4. INDIA DIGITAL PAYMENTS – A $500 BN POT OF GOLD

Increasing smart phone penetration,

is set to drive the penetration of digital payments in India. We expect the digital payments space to witness significant disruption in the days ahead.

The Future of Digital Payments in India

While the exact form and shape of disruption will only be unveiled over time, the crystal ball indicates seven trends set to transform the payments landscape over the next five years:

  1. Technology will make digital payments simpler
  2. Merchant acceptance network to grow 10X by 2020
  3. Payments will drive consumption — and not the other way around
  4. Consolidation will drive ubiquity
  5. Modified UPI [1] will be a game changer
  6. Digital identity will accelerate customer acquisition
  7. Cash to non-cash ratio will invert over the next ten years

Technology will make digital payments simpler

Widespread adoption of digital payments will require such transactions to be just as convenient and safe, if not more, as cash. This is only possible with new solutions being developed to make digital payments easier for customers as well as merchants. Smartphones are expected to displace cards, ATMs and POS as an issuing and acquiring device. Ubiquitous connectivity, biometrics, tokenisation, cloud computing and the Internet of Things are just a few of the trends that will affect the way consumers transact and interact with payment service providers in the future.

Some payment innovations that could be relevant in the Indian context are:

In summary, while the exact uptake and penetration of different technologies is unclear, it is obvious that technology will be a key disruptor and further developments will make digital payments simpler, more convenient and easier to use.

Merchant acceptance network to grow 10X by 2020

The merchant acceptance network for cards in India has by and large been stagnant for the last several years. With approximately one million POS terminals [5] accepting card payments at an estimated 700,000-800,000 merchant outlets, it is one of the most underpenetrated in the world (Refer Exhibit 4.1). The potential of this segment is estimated to be nearly 15 million establishments including unorganised retail and small “mom and pop” stores.

One of the key reasons for this low penetration has been the high cost of “terminalising” merchants. Despite the cost of EDC machines [6] coming down significantly over the last several years, a certain minimum threshold of transactions is still required to recover cost of deployment and maintenance. Further, the current economics of the merchant acquisition business make it unviable for acquirers.

We believe that mobile based payment solutions will significantly drive merchant acquisition. The use of technology will create solutions that require nil or minimal additional investment on point-of-sale hardware. Use of proprietary or mobile based payment networks is expected to make economics more attractive for both merchants and acquirers. Primary research indicates that merchants believe accepting digital payments could help boost their sales, and are open to accepting payments through mobile provided fast and convenient solutions are available.

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Offline is an indispensable channel to attain scale of digital payments. It also provides extensive richness of consumer profiles by being able to merge offline and online behaviour. An offline strategy should involve analysis of customer lifecycles for use-cases to identify points of value addition for customers and merchants. We believe that offline should, and will be a priority, for all payment service providers.

Take the example of China. Both Alipay [7] and Tencent [8] are leveraging offline, albeit in different manners, basis their strengths. Alipay is using its massive scale to challenge Union Pay (credit and debit cards) by signing up more Points of Sale (POS), partnering with large retailers (7-Eleven, In Time Retail), using strong promotional schemes (offering discounts offline of up to 50 percent at restaurants and supermarkets) and offering international shopping offers to high-end customers. WeChat (Tencent’s instant messaging service) on the other hand, is using its chat platform to deeply integrate with user behaviour. Peer-to-Peer (P2P) transfers are encouraged through WeChat messenger, adding value to merchants with WeChat service accounts. Merchants can also engage with customers on WeChat, for food orders, store location services, reservations, customer service etc.

In light of all of the above point, we estimate that 10 million plus merchant establishments will accept digital and mobile based payments by 2020. This will be a key factor in driving the penetration of digital payments in the country. This 10 million is expected to come from the current 15 million universe, plus the potential use with “mobile merchants”, for example, newspaper vendors, milkmen, cable TV providers, insurance agents etc.

Payments will drive consumption — and not the other way round

Digital payments will enable payment service providers to get access to customer transaction data, and will soon become a ubiquitous ecosystem comprising marketing, transactions and payments. Customer will be offered digitised valuables such as offers, coupons, loyalty points, rewards, etc. from multiple brands while enabling payment transactions through the use of data and analytics. It will work parallel to merchants’ apps complementing them and engaging with users, thereby providing a seamless shopping experience and giving merchants a presence on customer’s mobile device. Digital payments will pivot into an experience influencing consumption going beyond payments.

Consolidation will drive ubiquity

The last few years have witnessed the entry of several participants in the payments space, with many of these being non-bank entities such as PPI’s, [9] telcos etc. Some of these players have focused on providing niche or limited solutions. Most of these players have been subscale and have not been able to acquire critical mass with some even shutting down operations.

Primary research indicates that customers prefer ubiquitous solutions to using different payment instruments for different use-cases. Smartphones shipped to India are often stripped down versions, and have less memory, limiting the number of apps that can be downloaded and stored therein. Given all this, customers would prefer to have fewer wallets / apps with multiple uses than several single-use apps.

This will drive consolidation in the payments industry. Niche or single use case solutions / apps will get acquired by larger players, in the quest to develop universal and ubiquitous solutions. This is also likely to increase throughput or velocity of transactions happening through digital payment instruments.

Modified unified payments interface (upi) will be a game changer

NPCI’s Unified Payments Interface [10] is aimed at enabling interoperability between financial instruments using a mobile interface. As outlined earlier, UPI is an open architecture system, wherein any payment service provider connected to UPI will be able to provide payment and payment management solutions to users registered on UPI. This would enable multiple use-cases on the UPI platform — including peer to peer payments, person-to-merchant payments and business-to-business payments. Furthermore, users will not have to remember cumbersome details like MMID numbers, [11] branch IFSC codes [12] etc. to make payments with only the UPI ID sufficing to carry out transactions. UPI will also have a two-factor authentication process to ensure security of financial transactions.

UPI is currently in very early stages, and hence, a few challenges are yet to be overcome.

Firstly, NPCI needs to ensure the integration of leading banks, PPIs and other financial institutions on this platform. This is expected to be difficult and time consuming.

Secondly, providing a seamless and consistent experience to customers across mobile banking platforms of varied banks will not be easy.

Finally, ensuring that all users are able to generate UPI virtual IDs on their own, will be significant to the success of this initiative, especially for merchant transactions.

Despite these challenges, UPI holds the promise of being a game changer for the digital payments world. If suitably modified to overcome challenges, it can drive large scale adoption of digital payments in the country, in times to come.

Digital identity will accelerate customer acquisition

Using Aadhar, [13] for online authentication and confirmation of KYC data, [14] will boost growth of digital payment systems. Payment service providers will be able to acquire customers digitally, significantly bringing down customer acquisition costs and improving economics of the digital payments business. This will also transform customer experience as customers will be seamlessly on-boarded on to the digital payments platforms.

Cash to non-cash ratio will invert over the next ten years

Traditionally, India has been a cash economy. Cash lends itself to certain characteristics of universal acceptance, with no language barrier, simplicity of use and speed of payment due to which Indian customers have largely preferred dealing in cash. Currency in circulation in India accounts for 18 percent of the GDP versus 3.5-8.0 percent in mature markets such as UK, USA etc. India lags behind mature markets as well as key emerging markets such as Brazil and China in the move towards a cashless economy. In 2015, cash contributed to just 20-25 percent of overall consumer payments in developed nations, for example, US, UK, France and Germany as compared to 78 percent in India. Of the remaining 22 percent, 13 percent comprises digital (including NEFT, [15] RTGS, [16] internet banking and mobile banking), 7 percent are cards, and 2 percent are paper (cheques) (Refer Exhibit 4.2).

While India has traditionally been a cash-centric economy, the contribution of cash for transactions has seen a decline at a rapid rate. In 2015, 78 percent of all consumer payments were made in cash, down from 89 percent in 2010 and 92 percent in 2005 respectively. Over a 5-year period from 2005-2010, the rate of decline in cash contribution was 0.8 percent whereas from 2010-2015, this same metric was at 2.6 percent, indicating a rapid increase in adoption of non-cash instruments such as cards and digital payments (electronic / ECH payments, [17] mobile wallets etc).

“Digitisation of cash” will accelerate over the next five years with non-cash transactions overtaking cash by 2023.

We expect the trend of increasing penetration of non-cash payments to continue at a faster pace (Refer Exhibit 4.3) The increase in the contribution of non-cash payments would, inter alia, be significantly and substantially aided by the penetration of digital payment instruments. This “digitisation of cash” would be supported by several macroeconomic and demographic factors in India, along with the new developments expected in the digital payments space.

The non-cash contribution for payment transactions is estimated to increase from 22 percent today to 40 percent by 2020 and 59 percent by 2025. Within the pool of non-cash payments, digital payments are expected to contribute to an extent of 26 percent by 2020 and 37 percent by 2025 (Refer Exhibit 4.4). By 2025, cash contribution in India is expected to match current cash levels of emerging markets at 40-45 percent.

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Alternate digital payments instruments will drive the growth in non-cash payments.

Alternate digital payments have grown exponentially in the past few years. Stored value instruments like mobile wallets (Paytm, MobiKwik, Freecharge), store credits, prepaid and gift cards etc. have made payments through internet devices convenient and easy. These instruments can be recharged with required value through cash, money transfers from bank accounts or even by debit or credit cards. The prepaid amount can then be used as per customer requirement.

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Digital payment instruments can also store information such as the credentials of an existing payments instrument, making the payment process at the point of purchase simpler. NPCI’s Unified Payments Interface (UPI) is also expected to support interoperability in stored information as well as stored value instruments.

Digitisation of Payments is a Large Opportunity

The large spectrum of payment use-cases in India can be illustrated using two axes, one being the source or origin of payment transactions, and the other being the destination of the transaction. We have considered three types of entities — individuals (or Persons), business entities (or Merchants) and the Government and correspondingly classified payment use-cases into nine categories (Refer Exhibit 4.5).

Large size of prize in India

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Merchant Payments (P2M) will be the largest use-case of digital payments

We estimate Person-to-Merchant (P2M) payments to constitute around 40 percent of total payments done through digital payment instruments. The universe for these payments is very large and even with moderate adoption estimates, this would translate to being the single largest use case for digital payments. Unorganised retail, rent and professional service payments (payments to doctors, school fees) and financial services payments (insurance premiums etc.) are expected to drive the growth in this segment. The remaining contribution in the P2M segment will comprise other use cases such as bill payments, organised healthcare, restaurants, modern trade shops, travel and e-commerce (Refer Exhibit 4.7).

images/exhibit-4.6.jpg images/exhibit-4.7.jpg

Micro-transactions (small ticket size of INR 100, high frequency transactions) are expected to form 50 percent of the total transaction value on digital payments instruments within P2M payments by 2020. A critical criterion for digital payments’ success is for them to translate into customer habits. Frequency of using the instrument, therefore, assumes great significance. Constraints of memory space in smartphones shipped to India cause any app that is not frequently used to be deleted. Therefore, much like cash, a wallet needs to be usable in multiple, high-frequency, everyday transactions to have relevance and consequence as these transactions by nature are small in amount. While there is large propensity for micro transactions to move to digital payments, a non-prohibitive fee structure will be important to render this into reality.

Business to Business (B2B) payments will gain traction

Another potential use-case of digital payments is the exchange of payments between small businesses and SMEs. Currently, these payments are largely made in cash or through bank cheques. As digital payment instruments gain prominence, we expect payment service providers to create customised solutions that cater to small businesses specifically. These could include supply chain payments, retailer to distributor payments, dealer and vendor payments etc.

The digitisation of supply chain payments could also play a key role in supporting the digitisation of P2M payments as retailers would be more comfortable accepting payments from consumers in digital currency. This would also enable them, in turn, to be able to pay their suppliers or distributors in a similar currency. We thus, expect B2B payments to become the second largest use-case for digital payments by 2020.

Digital Peer to Peer (P2P) payments to double by 2020

Remittances or Peer to Peer (P2P) payments through digital payment instruments have seen good adoption and growth over the past few years. We expect this trend to continue and estimate the penetration of digital payments instruments for P2P payments to grow from 15 percent currently to 30 percent by 2020. However, primary research indicates that there are certain challenges to overcome in order to make the digital remittance value proposition stronger.

A comparative analysis of prevailing modes of money remittances indicates that while traditional modes like banks, money orders and cash constitute top 3 modes, mobile wallets are the next preferred method. (Refer Exhibit 4.8). Digital payments offer convenience and 24x7 access to overcome issues related to timing, security and restricted usage synonymous with traditional methods. However, the fee incurred and limits on transaction amounts remitted via digital instruments act as deterrents to usage. Post offices, banks and cash remittances were perceived to be cheaper, though less convenient, while digital instruments, private companies and agents are perceived to be similar on charges.

For existing remittance users, pain points include being habituated to cash, lack of product clarity and narrow reach leading to churn. In addition, concerns of not being able to access money in case of limited mobile network coverage or not being able to transfer money to bank accounts add to reasons why many customers have never tried a digital payment instrument for money transfers.

Payments service providers looking to acquire customers should invest in promoting the product and in educating the customer, equally.

Research also shows that the primary reason for needing such assistance is lack of product know-how and usage awareness as well as lack of understanding of English — both facets being progressively worse in non-metros. As digital payment service providers target users and sellers, the importance of customer education and regional languages is only set to grow.

In summary, the opportunity for digital payments in India is nascent yet quite sizable with trends being positive over the last two to three years. The seven key trends identified, we believe, will disrupt the payments space in India making it more digital over the next five years. This will include inversion of the cash / non-cash ratio for payment transactions over the next five to seven years. The erstwhile value of digital payment transactions could increase 10X by 2020 from current levels.

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The Boston Consulting Group • Google | 39

reposter's notes

[1]https://en.wikipedia.org/wiki/Unified_Payments_Interface
[2]https://en.wikipedia.org/wiki/QR_code
[3]https://en.wikipedia.org/wiki/Block_cipher_mode_of_operation
[4]https://en.wikipedia.org/wiki/Iris_recognition
[5]https://en.wikipedia.org/wiki/Point_of_sale
[6]https://dir.indiamart.com/impcat/edc-machine.html
[7]https://en.wikipedia.org/wiki/Alipay
[8]https://en.wikipedia.org/wiki/Tencent
[9]https://en.wikipedia.org/wiki/Payment_protection_insurance
[10]https://en.wikipedia.org/wiki/National_Payments_Corporation_of_India
[11]https://en.wikipedia.org/wiki/Mobile_payments_in_India#MMID
[12]https://en.wikipedia.org/wiki/Indian_Financial_System_Code
[13]https://en.wikipedia.org/wiki/Aadhaar
[14]https://en.wikipedia.org/wiki/Know_your_customer
[15]https://en.wikipedia.org/wiki/National_Electronic_Funds_Transfer
[16]https://en.wikipedia.org/wiki/Real_Time_Gross_Settlement
[17]https://en.wikipedia.org/wiki/Automated_Clearing_House