A Merchant s View of Card Payments in Asia Pacific kpmg.com/cn

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1 PAYMENTS TRANSFORMATION A Merchant s View of Card Payments in Asia Pacific kpmg.com/cn

2 Our contributors Egidio Zarrella Asia Pacific Partner, Payments Transformation Simon Gleave Partner in Charge Asia Pacific Financial Services Thomas J. DeLuca Managing Director Advanced Merchant Payments Ltd. Nigel Hobler Partner Tax Jeremy Fearnley Director Payments M&A Matthew Ding Partner Performance & Technology Harry Hughes Manager Payments Transformation James Mckeogh Senior Manager Payments Transformation

3 A Merchant s View of Card Payments in Asia Pacific 1 Contents Our contributors Introduction Layers of complexity in the payments chain 6 - Managing multiple card brands - Fragmentation and sales channels - Systems - Geography - Treasury and bank reconciliation - Implications Case study: Next generation hotels 2. System strategy and channel architecture Case study: Airline industry innovation in onboard retail 3. Cash management across the payments silos Cross border and repatriation issues 5. Innovation, M&A and future states in payments ecosystem Case Study: A cautionary tale for online retail C-suite considerations Contact us

4 2 A Merchant s View of Card Payments in Asia Pacific Introduction While there are signs of a gradual recovery globally, many businesses, including those in Asia Pacific, are still focused on cost control and building business resilience. Executives are continuously looking for new ways to enhance their company s bottom line and gain a competitive advantage. In China and other parts of Asia Pacific, they also need to consider whether they have effective and unified platforms in place that will allow them to meet relatively ambitious growth targets. For companies that rely upon credit card and other electronic systems for their sales to customers, there may be substantial opportunities to reduce costs by improving the performance of payments platforms. Doing so can yield other benefits in the form of improved cash flow, higher sales volumes, reduced opportunity costs (for example the cost of lost sales) and tax efficiencies. In KPMG s first paper on the Asia Pacific retail payment sector, Card payments in Asia-Pacific: The state of the nations, published in July 2009, we discussed how different stakeholders in the card payments ecosystem were interacting and noted the evolving pressures on each of these participants. From there we explored several potential future states for the industry.

5 A Merchant s View of Card Payments in Asia Pacific 3 The traditional payments cycle Card holders Merchants Issuing banks Acquiring banks Card schemes Among other things, we noted how retail payment sectors in many parts of Asia Pacific have historically lagged behind other regions in terms of advances in technologies, regulations, and business practices. The result is payment processes that are fragmented and inefficient relative to markets in many other parts of the world. However, we also noted that there are many examples of innovation and that in many ways the payments ecosystems in Asia Pacific have been rapidly catching up with, and some cases surpassing, more mature markets. This paper is specifically dedicated to the position of the merchant in the value chain. We believe that almost any business which accepts cards for payment has an opportunity to improve its bottom line by focusing attention on its payment practices and treating electronic payments as a core element of business and strategic planning, not merely a by-product of everyday operations. The issues are largely irrespective of business category or size, although they can become more pressing as a business grows. They are applicable to retail outlets, airlines, hotels, restaurants, telecom companies or e-commerce businesses. In many respects, an airline selling tickets on its website has more in common with a small online bookstore than with other points of sale in its own business (for example, the airline s retail desks at various airports around the world). It is by focusing upon the channel through which payment is effected that opportunities for increased efficiencies and improvements to the bottom line are most easily recognised. We cannot assume that a sophisticated multinational corporation has adequately controlled its payment processes for maximum benefit, particularly in these days of ever-more-powerful technologies and more demanding regulatory transparency. It may have, but even the best-managed companies

6 4 A Merchant s View of Card Payments in Asia Pacific can benefit from a thorough review of their payment channels, sizing these up against overall strategic objectives. Some organisations have built their competitive advantage on the back of payments processing efficiency, but that advantage may erode over time as they expand into new markets and new technology starts to render existing platforms obsolete. Ownership is also critical, since responsibility for the payment channels is shared between various parts of the business. The finance function will always remain a key stakeholder, but IT or operations, treasury and often, sales, marketing and customer-service functions are also stakeholders. As a result, it is rare that a company can definitively point to one person who owns the payment channel, and this can determine whether payments systems are really handled in a strategic and proactive manner. At best, such situations result in inefficiencies in technologies and financial costs, the financial significance of which can be measured in real sales or savings not attained. At worst, such situations expose the business to dramatic and systemic financial risk, such as a business facing a customer service and PR nightmare of negative news headlines when the database of its best customers credit card details has been compromised. In this paper, we focus upon payments from a top-down perspective and challenge the reader to consider how their company s reliance on cards as a method of payment fits with the company s objectives in terms of growing the business, performance and IT infrastructure, treasury and cashflow management, and appropriate tax structures. We believe that almost any business which accepts cards for payment has an opportunity to improve its bottom line... treating electronic payments as a core element of business and strategic planning

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8 6 A Merchant s View of Card Payments in Asia Pacific Layers of complexity in the payments chain From the moment a cardholder tenders their card account details for payment to final deposit of hard currency into a merchant s bank account, there have traditionally been five major stakeholders in the payments ecosystem: issuing banks, cardholders, merchants, acquiring banks and card schemes. The process can also involve other entities. Different entities will be involved according to the environment in which the transaction occurred, the card brand tendered for payment and by jurisdiction. For this reason, an alternative way to consider the payment chain is as a series of silos, which facilitate the movement of transactions from point A (where the merchant exchanges goods for the customer s promise to pay) to point B (where the merchant has ready access to the funds for such transaction), with various stops and diversions along the way. Complexities are evident in the sheer number of payment silos which arise as a business grows, particularly across sales channels, currencies, and geographically disparate markets. This can inevitably translate into some inefficiency or lost opportunity when viewed from the perspectives of sales, processing costs, technology and systems costs, tax structures and treasury management. To better appreciate this complexity, it is helpful to consider the nature of the basic payment silo, a process which will be familiar to anyone who has made a purchase with a credit card.

9 Section or Brochure name 7 High Bank Geography Complexity System Channel Efficiency Card Customer High Number of silos High Low Source: KPMG analysis High Complexity Bank Geography System Channel Card Customer Efficiency High Number of silos High Low Managing multiple card brands Our first silo involves a merchant with one point-of-sale (POS) device, attached to the world both by electric cord and telephone line, and programmed with a specific merchant account number associated with the merchant, such that transactions processed through that device are ultimately funded to the merchant. The POS device would have been issued to the merchant by the local bank with the merchant s overriding consideration likely being to obtain the lowest merchant discount rate (MDR) for its transactions. To simplify we can simply regard the silo as a Card going into a Box which is linked to a Bank. As payment silos operate, the merchant account obtained from the local bank permits the merchant to accept Visa and MasterCard branded card products, but likely no others. However, most merchants appreciate the customer-service element of permitting a willing customer to pay with the card of their preference, even if that entails the extra cost of a higher MDR on some card brands. Consequently, this merchant will have likely signed up for merchant accounts with American Express, Diners, JCB and ChinaUnionPay. As a result, we can view the merchant s payment channel (or silos around Cards), starting with the retail POS device (the Box ), and running to each merchant account relationship with the specific scheme (the Card ) (perhaps five such accounts in our example, as Visa/Mastercard run on the same account). Each of these deposits transaction proceeds into the merchant s designated bank accounts (the Bank ), and each requires its own reconciliation.

10 8 A Merchant s View of Card Payments in Asia Pacific High Complexity Bank Geography System Channel Card Customer Efficiency High Number of silos High Low Fragmentation of sales channels In the same way that a merchant elects to accept multiple card brands in the name of customer-service, so too does it suit the merchant to allow customers to complete their purchases through card not present (CNP) environments. These include payments made over a phone (mail-order/telephone-order, or MOTO), through the Internet, and increasingly, using mobile devices. Reflecting the higher risk of CNP transactions, the MDR typically increases by 0.5 percent. In relative terms, this is akin to a percent increase in the cost of card acceptance. To minimise the risk of a chargeback situation arising for unauthorised transactions and to maintain favourable terms for transactions through traditional channels, the merchant needs to bifurcate the business by sales channel and seek a new set of merchant accounts from each card scheme specific to the CNP business. Another necessary sales channel for any merchant is an Internet-based sales channel, from which people can order and pay directly. In doing so the merchant must recognise that there are several available paths to choose from, which need to be assessed for their relative costs and benefits. As a result, we can now identify a second and third payment silo, replete with POS systems, or payment gateways, specially designed to accept card account numbers in accordance with card industry account data encryption requirements, and another set of merchant accounts, which all require reconciliation. High Complexity Bank Geography System Channel Card Customer Efficiency High Number of silos High Low Systems Even within one sales environment, different POS technology systems may be required. A hotel, for example, will feature a property-management system at the front desk, and perhaps at several restaurants, retail outlets, spas or golf course. For each of these there are specialised systems designed to serve a specific function (for one example, support for tipping in some cases). Add to this the increasing efforts to cater to consumers demand for on-the-go customisation, whether through kiosk or mobile phone. Even a single physical store location may support multiple payment silos, rendering significant challenges in integrating the payment process into the business management information systems. This complexity, however, becomes exponentially greater when viewed not from a single location, but from a broader regional perspective. Banks in different markets impose different requirements for POS systems (for example, different certification standards for Internet payment gateways), with the resulting inefficiencies for the merchant of operating multiple POS systems in parallel.

11 A Merchant s View of Card Payments in Asia Pacific 9 High Complexity Bank Geography System Channel Card Customer Efficiency High Number of silos High Low Geography For multinational merchants, it can be convenient to have all the card transactions from their various Asia locations linked to a single regional merchant account. However, this is made impossible by card scheme rules against cross-border acquiring, which mandate that, for each country of operation, the merchant must have a distinct merchant account relationship with a bank in the specific country. As a result, the multinational merchant faces a multiplier effect compounding the complexity of dealing with different card brands, sales channels, and technologies. Geography, however, does not always have a negative effect on our payment silos as efficiencies can be found by reviewing the business structure and adopting appropriate regional strategies for servicing sales channels. For channels including telesales and e-commerce, it has become common practice for multinational merchants to set up shared services facilities. As a result, merchants have realised benefits in terms of tax, wage arbitrage and processing efficiency. High Complexity Bank Geography System Channel Card Customer Efficiency High Number of silos High Low Treasury and bank reconciliation The level of reporting provided from banks, within a market and on a regional basis, provides different levels of information, some more helpful than others. This can often lead to an inordinate amount of time being dedicated to reconciliation of the business various payment silos. This information asymmetry can readily lead to significant inefficiencies, whether in effective cash management on a cost of funds basis or managing FX reserves. Though not exclusively a problem reserved for e-commerce and other CNP sales channels, these environments may offer particular opportunities for improvements among merchants. Implications Considering the various silos we have identified by card brand, sales channel, technology, geography and treasury the opportunities for mismanagement of sensitive customer data ought to be readily apparent. Certainly, after several years of concentrated effort by the card schemes, most merchants are aware of the requirements for protection of cardholder information. Most major payment related systems are certified as Payment Card Information Data Security Standard (PCI DSS) compliant, and in most places within the merchant organisation, any card account details in the company s databases are fully encrypted. This, however, creates its own complexities, in terms of providing more proactive customer-service in response to customer complaints or in mining the data to market better to customers.

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13 Case study: Next generation hotels A Merchant s View of Card Payments in Asia Pacific 11 Having endured the challenges of the global economic downturn and influenza pandemics, 2010 saw a strong recovery for the hospitality sector globally. In line with global economic trends, the greatest level of investment in the hotel industry is ocurring in Asia, with 444 hotel projects, comprising more than 100,000 rooms, expected to open during We also see hotel operating and delivery models evolving rapidly, with Asia leading the way in adopting new technologies and practices. The hospitality industry continues to remain in the spotlight for innovation due to the need to be constantly doing more to maintain customer loyalty. With the rise of social media portals and new software, guests are increasingly expecting a one-on-one personalised interaction when dealing with merchants. In order to do this, the hotel revenue and inventory management systems will come under greater pressure to provide functionality for every amenity in the hotel to be chosen, customised, packaged and paid for on demand. As this customer interface becomes increasingly virtualised, guests will demand the same experience from the payments infrastructure. While the process of billing may appear blissfully seamless to the hotel guest, this will mask some complexities and risks concerning the transfer and treatment of data. Challenges, therefore, lie ahead for hotel groups as they confront the complexity created by the current payment ecosystems and chart their course to a more virtualised state. The traditional methods employed by card issuers, schemes and acquirers will need to evolve in line with the technology requirements of the modern traveller. If they do not, the hotel industry will increasingly look to bring such functionality in-house with the use of mobile, application based technology and peer-to-peer (P2P) payments. However, such a future scenario is fraught with risk for an industry where customer interaction and data privacy are key. C-suite considerations Do my revenue, inventory and payment systems talk to each other? Can my current payment providers meet my guest requirements? As my payment systems evolve, can I be sure that my customer data is adequately protected? 1 STR Global, July 2010

14 12 A Merchant s View of Card Payments in Asia Pacific System strategy and channel architecture With the payments ecosystem currently in a period of change and growth across Asia, those responsible for providing the underlying technology infrastructure for payment processing have many opportunities to respond. Technology companies can consider how years spent augmenting legacy IT environments has affected the overall delivery of an efficient and effective payments business. Realising benefit Most organisations across Asia, not just those involved in the provision of card payment services to consumers, are currently considering the suitability of their IT environments. The current economic climate and desire for market expansion are making CIOs assess how they can improve on their legacy IT systems and position themselves for the increasing business potential that the market is promising. For card processing, this can mean considering everything from the card processing terminals and POS solutions through to back end reconciliation applications and management reporting capabilities. However, it is often difficult to justify to business leaders the benefits that can be achieved from such advances since the return on investment can often take a considerable amount of time to materialise. It may be difficult to quantify benefits that centre on customer experience and value-added services. In other areas it is much easier to understand the potential benefits. Although the need to improve on legacy environments is a key driver of this initiative, it is also worth remembering that Asia is in a leading position when it comes to adopting new technologies. The low-value payment market is growing fast in Asia, with China Mobile reporting payment processing volumes in excess of RMB 10 million daily. 2 2 China Mobile

15 A Merchant s View of Card Payments in Asia Pacific 13 3 Publicly available information 4 Whilst this service currently only supports merchants based in the United States, we believe it is likely that similar services will appear in Asia. When these transaction volumes are combined with the size of the domestic and regional markets, there is clear potential for huge growth at faster rates than in other areas of the world. The processing of these smaller payment amounts has driven the need for more efficient processing due to low recovery margins. Asia is commonly seen as a follower in global initiatives, but in the development and progression of the payment ecosystem, Asia has the potential to lead the way in delivering value-adding services to merchants and consumers. While not the only factor, this vision of how technology can be used is partly a factor when you consider the differences in investment that occur across the world, with Visa announcing investments of USD 142 million in the mobile payments arena compared to USD 5.83 billion by China Mobile. 3 Demanding more from existing relationships As well as looking at an organisation s own processing capability, merchants are no longer beholden to the technologies of their acquiring banks and should consider alternatives. The increasing number of payment processing intermediaries that provide online services as well as physical devices is creating a competitive and lucrative market globally. Companies such as feefighters. com 4 have responded by providing a comparative analysis of several players in the payments processing field. The online environments provided by their registered suppliers and ease of integration with off the shelf POS solutions makes it possible for cheaper and more efficient payment processing solutions to become even cheaper. Feefighters.com is using Internet technologies to allow payment processors to bid for new merchants business, helping to ensure that this new market remains competitive. Speed is key The secret to success in Asia will be how quickly new technologies can integrate with existing business processes in order to deliver the new functionality and products that consumers are demanding. The increasingly affluent young population has a high degree of technological awareness and expect to be able to spend at any time and in any way that they want. Being able to offer integrated payment services across multiple delivery channels is critical to merchants, and in turn merchants must start demanding more from the services provided by technology vendors. Don t forget about security Whilst technology is assisting Asian organisations in expanding their reach and developing new payment solutions, recent security incidents should also be a warning sign. The increase in what appear to be targeted attacks on gaming network users, including Sony, Nintendo and CodeMasters, and also on the providers of security solutions such as RSA and Comodo, are all signs that the value of information continues to increase and the technical capability of criminals is growing. Any new payments network or method for providing financial transfers is more than likely to be a target of such criminal and destructive activity, which makes ensuring the security of transactions a key priority. Responsibility for this security lies with all parties involved in the transaction, from the security of the card used in the payment through to the systems used by the merchant to process it, and even the payment processor s own settlement systems. In most cases, when things go wrong, it is the merchant that bears the consequences, with customers expecting compensation, payment networks issuing penalties and trade being suspended whilst investigations continue.

16 14 A Merchant s View of Card Payments in Asia Pacific Realising benefit from technological innovations Many of the recent developments in the technology industry are directly impacting the way in which we are or will be able to complete payments. Below are some current market developments that are enabling payment providers to try new things. Cloud computing The creation of payments processing has normally required upfront investments in technology, security and sheer processing power. With Cloud providers now delivering off-the-shelf payment solutions through the Internet and computing power houses able to ramp up and ramp down as transaction volumes dictate, the cost of using or establishing payment processing hubs is falling. Software as a Service solutions, where payment functionality is provided to the merchant as a web application across the Internet, are also enabling providers to offer feature-rich, value-added services. This is becoming increasingly part of the processors arsenal of differentiators and many merchants will now be looking for real-time reporting on payment processing times, full disclosure and transparency of costs incurred, and automatching between payments services and funds received. Near Field Communications Just as the chip in current credit cards began the demise of the magstripe in many countries, so the introduction of Near Field Communication (NFC) chips will do the same. Allowing the benefit of providing contactless payment facilities and allowing payment cards to be virtually any size and integrated within any device, this new technology shows a lot of promise. Organisations such as Apple, Samsung, NFC and many others are all keen to adopt it in order to enable tap-to-pay capabilities and, more importantly, potential mainstreaming of P2P transactions. Mobile Apps It is clear that consumers are demanding more from their payment experience. Greater functionality and flexibility in mobile devices is driving the development of software and applications for smart phones and tablets, which sees the social and gaming experiences of consumers being integrated with payments technology in order to provide a unified experience. Facebook Payments, AliPay and PayPal are integrating with the social networking and virtual gaming worlds in order to process transactions between participants and generate new revenue streams. As the content we access gets richer, so the ease of charging and storing payments will become more integrated with our online life.

17 A Merchant s View of Card Payments in Asia Pacific 15 Case study: Airline industry innovation in onboard retail In an industry looking to broaden its revenue-generating abilities, airline operators have a significant opportunity to harness technology to deliver more extensive in-flight retail formats. At least one recent study estimated that onboard sales had the potential to become a USD 100 billion per annum business, providing goods and services as diverse as theatre tickets or car rental. 5 As a result, bespoke technology providers are entering the market to capture this opportunity with advances in onboard Internet and mobile telephony driving such developments. We are seeing an increased focus on in-flight retail as a result of the unique nature of air travel and the captive shopping environment that it provides. Vendors and airlines are moving quickly to upgrade their capabilities in this space in order to take advantage of this opportunity for increased revenue. A greater emphasis is being placed on individual passenger requirements and buying patterns. Pre-existing customer loyalty schemes at the major carriers provide a great deal of information regarding the behavioural patterns of their customers. This information provides a unique opportunity for the airlines to personalise sales strategies in order to maximise onboard profits and enhance the customer s in-flight experience. For premier airlines on premium routes, there is potential for the range of onboard products and services to be contextualised to fit with the destination and nature of the trip. Be it for a vacation or business trip, airlines are beginning to allow their passengers to purchase local goods and services which are ready on arrival at their destination. With the greater emphasis on onboard sales, airlines need to address the systems and processes required to support growth. As transaction value and volume of sales increase from this business unit, carriers must pay close attention to issues concerning fraud, processing capacity and distribution. C-suite considerations Am I taking full advantage of my potential sales channels? Do my customers have a personalised and contextualised interface for interacting with me? Are my payment interfaces interacting with my wider business? 5 GuestLogix White Paper: Onboard Retailing 2.0, published 2010

18 16 A Merchant s View of Card Payments in Asia Pacific Cash management across payment silos In any business, poor visibility over cash flow is often caused by inadequate linkages between sales, operations, treasury and finance functions. With so many stakeholders involved, the payments chain is an aspect of the business particularly prone to miscommunication. Cash management concerns most commonly result from the level of complexity within the system and need for manual intervention when issues arise for example when transaction reporting does not match bank records as a result of manual reconciliation processes. Without clearly defined processes and interfaces between systems, such issues can rapidly escalate. Attempts to forecast cash flow or develop cash-focused performance indicators become futile. Varying technology and processes within each silo can also cause a significant impact on the time it takes for the transaction to arrive in company accounts. This can often be linked to the type of card that has been used as each provider (in each country) employs alternative methods (technology and process) for execution. In turn, there can be a significant financial impact caused by the speed to deliver each of these credit card payments. Aside from the financial impact caused, we also experience a number of difficulties arising from a reporting and planning perspective. Without a clear view of expected receivables across silos, reaching an accurate assessment of liquidity can be problematic. The importance of such cash visibility and control can be seen when organisations

19 A Merchant s View of Card Payments in Asia Pacific 17 attempt to plan future growth, forecast their cash and working capital needs, and ultimately measure their profitability. In order to address these difficulties, there are opportunities to implement standardised procedures to perform daily reconciliation between sales records and credit card payment records. Vendors have an opportunity to increase the visibility of transaction details through the use of technology while centralising bank/acquirer relationship management at group level to enhance bargaining power for improved service levels and reduced costs. C-suite considerations What is the level of manual intervention in my payment infrastructure? How long does it take for transactions to hit my bank account? Can I extract meaningful information from my payment silos? Do I have a centralised relationship with my acquiring bank?

20 18 Section or Brochure name Cross border and repatriation issues As a retailer or merchant grows to a certain scale, certain cross-border issues arise. The ways in which revenue is recognised and repatriated between jurisdictions can have tax and other regulatory implications, which need to be addressed proactively as part of the growth agenda. Recognising revenue Typically, sales transacted through a regional office are recorded as revenue for the merchant in that country, with income derived from these transactions subject to tax there as well. If some revenue can be attributed to services or intellectual property deriving from (or risks borne by) the parent location, then profits can be shared between it and the local office.this generally entails the local office paying a license fee or other similar fee to the parent. The parent may charge the subsidiaries management fees for administrative and back office functions performed centrally. These types of related-party transactions will typically attract scrutiny in both the local jurisdiction and the parent location. Transfer pricing rules exist across Asia, although levels of scrutiny and enforcement vary. Some countries authorities (China being a notable example) are becoming more proactive. Revenue authorities share a common expectation that any allocation of profits across jurisdictions is done on an armslength basis and supported with proper documentation. This is particularly likely where profits are being allocated to a relatively low tax jurisdiction (Hong Kong s corporate tax rate is currently 16.5 percent, compared to 17 percent