Three drivers fueling the digital transformation of retail payments

The rapid emergence of ubiquitous connectivity, increasing pervasiveness of the cloud and general increases in customer demand are all macro factors that, when viewed collectively, are driving a perception shift across the retail industry about the role and value of payments in the future of commerce. The card-issuing and -acquiring ecosystems are in some ways in the midst of an identity crisis as they work to respond to these shifts and evolve their value propositions. The general realization is that to move beyond providing what has become a largely commoditized service, a deeper commitment to digital transformation is required. In this report, we discuss three major payments market shifts that are creating new imperatives for transformation across the industry.

The forces of change are driving evolution up and down the retail payments stack. No longer are price, scale and lock-in the sole basis for competition. New competitive battlegrounds are being unlocked around the user experience, partnership model and data services, creating opportunities for emerging and sub-scale players to enter the market and thrive. More established players that have long benefited from the status quo are now reconsidering the role they will assume and value they will deliver in the future of commerce. This period of reflection marks the beginning of what will be a multiphase digital transformation journey for the retail payments ecosystem.
The recent realization that payments can and should be more than just a commodity service is driving an unprecedented amount of evolution across all facets of the value chain from a product, strategy and go-to-market standpoint. Below we detail three of the more pervasive paradigm shifts that are catalyzing broader industry transitions in both the card-issuing and -acquiring ecosystems.

Transactional focus to user experience and engagement focus

The traditional retailer mindset has been that payments are effectively a 'cost of doing business' – a necessary evil required to facilitate a sale. This perspective has meant that up until recently, payments have been viewed solely as a transactional activity, with little thought given to any deeper strategic value that they might hold.

The past several years have seen more enlightened thinking, with significant emphasis placed on the overall user experience of payments. Retailers increasingly understand that by making the transactional layer of the shopping journey effectively invisible, increased conversion rates and improved customer satisfaction will follow. This enhanced focus on the end user has created a greater emphasis on design across the payments industry and a sharper orientation on ease of use in friction-prone areas like authentication. Other impediments to the user experience, such as shipping and billing address entry forms, have helped catalyze the development of next-generation payment options such as digital wallets. 451 Research finds that two out of five e-commerce merchants want to make as many digital wallet options as possible available to customers.

It's not only cardholders who are benefiting from the growing focus on user experience. B2B payments service providers are also evolving to meet retailers' heightened demands for simplicity and ease of use in payment products. This trend has opened doors for companies like Stripe and Square, which have thrived in a market dominated by incumbents by creating a user-friendly abstraction layer on top of the existing payments stack that makes it easier for merchants to interface with. As evidenced by this example, the user experience is a battleground where financial technology startups present a major threat to well-established providers.

Retailers are also paying more attention to the role of payments within customer engagement strategies. Savvy merchants like Starbucks have noted that by embedding payments within their digital experience and wrapping it with a rich rewards and loyalty layer, more meaningful customer relationships can be formed. Many others have begun to heed Starbucks' guidance, with major retailers such as Walmart and Kohl's noting that a branded wallet offering provides not only greater control over an acceptance strategy, but also an avenue to expand relationships in high-value customer segments.

Mono-distribution to omni-distribution

For many decades, payments acceptance has been driven into the market via acquiring banks and their networks of ISO resellers. The rapid proliferation of internet connectivity, which has given way to digital commerce innovations such as the on-demand economy, is reshaping this distribution model.

Today, commerce touchpoints expand far beyond in-store and the browser. The migration of payments into native apps, wallets and other connected environments has created a seemingly endless list of partners for payment companies to align with. Many of these new commerce intermediaries, which run the gamut from application developers and technology partners to emerging payment gateways and facilitators, are ones that traditional players aren't accustomed to working with. To compete effectively in this more complex partner ecosystem, payments companies of all types – acquirers, issuers and networks – need a new and more scalable partnership model.

The growing importance of a new and largely nontraditional partner ecosystem in powering payments acceptance in the digital economy has already driven many well-established firms to re-architect their channel strategies. Today, developer programs are emerging across the value chain, with Visa, Ingenico, First Data and Mastercard just several of many providers launching formal developer outreach initiatives over the past 12-18 months. These developer programs, which include access to select APIs for core and strategic products, support services, testing environments and hackathons, offer early evidence of a broader digital transformation around the distribution and consumption model for payments.

Partner-driven transformation requires companies to distance themselves from their closed and monolithic infrastructure. The industry-wide push for APIs and ease of access against the backdrop of regulatory forces like PSD2 has led companies such as Visa – which launched VisaNet in 2016 after some 60 years of operating as a closed system – to transition to open platform models that make their technology stack more accessible and partner-oriented. Commerce innovation will only accelerate as more payment providers move to open platform approaches.

Data to intelligence

Payment companies and retailers have long enjoyed access to a wealth of purchase data. That data, both structured and unstructured, has often sat dormant or leveraged for fairly generic use cases such as customer segmentation or risk scoring. Today, we are noting a significant shift where transactional data is being leveraged as the basis for new products and customer experiences.

A primary focal point for the drive toward data-driven intelligence is anti-fraud. Many of the vendors we speak with in this market segment, including Signifyd, Kount and Feedzai, are investing heavily in artificial intelligence to help move merchants toward less-intrusive risk-based fraud controls that auto-adjust based on criminal patterns. Here, pooled transaction data paired with third-party inputs such as social media data help retailers better provide 'fast-track' purchase experiences for their most valuable customers while implementing more rigorous authentication only for those transactions deemed likely to result in a chargeback based on prior transaction trends. These types of frictionless anti-fraud protocols will become increasingly important as commerce migrates to Internet of Things environments that may lack physical user interfaces.

Payment providers with access to massive transactional databases are also taking steps to augment their businesses by introducing new services that enhance their value to customers. Visa, for instance, introduced both the Visa Commerce Network and Visa Advertising Solutions last year to position itself as a more strategic partner for retailers. By tapping data from VisaNet, both services help retailers attain greater value from Visa cardholders through access to customer targeting and advertising attribution. Square's unveiling of a lending product in 2014 is another example of a vendor utilizing payments as the lynchpin to move into adjacent areas. Square Capital leverages transaction data attained from its Square Register point-of-sale service to make a financing determination based on the health of the customer's business. The utilization of purchase data in this scenario helps Square keep default rates low while allowing it to serve as a growth partner for its customers.

The next major frontier for the role of payments data is personalization. Most innovations here have barely scratched the surface of what contextual commerce experience should and could look like. Starbucks, which recently began personalizing offers in its native app based on customer purchase trends, offers an early example of how payments data can be used to build a more relevant, value-added experience for customers. Chat bots also show the way forward for the future of transactional data in personalized service. Bank of America's erica bot, for example, is being designed to make personal finance recommendations based on inputs such as credit scores.

However elementary some of these early personalization experiences may seem, it's not difficult to see how automated banking and commerce interactions can become even more contextual via richer data integrations. The challenge for payment providers will come in not only linking customer data across their business, but also attaining the talent to convert it into actionable intelligence. As such, data science and software engineering backgrounds – not risk and finance – are the skillsets that we believe payment companies should be increasingly seeking.