As I think about payments developments in 2014, what strikes me is that the payments world is now in a phase of collaborative systemic innovation, the like of which we have not seen in 20 years.
I have written about the cyclical nature of network evolution before. It’s all about network effects – ie the reality that, in payments as in other network industries, the net value of a service is proportional to the number of other people using the service. Wherever there are large network effects, an evolutionary balance must be struck continuously between service innovation based on the existing network, and systemic innovation to enhance the network itself. The former uses new technology and/or new business thinking to improve services to end users without trying to change the network itself – because this is expensive and hard to do. Service innovation tends to be competitive in nature. A good example is Square, which innovates in the merchant/customer interaction by riding the rails of the existing card schemes.
The latter – systemic innovation – seeks to upgrade the underlying network so that new and better services can ultimately be delivered to end users. The current global enthusiasm for real-time payments is largely in this category – building new networks to (eventually) deliver better services. Because this needs a large number of existing participants to coordinate in upgrading their technology and operations at the same time, it is typically collaborative more than competitive, and government often has an important role to play.
What is interesting – and to payments tragics like me, exciting – is the interplay between the two. There is no theoretical reason why both types of innovation can’t happen at the same time, and at any given moment there is likely to be some of both. But history suggests a pendulum effect: when a network is relatively young, its full service potential is still to be explored commercially and competitively, and at such times the industry’s focus of effort swings towards service innovation and competition. In the 90’s we saw this with fully automated card networks, as their footprint and services expanded rapidly, first in credit cards and then in debit cards. Eventually, however, such a process reaches saturation – there are fewer new customers, and innovations that deliver a competitive edge over everybody else who uses the same basic system become rare.
Then, we see a swing back to collaborative systemic innovation – the focus moves to upgrading or replacing the underlying network, which (if done well) opens up new potential for future service innovation and competition. All around the world, we see effort to upgrade, modernise or replace ACH and other automated payments systems. Now that the United States has signalled a major project in this area, nearly all the developed economies and many of the developing ones are seriously engaged in systemic enhancement. While service innovation must go on in parallel, as demanded by the competitive market for payment services, it is much harder to take a competitive bet on new services when the underlying network is changing. The risks of disruption are all the greater.
For those developing payments strategy for industries or for individual competitors, one important observation is that the pendulum seems to be swinging ever faster. Cheques were the stable network platform for service innovation by banks for over a hundred years; ACH for maybe 40 and cards for only around 25 years. We are already seeing service innovation on top of real-time platforms – but it is going to be very important for us to form a view on the longevity of the new networks. So far as possible, we want to make the new networks future-proof – by which I mean capable of supporting a large amount of future service innovation without major network change. By this means, we are likely to maximise network efficiency and leverage the large investment that is always necessary in a new network. In the Australian New Payments Platform, this idea is embodied in the layered architecture.
So it is encouraging to see that in many places around the world, including Australia, the new era of collaborative network development includes a strong element of strategic planning, as well as network upgrade. This can be seen in the proliferation of national payment plans and national payment councils. The more we think about how the competitive market might use proposed new network infrastructure, the more likely we are to get the most out of our collective network investment.