By Brandes Elitch
CrossCheck Inc.
In my last two articles, I compared the changes in the payments system to the sweeping changes that occurred in the wine industry. In the old days, grape growers saw their product as "grapes," not "wine."
That changed when wineries in Sonoma County learned to recognize the specific characteristics necessary for each varietal: climate, topography, soil, temperature, wind and more.
This took a lot of time and effort - at least 20 years (from say 1975 to 1995). The changes didn't all come from the large producers; most of them were made by small winemakers who worked directly with growers. They focused on making a better product, but to do that they had to change the whole production cycle.
In the old days, the winemaker would be in the vineyard on just three occasions: to prune, to sucker and to pick. Now, they have people in the vineyards 20 or more times during the growing season, and they harvest grapes three or four times per season. In a sense, they reverse engineered the grape growing process, going from agriculture to horticulture.
Regarding distribution, there were no wine clubs, so winemakers had to reverse engineer that too. Now wine clubs are a lifeline for the small wineries, and there are 450 wineries in Sonoma County, up from a few dozen in 1975.
Without this new distribution channel, the smaller wineries would have to sell through the old distribution model - broker, distributor, retailer - with half of their revenue spoken for before they got a dime. Imagine: to get the cash flow to survive, small wineries had to change their whole distribution cycle.
The biggest change from the consumer perspective has been the vast expansion of brands, styles and choices. There are now over 190 AVAs (government recognized appellations or wine-growing districts).
It used to be a family industry, but the emergence of larger players has facilitated the rapid expansion of knowledge: business practices, research, forecasting, etc. Now, it's a global business.
All this happened over a 20-year period. It was a quiet revolution, not all that noticeable at the time. But, looking back, the whole industry was transformed.
That is what is happening now in the payments industry. As retailers know, their "moment of truth" happens precisely when the customer pays for a purchase. This is what is changing, both inside and outside the store, through mobile payments, contactless payments, stored-value and prepaid cards, digital coupons and vouchers, loyalty points, discounts, new forms of credit and debit, and micro-payments.
In The Future of Retail Payments, published in October 2009, the National Retail Federation stated, "Retail today is defined not by how retailers want to sell, but by how consumers want to buy, and that applies to payments too. Payments options provided with clarity, convenience and value are an important part of the retailer's brand identity."
The goal is to improve or enhance the shopping process for the consumer. Retail stores are by their nature technologically unfriendly, and there is a culture of risk aversion at the merchant level. To make it all work, there has to be a shift from the present decentralized ownership of payment systems at the store to a centralized payments infrastructure.
As the NRF pointed out, in the future the consumer will want to "buy anywhere, get anywhere, and pay once, in one channel, for all of it" - a pretty tall order.
While this won't be cheap, we should not ignore the fact that, again to quote the NRF, "Credit card interchange fees have risen exponentially faster than even retailers' health care costs, and as a result retailers ... are looking for new opportunities to reduce both the risks and costs associated with accepting noncash payments."
I cannot emphasize strongly enough how retailers feel about this.
Again, from the NRF: "For retailers' part, economic conditions, technology, competitive landscape, and consumer buying habits have seriously eroded margins, and credit transactions have become expensive and risky. The card networks have created disincentives for retailers to move consumers to debit by raising interchange. The question that retailers are asking is, are there alternative networks that provide new value at lower cost and risk?"
This is exciting news for ISOs and merchant level salespeople (MLSs). The retailers are asking you to offer them new payment solutions to meet these goals. The last time ISOs and MLSs had this type of far-ranging opportunity was when the card associations introduced electronic ticket capture. This will be an even bigger opportunity. But it won't be easy.
As the NRF said, "Few ideas can elicit bigger shudders from CIOs than 'let's change POS and our payment systems.' The one job that a CIO cannot fail at is processing transactions at the point of sale. Because of the mission critical nature of both the payments infrastructure, and the systems it integrates to, there is very little internal excitement over tinkering with it.
"But there is still opportunity, because the other side of this argument is that the existing legacy systems are 20 years old, with multiple patches and updates, that threaten to cause the system to collapse under its own weight."
Now let's look at how large retailers came to be in this position. Twenty years ago, the dominant commercial computing platform was the IBM mainframe. The programming language at that time was COBOL, which worked on every computer platform.
Two events happened to change this: Oracle made a database that worked without the mainframe environment, and Sun Microsystems invented a new programming language called Java, which they made open source. Java was free and easy to build applications with, and it became ubiquitous.
Most analysts would admit that Java was a key factor in the explosion of technology and innovation over that period. Free Java implementation is a big part of Google Inc.'s Android operating system. That mobile OS is an alternative to Apple Inc.'s competing OS, which powers the iPad and iPhone. The Apple platform is more expensive and "closed." What changed is that Oracle bought Sun. Then, two years ago, Oracle sued Google, contending that Google's use of application protocol interfaces (APIs) infringed on the Sun patents. The question is, can you copyright an API if it is written on an open source platform? Or put another way, can you separate the API from its programming language?
Google argues that APIs are not patentable. Oracle argues that they are part of Oracle's intellectual property and are patentable. If Oracle wins, it will take years to negotiate all the copyrights and licensing arrangements. This would give Apple an even more commanding position in the retail world.
Now, let's take another look at Apple. What if Apple, which has $100 billion in cash reserves, was to buy both Square Inc. and foursquare? Foursquare is a mobile application that allows users to "tag" themselves at local businesses they go to regularly, like Starbucks or Jamba Juice, for instance. Twenty million people have downloaded this app in the last three years.
If Apple can track customer preferences, it can deliver relevant "iAds," which currently form the core of Google's revenue. The iPhone would gain a better local search capability. If Apple could offer location-based posts, and add content (and maybe even photos), it would dominate the consumer side of the transaction.
All that remains is to determine how the merchant will process the sale. Square would handle that, although my sense is Jack Dorsey's company would only work for smaller merchants - the 10 to 20 million small U.S. businesses, most of which do not take card payments now.
Square would be easy to sell to those merchants, who may not process a significant number of transactions or for a large amount of money, but in the aggregate would be a very desirable customer base for somebody.
I am not suggesting that the top 200 retailers use Square to process transactions. But they will need a POS system that accepts input from both Android and Apple applications. If you were the information technology manager of a large retailer, what would you be doing now?
Merchants have historically looked to ISOs and MLSs to explain these things to them, and our industry's feet on the street have succeeded because they have done a better job at this than the acquiring banks.
As I wrote in a prior article, "Big changes ahead," The Green Sheet, Feb. 13, 2012, issue 12:02:01), about 11 million terminals are in the United States, and these will have to be replaced in the next few years to accept chip and PIN transactions. That is a big enough challenge right there.
The retailers' challenge is to find a payment system that meets industry standards and provides consumers with the alternatives they want to use to make purchases, and these alternatives are expanding every day.
It is a challenging environment, but this could be another golden age for ISOs and MLSs, just like when electronic ticket capture emerged. Stay tuned for further developments.
Brandes Elitch, Director of Partner Acquisition for CrossCheck Inc., has been a cash management practitioner for several Fortune 500 companies, sold cash management services for major banks and served as a consultant to bankcard acquirers. A Certified Cash Manager and Accredited ACH Professional, Brandes has a Master's in Business Administration from New York University and a Juris Doctor from Santa Clara University. He can be reached at brandese@cross-check.com.
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