The traditional Payments Stack is the product of decades of technological and business model innovation (BMi).
Over the last decade+, we have seen a slew of ‘disruptors’ enter the Payments industry, including (but not limited to): Stripe, Square, Venmo, and others. Nevertheless, it is ‘the stack’ itself that is still in need of disruption, so in this post we look at some of the alternate payment models that could manifest in the future.
Payments Stack – Reference Model
To understand the current payments stack requires significant research, so a visualization or two always helps to make it easier.
- The merchant is charged ~2% on every credit card transaction (1.8% in the U.S) and about 6X less than that on every debit transaction (0.3% in the U.S.) – these “Interchange Fees” are the backbone of the Payments Business Model. The average debit transaction fee was $0.23 in the U.S. in 2019
- From there, the money is split between multiple different parties including the Payment Processor (ie. Square), Card Networks (ie. Visa), Processor, and then the Issuing Bank (ie. the consumer’s bank)
- The Issuing Bank will make the lion’s share of the profit on each transaction, with the Merchant Acquirer in second place. Card Networks and Processors make the least, but as Payments is a $2 Trillion+ industry, $Billions are made by all parties in payments
- Consumers will mostly use debit cards to pay in store, while the majority will use credit cards to pay online
BNPL (Buy-Now-Pay-Later) Model
BNPL was considered a ‘disruptive’ model in and around 2020 when it started to become prominent among young people as a “new” way to pay online. The concept was based on the old ‘layaway’ model of payments popularized by Department Stores several decades ago where you would make a payment in four installments with no interest. The Big 3 of Afterpay, Klarna, and Affirm have re-popularized the industry on the back of a modernized tech stack.
- The merchant is charged 4 – 6%, on average; this includes the payment processing fee (which merchants hate paying anyways) and the merchant is then no longer on the hook to collect any payments from the customer, they get paid in full. The diagram below shows what the original Afterpay business model looked like at launch
- From the consumer perspective, it is a hybrid between cash and a loan, offering additional benefits beyond a credit card under the assumption they pay on time
- BNPL essentially competes against credit cards in the eCommerce checkout flow, and as such has become a huge market for those competing in it in the retail sector
- As we saw in the consumer preferences diagram in the section above, however, it represents only a tiny fraction (0.3% in Q4 ’21) of payment volume
- From the consumer perspective, BNPL is a fresh model (although not without risks), but for merchants it is still a heavy cost. Merchants tend to see it more as a Customer Acquisition funnel, but its use case is principally limited to retail purchases
The Micropayments model is the emergent model in the payments stack that could significantly change how commerce is done online.
- Micropayments can best be described as the ‘missing middle of payments’ online because it is not a subscription model, nor an ads-based freemium model from the consumer’s perspective
- The problem is that a lot of the now incumbent online payment processors have minimum transaction fees of at least $0.30, making the micropayments model impossible to execute
Cost per transaction – if the cost of using incumbent payment processors (ie. Stripe, etc.) is $0.30 + tx fee then the model falls apartMicropayments Business Model Vision
- To change the incentive structure – and ultimately the payments business model – would require significant technological innovation, as the ultimate business model is simply a much lower net margin for whoever innovates in that market
Micropayments Mockup Canvas
- As such, we see frequent discussions around the micropayments business model linked to platforms and in relation to the Ads model, as the major Web 2.5 or Web 3.0 platforms are the most likely to implement and benefit from a micropayments model
- Ultimately, the vision is that micropayments could revolutionize markets like Music, Media, and other markets where artists/creators find it difficult to make a living (Photography, etc.)
Twitter – Creator Payments Model
- As we saw in the first section, cryptocurrencies form a minute part (0.6% in Q4 ’21) of payment volume by consumers
- With Musk’s original experience in the Payments industry (founder of Paypal) and the company’s precipitous drop in Ad Revenue following the $44B takeover, this type of BMi by Twitter makes sense strategically
From a business model perspective, the strategy may be to incentivize Creators to become Twitter Blue Subscribers and embed Payments features that skew the playing field towards them.Twitter Business Model Vision
- Twitter has the Key Resources and a large community of Creators who they could test the model on, which is probably why it is a blank slide. Whether it does end up being a blockchain-based currency or something else, Payments makes a lot of sense for Twitter
- Brazilian-based Nubank – a digital bank with more than 70M users – has announced the launch of its Nucoin token in early 2023, a concept that will be tested on Power Users from within its NuCommunity
- UK-based Revolut – a challenger ‘super app‘ bank with more than 20M users – has just launched a trial run of their ‘Pay with Crypto’ feature, a feature that allows users to spend in crypto and earn cashback (in the same crypto) right from the Revolut app
- These combined models demonstrate how banks themselves will enter the fray with their own types of innovations, as the Payments stack is so lucrative for Issuing Banks that they want to own as much of the model on their platforms as they possibly can
Overall, we have seen several examples of ‘alternative payments business models’ in the post above. As we are in such early stages of these new models, there is not yet a dominant model. In the future, we may see multiple different models emerge depending on the platform, and the speed that these innovations happen will likely be staggering going into 2023 and beyond.