Prepaid Micropayments and the Bankcard Industry: Ways to Play a Growing Trend

Prepaid -- until recently, it was a category that garnered little attention for Financial Services Institutions (FSIs). Prepaid macropayment solutions such as the Starbucks Card were largely merchant-sponsored, and thus closed-loop. Prepaid micropayment solutions were concentrated in a few isolated market areas, including tolling, transit, and prepaid long-distance.

But several developments in the rise of prepaid are changing that. First, FSIs have begun to embrace the issuance of prepaid macropayment solutions and are seeing the need to seek a strategy in the recharge process as well. This shift will continue: TowerGroup predicts that bank-issued prepaid gift cards will rise from 7% to 35% of the total US gift card market between 2003 and 2007, as merchant-sponsored gift cards cede share to their bank-issued, open-network relations. Issuers are seeking to boost growth in an increasingly saturated bankcards industry, and prepaid solutions mark an important extension of the traditional pay-later (credit) and pay-now (debit) product sets.

Second, the success of prepaid mobile is forcing FSIs to consider more closely the impact of prepaid micropayments on their business models. The size of the global recharge market, and the opportunities to use prepaid mobile and recharge as an entry point into other types of mobile commerce services, give FSIs a reason to watch the emerging payment-services providers that have embraced prepaid and prepaid recharge. Increasingly, these alternate payment processors are seeking to use their foothold with consumers to support other prepaid solutions that could compete, directly or indirectly, with today's core FSI payment offerings.

Yet prepaid micropayments (those for electronic transactions of less than $2) still place the average FSI at a competitive disadvantage. The interchange and support levels necessary for effective customer service for $20 transactions would be unprofitable for sub-$2 transactions. What role can FSIs play?

TowerGroup believes that FSIs can form alliances, either with leading industry payments vendors or initiatives from within the telecommunications or financial industries, to embed themselves in the recharge process. This kind of alliance could make FSIs the macropayment transaction behind the micropayment when a direct bank link, debit card, or credit card is used to reload monetary value onto the stored-value account or card. Prepaid payments will expand from proprietary niche solutions to applications with greater reach across multiple market verticals, and driving user adoption will depend in part on creating a trusted, standardized electronic recharge capability that is more convenient for users than cash payments. This recharge solution must be cost effective and ubiquitous enough to compete with physical points of recharge that accept cash. FSIs' scale, breadth, and trusted relationships with customers give them important advantages over emerging competitors.

Several options exist for FSIs. The first is to purchase part or all of a vendor involved in this space. Such deals have already been signed in several world markets, particularly as payment processors in the financial industry attempt to establish a stronger role in this value chain. The second option is to internally develop and market a proprietary recharge solution. A few banks have taken steps in this direction, but most FSIs will find this approach to be a drain on financial and development resources.

The third route is partnership. In this approach, FSIs are aggregated together within a recharge services portal aimed at the consumer market. This portal is branded to bring the trustworthy nature of the FSI into a standardized and recognizable consumer brand for recharge services. The FSI thus skirts the question of supporting micropayment transactions directly without sacrificing brand or market position. In exchange for this participation, banks can receive a portion of the revenues generated through the automation of previously manual processes as well as gain the opportunity to offer new services of interest to a portion of their customer base. This approach allows FSIs to maintain a presence in the growing market for prepaid services.

What's more, it enables FSIs to issue some prepaid macropayment products of their own while working with their partners on a trusted brand identity for both micropayment and macropayment recharge products. This approach leverages a bank's existing relationships with issuers, users, and merchants to provide recharge services cost effectively for "banked" users. Banks continue to hold the customer details for banked recharge customers, which allows consumers the added flexibility and security of maintaining an established financial "master account." It also enhances the bank's stickiness with both new and existing consumers and with the payments loop itself. This strategy enhances the utility of existing payment tools and keeps payment details within the control of a primary financial services provider. This is important because a significant portion of consumers have indicated they are most comfortable when these details reside with FSIs.

If FSIs can drive the payment component of recharge, they can bring both brand and scale to this area of the value chain. Partnering with merchants, vendors, and network operators in specific vertical markets will enable FSIs to leave the affinity and micropayments issuance to others while they concentrate on the larger-value transactions that reside behind the scenes. Even operators that choose to remain in a closed environment, in such areas as single-merchant gift cards, tolling and transit, and mobile, will be able to benefit from the lower costs and increased brand and service awareness of scalable recharge offerings that support an integrated, multi-FSI-supported brand. These add value to the services' utility much as credit and debit card acceptance does for a physical, telephone, and online merchants. A successful partnership will provide a clear marketing message that the combination of the prepaid mobile operator and the FSI is best positioned to deliver coherent, convenient, and accessible recharge to consumers.

Mr. Edward Kountz is a senior analyst in the Emerging Technology Solutions practice at TowerGroup, a leading research and consulting firm focused exclusively on the global financial services industry. He can be reached at [email protected].