The impending consolidation of Payment Startups
June 2024
When astute and audacious tech entrepreneur, Peter Thiel and his so called ‘PayPal mafia’ set out to disrupt the then bank-monopolized sector of fund movement, aka payments, the simple idea was to get the 2-sided market of payers and payees to use a single platform whose account holders can exchange cash on a ‘Netted Basis’ thus minimizing overall bank commissions and clearing network fees. Besides the initial cost of building the platform, the recurring cost of maintaining it and the settlement charges on the netted transactions were the principal expenses. The business model was the perfect recipe to woo the exasperated millennials into free electronic payments thus fostering a burgeoning customer base that we now know is quintessential to a growth-stage-startup. Once a critical mass with the customer base was reached, revenue streams from differentiation creating services were carefully repriced based on the customer’s willingness to pay for value added services. Today an intra-PayPal-account international fund transfer, seemingly a non-SWIFT settled one charges higher than legacy financial institutions in the US. This is the revenue that would bring profitability to a company that has worked so hard in the startup phase to reach the stage of perpetuity. Following this model, other FINTECH startups sprang-up across the world forcing financial regulators and monetary authorities to issue payment-only licenses to non-banking entities, something that had just been clubbed with the function of lending until then. American FINTECH apps @Venmo, @CashApp along with European ‘Challenger Bank’ startups @Wise, @Monzo, @Revolut not only started capturing a share of the customer base, but also began investing the surplus liquid cash in high yield instruments, retaining a share of the returns they gave these customers as an additional source of income thus earning the blue-eyed status among investors.
Looking into the crystal ball
This segment that was so promising until somewhere in the middle of the pandemic is now experiencing a stagnation primarily because of the number of incumbents, several of which are struggling to get that lucrative market share. Investors are not seeking the humdrum instant electronic payment tech innovation anymore. With the barrier to entry in this space being the lowest among all traditional banking functions (other functions of credit and investment have higher barriers to entry in their respective segments and players such as @LendingClub, @Betterment, @Wealthfront etc. have gained market-share through distinct differentiation that is not easy to replicate), the digital payments market is becoming extremely commoditized with little or no difference between offerings of all startups although they certainly exceed the capabilities of banking behemoths who seem to have mastered the unaesthetic art of reinventing the wheel when it comes to adopting new technologies and continue nurturing unnecessary amounts of manpower in running daily operations. With the proliferation of OpenAPI, AsyncAPI and OpenBanking, the entire payments market continues to be decentralized and democratized under the Web 3.0 premise and in open seas, turbulent waves seem to be rocking the boats of cash starved startups putting premature pressure on the bottom-line. As in any market correction cycle, the Darwinian theory will also be applicable to this sector and a series of consolidation among players is due. The customer base being so evenly distributed among incumbents is impediment to consistency of customer experience and when SMEs, the primary target market, start valuing this consistency of experience for their expansion plans, the market will flock to the players with that forte. M&A’s will trend, and a few well-funded, well-managed, well-branded entities will emerge as victors continuing their differentiation from banks in a supercharged way. Prophesies by activist investors like @ValueAct of segregating the payments business into separate entities will materialize forcing banking behemoths to manage it as an outsourced function and offloading the eternally haunting regulatory obligation of AML money laundering to third parties.