Lately I had the chance to talk with a really smart entrepreneur who’s into payments. I was baffled, frankly, about why someone would go into online card acceptance, a fragmented and crowded market. He offered a great piece of insight: payments are an obviously broken part of the shopping experience, an interesting and big market that’s not advertising or gaming which is usually where young entrepreneurs go. I respect that, and I also respect the fact that he is knowingly marching towards the unknown; hoping for his and his team’s success, I know they’re going to rightfully earn some gray hairs in the coming few years.
However that raises a question that I’ve dealt with in this blog in the past: what does it mean to succeed, to “win” in payments, and what it takes to get there. Offering a solution such as card acceptance for small merchants or starting with a niche like college payments or digital content can provide good initial traction for a budding payment service. The question is, however, whether you can expand on that early start and scale; at this point you have to deal with money movement being a commodity.
Small and medium merchants are growing more sophisticated with their webdev capabilities, and they will integrate you for a better price. It’s that simple: a better price or a slightly better integration or a slightly conversion-growing experience will get you a small crowd, enough for initial traction; some of them will just add you to the pile of services they are already using.
That’s exactly what most of the new startups in payments do, and that allows them to stick around while they fund their merchants’ business using VC money or burrow deeper into a high-margin market segment like digital. Unless you have very deep pockets or can raise money effectively (and there are few players that can), you’re in trouble: price hikes, alternative revenue streams or an obligatory move to ACH payments will ensue, probably resulting in an exodus to the next low-price service, and you will never reach scale (there are other, better options – I will discuss them in a following post). At some point, it’s convert users to low cost funding sources or get out of the game.
If you think I’m exaggerating, read this post and then these great answers on Quora; price wars are not sustainable, and the market can’t support so many payments companies trying to reach scale at the same time. Something has to give.
How do you differentiate? This is the time to ask yourself whether what you’re building is a feature or a product, and whether you’re really providing any added value, and lastly whether you have an exit plan at $50M, $200M or are really playing for the big league. Each should be planned for differently. Payments are not a pure consumer play; you rarely go viral. The really interesting problems in payments have very high barriers for entry; the type of problems currently being tackled, not so much:
- Have a beautiful dashboard for merchants to view their customers’ behaviors? So do others.
- Looking at easy integration and no need for a merchant account? Stripe and Braintree have that figured out, and they’ll have to start thinking about merchant retention and higher pricing very soon, if not already.
- Thinking of a coupons and loyalty plan? Good luck with adoption.
- Planning to use ACH or other bank payments? Gear up to challenge PayPal adoption in the US, and consider whether Dwolla’s approach to bank payments isn’t the main driver behind its slower growth compared to other services.
- Thinking of a new POS system? Even Square, doing so many things right, is going to be pushed on price and market share by companies replicating its model. It comes down to brand and convoluted termination clauses in long term agreements, like any other commodity business.
This is deep pockets land with some talent acquisitions around the edges, not a place for innovation.
Does this mean that there’s nothing to do in payments? No. There is a lot to do in payments, and I believe that this guy I mentioned and others will find success in their business, even if not displace PayPal and others. There is, though, a more interesting aspect of the market to attack. More about that in my next post.
Regardless of whether it’s a three-card monty play or a brilliant PR move, Seth and his team are transitioning interchange from a tax-like pain point to a revenue generating value-add. They’re reinventing the commoditization of interchange in a way that works for a merchant’s bottom-line.
But I think I see the point (and correct me if I’m wrong): in truth, the current system is extremely efficient and considering the massive risk, investment and ubiquity needed to succeed, it’s pretty much impossible to disrupt.
But the fact that he can do this underscores the existing tension, hate and friction the current system creates for businesses. Hell hath no furry like a merchant’s scorn for swipe fees.
I’d also like to add one more thing.
There’s something powerful about shifting the traditional paradigms of entrenched industries. If a company is able to alter a behavior, improve on existing efficiencies, or create new value within the existing [or perhaps entirely new] system, you’ll essentially be creating an entirely new an entirely new market for payments. With new markets come the new sources of revenue streams.
disclaimer: I have never spoken to Seth personally, or anyone from his team. I also work for Dwolla.
My point was indeed about the system. I think it can be disrupted but not the way the problem is approached by most companies. Dwolla may be one of the unique ones, although you guys are facing your own challenges.
As for LevelUp, they just happened to be a comfortable example. Calling this a 3-card monte will be too strong a statement, I don’t think anyone is looking to mislead. On the contrary, I’m sure the team there feels that they’re doing a good thing. I am pointing to the fact that, as you noted, much of that effort is futile due to market constraints that are being ignored.
As you previously broke down the payments space into roles, it is clear that LevelUp is an engagement driver for the offline space. Seth’s press strategy purely fits the challenge that he is trying to overcome – network additions of users and merchants.
I spent over 2 years in business development and in product forums with Seth at LevelUp and have realized that the company has adapted to his unique strengths – an ability to control press and to create payment structures meant to disguise revenue generation. However, this move and plan marks his best step towards profitability (although as the numbers show a bit far off).
Also to take into consideration, Seth is in the middle of raising a round of funding and it appears that it has been difficult to find a serious financer to step to the plate.
Something to also consider – Seth also makes claims as to reducing risk and its impact on interchange fees. Disguising the consumer cc number is a very small part of the risk in offline transactions. I’m surprised that no one has pointed out this claim as well – valid?
I don’t think I’m in a position to comment about what’s going on inside LevelUp. It won’t be the first or last company in payments, and generally, boasting capabilities it doesn’t necessarily have. I just gave them as an example of a trend, or a reality, in the payments market that many don’t realize.
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