Viewpoint: Strategic Priorities for Success in Today’s Prepaid Environment
The primary ingredients for survival and success in prepaid have fundamentally changed over the past three years, as have the likely sources of growth. Just a few years ago, the top priority for prepaid processors was to be nimble and innovative—at all costs. Processors were driven by the desire to build cutting-edge card program features/functionality to enable program managers to get into markets quickly with creative marketing and distribution concepts. The prevailing attitude seemed to be that a large portion of the industry’s growth would come from small and pioneering program managers driving explosive organic adoption of GPR cards in the underbanked consumer market.
Here’s the catch: In the past several years, the North American GPR market has matured significantly and is showing clear signs of saturation, at least from a service provider standpoint—not in terms of market penetration. Regulators are focused on prepaid and driving substantial change in how our businesses operate and interact with one another. Yesterday’s strategy of fast feature/functionality innovation at all costs no longer is sufficient to produce meaningful long-term growth in prepaid. It’s true, of course, that we’ve seen examples of startup program managers excelling in the market, and we recognize that agility and innovation are important components of success. That said, other issues have taken center stage in major growth opportunities in our industry, pushing feature innovation and speed to market down a notch or two in prepaid’s hierarchy of needs.
Let’s look at some of the strategic priorities that have emerged during the last few years.
Regulatory Compliance and Increased Exam Scrutiny
Regulatory pressure is escalating costs across the industry in the form of human resources, reporting capabilities and security infrastructure. Issuing banks are being required to provide more oversight and control of the programs they support and this responsibility is flowing directly to processors. The legal, operational and technological relationship between processors, banks and program managers is shifting—increasingly centered around the issuing bank and its ability to control and report on risk and compliance. This is requiring investments to be made in process and integration that operationalize the banks’ control of programs, as well as legal formalization into tri-party agreements that give issuing banks the control to match the responsibility placed on them by regulators.
Regulators are driving banks and processors to own the risk of not only their own operations, infrastructure and hiring practices, but also those of their vendors and partners, such as customer service representatives and third-party software developers. Organizations that have made, or can afford to make, the significant investments to fully address this new era of regulatory scrutiny will thrive.
Risk, Fraud Control and Stability
As GPR and other prepaid financial vehicles have settled in the mainstream, predictable and consistent performance has become critical. The attributes most sought after in the market include operational stability, data security, fraud risk mitigation and financial/business viability. Clients want a partner with a nimble organization and a flexible and feature-rich technology stack, but not at the expense of business and operational reliability.
It’s also evident that, as discussed above, banks, program managers and processors all are concerned with their key partners staying on the good side of federal regulators.
|Yesterday’s strategy of fast feature/functionality innovation at all costs is no longer sufficient to produce meaningful long-term growth in prepaid.|
Increasingly aggressive and creative fraud schemes continue to target prepaid programs and platforms, adding cost and requiring escalating investments in defense. Unfortunately, fraud aimed at the prepaid space has had a dampening effect on innovation in areas such as online gift card sales and virtual card enhancements, because new features and form factors are as attractive to fraudsters as they are to legitimate consumers. The implication is that processors need to offer more comprehensive anti-fraud solution portfolios, establish program design best practices, and then must guide banks and program managers on integrating those anti-fraud solutions into program design. Innovation in fraud prevention is more valuable than innovation in cardholder features. Geolocation and out-of-wallet for CIP, enhanced transaction and value-load monitoring and analysis, and next-generation case management tools are just a few examples of where processors need to spend their investment dollars to stay current.
The bottom line is that the opportunities we see requiring cutting-edge program capabilities as a top decision criteria are dwarfed by those requiring a demonstrable track record of predictability and reliability.
As prepaid matures, there are clear financial advantages for companies that can afford to acquire or build a larger portion of the value chain. Not only can providers capture more revenue and EBITDA from a given card program, but they also can go to market with more tightly packaged and cost-effective offerings. Add to this list the cost of compliance, security and fraud control, as previously discussed, and prepaid’s traditionally complex value chain seems even less sustainable. Vertical integration has already begun (e.g., U.S. Bank, TSYS, American Express, Visa) and certainly will continue. Beyond simple vertical integration of issuing, processing and program services, we’ve seen the emergence of domestic GPR programs with major FI and retail players treating prepaid as a relationship hook to draw consumers into a broader set of financial services. These providers increasingly are content to break even or even use prepaid as a loss leader to establish consumer relationships. This doesn’t mean there aren’t other successful paradigms for domestic GPR, but it does mean that if you’re relying on fees and interchange alone as your organizations life’s blood, you’re in trouble.
We see three general strategies to face this trend:
The first is vertical integration—building or buying a processor or program management capability. This applies to banks, processors or program managers, and we can see examples of each in the market. This approach has challenges for each scenario. Processing is complex and expensive. Program management isn’t a walk in the park, but the capability alone isn’t valuable unless you solve the distribution puzzle.
The second strategy is to find a niche and exploit it. This is a great approach; however, it typically comes with a market size limitation. The conundrum is that once you grow the niche to a certain size, you typically have to sell to a major player or face having said major player move into your space with superior firepower.
Finally, there is horizontal payments capability and scale. Organizations with a broad set of payments-based technology solutions that have the scale to fill in gaps will be able to occupy a healthy portion of the market, provided they remain flexible and their services remain relevant. For example, cardholder technology, anti-fraud solutions, international processing capabilities, data analytics, payment guarantee solutions and many others, are solutions for which no single program manager or bank has the time or money to solve.
You have to either have huge volume and scale or you need to be a part of a greater ecosystem to compete and win.
Well, So What?
Prepaid service providers and banks that already have run the gauntlet of technology hardening and regulatory compliance will leave behind less seasoned and tenured players in the next two to three years. Program services standardization is key to driving down costs, consistently complying with regulators, limiting fraud and ensuring program scalability. Product road maps should reflect the fact that financial and operational security and stability have to be prioritized alongside sexy and “cutting edge” features/functionality. I believe it will prove increasingly challenging for any, except the most well-established providers, to remain independently viable. Even those providers must have the size and scale to survive price compression, invest heavily in security and compliance, and expand into international markets.