Building a transformation vision
While continuing to focus on customer-facing innovation, payment services providers (PSPs) must transform their payments processing to keep pace with the changes taking place at the customer-facing end of the payments chain.
As analysed in World Payments Report (WPR) 2013, the customer-facing part of the payments value chain is undergoing a high degree of innovation. Catalysts for innovation are threefold: customer demand, entry of non-banks and convergence of delivery channels. In addition, accelerated technology changes are helping innovators to integrate and leverage the new technologies for payments solutions at the front end.
- Customer demand: Retail and corporate customers are demanding easy, efficient and faster payments. More specifically, retail customers want anytime, anywhere payments using their choice of payments methods. Corporate customers want improved control, visibility and speed in payments.
- Entry of non-banks: The entry of non-banks has driven a high degree of innovation in the past decade. Retail innovators include Square, iZettle and M-Pesa, while innovators on the corporate level include Odette, Coface and Swift.
- Convergence of channels: As those selling goods look to leverage all channels – physical, electronic and mobile – new, innovative products and services are being developed that offer integration and consistent customer experience across all of these channels.
On the other hand, innovation has not been as apparent in the processing and clearing and settlement elements of the value chain, beyond some efforts to improve efficiency. The firms using legacy systems in their back offices are constrained by multiple external forces and internal challenges. The main external challenge emanates from multiple key regulatory and industry initiatives related to security and data privacy. European regulators, for example, have drafted or approved regulations related to internet payment security, mobile payments security and cyber security. Data privacy and payments initiatives require firms to understand the differences between data privacy laws in different jurisdictions. Such regulations are putting pressure on banks to revamp existing processing operations.
Other external challenges include overcapacity in the payments processing space, which has led to pressure on traditional business models and the need to find revenues from sources other than volume growth. The entry of non-banks is creating increased competition in the client-facing part of the value chain, putting pressure on incumbent players to improve processing and support new payment methods. As clearing and settlement mechanisms evolve, there is also greater scope for real-time payments processing. Disruptive technologies such as mobile and customer demand for data visibility with improved analytics capabilities are also key forces.
Based on interviews with payments executives, we have found that the areas of greatest focus are revenues and compliance. Security and data privacy regulations and real-time information and processing were estimated by the executives as having the highest impact on their payments processing activities. Other challenges include pressure on the traditional business model, disruptive technologies, a changing product mix, reorganisation (including regulatory requirements to ring-fence banking activities) and customer demand for data visibility.
The key internal challenges for traditional payments processors are related to the complexity of their legacy IT landscape and the ability to manage their internal resources or bandwidth in an environment of limited resources. The legacy IT landscape is characterised by different payments processing systems for different products. This siloed approach has led to increased complexity in managing legacy systems. For example, banks usually operate different systems for processing domestic and cross-border payments, direct debit and credit transfer payments, as well as cards and other payments. Historically, cheques, automated clearing house (ACH), credit cards, debit cards and high value-payment systems were each managed as separate payment products within well-defined boundaries. In addition the banking industry has undergone significantly high levels of mergers and acquisitions, leading to multiple systems even for a single product. It is challenging for firms to manage their efforts on multiple fronts, given the limited resources, both in terms of management attention and budget. This is regarded as one of the main challenges in managing resources across different areas such as regulatory compliance, customer-facing innovation initiatives and payments processing.
Other critical factors include the high cost of processing, siloed operations, product proliferation and the need to select the right partner for processing. In addition to these challenges, ensuring stability or business as usual, of payments processing systems is critical. This has to be undertaken in an overall landscape of rapid change via transformation, innovation and regulations.
As the complexity of mitigating internal challenges constrain firms from developing a full response to the external forces they face, traditional players can no longer delay a strategic review of their payments processing activities.
While customer demand is driving the innovation seen in the client-facing part of the payments value chain, it is also a driving factor when it comes to innovation at the processing, or back-end, of the value chain. Across the retail and corporate payments markets customer demand is regarded as the main driver of transformation and innovation.
In the retail and corporate worlds, customers increasingly expect real-time capabilities, which are tightly linked to core processing systems. Given the age of some of these systems within traditional payment processors’ operations, this consumer expectation can be met only by reengineering their processing infrastructures. Says a senior payments executive at a leading European bank: “Consumer experience of real-time services in other areas is creating a demand for payments to be in real time. In addition, corporates are also looking for real-time information, especially in the intraday liquidity area, which is being targeted by non-banks due to multi-bank integration requirements.” Similarly, multiple requirements such as fraud detection, identity checking and customised offers are putting pressure on legacy data formats.
In the bank to corporate space, corporate treasurers’ needs are tightly linked to their expectations of the payments processing capabilities of their banks. There are six areas of focus for corporates:
- Visibility: Corporates require enterprise-wide cash visibility to enable greater control over liquidity and more effective working capital management. Corporates with multiple banking relationships are dealing with disparate systems, which hinder visibility and solid forecasting. Corporates also want more efficient investigations and reconciliation processes within their treasuries. Corporates expect their banks to remove silos, enable omni-channel communication and predictable processes as well as provide visibility of intraday liquidity positions through capabilities such as real-time information.
- Cost containment via efficiency in payments processing: Corporates require straight-through processing (STP), standardisation and centralisation in their treasury activities. They want their bank providers to offer true standardisation, rather than the less optimal standardisation that has been delivered via the single euro payments area (Sepa). True standardisation would eliminate the differing interpretations of standards that have arisen from Sepa.
- Risk management: Corporates want to eliminate operational risk in the end to end payments process. They expect their bank providers to simplify, rationalise and centralise processes in order to ensure that processes are as risk-free as possible.
- Counterparty risk: Since the financial crisis, the awareness of counterparty risk has been heightened and corporates wish to reduce their bank concentration risk. As a result, there has been a move towards multi-bank operations. Corporates want quick access to all of their bank services providers. Corporates want banks to offer real-time booking and reporting of transactions and rapid updating of accounts.
- Treasury technology compliant with corporate IT standards: Corporates are increasingly demanding the integration of payment, enterprise resource planning (ERP) and treasury systems. They require banks to synchronise reference data, using a single set of data within the bank. Also, there is a demand for banks to develop common standards for treasury and bank systems.
- Value-added services: Additional services such as ISO 20022 standardisation, liquidity management linked to ERP systems and improved reconciliation processes are also requirements of corporates. To meet these requirements, banks are providing virtual account facilities. Also needed are data analytics and services based on commercial information.
Interviews with payments industry executives at traditional payments processing firms indicate that for a majority (55 per cent), the transformation of payments processing is a top priority in the short term. Says an executive from a traditional processor: “Although it is a long journey, banks need to act now as simplification of payments systems has a strong commitment from key stakeholders.” Those interviewed recognised that payments processing transformation takes time and hence have retained transformation as a top three priority over the longer term. Our research indicates a strong inclination towards quick prioritisation of payments processing transformation projects.
Key areas of focus in the short term tend to be operational, whereas longer-term priorities tend to be focused on integration, flexibility and convergence. In the short term, the focus is on regulatory compliance, improving operational efficiency, eliminating internal formats, rationalising products, supporting front-end innovation, stabilising processing platforms and supporting multiple payments options at the point of sale. For the medium and longer terms, key areas of focus include a single integrated platform covering both retail and corporate payments, adopting a hub approach to all areas of payments, real-time retail payments, data and analytics-based value added services and flexible payments platforms (with sourcing flexibility). A representative from a global technology provider says: “Payments hubs are a payments trend in the right direction. We are making the hub concept part of everything we do.”
In addition to the priorities above, all players agreed that customer demands are the foremost focus in both the short and long terms.
Based on our research findings, we believe that some traditional processing firms are likely to delay the start of their processing transformation projects. This could have significant negative implications. There are some common constraints for these firms as they look to transform their payments processing. These constraints include complexity and higher costs involved in consolidating different, siloed legacy systems. In addition, many firms are struggling to consolidate multiple products and services offerings that have been rolled out over a number of years. These complexities and costs are lengthening the time required to transform processing, which conflicts with the desire of firms to improve their time to market with new products and services. An executive at a global bank says: “Banks are pushing for client innovation now, while trying to manage the back office with quick cosmetic actions. This will add to the complexity of the landscape.”
Given the proliferation of front-end, customer-facing innovations, traditional processors cannot ignore or implement a ‘quick fix’ approach to their processing systems. Applying small enhancements or wrappers to individual back office processes could further complicate an already complex systems landscape. Traditional processors, particularly the global firms, face reputational risk arising from any failure of an innovative product roll-out, which has led to increased investments and slower time to market.
There is a need for collaboration among banks and non-banks in order to accelerate innovation. The leading customer-facing players are likely to choose a collaboration partner based on the strength and flexibility of its processing systems.
While traditional payments processors have taken an incremental approach to transformation, some might benefit from more robust, end to end project management and execution that is aligned to a clear business vision. Such an approach could help firms avoid delays and will deliver clear benefits to them as well as their customers. While incremental, agile transformation is common sense, firms need to more closely follow the basics of program management to achieve their goals.
Based on our experience and interactions with industry executives, it seems that while firms usually begin their transformation journey with an incremental approach in mind, the majority of them deviate from this when faced with challenges. This deviation might occur during execution or sometimes in the planning phase. Based on our interviews with industry executives, we have identified some common constraints that occur during transformation initiatives, which restrict the ability of firms to derive clear benefits from transformation. These constraints include:
- An environment of rapid change and increasing demand from various client segments, which makes it difficult to draw a complete picture of all customer demands. Therefore aligning the transformation vision or plan with the needs of customers is challenging;
- Managing the complexity and higher costs involved in achieving the desired capabilities and features of payments processing;
- Balancing the time it takes to implement robust transformation with the desire of improved time to market for new products and services;
- The challenge of balancing compliance and innovation. A payments executive from a global bank says: “The biggest hurdle to overcome is getting top management to approve the budget for an infrastructure upgrade”;
- Reputational risk arising from a potential failure of a transformation project. Legacy players, especially the global giants, face heightened risk if a product or service roll-out fails; and
- The availability and long-term retention of senior payments executives. A representative from a leading bank in Asia-Pacific says: “One of the key challenges we face is the lack of subject matter experts who are able to understand complex issues of transformation.”
At the higher level, payments processors should continue to take an incremental transformational approach to deliver value for themselves and their clients.
Building a long-term payments processing vision is an exercise that will build on the inputs from an analysis of objectives and a maturity assessment of current payments processing functionality and the desired future state. The outputs of the exercise will be the benefits for the firm and for its clients that result from the transformation.
This will be the key to success of the transformation project. Objectives should be analysed and a maturity analysis conducted. Based on our analysis of transformation projects we believe firms should answer the following three strategic questions, which will help them to clarify their objectives and establish the transformation vision:
- What are the key business objectives?
- What is the core objective of the payments function?
- What is the strategic intent of the payments function?
Firms also need to diagnose their current processing maturity on eight key components and agree on the desired maturity levels across these components. The following questions will help firms to assess these components and their level of maturity, ranging from worst in class up to best in class:
- Scale: How would you rate your system efficiency in processing a large number of payments transactions? (for example, number of cards transactions per second, or number of credit transfers in a single file)
- Speed: How quickly can you process the payments for your customer and product base? (for example, full STP credit transfer with sufficient funds and before cut-off time: day, hour, minutes, or seconds);
- Efficiency: What is the extent of STP in your firm overall and per instrument? (for example, cross-border credit transfer, domestic credit transfer, direct debit);
- Channel coverage: To what extent can your systems process payments originated from any channel?;
- Geographic reach: What is your geographic reach for payments processing (for example, country level, regional, or global)? Do you have a single payments processing factory per country, currency, or regions?;
- Insights: To what extent is your firm able to leverage data to drive internal improvement and customer value-add? (for example, regulatory compliance, better KYC/AML, process/supply chain advisory to corporates based on payments data, improved risk management );
- Price: To what extent are you able to provide customised pricing based on products, channels and reach? (for example, providing lowest pricing for credit cards, flexibility to provide price for bundles of services, ability to offer different prices based on clients’ systems); and
- Product coverage: To what extent can your systems process payments initiated from any product, such as credit card, debit card, etc.?
The majority of firms indicated that fast evolving customer needs are forcing them to opt for projects that can be achieved in a short timeframe. While this is not a new concept, firms have an opportunity to improve their focus on the integration of agile development concepts, such as short-cycle projects and to take a consistent approach to program planning. This will help firms to fulfill their vision of delivering long-term business benefits.
Based on our experience, we believe that more effective use of short-cycle projects could help firms to derive immediate business benefits at completion, while striving for an overall, long-term vision. A short-cycle project could comprise a mini business case, execution phase and value delivery. A mini business case is a simpler form of a traditional business case exercise whereby objectives for the next short-term project are defined, required investments and focus areas are identified and targeted benefits are outlined. As objectives and benefits are discussed during the mini business case exercise, firms can also ensure that the project is aligned to the long-term vision. Short-term projects could be completed within 12-18 months. After each short-cycle project is delivered, there should be some immediate business benefits either to the customers or to the firm.
Short-cycle projects allow firms to review the lessons learned and to apply these to the next short-cycle project. In addition to this, firms can analyse the external market changes and include feedback from internal innovation initiatives into the next cycles. The external changes could include competitor activity or customer demands, or changes in regulations affecting payments. Feedback for the payments processing transformation plan could also result from internal organisational initiatives focused on innovation, for example. An executive from a leading global bank told us: “Our business transformation approach is business case driven and global. We want to test and learn with new use cases as we go along. We do not want to take a big bang approach.”
Payments processing firms at every stage of a transformation initiative can benefit from the short-cycle approach to create business value. This approach is particularly effective when dealing with the challenges to transformation initiatives.
As firms look to develop a stable and agile platform to meet customer and internal needs the transformation also touches multiple aspects beyond payments. A customer-centric technology architecture must focus on six key areas:
- Payments: As seen above, firms need to develop a single payments platform and approach for all customer segments, regions and payments schemes. In addition, payments data could be leveraged to derive real-time insight;
- Distribution: Firms should provide a channel-agnostic service, enabling access to products and services across the firm in order to implement common, customer-centric business processes. This will ensure that customers are treated as a customer of the firm and not of a channel, product or division;
- Application simplification: There is a need to simplify the technology base so common business processes are consistent and supported by appropriate components of a modular architecture. This is likely to reduce the operating costs and simplify future change;
- Data: Data should be simplified and organised to enable its identification and use. This will help to establish sources of shared reference data and to de-fragment customer data;
- Infrastructure: Firms should look to rationalise infrastructure and data centres through cloud hosting, decommissioning and virtualisation.; and
- Workforce enablement: Depending on the requirements, firms should rationalise ‘owned’ devices, embrace workforce use of their own devices and the ability to work anywhere. This could enable location flexibility for staff, including call centre employees.
There is an opportunity for corporates to become more involved with their payment processing partners during the initial phases of processing transformation projects, such as the design of new products and offerings. A managing director of global enterprise payments at a leading global bank says: “Corporate customers are increasingly helping in the design and roll-out of innovative products by banks.” Corporates can also help in lobbying for common data standards across the payments industry.
The transformation of internal processing environments is important, but must be achieved in addition to addressing external challenges. These external challenges, such as regulation, are best addressed collaboratively by the industry. The development of real-time, low-value payments, initiatives to standardise approaches to payments security and fraud and retail cross-border payments are all areas that benefit from a collaborative approach.
While firms should look to continuously improve their processing in order to keep pace with changing customer demands and regulatory environments, the above areas require joint discussions among industry stakeholders. For example, a discussion and agreement on expected service levels of immediate payments could be achieved only through collaborative efforts.