By Peter Williams FCA and Peter Evans-Greenwood

The introduction of the modern smartphone (and iPhone) has resulted in an explosion of new payment solutions, each intended to erase one of life’s little inconveniences.

Alternative payment solutions have come to the fore, unshackled from their physical limitations. New payment solutions have also emerged. Many, such as Stripe, a smartphone- and tablet-based PoS solution, are only practical in an always-on and always-connected world.

We seem to be at the leading edge of a Cambrian explosion in payment solutions, with more appearing every day.

At the same time, incumbent payment processors are investing in their next generation of platforms. These platforms, such as the New Payments Platform being developed by the Australian Payments Clearing Association (APCA), are intended to support real time low-value payments, initially between deposit taking institutions, but eventually including “suitably accredited” institutions (institutions that could easily include new, alternative, payment providers).

The recent explosion in payment solutions might be a sign that we’re approaching a point where the confluence of mobile apps, cryptocurrencies (a type of digital currency that uses cryptography for security and anti-counterfeiting measures), loyalty schemes, gift cards, and cheap and effective low-value bank-to-bank transfers change how the customer and merchant manage their commercial relationship.

The unknown in this equation is Apple Pay. The huge resources at Apple’s command ensure that Apple Pay will see short-term success. However, long-term success, and particularly success outside the US, is uncertain.

The question at the front of mind of many merchants and institutions is whether to invest in yet-another next-generation expensive payment infrastructure.

How we pay is changing

How we pay for the goods we receive is clearly changing. The development of cheap and ubiquitous digital communications has resulted in payments moving from the physical to the digital world.

Electronic funds transfers (via debit and credit cards, BPay, etc) are increasing at the expense of cash and cheques. Consumers are choosing to pay with a tap and a wave, the click of a mouse or tap of a finger, rather than via the physical payment methods that we’ve used for living memory.

The Reserve Bank of Australia’s (RBA) latest Trends in Retail Payments survey (the third in the series) found that the use of cash and cheques has declined noticeably over the past three years while the main electronic forms of payment (debit and credit) increased. This is the result of a number of factors, from the adoption of contactless-card technology (one of the drivers for the adoption of Apple Pay in the US) to the increasing importance of remote transactions (particularly to support online commerce).

Electronic transactions (both payments and cash withdrawal) now average around 250 per person, an increase of around 55 per cent from five years earlier, while cash accounts for 18 per cent of the value, and 47 per cent of the number, of transactions.

While cash is in decline, it remains the most frequently used means of payment. Consumers are using it for the majority of their low-value transactions, with around two-thirds of payments under A$20 by cash.

Cheques, in contrast, are retreating to the high ground. While also in decline — with eight cheques written per person in Australia in 2013/14, down from 28 cheques per person 10 years earlier — the average value of a cheque rose by 19 per cent to roughly A$6,800.

Cheques are being used for high-value payments where there is no suitable digital alternative. This may change with the introduction of point solutions, such as the electronic conveyancing platform by Property Exchange Australia Ltd, or general solutions, such as the New Payments Platform from the APCA.

This shift from physical to virtual payments suggests that the future of payments is online and real time.

Predicting the future is hard

Initially micropayments — transactions involving small sums, typically under $1 — were seen as the future of internet commerce. Our ability to cut value into ever-thinner slices would enable a magazine to charge for the article, rather than the entire publication. Standards were developed, business models crafted, and start-ups launched.

It was all for nought as micropayment providers struggled to keep costs low enough to be commercially viable while consumers found frequently acknowledging small payments an unwanted burden.

Digital wallets came, and largely went. They provided a compelling proposition to the smartphone manufacturers and to the telcos who would sell the smartphones to consumers. Consumers, however, did not find them as attractive.

A digital wallet might remove the need to carry credit cards, but consumers found that they still needed to carry a physical wallet.

While there have been many failures, we have also seen some notable, though limited, successes.

M-PESA is the world’s most successful mobile payments solution. Launched in 2007 in Kenya and Tanzania, M-PESA enables consumers with 3G phones to open accounts, store money and transfer it to other accounts, with a small fee for transfers and withdrawals.

M-PESA provides a compelling mobile solution in an environment without significant fixed infrastructure. Its value proposition, however, is less compelling in the developed world.

We can also consider Apple Pay a qualified success. It has seen significant adoption in the US, but then the US has poor chip-and-pin penetration and the banks saw Apple Pay as a tool to improve adoption. This triggered intense competition between the banks to be the first account registered in Apple Pay, as the typical user only registers one card with Apple Pay.

The story might not be the same in Australia or New Zealand where there is high chip-and-pin penetration and the regulated service fees mean that banks would need to give revenue to Apple.

There’s also an open question over bitcoin and other cryptocurrencies. They have been touted as the future of international exchange, with their unregulated nature enabling thousands of start-ups to create new wallet and payment solutions. Cryptocurrencies have also been proposed as a tool to bring the unbanked into the digital economy, as their low fees will enable the creation of lower-cost solutions.

However, the volatile nature of cryptocurrencies means that they are not attractive outside the early adopters.

We expect to see ongoing innovation in the area from local players such as Coinjar, which has recently released products such as Swipe which allows you to use bitcoin through the EFTPOS system or others such as Coindesk that has 7,000 developers in their open development community.

Changing drivers for adoption

Our digital infrastructure has improved to the point that we’re moving away from needing to deploy ever more capable solutions, to focus on how consumer habits are changing.

Stripe showed us that the PoS solution could be built on the consumer internet and smartphones. This technology shifted the balance of power from merchant to customer. The contours of the future payments landscape will be shaped by consumer preferences.

Consumers seem to prefer to pay somewhere other than the till. They are inspecting merchandise in a physical store and then purchasing from an online merchant, a trend called showrooming as the consumer is using a physical store as a showroom.

Some online merchants are capitalising on this trend. Amazon has a mobile app which enables consumers to scan a barcode to buy a product and have it shipped directly to their home. The barcode they scan could be on a friend’s book, or a book plucked from a merchant’s shelf.

Apple has taken this idea a step further, blending on- and off-line experiences in their Apple Store app (as opposed to the iTunes Store app) that enables consumers to pick a product from a shelf in the Apple Store, scan the barcode with their iPhone, and walk out of the store with the same product. The purchase is made virtually via their Apple account rather than via the store’s till.

The exchange of goods is also separating from payment. One of the drivers behind this shift is servitisation. This is a shift to sell value-added services that include products, rather than simply selling the products themselves. Servitisation started with expensive, complex products — Rolls-Royce’s TotalCare “power by the hour” service for jet engines is considered the first, and classic, example. It has since moved downstream to consumers. The music industry, for example, is in upheaval as music-as-a-service vendors such as Spotify replace traditional product-based models.

Some firms are using loyalty schemes to shift payment from the centre of the consumer-merchant relationship. Starbucks is putting the firm’s loyalty scheme (My Starbucks Rewards) at the centre of their relationship with the consumer, enabling the consumer to load funds into the scheme and make purchases, as well as to accumulate reward points. It’s not a long stretch to create a similar solution based on a post-pay, rather than a pre-pay model.

This is something that Skip has done, creating an app that enables consumers to find a café and order their coffee before they arrive, with the transactions accumulated and billed weekly.

Merchants are finding that the growth of digital payments has made transaction fees a significant expense, leading them to question the value provided by established payments networks. At the small end of the market we find restaurants encouraging customers to pay via cash to avoid fees. At the other end of town we’re seeing larger retailers fund the development of alternative payments solutions such as CurrentC, led by Walmart in the US, that sidestep the payment networks and their 2-3% fees.

What might the future look like?

While the future is an undiscovered country, there are some general observations that we can make, and which will guide our actions.

First, the obvious. The trend for virtual payments to supplant physical will continue. Governments see organised crime as a major beneficiary of cash and its anonymity, and would like to scale back its use. Financial institutions would also like to reduce or eliminate cash as its physical handling is seen as an unnecessary expense. And finally, consumers would welcome the opportunity to eliminate the need to obtain and carry cash. However, we need to ensure that the unbanked, often the disenfranchised and poor in society, are not marginalised by its elimination.

High-value payments will move from cheque to direct account-to-account payments.

Next, the not so obvious.

The shift from physical to virtual payments should be considered a shift from physical to mobile payments. The long-term trend we can see emerging is for consumers to use their mobiles to mediate their interactions with merchants, including payments.

We can see many incidental, day-to-day payments migrating to loyalty schemes as merchants use the customer’s financial account to foster loyalty by rewarding use. This provides a platform to integrate value-added services and separates the exchange of merchandise from the payment.

Finally, the long-term winner may be real time, bank-to-bank transfers, as merchants aggregate transactions and then use low-cost, real time account-to-account transfers for settlement.

As a merchant, you need understand that how your customers pay is woven throughout your interactions with them, and that the customer will determine when and how the payment is made. If the merchant makes the payment inconvenient (by forcing the consumer to find their way to a physical till, for example) they can expect the customer to find a more convenient option (using Amazon’s app from the aisle, perhaps).

Choose payments technologies that help you build a closer relationship with the customer, rather than simply upgrading to latest and greatest solutions provided by the incumbents.

Financial institutions have a different challenge. They need to consider themselves as a platform that enables the creation of payment solutions, rather than as the provider of a small number of well-defined end-to-end payment solutions.

The payments landscape is becoming an innovation battleground where the winners will be determined by consumer preference rather than technical merit. While we can be confident that these payments will be in sovereign currency, how and when these payments will be made is not certain as we can see the cracks in the head-to-the-till-to-purchase model.

Peter Williams FCA, a global thought leader on innovation and use of web technologies, is CEO of Deloitte Digital. Peter Evans-Greenwood is an engineer, author, futurist and a fellow at Deloitte's Centre for the Edge.

This article was first published in the June 2015 issue of Acuity magazine.