The spectre of commoditization, with ever decreasing margins, looms over the payment industry. A key strategy for payment services providers (PSPs) is to move up the payments value chain by innovating in adjacent industries. Let us explain.
There has been a stream of vanilla services in the past half-decade all promising pretty much the same thing. This impact of this industry evolution has been for rivals to primarily compete solely on price.
In a crowded marketplace PSPs need a feature, or new service, that clearly illustrates to their merchants how they differ from competitors. One such feature – which is a must-have rather than a nice-to-have – is that of compliance with regulatory requirements in relation to the global taxation of digital services.
The payment service provider (PSP) market is crowded and the challenges facing the key players in this market are four-fold:
- How to avoid commoditization
- Move up the value chain by positioning, or repositioning, the service
- Understand the competitive forces shaping strategy
- Innovate in adjacent industries and explore access to new markets
1. Commoditization of the payments industry
The most common refrain from companies operating in the payments processing industry is to declare how their service is the easiest, fastest, and the most secure around.
But what happens when the majority of such services are all as easy, as fast, and as safe as the next? That’s when price (not ease, speed, or security) becomes the key service difference. This is also the key attribute of an industry being commoditized.
This is what is happening right now within the payments industry.
The payment service provider (PSP) industry has become generic and it is increasingly difficult to differentiate one provider from the next.
Christoffer O. Hernæs writing a TechCrunch feature titled When Payment Processing Becomes A Commodity states that disruptive services (such as cryptocurrencies) have led to payment processing becoming a commodity and that the analysis of transaction data is the new king, not price.
“A commoditization of payment processing will require new business models where cash no longer is king, but analysis of the information gathered through transactions is the new competitive advantage in the digital payment processing space,” said Mr. Hernæs.
This value chain disruption leads to the probability of payment processing becoming commoditized.
Disruption of an industry typically leads to lower transaction costs for merchants, thereby making the disruptive alternative more appealing and leading to a race to the bottom on price.
That’s why Hernæs expects the birth of new business models, not defined by price, but by the analysis of data.
In recent years competitors in the payment processing industry have jousted with each other over how they are different.
To augment their services and make it stand out from the crowd they have:
- Integrated loyalty programmes
- Implemented the use of tokenization
- Promoted cloud solutions
- Developed application programming interfaces (APIs)
But what happens when everyone is doing this, it becomes the blueprint for a service and it becomes generic: commoditized.
Of course, there are also ongoing barriers to service development in this industry space, such as:
- Industry convergence
- Access to capital
- Regulatory complexities and resultant compliance demands (e.g. new rules on the taxation of the digital economy)
- Cross-border sales restraint for certain services (e.g. geoblocking of video on-demand services)
- Security issues, especially for card-not-present (CNP) transactions
New features are increasingly hard to come by. They all – effectively – offer the same service. So how do merchants differentiate between PSPs?
The commoditization of PSPs has led to rivals simply competing on price. PSPs, however, should be looking to add strategic value to their offering via adjacent industries.
Intense competition – and an increasingly lower barrier-to-entry for new players – has led to these vanilla payment processing services, primarily competing on price. In order to differentiate themselves in the crowded payments market and to offset price pressures, PSPs must invest more to offer new revenue-generating services to their merchants.
Some PSPs offer value-added-services such as couponing and loyalty programmes but price is still the crucial debating point for anyone comparing services. When you are comparing like-for-like price is always the deciding factor.
One area that is ripe for exploitation is the taxation of the digital economy. More and more tax jurisdictions across the globe are introducing regulatory frameworks aimed at recouping tax revenue from digital services. These new rules require PSPs to collect evidence of consumer location; provide compliant invoicing, and to store transaction data. This type of market is still nascent – as many tax authorities are still in the planning phase – but it should be a key target for PSPs, as it is a significant feature to offer merchants across the globe.
2. Where to position, or reposition, a service
A key challenge for PSPs to avoid the pitfalls of commoditization. In essence they are all seeking to retain their ‘start-up culture’ for life. This is extremely hard to do and requires foresight (the ability to realise that commoditization is on your doorstep and to act accordingly) and bravery (the ability to make tough decisions to reposition the payment service).
In repositioning a service to take advantage of regulatory changes a PSP is instantly repositioned. They will have distinguished themselves from their competitors.
In a Harvard Business Review (HBR) May 2005 issue Youngme Moon penned an article titled Break Free from the Product Life Cycle. Moon argued that one consequence of the traditional product life cycle is that new product benefits are layered “on top of the old in an endless struggle to differentiate and rejuvenate their offerings.”
In reality this is a fruitless exercise as it misunderstands the needs of consumers. They became your consumer at the very start for one simple reason, the service solved a specific problem. The crux of the matter is retaining those consumers and convincing others that this is still a critical feature of your service.
Moon states that this quest to “differentiate and rejuvenate” can be achieved by positioning – or repositioning – products and services. In this way companies can rescue services in danger of commoditization and return them to growth.
Moon outlines three positioning tactics:
- Reverse positioning: offer something that competitors don’t. This is the return to ‘start-up culture’ approach. It involves stripping the service back to its bare bones, a back-to-basics approach to regain competitiveness and differentiate from the perceived generic competitors.
- Breakaway positioning: this is an complete escape of a company’s existing category. This approach is used to redefine the competition and position the company and its service on a different level.
- Stealth positioning: a covert approach, the act of sneaking a new service into a marketplace to gain acceptance. Also the riskiest approach.
Moon urges companies to “defy the old rules of the product life cycle” – where there is a demand for constant feature upgrades – by “simply challenging consumers’ notions about what, exactly, they are.”
Of course, to position – or reposition – correctly businesses need to have a thorough understand of their own industry.
3. Understand the competitive forces shaping strategy and profitability
What shapes strategy and profitability? This is the question on the lips of boards and executives across the globe and for over three decades they have used one framework to help them understand this conundrum.
In 1979 Michael E. Porter penned his first HBR article titled ‘How Competitive Forces Shape Strategy’. The piece has become the standard for businesses worldwide and was the genesis for a framework on how to analyse the level of competition within an industry and, as a result, predict profitability.
Porter returned to this topic in a follow-up HBR piece titled ‘The Five Competitive Forces That Shape Strategy’.
In his updated article Porter clears up any confusion or complexity involved in implementing what are now known as the ‘Porter five forces analysis’.
Competition, states Porter, can sometimes be too narrowly defined as in only relating to direct competitors. But competition involves all those industry sectors who seek a piece of the profit pie. This includes customers (seeking lower prices); suppliers (seeking higher prices); new entrants (trying to take market share) and business alternatives (again eyeing market share).
Interestingly, Porter in a recent interview advised businesses not to be trapped by trends and to focus on the fundamentals. His framework, he added, was robust and can be applied to any industry. He cited the birth of the internet as an example. People thought that the internet alone was going to be the force for change where in actual fact it has been an enabler for new tech, but new tech based on the old reliables as already outlined by Porter’s 1979 HBR article.
Porter urges companies to understand what rivalry means and how it can affect profitability.
Direct competition is always intense and almost exclusively focused on price. Focusing solely on direct competitors, inevitably, leads to price wars where only the consumer wins. But the result is that there is little or no choice. This, according to Porter, is a zero-sum approach.
The alternative is a positive-sum approach where competition is based on companies competing with new features or support levels. Here Porter feels that companies can benefit from each other’s competition.
4. Access new markets
Another quiet revolution happening to online digital commerce is on foot of OECD initiatives on digital tax.
New rules already introduced in the EU, and soon to be introduced in other countries, mean that there is a new role emerging for PSPs to help digital merchants address these new compliance requirements. As PSPs already collect much of the information required by these merchants, they are in a prime position to play a value-add role in helping merchants achieve compliance with these new tax rules.
Taxamo is the de-facto avenue to new markets for PSPs and their merchants.
Digital service merchants need to cognisant of the fact that global digital taxation rules are now in use in many jurisdictions and merchants need a comprehensive solution to charge the correct tax rate; correctly report the tax due to settle with tax authorities.
This, of course, opens up new markets and opportunities for PSPs. By integrating with Taxamo’s global digital tax solutions PSPs will be able to illustrate a clear distinction from their competitors. In the world of generic, commoditized payments this is a win-win for PSPs, their merchants and, of course, Taxamo.
Taxamo, the digital tax solution market leaders, offer PSPs partnership opportunities to introduce new digital tax compliance services to online merchants. This allows PSPs to move up the value chain and generate significant extra revenue in the process.
In the world of commoditized payments this is a win-win for PSPs and for merchants as it allows PSPs to give digital merchants a new value added service that is a critical and not just a ‘nice to have’.
Note: Taxamo content is created for guidance only, please consult your local tax advisor.