The international remittances market is a high-volume,highly-competitive, globalised, and technology-driven business. Official estimates put the flows from private individuals at over $550bn per year, mostly for private consumption, with adjacent flows from businesses involved in international trade even larger, writes Nick Day
The volume of these cross-border paymentsalso continues to show impressivegrowth at over 11% per yearaccording to the World Bank. The fact is that we live in an increasingly globalised and mobile world, characterised by rapid population growth and increasing regional and international migration – and the rapid growth of the international payments market is just one consequence of this.
We all know that the traditional banking world has always had a comfortable position within this market. For many the banks are the natural people to turn to when looking to send money abroad, and as such banks havealways had a large customer base.
People use banks to handle money, because…well, they just do. But things have changed in the past decade. Technology has changed the game for the financial services industry, with payments in particular cominginto the limelight as a sector that is ripe for disruption.
As such, we have witnessed many new competitors emerge to focus exclusively on international payments – whether these be self-service kiosk models, online, mobile, peer-to-peer or a combination of the above – and investment has naturally followed. As such consumers and businesses have never had so much choice. So what are the key trends, besides from global migration, that are driving this development?
It’s technology, stupid
It is clear that new technologies are presenting new ways for people to make international payments, most noticeably with new online applications and mobile apps purporting to revolutionise customer service and transaction costs. Yet the truth is that not all of these new services can be successful. How much space is there really for ever more payment methods? Which companies will be the winners in this dynamic payments space?
As new generations grow up surrounded by new technology solutions, a segment will certainly favour new emerging payment options over traditional methods – but this is a very slow process, and in a market as traditional and trust-based as the remittances market, where the volume business is driven by the "stock" of migrant workers rather than the new entrants to the market, this could take decades.
Many of the tech solutions coming onto the international payments market are also ‘low cost’ propositions,offering dramatically cheaper solutions through ‘leveraging technology’, or offering ‘peer to peer’ to cut out the banks – or at least that is what their marketing departments are saying. In reality this is mostly marketing spin.
This has been an intensely competitive market for many years and other than having significant venture capital financing to support ongoing losses, new entrants don’t have that much of an advantage. There is a much-touted myth, based on a poorly conceived World Bank study, that prices are at the level of 10%, and that it is an industry ripe for disruption -but this is just not the case.
The mid-market operators who control the bulk of the volume in the market generate revenues of between 2.5% and 3.0% of funds transferred in a combination of fees and foreign exchange gain on an average transfer of around £300, and have deployed technology throughout the value chain for many years to automate procedures, tempt early adopting customers with new solutions, and drive lowest unit costs.
This is where technology impacts pricing. The key trend in pricing is this convergence into mid-market pricing levels, that have been consistent and stable for some time – the only real way to undercut these levels is to benon-compliant with anti-money laundering requirements, which will catch up with you in the end, and the fierce competition is pressuring those above these levels to reduce their charges, as we are seeing with Western Union and some banks.
Scale, competition and consolidation
The international payments scene has recently become awash with glitzy PR and shiny technology awards, all driven by impressive venture capital investment. Yet to focus on cool advertising campaigns and sleek mobile apps is to ignore a much bigger and far more important trend which is reshaping the market – consolidation.
At present the industry is huge, but it is also enormously fragmented – by some estimates there are over 3,000 companies offering international retail payment services in Europe alone, and countless more targeting the business community. Consolidation of smaller remittance companies is being driven by economies of scale and increasing regulatory pressures.
This is an industry with enormous returns to scale – the largest operator, Western Union, has operating profit margins in excess of 20% with over 100 million transactions per year (although down from 25% not long ago), roughly twice those of their nearest competitor MoneyGram – there are clear rational and economic benefits of putting incremental volume onto a fixed cost platform, and the M&A track record in the sector demonstrates the opportunities for those with a global platform on which to add new acquisitions.
Yet consolidation isn’t simply a result of economic scale – after all, lots of businesses don’t act rationally. This is where regulation plays a part. The regulatory environment is getting tougher every day – for banks, but in particular for payment service providers.
The world has changed from one where the authorities were happy to see the international payments flow through ‘formal’ channels that could be tracked and audited, to one where the authorities are clear that they wish to see a business that they see as being ‘high risk’ in the hands of a small number of large, well-governed, highly-capitalised, technologically- advanced entities. Big bank activity in the space will always make the news headlines – think HSBC’s £1.5bn fine for handling laundered money, or Barclays Bank’s decision to close the accounts of almost all of its payment institution clients.
Yet the reality is that banks are increasingly less willing to service payment institutions – especially small, new ones. This business activity is being driven onto the platforms of those few global operators who are able to prove their reliability, experience and controls to the banking community and regulators – and pulling up the drawbridge for new entrants or any small company trying to expand into new markets. The barriers to entry continue to go up, and the pressure on the smaller end of the market continues to grow. This is very much good news for established platformswith diverse, robust global infrastructure.
What does it all mean?
Unfortunately all of these changes – technology, consolidation and regulation – are not necessarily good news for consumers. The modern day consumer wants choice and value for money, driven by competition. But the established operators remain in by far the most advantageous position to benefit from accelerating market growth due to the diversity of their existing services; from new technology solutions due to their existing deep engagement with customers and their market experience; and from regulatory pressure driving out smaller or less sophisticated operators – not just because they have robust, established global operations and high volumes of customer traffic, but because they have spent decades earning the trust of their customers with a range of highly-tailored and specific payment solutions tailored to each receiving market.
Combine this with the current wave of bank account closures by large banks affecting operators with insufficient controls, as well as the ongoing race to carve out market share in cyberspace, and its not difficult to foresee market volumes continuing to move onto the platforms of the established global operators, rather than to new start-ups.In the years ahead, I believe that the larger global platforms will prosper as these trends combine to benefit their business model – in addition a small number of new entrants will carve out a profitable niche for themselves, but it will take them many years and massive investment to reach any material scale – and the total number of operators will continue to fall.
Nick Day is the CEO and co-founder at Small World FS