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Evolutionary Cycles In The Payments System

Evolutionary cycles in the payments system

The publication of the Reserve Bank’s Conclusions for its two year Innovation Review is shaping up as the catalyst for a new round of structural evolution in the Australian payments system. Payment participants have been set a challenge: establish a better long-term payments platform.

Doubtless, effective coordination of industry participants is needed to meet the challenge. Nevertheless, it will be good old-fashioned competition that delivers the new products that ultimately benefit customers. Bluntly, new payment systems only take off when schemes and participants work out how to use them to offer stuff that customers want, and will pay for.

To see the logic of this, it helps to think in evolutionary terms. At the end of the 80’s, “payments” still meant cash or cheques – with voucher-based card systems as an add-on. Starting around that time, Australia got an evolutionary jump on many other countries, establishing the basic electronic “rails” on which our payments system still runs.

Within 10 years, the financial institutions working with the Reserve Bank:

  • created the current real-time high-value payments infrastructure;
  • built and consolidated direct entry systems to deliver salaries and government payments into accounts electronically, and then support all other payments into accounts;
  • extended and consolidated ATM networks; and
  • built an integrated point of sale network allowing full electronic processing of consumer card transactions.

With the basic rails set up by the late 90’s, a deregulated, more competitive financial sector could work out how to use these rails to serve customers better, and make a profit. Thus, a cycle of structural evolution gave way to a cycle of product evolution, visible initially in card products to meet every taste and budget: low-rate cards, rewards points, cobranding, premium cards, companion cards, pre-paid and so on. New products were fuelled by the internet revolution, too: networks and systems designed for a different era proved themselves adaptable to the internet. “Pay anyone” screens and card-not-present transactions are examples. BPAY’s rapid expansion in this period was driven by similar factors.

The 15 year cycle of product innovation is nowhere near tapering off: new entrants like PayPal have found ways to carve out niches, and incumbents are spurred to respond competitively. Mobile commerce and social networking appear to offer as many new competitive opportunities as the internet. Competitors both large (ANZ’s GoMoney, CBA’s Kaching), small (mHITs text-based mobile service) and alternative (PayPal’s Here) are still engaged in the rapid deployment of new products in these areas. This suggests there is plenty more energy left in this cycle of product innovation.

Even so, the next cycle of platform evolution is emerging. The global cards system is well down the track on converting to chip; contactless has also moved ahead quickly in Australia, enabling card activity to migrate onto the mobile in the future. The industry has been working on enhanced electronic payments as well, albeit rather more slowly.

The RBA’s Conclusions paper amounts to a call for more aggressive platform evolution. Much reference is made to overseas developments like the UK’s Faster Payments service. Perhaps surprisingly for a paper focused on innovation in the payments system, it says very little about the long cycle of competitive product innovation in Australia. This may be because the RBA thinks the payments market is working: there is no need for public policy comment or direction on this aspect.

In essence, the RBA proposes faster modification of the direct entry system to speed up payment delivery, and the development of a new platform for retail real-time payments. The industry has been given three months to give feedback, and APCA is attempting to promote as much consensus as possible. When it comes to platform evolution, collaboration rather than competition is the key.

We are yet to finalise views, but my sense is that payment participants broadly acknowledge the need for structural evolution to set Australia up for the digital economy of the future – although there are many views on what to do and in what order. But they are all pretty clear on one thing, and history confirms it: whatever enhancements we make to the basic platform, long-term customer benefit depends on businesses developing products and getting customers to use them. Competition, not collaboration, is key.

The UK’s Faster Payments service is a case in point. It has been around for four years, but did little volume in its first two years. This is a little surprising: in the UK, electronic payments have a three day cycle and there is no equivalent of BPAY. In that environment, one might have thought a new real-time service would sell itself. But the development was originally approached as a matter of public policy, with relatively little regard for market economics. It is now doing good business, because the participants have worked out how money can be made from competitively offering new services people want, such as Barclay’s Pingit, an instant mobile payment service.

So as we collaborate to renovate the platform, we need to leave room for the competition and product innovation that will ultimately deliver the goods. This time around, there is an extra twist: competition and product development is going to happen as much amongst payment schemes and networks as amongst financial institutions and other payment providers. If new real-time payments architecture is available for everyone to use in a few years’ time, how will the likes of Visa, MasterCard, BPAY and PayPal react? We don’t yet know, of course, but you can be sure it will involve new products and services designed to win business.

This makes for a more complex, multi-layered competitive environment, and that can make it harder to get competitors to collaborate too. But the principles remain the same: As we enter the next cycle of structural evolution, we need to collaborate on the platform, leaving room for future product competition to deliver what the end customer really wants. This combination will get the best long term results for the economy.

Chris Hamilton

Chris Hamilton

Mr Chris Hamilton was the Chief Executive Officer of APCA from January 2006 to May 2016.

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Here at APCA we have been thinking about network innovation a lot lately – not least because the Reserve Bank is also thinking about it, in their Strategic Review of Innovation in the Payments System. There is a lot of management theory on innovation: diffusion of innovations, disruptive and sustaining innovation, even plenty of recent thinking about clustering of expertise and innovation networks (not the same thing as innovation IN networks, by the way). But none of the theory I’ve read so far really grapples with the special problems of services that have a network effect – ie where the number and kind of other users of a service affect its attractiveness to any one user. Payments is a classic network service – merchants want to accept a card with the biggest possible issued base (or perhaps issued to lots of high net worth people); consumers want a card that is accepted in every shop near their home, and so on.
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