I'd say what's really changing right now is the mindset around payments. And it's interesting, when I became an analyst about 10 years ago and started following this space and talked to lots of different enterprises, back then, payments were largely viewed as an expense.

And it sort of led to this reputation where payments where seen almost as a commodity, right, sort of this necessary evil that was required to fulfill a sale. And because payments were viewed as a utility of sorts, most of the conversations back then were purely around cost. How do we scrap a few more basis points off of our cost of acceptance? Who can beat our current processing rate?

A good payment strategy back then was really seen as a low-cost strategy. And I don't want to pretend that cost doesn't matter anymore in payments. It definitely does. But today, the merchants that get it, they have much more enlightened thinking about payments and the role of payments within their business.

They understand, yes, cost needs to be managed, but it also needs to be balanced with some other priorities around customer experience and growth of the business. And I would say what's happening today, right, the big change that we're sort of seeing unfold is that more than ever, payments are seen as the inflection point of the customer journey.

They're this stage when your prospect, which you've thrown a tremendous amount of money at to get to that point, you've spent all this money on marketing, on advertising on your digital experience, you're about to get that prospect to become a customer. Everything is going as planned, but there's also a lot that can go wrong at that payment stage, right?

The customer might get incorrectly declined. They might not be able to pay with their preferred payment method. They might get discouraged by all the steps in the checkout form. And if one of those things goes wrong, right, every investment you've made further up the funnel is basically squandered, right? It was kind of all for nothing.

So again, I think the merchants that truly get it and truly understand where payments are going and what's changing, understand that payments are the strategic lever for their business, something that they can use to optimize their customer experience, something they can use to optimize for growth.

And they really understand that payments are an area where if they really double down and they think strategically, it's not unrealistic to drive a 10% swing in revenue, and I think you're going to be hard-pressed to find really any other area within enterprise where just a few strategy and technology changes can drive a 10% revenue swing. So it's really interesting to see how that mindset has evolved in recent years.

Eric Hanselman

Well, it's that final piece in which you're closing the deal with your customer, as you've said. And so many, I mean, we've all seen statistics on abandonment and all of the challenges that presents. I mean, that really, as you're outlining, is that fundamental piece.

And if you don't invest in ensuring that, that final aspect of the customer experience is a successful one and more than anything else, a pleasant one, you risk all those other investments.

And that's -- I mean the other thing also is it's -- that's the final experience that your customer has with you. And that's, as we all know from our basic psych classes, that's the thing that's really going to linger to the greatest extent for that impression for your customer.

Jordan McKee

Yes, that's exactly it, Eric. I mean, you really have to look at payments through the lens of the customer. And I'll give you a simple example. If you're a merchant selling domestically in the U.S., you're going to do pretty well just offering Visa and MasterCard and Discover and American Express and maybe PayPal.

You'll cover most of the market, you'll provide a pretty decent customer experience. But if you take that same strategy and try to apply it to a market like the Nordics, you're not going to do so well, right? In the Nordics, there's a payment method called iDEAL which is a bank transfer system.

It accounts for about 60% of e-commerce volume over there. If you don't offer that payment method, you're going to see a tremendous amount of abandonment. And to your point, you're going to negatively impact customer lifetime value, right?

The propensity for that customer to come back to your business is going to be significantly diminished if you're not serving up the payment methods that they expect. So that's exactly it, right? A ton of bearing on not just closing the deal, but ensuring that you're creating a good relationship long term.

Eric Hanselman

So much of that is matching expectations with your customer base to avoid that, "Oh, wait a minute, take PayPal" moment of that transaction, and that requires a certain amount of research into -- you spend a lot of effort figuring out who your customers are, what their buying preferences are, but you also need to understand what their payment preferences are.

Jordan McKee

That's right. You've got to understand it from a demographic standpoint because different segments of the population are going to expect different types of payment methods.

So for instance, in our research, we see younger consumers, right, such as millennials are going to expect a buy now pay later option like Klarna or Afterpay so they can pay in installments, right? That's going to be critical to serving that part of the population effectively. And then as you go internationally, you really need to think local, right?

You need to understand the local needs of each and every market you're selling into because from a payment standpoint, all of those geographies have evolved different and they have a different set of needs.

Eric Hanselman

So you're checking off a whole set of different types of payment technologies. Is it part of a larger fintech transformation? Or is it something more specific?

Jordan McKee

I think the answer there is yes and yes. And let me sort of unpack that a little bit. So it most certainly is part of the broader fintech trend. Payments are, at the end of the day, a type of financial technology.

And just like any of the other areas in fintech, the focus is very much the same, right? It's around digitization. It's around applying digital technologies to level up the customer experience, to improve operational efficiencies, to unlock different types of value. There's a very similar transition going on across the board in fintech, right, from payments to lending, banking, investments, everything in between.

So payments are definitely part of that. But from my vantage point, they're also pretty distinct. Payments touch literally everyone, from consumers, to enterprises, to financial institutions, to governments. Payments are also embedded in just about every area of fintech, right?

They're sort of the shared utility that acts as an on-ramp and an off-ramp and you can think of an investment application that perhaps a fintech provider is offering. Well, they're going to need payments as part of that application to ensure that I can, one, move funds into my account on that app; and two, right, have a payout process so I can move those funds back to my bank account.

So I think you're going to be hard-pressed to find another area in fintech that's so pervasive and has so much applicability. And I think that's also one of the reasons why we see so much activity in payments at the moment. We see it in the funding environment where I was just looking at some data from S&P's Capital IQ Pro.

In the first half of this year, we saw a $5.5 billion raised by payment service providers and 14 of those rounds were in the 9-figure range. We're seeing it in the M&A environment. I was just doing some analysis with our M&A knowledge-based data. We saw so far this year, $44 billion spent to acquire payments targets.

And we definitely see it in the revenue opportunity as well. McKinsey believes that the global revenue opportunity and payments right now is about $2 trillion, trillion with a T, right? So payments is a fairly unique area in fintech from a lot of different angles, right, in terms of the scope, in terms of the applicability, certainly the amount of activity we're seeing in definitely just the sheer size of the opportunity in front of the industry.

Eric Hanselman

How do you see this shifting in terms of who's actually engaging. I mean, originally, as you were saying, payments was really the specialized sphere and that really, you're looking to ensure that the costs of actually closing a payment weren't going to hurt you in any meaningful fashion or the optimization play.

How do you see that changing and our merchants and others in this environment starting to get more involved in the actual payments? And is this something that's becoming less of a dark art?

 

Jordan McKee

Yes, I think that's a good way to characterize it, right? More than ever payments are less of a dark art. They're no longer this backwater of the banking industry. What you're seeing today is payments quite literally becoming embedded in just about every technology experience, technology service that enterprises and consumers are leveraging.

And you're really seeing payments almost become part of the tech stack for a business where if you look at a company, let's say, like Salesforce or Adobe, right, software providers, they have this year, right, embedded payments in their offering.

So it's been interesting to see how that in itself has also evolved the distribution model for payment services. It's no longer just the banks, the incumbents in the financial services industry serving as the conduits into the market. Increasingly, it's tech companies, it's software companies actually embedding payments as part of a broader value proposition.

Eric Hanselman

And it seems like this is really moving to the point at which any time there's value exchanged, you want to have the opportunity to capture some of that value, in whatever form that transaction happens to take.

Jordan McKee

That's it. And that value can be thought of in multiple different ways, right? If you're a software company and you choose to embed payments as part of your offering, well, that gives you a lot more control over the user experience of your software over the onboarding into your software applications.

Certainly, from a revenue standpoint, there's a lot to be gained. If you already have millions of dollars flowing through your software. Well, why not offer a payment processing service and dip your hands into some of that opportunity?

And certainly, it allows you to embed yourself deeper into your customers' operations or your customers' experience and make yourself a more indispensable provider. So there's definitely multiple value sources that can be attributed to more tightly coupling payments with a software technology experience.

Eric Hanselman

So is this an area where you're just seeing sort of major ISVs are heading in this direction? Is this something that sort of broad market participants should be considering how they can better manage and integrate, maybe own some of that payment process? Or is that something that's just a larger organization path?

Jordan McKee

It's software companies of all shapes and sizes. We've definitely seen it with vertical SaaS providers. You can look at a software company like Mindbody, which focuses on the health and wellness vertical. And in many ways, has sort of become this operating system, for instance, gyms.

They have moved in the direction of accepting payments and now have positioned themselves as really a full stack provider for the industries that they're serving. You see this absolutely with large software companies, right, Salesforce, HubSpot, Shopify, Adobe, all great examples of larger players that have moved in this direction.

But what we typically see is if you're an ISV, a software company that is facilitating somewhere to the tune of about $50 million in transactions annually, you're in a good spot to participate more directly in the payments industry, whether you become a payment processor yourself or you partner with a payment processor to offer that capability as part of your software, but definitely a trend we're seeing accelerate as we reflect on the last few years and think about what's ahead.

Eric Hanselman

And do you see payments processors actually more actively seeking out those kinds of partnerships? Or is that something where they're more than happy to hang on to the business they've got and expand as required?

Jordan McKee

So they're approaching it from a few different ways. You're seeing some like Stripe really position themselves as partners to the ISV community and SaaS companies and have developed a payment platform that can be very easily integrated into a software experience.

And so they are, in effect, the quiet engine that is powering the processing capability within many different types of software companies such as Shopify and there are other payment processors that are heading in that direction, kind of positioning themselves more as enablement partners.

What's also interesting from an M&A standpoint, you're seeing some of the larger payment processors go out and actually acquire vertical SaaS companies, acquiring companies that focus on a particular vertical and offer a particular capability such as point of sale.

And then using that target and embedding their own payment processing capabilities within that target to sort of make themselves part of the company they've acquired, part of their offering. So you're seeing an approach from both directions there.

Eric Hanselman

Turning that process around. Wow.

Jordan McKee

That's exactly it. Yes.

Eric Hanselman

So where is this headed from a payment technology perspective?

Jordan McKee

I think more of the same in terms of payment technologies are increasingly evolving from a distribution standpoint and a consumption standpoint. And as we talked about, right, for many years, financial institutions really were the primary on-ramp for merchants, for enterprises into the payments industry.

And the reason for that was pretty simple. As a new business, you would go into the bank to sign up for some financial products. You might need a loan, you might need a bank account to start your business. And having payment processing in a merchant account was a pretty natural next step.

And for those merchants that didn't sign up for payments at the bank branch, the bank and their payment partners would employ these large feet on the street sales forces, they would go door-to-door. We call them ISOs and agents, and they would really extend the reach of the bank into the market.

And what's happening today is that more and more of these on-ramps into the industry are both multiplying and shifting. And it really is these large SaaS providers like Shopify and Mindbody and Salesforce that have sort of become operating systems for the companies they serve and are now moving into financial services.

And they're embedding payments into their software to do a lot of the things we discussed, right, improve their customer experience, make themselves more indispensable, capture a new revenue stream, and they're now starting to take this another step further by offering loans by issuing payment cards, by offering bank account products to their customers.

And it's a large opportunity, right? If you look at a software company like Toast, which is a point-of-sale software system based in Boston, right? They focus on restaurants and hospitality businesses. They recently had an IPO. They attribute more than 80% of their revenue to financial services. And again, they're a software provider.

So the trend that I see is more software companies getting into payments for a lot of the reasons we talked about and really starting to reshape what distribution and what consumption looks like in payments. And for payment companies, they'll need to start to think about the world differently.

And they'll need to invest more heavily in their tech stacks to position themselves as partners to this new ecosystem of distribution partners, right, software companies as some like Stripe already have.

Eric Hanselman

Well, it seems like this is one of these things that we see in so many areas, this transition to platform capabilities that really raise the fundamental functional aspects up a notch in terms of levels of abstraction. You don't have to deal directly with some of the payments pieces, you can get them integrated as part of a platform.

They come along with the adoption of the platform. But the thing that I find fascinating is the part that you're identifying is that all of these adjacencies that now these payments providers are starting to blend or to shift out into.

So, if you've got financial services pieces, all of those financial services products like a Toast contributing that much to their revenue, it seems like they identified what that merchant journey was, which was, "Hey, I'm going to minimize or I'm going to optimize cost for payment."

And they've moved forward and given reasonably priced payment processing costs and they're going to make it up on the adjacent services. How many times have we seen that in tech?

Jordan McKee

That's exactly right. And the trend is really moving from a world where payments were once kind of bolted on to a business to a world where payments are really embedded and integrated into the software that they're using. And that creates so many sources of value for that business, right?

They have access to better data, which they can use to better understand their operations, to better understand their customer base. They're able to view all of their reporting in one location rather than dealing with multiple reconciliation files and formats.

And as we talked about, right, for those software companies that are offering payments, payments can be used as this linchpin where, "Hey, I'm already getting a ton of understanding into the financial operations of my customers because I see what's going on from a payment standpoint.

I'm now in a position to perhaps offer them a working capital loan because I really understand, and I can really make assessments around the risk of a lending decision." So this is a trend that I think, while has been here for some time is really just in early innings in terms of the impact and how it's going to really play out as it relates to distribution and value-added services around payments.

Eric Hanselman

Well, and that really closes the loop and the point that you were making at the outset, which is that businesses need to understand their customers, here's one way to expand what that view looks like.

To be able to know your customer that much better with one more aspect that you can bring together and to have the additional benefit that if you know your customers better, you can better predict, better manage risk, all those good benefits that roll in with it. That's wonderful.

Jordan McKee

Absolutely.

Eric Hanselman

Well, Jordan, I think I've done most of my holiday shopping already. So I'm not ended to go out and buy anything yet, but now I'm going to be certainly a lot more aware of what's taking place under the hood.

So -- and there's a lot more -- as we start looking into sort of what's happening for those next stages that definitely is another episode of the podcast I'd love to be able to dig into, because there are so many different pieces about this ecosystem that need to get bolted together.

Jordan McKee

That's right. It's a very fragmented market, and it's just mind-blowing how many intermediaries there are to get the transaction from point A to point B, but that's the fun part of being an analyst, right? We get to sort of put this confusing world all together and figure out where it's headed.

Eric Hanselman

More puzzle pieces. We love it. Well, thank you very much. And that is it for this episode of Next in Tech. Jordan, thank you very much for all these great insights. Thanks to our audience for staying with us. And I hope that you will join us for our next episode where we'll be talking about transitions into technology services with Dr. Katy Ring.

A lot of those things that we talk about, challenges moving into a greater level of adoption of tech services is now taking a much greater role in terms of being able to overcome, I think, a lot of the things we're talking about today, skills issues, technology, big technology hurdles, all those kinds of things. So I hope that you will join us then because there is always something Next in Tech.

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