Some European payments pundits believe that payment transaction fees are racing towards zero, compelling payment services providers to make money from data to survive in the long run.
They are not alone in their thinking. Nearly three-fourths of the European banks we surveyed recently agree that payments are becoming free; 69 percent believe payments are already free or will be so over the next 12 months.
While this might be applicable for the oversupplied bank payments space, payments transaction economics across other segments are still generally healthy.
We observe that the more commoditized and oversupplied a market segment becomes, the greater the pressure on transaction economics, and at the same time, specialized segments which are undersupplied continue to demonstrate healthy transaction economics.
And although data monetization is still at a relatively early stage of evolution, traditional value-added services are outgrowing core processing revenues and revenue diversification is key to outperforming market fundamentals.
Not all payments segments are created equal
There are wildly different transaction economics within payments business segments, as shown in Figure 1. Bank payments and card processing, which are somewhat more commoditized and subject to pressure from large clients, show weaker revenue yield and growth than alternative (and more differentiated) payments or FX/remittance.
Transaction economics are closely linked to the payments service’s supply, demand and relative value creation. SEPA bank payments are simple, effectively commoditized and mostly undifferentiated among bank providers. Therefore, the average revenue per transaction earned by banks is low and under significant price pressure (declining at 25 percent per annum). In SEPA payments, pricing is often cost-based with both prices and costs declining rapidly. Online alternative payments, on the other hand, are value-based. They drive incremental sales for merchants, resulting in revenue of about €1.80 per transaction and more than 20x revenue on SEPA bank payments. Retail business models which serve many customers (such as PSPs servicing SME merchants) also tend to exhibit less price pressure than wholesale business models (such as service bureau processing).
Pricing pressure is a reality in payments. While prices almost always go down, it does not mean the transaction profitability fundamentals are poor. As long as scale economies (for example, growth in costs per transaction) outpace pricing pressure (such as revenue per transaction), EBITDA outcomes capture the benefit of transaction growth (Figure 2). Price pressure leads to revenue growth that lags transaction growth (though still positive). However, costs are declining at an even greater rate, which leads to increases in EBITDA per transaction in sync with overall transaction growth.
Clearly, scale economies matter. They drive EBITDA margin expansion and, thus, scale to accelerate shareholder returns. Within our sample, large payment providers (>€250 million of revenue) experienced 10 percent year-over-year EBITDA margin growth from 2015 to 2017, compared to three percent for small providers.
Along with scale, scope of service also matters. Based on our analysis, value-added services (such as fraud management or FX services) are increasingly important drivers of revenue and growth. For e-commerce PSPs, value-added services beyond core processing and collecting now account for 39 percent of revenue and these services are growing at 20 percent per annum relative to five percent growth among core revenues.