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Bumps in the Night


January 8, 2015 | by John Barlow, President, Barlow Research Associates



Three million small businesses accept credit and debit cards at the point of sale. That's one third of all small businesses. And users of merchant services are one of the least loyal to their primary bank. This is a dangerous time. EMV is creating an opportunity and a threat.



POV: You have to lend to be profitable.


As a parent, I am certain that you have been awakened by footsteps, sprinting down the hallway and a 30 pound bundle of frightened energy piling into your bed. Or perhaps you yourself were trying to get to sleep and heard a unidentified noise down stairs. It is easy to jump to conclusions at times like these. Some of us will get up and check it out and others will simply ignore the noise and try to fall asleep. Those are bumps in the night.


There is a whole new world surrounding us in payments. During the recession we were busy chasing OREO and building capital and comforting our small business customers. The payment world was busy building new products. Even the Fed has been busy talking about a new payments system. Some of it because of consumer protection and some of it is a shot right across the bow at interchange rates.


I am starting to hear some noises and it is difficult for me to tell whether these are good noises, bad noises or truly game changers. Maybe you can help me figure this out?





Let me tell you a story. I was at the BAI Retail Delivery Conference last week and heard the words Apple Pay mentioned a few hundred times. More than any other product or brand name. There were 3,000 bankers and service partners there. Yet, there was not one person from Apple. That's a bump in the night. OK, we are partners with Apple, right? They provide a security feature and we give them all of our customer transactions. But, there aren't enough NFC enabled merchants out there right now and Verifone and Ingenico are not selling enough terminals to change that trend. That's a relief. But, how about the October 1, 2015 deadline and the EMV mandate? The timing is perfect for NFC. Our world is about to become NFC capable. Will our customers blame us for the expensive upgrade and take their business elsewhere?


Three million small businesses accept credit and debit cards at the point of sale. That's one third of all small businesses. And users of merchant services are one of the least loyal to their primary bank. This is a dangerous time. EMV is creating an opportunity and a threat.


Here is another story. One of our analysts at Barlow Research is an avid user of SnapChat. She is just one of the 100 million people that actively use the service to send pictures that can be viewed once and then disappear from the internet forever. Plus, you can include a message. This week, Snapchat introduced Snapcash. You put a $ sign and a number in the message and the money is drawn from your bank debit card and sent to the recipient of your message. The payment is handled thru Square — the company that took the card swipe business away from us. I guess that's OK because we are still involved. We have the checking account, we get all the BSA, photo ID, signature cards, come into the branch to open your account and all the other compliance costs plus the error resolution. They get the transactions. I'm not worried about that because I don't understand SnapChat. I will never use it. I will go back to sleep on that one.


I said I would never have a Facebook account. Swore that I would not be one of those people. How many of you once said you would never have a Facebook account and now you do. Now I have one. Recently, Mark Zuckerberg hired the President of Paypal, David Marcus. Why would the President of Paypal go to work for Facebook and give up the title of President. Plus, Zuckerberg put him in charge of the Paypal Messenger Product. That's the FaceBook chat product with 1.2 billion active users. This guy is a specialist in payments. Now, that's a bump in the night. I think we just lost the P2P payment market. Game over. But, we don't care because that product is in the consumer bank.


Nearly 5 million small business use some type of electronic bill payment initiated on-line and 92% use it at their primary bank. That's close to home.



Speaking of payments the Fed requested comments on a white paper on the need for a NEW NEAR REAL TIME UBIQUITOUS PAYMENT SYSTEM to be developed within ten years. They received 200 comments that collectively said: do it quicker — how about 7 years. Their response to those comments is due before the end of the year. Watch for it.


What has been suggested is the development of an entirely new payments system similar to the FAST Payment Service in the UK. FPS processes 90% of salaries, 70% of household bill payments and 100% of State benefits. In 2015 they will introduce a mobile version called Zapp.


This could be a total rewrite of bank operations. Instead of settling at the end of the day, each payment settles real time, one at a time. Instead of a debit pull, the system that is being talked about is a credit push. Today, when you swipe your debit card at a merchant, the merchant's bank goes to your bank and retrieves the money. That's the equivalent of them grabbing your billfold and taking the money they need. The new system will be a credit push. You will open your billfold and send them the money. It eliminates overdrafts, return items and much of the fraud. Think about the implications for bank operations and core processing? That's a huge bump in the night. But, the industry is behind it as long as it contributes additional revenue to pay for the system, right?


When we polled small businesses about real time payments they thought is was a great idea, as long as they didn't have to pay for it.


Real time payments are coming whether we like it or not and the forces driving the change are the Walmarts and Targets who aim to eliminate the interchange fee. Walmart's net profit margin is 3.5%. What would eliminating interchange do to their earnings?


The Fed is not the only one interested in being at the center of a new payments system. This might have been a moot issue had our industry moved ACH to real time. But, there was resistance because of loss of revenue from wire transfer. Both The Clearinghouse and NACHA have announced intentions to develop a near real time payment system. There are others including CurrentC, Clear Exchange, POP Money and Paynet. The key to this is who controls the account numbers. In the UK the Zapp system is based on your telephone number. Anyone with a phone number has a bank account. Payments are about to get messy.


Sixty-one percent of the small business market plans to convert more payments from paper to electronic. Fifty percent of the payments made by the smallest of small businesses, the micro segment are today, paperless.


Middle market companies today write as many checks as they did five years ago. Innovation for once is happening at the bottom of the market, in small business and being pushed up. It is the part of the market that we struggle with. That's why Silicon Valley is flourishing. That is a bump in the night.


Let's bring in the Voice of the Business Customer. Too often, we leave it out when making plans.



The largest part of the market is the smallest of businesses. Let's call her Mary Micro. Mary is 30 years old. She is tech savvy and a college grad. But, her passion is flowers so she recently started her own floral boutique. She has five employees, uses 1.7 financial institutions, more than business twice her size. She likes her bank but has little loyalty because she has no relationship. Her most trusted advisor is Google. She is the most likely to be a millennial of all the segments and also the most likely to skip internet banking and go right to a mobile experience. She is most likely to use a very large bank with many locations because that is where she has had her personal account since before college. Mary's primary personal contact is a teller.


Mary pays $308 in fees annually which does not sound like a lot but there are almost 8 million Mary Micros that makes this, potentially, one of the most profitable segments. She wants it simple and free and her fastest growing product is bill pay.


Here is the challenge. 91% of the net revenue potential from this segment comes from CREDIT related products. In order to profit from this segment you must lend to them. That is not a bump in the night. You knew that.


Let's fast forward to 2025. Call it a ten-year forecast. What does Mary's relationship look like with her bank? Here is one scenario:





Mary's bank has done a marvelous job integrating all the data that is derived from her banking relationship and providing it back to her as value added information. Her merchant receipts automatically update her financial statements and adjust her inventory of flowers. Payments to suppliers include information about purchase orders. This bank provided system is also a CRM that sends thank you notes and reminders to her customers for birthdays and anniversaries.


Mary's bank has a customer service system that records anyone talking to Mary. Everyone can know the services she uses, the anticipated next product to purchase and the reason for her last contact. Service is available 24 X 7, the same hours that Mary works. She does not have an assigned banker but it seems like everyone knows her when she calls. Mary knows that when she needs working capital she can draw an advance on her cashflow — whether merchant receipts, cash or checks — that is tracked by the bank as part of their customer data management system.


In the perfect world this seems to be where we need to head.





Mary has an unprofitable relationship because the bank is unable to lend her working capital. She was told she was not credit-worthy and was referred to a company that the bank uses to find money for small businesses. Instead, she searched on-line and found another company that was recommended on a blog for florists. As Mary's business grew she used this same blog to search for a retail business management computer system. She found one in the cloud that was reasonably priced and did everything including paying her bills thru bill pay in the cloud and processing her merchant receipts. They have a mobile option that tells her cash register receipts on a real time basis where ever she is.


Mary's bank is a repository of funds that is controlled by the non-bank retail business management software. Mary knows no one at the bank and if they dare to charge her she will move the depository account. Along with that goes her personal relationship.





Mary stopped using her bank once the Bitcoin market became ubiquitous. Her money is all digital. When she is paid in any currency she immediately converts it into Bitcoin using a service provided by VISA. They convert 170 different currencies and one more was little trouble. She can borrow working capital based on a measure of her character that is derived from her on-line behavior and translated into a line of code that can be used as collateral in an on-line credit market place. Mary's bank branch recently turned into a book store as paperbacks have become trendy again.


How will this play out?


This feels a bit like Chaos theory or the butterfly effect. It is difficult to see how this all will play out. But, one thing is clear to me. We need to stay close to each and every customer. It is our challenge to make them profitable. The data shows they can be if they can figure out how to serve them and win their business. If the service model is thru an advanced information system, then fine. These systems have been successfully implemented by several discount brokers. However, I have not seen one at a bank. Nothing even close. Or we need to develop and maintain a personal relationship with the Mary Micro until we can develop the tools necessary to manage the experience in a more efficient way. That also means solving the credit challenge now.



I believe our feature success will not be dictated by payments. That business is being commoditized. It is about credit. Especially in a low interest rate environment, you must loan money for the small business market to be profitable at your bank.



John Barlow, President Barlow Research Associates

John Barlow was a founder of Barlow Research in 1980 and is responsible for overall business strategy and research methodology. In his position he works with clients to understand their strategic needs and develops research methods for multi-client and proprietary research assignments. John graduated from the University of Iowa in 1972, and is a graduate of the ABA School of Commercial Lending and past President of the Minnesota Chapter of the Bank Marketing Association. Prior to Barlow Research he worked for Norwest Bank where he was a commercial lender and manager of marketing activities for the commercial, international and trust divisions of a regional bank. John and his wife Kathy, also a principal in the company, live on Lake Minnetonka near Minneapolis. He is an avid E-scow sailor.