MarketView is Edgar, Dunn & Company's e-letter providing you with timely views on the critical issues at play in today's global payments economy. MarketView taps the opinions and knowledge of EDC's payments experts across global markets, translating developments with immediacy and relevance to the challenges you face today and in the future.

IN THIS ISSUE:

The State of the Central and Eastern European Cards Markets

Central and Eastern Europe (CEE) spans a vast geography, including Central European countries like Poland and Czech Republic, but also the Baltics, the Balkan region as well as Russia and Ukraine.

Often outsiders have a tendency of bundling these countries together, treating them as one large, homogenous market. That often is misleading. There might be a common history of being on the same side of the iron curtain, but as far as economic development and current economic conditions are concerned, there are considerable differences amongst them. Organisations that are looking at CEE markets, for example as part of their expansion strategies, need to recognise that these markets can be very different. This article highlights some of these differences.

In terms of economic strength (such as GDP per capita), countries in the CEE region generally are trailing Western Europe. But, there are considerable differences from country to country, ranging from US$29,500 in Slovenia to US$2,500 in Moldova. Whilst some banking analysts are now predicting that the worst of the global economic turmoil is over, CEE countries have had very specific problems such as an over-reliance on oil prices to back the economy (Russia); a large exposure to Euro or Swiss Francs denominated borrowing (Hungary); an accelerating decline in GDP (minus 21% in Q1 2009 in the Ukraine, despite an emergency loan from the IMF or minus 20% in Q2 2009 in Lithuania). Given such economic metrics, many analysts are concerned about the exposure of Western European banks that have invested heavily over the last few years in CEE markets.

CEE markets have come late to electronic payments, but have demonstrated rapid growth, that might appear similar between countries. There are headline grabbing figures of growth rates for cards issued in the region. For example, the number of credit cards in issue has increased from less than 1m to 16m in the Ukraine and from 100,000 to 11m in Russia over the last six years. In 2008, approximately 55m credit cards and 200m debit cards have been issued in the CEE region in total.

There has also been an impressive growth in transactional activity. For example, credit card transactions in Russia have seen a compound annual growth rate of 70% over the last 6 years; Hungary has experienced a CAGR rate of 38%; and Slovakia of 41%. Transactional activity (POS and ATM) on debit cards has also increased with a CAGR of 34% in the Ukraine; 24% in Romania; and 17% in Poland. Intuitively, these statistics indicate a very attractive growth scenario in some CEE markets, but what is the relative growth between cards and transactions between markets?

An analysis of transactions per card provides better insight on some of the commercial challenges now and in the future. Differences between markets indicate varying levels of card market maturity and differences in payment preferences. Over the last few years, transactions per credit card have decreased in all of the markets analysed despite strong growth in cards in issue and absolute transaction levels, thereby suggesting that many of the cards issued are in fact inactive or hardly used at all. It is also interesting to note that in some countries (e.g. Russia, Ukraine or Romania) credit cards are mainly used at ATMs for cash withdrawals, which indicates a fundamentally different use of credit cards than in more developed markets and a different set of commercial economics.

As for debit cards, transactions per card are growing in all markets, indicating transaction levels are not just increasing because more cards are issued but because consumers use an individual card more frequently. In terms of achieving greater debit card penetration for retail purchases, this is a good sign.

But even with an increase in debit card transactions per card, market differences exist. Let’s look at two examples. In Romania debit card transactions per card has increased from 19 to 24 since 2002. This increase is almost exclusively linked to an increase in ATM transactions, whereas the usage of debit at the point-of-sale remains fairly flat indicating that Romania retains a preference for cash for retail purchases. In Slovenia debit card transactions per card increased from 49 to 56 transactions since 2002. In contrast with Romania, ATM activity decreased from 30 to 25 transactions per card and purchases increased from 19 to 31 per card, demonstrating consumer’s changing preference towards using their debit card at the point-of-sale instead of withdrawing cash. Slovenia is a good example of a market that is showing signs of debit card POS usage similar to developed markets in Western Europe.

Broadly speaking – and with regard to transactional activity patterns – CEE markets can be categorised as follows*:

It should be stressed that in addition to card usage patterns, there are many other market factors that require careful evaluation in assessing the card opportunity for any CEE market. Regulation, technical infrastructure and the maturity of the acquiring market are factors that require consideration, in addition to general market trends such as GDP, PCE, and demographics.

EDC regularly undertakes market research in the CEE region. Earlier this year, EDC conducted research with more than 30 senior banking executives in the region to understand their view of what the key implications for the cards business would be following the economic crisis. The following points outline some of the general perceptions coming out of this survey.

1. Market attractiveness varies considerably: On one side of the spectrum, Poland is considered the country with the most promising outlook. 66% of respondents would see this market as an attractive or very attractive cards market. The other two markets that also score highly are the Czech Republic and Romania (50% and 48% of respondents, respectively). The three Baltic countries (Estonia, Latvia, and Lithuania), Ukraine and Bulgaria are perceived as less attractive markets. The Ukraine scores worst of all countries, with 45% of respondents having a very pessimistic view of its cards potential. Bulgaria, Estonia, Latvia and Lithuania all scored as less attractive by approximately 35% of respondents.
2. Consumer attitudes will play a key role going forward: Not surprisingly, the reputation of the banking industry has been tarnished following the recent global financial crisis. This is underlined by 61% of respondents expecting consumers to now have a more negative attitude towards banks and banking products. Furthermore, consumers in these markets are just now beginning to fully understand the pros and cons of card-based payment options. Following the dissolution of communist or socialist regimes in these markets, more liberalised market regulation and the increased availability of sophisticated banking products led many consumers to take up offers for payment products that they did not fully understand. Just like buying a Western car, credit cards in particular were seen as a status symbol, a symbol that was to show that “I have made it”. In many cases, the immediate consequences of borrowing were not obvious, but many consumers will have learnt the challenges of consumer credit by now. Survey respondents are expecting that more educated customers are likely to take a more conservative or cautious approach to credit card and loan products.
3. Debit and Prepaid cards will drive the payment markets: As a result of the new, more risk adverse approach of consumers, there are strong indications that debit cards, but also prepaid cards, will be the driving force for the cards and payments markets in the CEE region. Prepaid cards already exist in many markets, with some of the public sector programs, like the municipal prepaid cards in Poland, being examples of successful product launches. Regulatory limitations on a consumer’s ability to borrow, as in Romania, are a further reason for the expected growth of prepaid products in the region. The ability of the consumer to control his / her spending appears to be a key driver for consumers as was confirmed in the survey with 72% of respondents viewing debit cards as attractive or very attractive (the highest rating among payment methods), with prepaid cards being second with 56%.
4. The long-term prospects for CEE markets remain promising: A lot has been said about the economic challenges in most markets in the CEE. However, based on the market research, the long-term prospect for the region are encouraging: 45% of respondents see the region as attractive or very attractive, whereas only 18% have a negative outlook. Interestingly 84% of respondents consider the CEE region as more promising than Western Europe and consequently 94% expect increased investment in the short-term future.

Regardless of the current economic challenges, the CEE region appears to provide good opportunities for organisations to invest and grow their cards business. However, the CEE region consists of many discrete markets, each of which has different characteristics, different challenges and are at different stages of development. Relative opportunities vary significantly by market and nuances of each market need to be evaluated carefully when defining a go-to-market strategy. Through undertaking some basic market research, opportunities can be identified and profitable markets, products and businesses can be developed and grown.

The Rise and Continued Momentum of Card-based Bill Payments in the U.S.

How often have you thought “Uggh! More bills in the mail”. People generally do not react enthusiastically to the process of paying their personal bills. However, “bill payments” is a critical business function for billers, and an attractive opportunity for financial institutions offering payment products.

First, the market for consumer bill payments in the U.S. is extremely large – we estimate that the market size for recurring consumer bills was approximately $5.8 trillion in 2008, representing 58% of the size of personal consumption expenditure. Secondly, the market has demonstrated historically stable growth (~4.5% CAGR). Finally, there has been a significant shift from paper to electronic payments (e.g., ACH, direct debit, credit card, debit card , etc.) facilitated by the Internet and because:

• Electronic bill payments are generally more efficient than paper payments for all industry participants – consumers, billers, and financial institutions providing payment products
• Consumers find it more convenient to pay electronically
• Banks are focusing on online bank bill pay as one way to enhance customer relationships
• 3rd party providers have entered the market and are increasing their market reach to enable bill payments , capturing a portion of the bill payment value chain.

The size and growth of the consumer bill payment market, coupled with the shift from paper to electronic payments, has created growth and profit opportunities for organizations that enable and accept electronic payments – and there is still a significant opportunity to further displace paper payment with electronic payments.

To date much of the check displacement in bill payments has been the result of increased ACH/direct debit usage, but there is also an opportunity to grow card-based bill payments, such as debit card and credit card:

We expect an increase in the card-based share of consumer bill payment volume because of the inherent benefits that cards provide over other payment options:

• Consumers/bill payers are familiar with card-based retail payments and often prefer using a credit card because of card features such as reward programs. Confirmation of the payment can be obtained by the consumer much faster when paying with card, compared to paying with check where there can be potential delays in the mail. Cards are typically easier for the consumer to use than ACH, since card numbers are in-wallet compared to ACH where payers need to find their checkbook/ bank’s ABA routing number.
• Billers are increasingly focusing on the online channel as a low cost and efficient way to present bills, accept payment, and generally support customer service -- accepting cards is integral to this strategy. Many billers recognize that consumer payment preferences are evolving, and believe that it is important to meet the changing needs of their customers. Billers are finding that cards often have lower risk (because of the payment guarantee) compared to ACH as billers often underestimate the impact of ACH returns. However, the economics of debit and credit cards are a primary issue for billers. While billers typically should accept any form of payment using any channel that is practicable, their willingness to do this is often tied to payment economics and their motivation to “push” some payment products / channels over others.
• Issuing banks want to provide their customers choice and payment options that consumers prefer; and they benefit from additional revenue opportunities from the incremental transactions on cards compared to other payment options such as cash, check, and ACH.
• Payment brands benefit from incremental transactions over their networks. They are investing resources and infrastructure in bill payment opportunities, such as biller directories, email reminders for bills, and other promotions on their websites. Merchant acquirers also benefit from incremental transactions from card-based bill payments versus other payment options.
• 3rd party providers view card-based payments as easier and more automated from a settlement/processing perspective compared to checks.

Despite the benefits of card-based bill payments, there are several opportunities to increase debit and credit card usage and acceptance:

• More billers need to understand the value proposition of card-based payments to increase card acceptance and promote usage. Although consumers have often shown a preference for card-based bill payments, some billers either choose not to accept card, or do not actively promote their use because of a perception of higher costs compared to other payment types. Therefore, issuing banks and payment brands need to prove the economic value proposition of card-based payments to billers, and focus on the all-in cost of acceptance (e.g., cost of carrying cash, resources, reconciliations, etc.) and incremental benefits to billers (e.g., reduction in ACH returns, a lower cost reconciliation process, etc.) across all payment types. Banks should evaluate the value proposition (including costs and benefits) by payment type both at the channel and industry segment/ bill type level to determine which payment types to promote – the optimal payment method will differ across these dimensions (e.g., card value proposition for charities, versus ACH value proposition for recurring utility payments). Banks often have a better ability to assess the cost / benefit alternative than the billers, as payments are not a core competency for many billers.
• Consumers need to be more aware of the ability to use cards for bill payments. Payment brands and issuing banks should educate and communicate the ease and convenience of cards for bill payments, and also promote the consumer value proposition (e.g., immediacy of payment, ability to earn rewards). Additionally, issuing banks and payment brands should provide motivation to consumers to encourage first time and continued usage of cards for bill payment (e.g., enhanced rewards to motivate bill payment sign-up and use).
• Consumer banks offering a fuller suite of consumer payment products (e.g., debit card, credit card, bank bill pay) must work across products to optimize their approach to bill payments. Fuller-service retail banks often have product “silos” with differing economic models, motivations, and goals. These organizations should work across product silos when developing strategies for bill payments. For example, there could be ways to actively promote the bank’s credit card as a funding option for online bank bill pay or modifying online bank bill pay enrollment to align with the customer’s debit card number versus direct funding via the DDA account number. Payment brands could partner with banks to help support these efforts.
• Existing players (e.g., banks and payment brands) could better collaborate with 3rd party providers to create win-win strategies for increased card-based bill payment transactions. These 3rd party providers should not be viewed as competitors in this space, but rather partners, helping to educate consumers and billers about the value of card-based bill payment and helping shift additional check volume to cards. However, in some instances they could resist change because of their different business and revenue models.

Although difficult, these opportunities can and will be realized in the near and medium term due to the significant value that card-based payments provides the bill payment market. Great rewards in this large and growing market await those players – whether they are billers, issuing banks, payment brands, merchant acquirers, or 3rd party providers – willing to invest and further move the market towards card-based bill payments.

Notes: (1) The market size differs depending upon the industry segments/ types of bills included. EDC estimates consumer bill payments in 2008 range between $4.8 to $5.8 trillion, or 46% to 58% of personal consumption expenditure, respectively. The $4.8 trillion estimate includes Debt Repayment (Mortgage, Auto Loan, Credit Card and Educational Loan Payments) plus Traditional Segments (Insurance, Property, Utilities, Household Connectivity, Wireless, and Memberships); the $5.8 trillion estimate includes a broader set of segments such as Elder Care, Courier Services, Uniform Rental, Cleaning Services, and Storage Rentals.
(2)“Debit cards” refers to scheme debit cards that have both POS and ATM access and can be used in a non-PIN environment for online payments
(3) First Data estimates that paper-based bill payments were 78% of bill payments in 2001 and 38% of bill payments in 2008.
(4)3rd party providers enable online bill payments – either directly through billers’ websites (“biller direct” model), through bank online bill pay, or through payment “hubs” where consumers pay bills to multiple billers. 3rd party providers have differing business and revenue models.

2009 Global Payments Survey

For the second year running, Edgar, Dunn & Company (EDC) has conducted a survey of payments professionals globally on key industry dynamics in their markets. The response to this year’s survey was outstanding, with 645 professionals representing 52 countries taking part in the survey – almost double the number of respondents in last year’s survey.

The survey questions were focussed on five main topics:

1. Current and future importance of individual payment products
2. Expected future importance of payment technologies
3. Most influential market participants
4. Key industry events that will shape payments markets

The findings illustrate where common themes are developing globally in relation to future trends and, perhaps more interestingly, highlight the key differences in expectations between regions and countries. The diagram below shows a high-level overview of the key future trends between the different regions – North America, Europe, Asia and Australia / New Zealand. The growing expectations surrounding mobile payments in both North America and Asia are notable, while contactless and e-payments feature more prominently in Europe and Australia / New Zealand:

Watch out for more information from EDC – in the New Year we will be providing a more detailed analysis of the results of the 2009 Global Payment Trends Survey on www.edgardunn.com.

About Edgar, Dunn & Company

Edgar, Dunn & Company (EDC) is an independent global financial services and payments consultancy. Founded in 1978, the firm is widely regarded as a trusted advisor to its clients, providing a full range of strategy consulting services, expertise and market insight. Global capabilities include in-depth industry and consumer benchmarking, strategy, risk management, marketing, profitability improvement, operations, and new products and technologies. With locations in Atlanta, Frankfurt, London, Paris, San Francisco, Singapore and Sydney, EDC serves clients in over 30 countries on six continents. More information can be found at www.edgardunn.com

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