Themes On Our Radar in 2015

Navigator Edition: January 2015
By: Ben Brown

The payments industry is going through a multi-year period of disruptive change. Not only are payments companies reacting to positive and negative forces – shrinking revenue pools, increasing regulation, changing customer behaviors, the growth of digital commerce, technical change, and more – but outsiders also continue to try to enter and re-shape the business. With that in mind, we gave some thought to the most notable events of 2014 and what we are watching in 2015.

As we looked back, a number of events rose to the top as particularly notable:

  1. Data Breaches: It seems like there was a merchant data breach on the front page of The Wall Street Journal every month in 2014. The scale and frequency of card breaches over the past year was unique as hackers compromised hundreds of millions of cards used at major retailers. These events made payments a C-level issue for merchants and also changed the narrative around EMV. Executives stopped talking about delay (of the October 2015 liability shift) and started talking about defense (against sophisticated hackers).
  2. Apple Pay: Apple announced its eagerly-anticipated but closely-guarded mobile payment service in September. In some ways Apple Pay mirrored much of what Softcard and Google had done before but it was also a showcase of new technology: network-standard tokenization, biometric authentication, and deep iOS integration for in-app payments. (Each of these technologies deserves its own mention, but we can cheat by pointing just to Apple Pay.) The level of influence Apple was able to exert on industry stakeholders was unprecedented. It is very early, but Apple Pay could be the watershed event needed to stimulate mobile payment adoption at both the consumer and merchant level.
  3. Interchange Reform: Interchange continues to face headwinds around the world. The European Commission proposed strict limits on debit and credit card interchange in Europe (0.2% and 0.3% respectively) while Visa and MasterCard volunteered to reduce credit card interchange in Canada. These moves will eliminate billions of revenue worldwide, require creative rework of products and partnerships, and ensure that interchange remains a topic of debate in the U.S.
  4. Payments IPOs and Investments: A number of fintech companies went public, including peer lender Lending Club, alternative business lender On Deck Capital, and the Chinese e-commerce giant Alibaba. These are not small IPOs: Lending Club’s $10 billion valuation puts it on par with top-40 banks and Alibaba’s $25 billion listing is actually the largest IPO – ever. These firms are just the leading edge of a wave of new players challenging legacy business models with the tailwind of venture capital and private equity interest. Firms such as Square, Stripe, Adyen, and others closed funding rounds at multi-billion-dollar valuations.
  5. Banks Move to Silicon Valley: While the need for digital innovation is no surprise to anyone, we saw a notable increase in Bay Area innovation labs and investments as financial institutions double down on innovation. American Express, Capital One, RBS, First Data, Vantiv, and others staffed up in the Bay Area this year. FIs also made a number of notable deals, including BBVA’s purchase of the direct bank Simple and, on a different note, Capital One’s acquisition of design firm Adaptive Path. These deals foreshadow where the market is likely to evolve in the future: more M&A by established firms to buy up innovators and boost their digital capabilities.

We expect more excitement to come in 2015 and beyond. Events from this year (or years past) will play out, new players will emerge, and the industry will continue to position for the future. The following ten themes are top of mind for us in 2015:

  1. EMV in the USA: EMV mandates in the U.S. gain some teeth this year. Starting in October, whichever party does not support chip cards will bear increased chargeback liability. Some groups estimate we will see 500 million more chip cards flood the market in 2015, but consumer education hasn’t really begun yet. How will issuers train consumers to dip their cards? Will they promote mobile wallets and contactless alongside EMV under the banner of “next generation payments”? Will the banks rely on merchants to steer consumers? Clearly, there is a lot of work to be done on the EMV front in the U.S and time is short.
  2. Data Security and Identity: EMV is only one part of the journey to a more secure payment system. The broader question of how to stop data breaches, reduce card fraud, and secure digital commerce is a red hot discussion. There are already lots of tools here – point-to-point encryption, tokenization, 3-D Secure, biometrics, device fingerprinting, etc. – but staying one step ahead of hackers and fraudsters is a constant challenge on which many players are focused, as demonstrated by Experian’s $324 million acquisition of 41st Parameter in late 2013.
  3. Mobile Payments: Apple Pay’s U.S. launch reset expectations around the potential for NFC, established a benchmark for partnership economics, and introduced new security protocols. (That said, it remains to be seen how consumer and merchant adoption will truly ramp.) In other news, Amazon released Login and Pay with Amazon. In 2015, Apple Pay is likely to expand to new markets and the desktop Web, the major retailers’ CurrentC payment system should launch, PayPal is set to spin off from eBay, the European service Klarna will enter the U.S., and all indications are that Facebook is working on adding payments to its messaging products. We expect several chess moves among wallet players such as Softcard, Google and alternative payment schemes like LevelUp as they position to win in what is highly developmental market.
  4. Cryptocurrency: After several years incubating in niche use cases, Bitcoin caught the public (and investor) eye in 2013. The value of a Bitcoin skyrocketed and entrepreneurs worldwide laid plans for cryptocurrency startups. A lot of these ventures came to market in 2014, but at the same time the industry experienced its share of negative events (e.g., Mt. Gox closure, Chinese bans, BitStamp breach) and Bitcoin values remained highly volatile. We expect continued interest in cryptocurrency in 2015, but fewer calls for Bitcoin to replace the dollar and more focused discussion of where the technology is appropriate and useful. And regardless of where Bitcoin heads in 2015, it is already having an important impact on advancing industry dialogue on making mainstream payment systems more efficient and cost-effective.
  5. Smart POS: Mobile POS solutions were battered by the press in 2014. Wasn’t a mobile card reader supposed to be in every plumber’s pocket by 2012? Why are traditional POS OEMs and ISVs still in business? Is there even a business model in mobile POS? What we saw, though, was real progress in next-generation “smart POS” for small and midsize retailers. Cloud-based tablet POS solutions have continued to mature and scale; see Square’s $6 billion valuation, Revel’s $100 million investment, First Data alliances beginning to sell Clover with success, and the wide support that players like Poynt and Boomtown have gotten soon after launch. We expect some players to break out this year as leading contenders to be the “merchant operating system” of the future, which is a huge and appealing business opportunity, if these players can carve out a share of the merchant market and deliver on broader commerce and business software plays.
  6. Alternative Lending: Lending Club has taken center stage among alternative lenders following its IPO but there are many other platforms and players worth monitoring. Players such as AvantCredit have raised significant capital while other peer platforms like Prosper and Zopa are originating billions in loans overall. We expect innovative financing models to extend into new consumer and small business niches in 2015. These new players could also provide a catalyst for innovation across the broader credit value chain, allowing players like Orchard Platform (portfolio management), ZestFinance (scoring), and TrueAccord (collections) to grow to the next level.
  7. Marketplaces and B2B Payments: Although not covered as much as B2C payments by popular media, there is a lot of activity on the B2B side of the industry, from payment facilitators like Kickstarter to supplier portals like Taulia to alternative lenders like On Deck Capital. To some extent, the vertical marketplaces enabling the “On Demand Economy” and “Sharing Economy” (think Etsy, Uber, Airbnb, etc.) are also B2B payment solutions. We are watching how these innovators productize and scale payment services in 2015.
  8. eBay/PayPal Separation: eBay announced that it would spin off PayPal in 2015. This should provide both entities with greater freedom to grow. It also makes both entities potential targets for strategic buyers. The strength of the PayPal brand, its share of on-line transactions, its 157 million active users, and its global reach are quite compelling.
  9. Alipay and Interregional Commerce: Alipay is China’s largest digital payment service with more than 500 million active accounts, which makes it about four times the size of PayPal worldwide. And yet few in North America or Europe know much about it. We expect that will change in 2015 as Alibaba positions Alipay as the best way for Western merchants to sell to Chinese consumers, a strategy which it has already begun to pursue with deals like its $200 million investment in ShopRunner, the e-commerce logistics player run by former PayPal president Scott Thompson.
  10. Wearables and Connected Devices: The launch of the payment-enabled Apple Watch in spring 2015 should be a catalyst for interest in wearables. And wearables are just a facet of the “Internet of Things”, in which everyday devices are computerized and network-connected. Futurists love to talk about the fridge which can automatically order groceries – and enabling the automated, unattended payment behind these experiences will be an interesting challenge.
  11. Beyond 2015: While this is a top-10 list of sorts, it would be remiss of us not to break the rules a little to talk about themes likely to play out beyond 2015. One is real-time ACH, another technology (like EMV) that will be old hat in Europe by the time it arrives in the USA. Nine of ten industry professionals surveyed by ACI think it will happen here by 2019. Real-time ACH will be a painful transition but it will be a valuable platform for innovation once in place, as it has been in Europe as the underpinning of new payment services like Zapp. The second theme is orienting to serve Millenials. Millenials are a bigger and more diverse generation than the Boomers and even the youngest Millenials (born in 2000) will soon be financial services consumers. These consumers prefer digital channels, seem slow to use revolving credit, and lack many of the brand allegiances of their parents. Capturing the attention of Millenials will require a unique approach but it could move share in the industry.

Some of the themes discussed here will percolate in 2015 while others may take a while longer to develop. But these trends are broad and meaningful. Innovation is no longer about just one topic, nor is it a question of whether competitive norms will change – only when.

It is important for payments stakeholders to have a clear vision of the future and a strategy for how and where to engage in the market’s evolution. Some players will try to lead the market through internal product development. Others will experiment with investment, incubation, and partnership strategies to engage with outside innovators. Many will likely hang back, participating in innovation only once it has reached a critical mass. Each of these strategies has its own risks and no one strategy is right for everyone. At First Annapolis we are excited to continue guiding our clients through these interesting challenges.

For more information, please contact Ben Brown, Senior Consultant, specializing in Credit Card Issuing and Payments Innovation,

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