THINKING BEYOND PLASTIC: BUILDING REVENUE BY ALIGNING B2B CARD NETWORK AND TREASURY SERVICES SOLUTIONS

THINKING BEYOND PLASTIC: BUILDING REVENUE BY ALIGNING B2B CARD NETWORK AND TREASURY SERVICES SOLUTIONS BY Hugh Thomas Commercial cards have existed in one form or another since the early 1980s. First conceived as a solution for payment of corporate travel and entertainment (T&E) expenses, commercial card networks have evolved to meet a variety of payment needs for businesses of all sizes. While corporate and purchasing cards remain profitable and growing product types, new offers, such as Accounts Payable Cards, Virtual Cards, and Payment Gateways, are expanding the use of these networks to offer innovative value-added solutions for commercial procurement and settlement. 13% only two product areas increased their share of measured fee-equivalent revenue: purchasing cards and wire transfer. Purchasing card revenue advanced from an 11% share in 2009 to a 13% share in 2010. - Ernst and Young s 28th Annual Cash Management Services Survey (2011) Executive Summary When first launched, the functionality of these products did not go far beyond that of consumer cards. T&E cards were designed to make life easier for traveling staff by offering various insurances, and Purchasing Cards, which came later, were designed largely to replace small dollar purchase orders and petty cash for maintenance, repairs and operations (MRO) spending. Products were run out of consumer card operations and were sold mainly on a reactive basis by treasury services personnel. Customer choice was based mainly on acceptance and bank relationship, and there was little differentiation of functionality. The late 1990s saw the creation of online marketplaces and supplier relationship management services such as Ariba and Oracle, as well as the advent of ubiquitous desktop Internet access. These changes drove issuers to build value-added technology designed to better integrate their products into the procure-to-pay value chain. Sales and product management were typically run from the consumer card side of the business, so as to better leverage investments in card management systems. In the mid 2000s, as value-added technology was quickly replicated among competing banks, price began to play a greater role in differentiation. Spend volume rebates for very large programs had existed since the 1990s; however, by the mid 2000s, these offers were becoming the norm for purchasing and corporate card programs of all sizes. Card programs run within the retail banking arm found themselves in a race to the bottom for who could offer commercial card programs with the thinnest margins. MARCH 2013

Figure 1: THE EVOLUTION OF COMMERCIAL CARD PRODUCT SALES 1990s Early 2000s Mid 2000s Late 2000s - Early 2010s Differentiated by acceptance and bank relationship Sold by commercial bankers Used mainly at retail suppliers Differentiation through technology Sold by card specialists Usage expands to B2B vendors Differentiation by price Sold by card specialists Usage expands to online procure-topay solutions Differentiation through integration of end-to-end payments solutions Sold by commercial bankers assisted by product sales specialists Usage expands to accounts payable payments By the end of the 2000s, many forward-thinking issuers were beginning to realize the opportunity to differentiate themselves by offering integrated payments solutions and pricing across their complete suite of payments products. This change in approach was also spurred by new card network rates and products, which have expanded the target purchase types for card network-enabled transactions. These efforts have plainly paid dividends. In the U.S. in 2011, as in each of the past five years, purchasing cards led all other treasury services products for both growth and profitability (Fig. 2). By the end of the 2000s, many forward-thinking issuers were beginning to realize the opportunity to differentiate themselves by offering integrated payments solutions and pricing across their complete suite of payments products. FIGURE 2: 2010 REVENUE GROWTH BY PRODUCT Ernst and Young s 28th Annual Cash Management Services Survey (2011) 20% 18.0% 15% 10% 5% 0% -5% -10% -15% -20% Check CDA DDA RLBX ARP INFO -9.5% -9.0% -6.5% -4.0% -1.0% -0.5% 0.0% 1.0% 2.0% C&C WLBX ACH / EDI 4.5% WIRE PCARD (Purchasing cards ) role in overall growth can perhaps best be summed up by noting that without the purchasing card contribution, total fee-equivalent revenue would have fallen by nearly 2% in 2010. Source: Ernst and Young s 28th Annual Cash Management Survey (2011). 2

THERE IS STILL LOTS OF ROOM TO GROW At present, card network-led commercial payments globally account for less than 2% of all B2B payments by value, while check payments continue to account for more than 23% and even cash accounts for nearly 4% (Fig. 3). These estimates suggest there is considerable room to grow within cards traditional sweet spot of low-value, high-volume procurement. Larger still are opportunities for growth to be found by moving beyond these traditional card-based procurement uses. At present, card network-led commercial payments globally account for less than 2% of all B2B payments by value, while check payments continue to account for more than 23% and even cash accounts for nearly 4%. FIGURE 3: SHARE ESTIMATES OF GLOBAL AND REGIONAL B2B SPEND VALUE BY PRODUCT 100% 90% 80% 70% 60% Card Other Direct Debit Credit Transactions Cheque Cash 50% 40% 30% 20% 10% 0% Asia / Pacific Europe Latin America North America Global Source: Bank for International Settlements Data, MasterCard Advisors Estimates. B2B CARD NETWORKS OFFER ADVANTAGES OVER OTHER PAYMENT OPTIONS While B2B card solutions started off as a spot solution for low-value purchases, their growth over the past two decades comes as a result of the many advantages they offer over other payment options. Effectively deployed, B2B card solutions can drive efficiencies in working capital, payments processing, and global settlement, all areas of key importance to large market buyers. B2B card solutions reduce risk and drive efficiencies in payments processing by providing a higher level of information than other payment products such as ACH and wire. Basic card transaction information is suitable for most purchases, and efforts to augment the level of value-added data provided by merchants are being driven by networks and banks. The rules B2B card networks manage and enforce allow for improved risk management versus other payment methods, and risk is also reduced by network spending controls. The hub-andspoke model offered by B2B card solutions also makes for a simpler means by which to make cross-border purchases. 3

Finally, effectively deployed card network solutions can improve the financial supply chain by automating and accelerating the sales-to-cash cycle, making cash flows more transparent and allowing prudent working capital lending (Fig. 4). FIGURE 4: CHARACTERISTIC COST OF FUNDS RATIOS BETWEEN LARGE BUSINESS BUYERS, SMALL BUSINESS SUPPLIERS AND BANKS Large Enterprise Cost of Funds = 5-7X Traditional Payment: Working capital funded by supplier / buyer. SMALL Enterprise Cost of Funds = 15-20X Bank Intermediation: Working capital funded by banks. CARD BALANCES 1. $28.84 2. $95.25 3. $79.72 INVOICE 1. $28.84 2. $95.25 3. $79.72 $28.84 $95.25 $79.72 CARD BALANCES 1. $28.84 2. $95.25 3. $79.72 Bank Cost of Funds = X Sample Data For Discussion Purposes Only. THE CHALLENGE IN REALIZING THESE OPPORTUNITIES As with any change to long-established practice, growing payments product revenues through commercial card payment networks will require an adjustment of mind-set. For banks seeking to grow card network payments businesses, this means that network-driven commercial payments products will need to be fully integrated with broader treasury services lines of business. For reasons having chiefly to do with the cost of card management systems, in many cases commercial card lines of business have been developed as an offshoot of consumer card businesses. For banks with smaller commercial card portfolios, the cost of systems and processes for issuing cards needs to be borne by both consumer and commercial card products to be economical. For this reason, many commercial card businesses were developed within consumer banking lines of business. For banks with smaller commercial card portfolios, the cost of systems and processes for issuing cards needs to be borne by both consumer and commercial card products to be economical. For this reason, many commercial card businesses were developed within consumer banking lines of business. Many banks have since taken steps to better align card products with treasury services products; however, in most cases, the value proposition for card network payments solutions is still not well understood by treasury services professionals. Conversely, sales and relationship managers for card programs often receive little or no training on other treasury services products. This lack of broader understanding is leading to missed opportunities to better serve the needs of corporate customers. 4

As card network-driven commercial payments products expand to capture larger and more numerous B2B transactions, the banking arrangements that facilitate them will, by necessity, become more strategic in nature. As card network payment solutions begin to cover new areas of procurement, such as Accounts Payable spend and recurring payments, these solutions will likely require larger lines of credit than those presently extended. This again illustrates the need for better integration, as new solutions begin requiring larger portions of bank customers available credit. ALIGNMENT AND FOCUS WIN To capitalize on these new revenue opportunities, banks will need to develop strategies that build alignment and focus between what may often be two distinct lines of business. Working in consultation with MasterCard s partner banks, Advisors has created a list of recommended tactics, which, properly embedded within a commercial payments strategy, will help banks to build alignment and focus on the right opportunities. Once the decision has been made to integrate or align treasury services and commercial card lines of business, executive sponsorship of this change should be communicated across both organizations. Tactics to Create Alignment: 1. Communicate Executive Sponsorship 2. Understand Your Customers Revenue Potential and Price Accordingly 3. Integrate Payments-Related Lines of Business 4. Develop Segment-Specific Solutions 5. Start with Quick Wins 6. Monitor and Reward Progress COMMUNICATE EXECUTIVE SPONSORSHIP Once the decision has been made to integrate or align treasury services and commercial card lines of business, executive sponsorship of this change should be communicated across both organizations. Messages from senior sponsors should explain the rationale for the change (i.e., why integrate, the risks of not integrating), the benefits of this change (i.e., new revenue, improved loyalty), and the implementation plan. 5

UNDERSTAND YOUR CUSTOMERS REVENUE POTENTIAL AND PRICE ACCORDINGLY Card network payment solutions differ from other treasury services products in that much of the revenue they generate comes from a third party, typically the supplier being paid (Fig. 5). However, because of their relative novelty, the potential revenue opportunity from card network payment products is often not as readily quantified as is the revenue potential for other treasury services products. This challenge in forecasting creates a host of other difficulties, from budgeting to sales incentives and planning. Advisors recommends that issuers take the time to benchmark their own portfolios by industry type, comparing spend patterns against annual sales, operating costs, or use of complementary payment products to gain better insight into the revenue potential of new sales. If your portfolio is too small to be considered representative, look to secondary sources for revenue benchmarks. FIGURE 5: REVENUE AND COSTS FOR $100 OF REVENUE: COMMERCIAL CARD PAYMENTS VS. ACH PAYMENTS Commercial Card Revenue and Cost This challenge in forecasting creates a host of other difficulties, from budgeting to sales incentives and planning. Advisors recommends that issuers take the time to benchmark their own portfolios by industry type, comparing spend patterns against annual sales, operating costs, or use of complementary payment products to gain better insight into the revenue potential of new sales. $94 $1 $3 $1 $100 $10 $45 $5 $40 $1 Fee/Trans Based Revenue Ad Valorem Based Revenue Value Date Rev. Acct Maint Rev. Balances Total Direct Trans Acct Maint Balance Related Net ACH Revenue and $65 $100 $5 $35 $50 $30 $- $2 $3 $10 Fee/Trans Based Revenue Ad Valorem Based Revenue Value Date Rev. Acct Maint Rev. Balances Total Direct Trans Acct Maint Balance Related Net Sample Data For Discussion Purposes Only. 6

Once you have a clear picture of how all the respective payments solutions deliver revenue, you should be in a position to develop holistic pricing structures. If, for example, a potential new customer is seeking bids for its check processing business, and you can see that there s a potential to significantly improve the economics of the relationship by migrating a portion of these transactions onto card network payments, this understanding, coupled ideally with alignment across lines of business, may give your bank an edge in pricing. INTEGRATE PAYMENTS-RELATED LINES OF BUSINESS All personnel from cards and treasury services will need to be able to identify and capitalize on new opportunities. This means that all parties need to be well versed in your complete suite of payment products. While achieving this goal will require time and focus, it need not entail organizational redesign. By ensuring that every member of your team is cross trained on all products, you can build on existing relationships and capture a greater share of customers banking business. Integrated Data Improves Retention Several recent surveys of treasury services decision makers have shown that, in the wake of the financial crisis, there is ever greater focus on the availability of real-time information for critical decision making and optimization of working capital. This means that solutions should offer integrated information on payment flows of all types, available through a single point of access. These solutions should also automate labor-intensive processes and eliminate paper. Effective integration of such solutions into customers processes can deeply embed customer relationships. Several recent surveys of treasury services decision makers have shown that, in the wake of the financial crisis, there is ever greater focus on the availability of real-time information for critical decision making and optimization of working capital. Help Your Customers to Optimize Their Payments Many banks see the value in offering consulting on payments optimization. These value-added services, when offered by commercial card providers, typically review large customers A/P or G/L activity to find new opportunities for card products. Effectively integrated, these services can be repurposed to identify new opportunities for all commercial payments lines of business. The insight into customer needs these services offer can also be used to develop holistic pricing. Integrate Acquiring Offerings to Expand the Reach of Your Programs Since the inception of card networks, acceptance development has focused primarily on retail and other consumer payment locales. Pure B2B businesses have only recently become a focus for banks acquiring operations, and these expansion efforts often require a complete repositioning of the card acceptance value proposition. Efforts to expand use of commercial payment networks will benefit from targeted acceptance expansion, and issuers succeeding in these efforts are collaborating with their strategic corporate customers to target suppliers. Often the suppliers that will benefit most by being paid via card networks are smaller firms with higher costs of capital. These sorts of firms are rarely targeted by merchant-acquiring sales forces, so banks that can coordinate sales efforts between card-using large corporations and their small-business suppliers may be seen as offering a differentiated service. 7

DEVELOP SEGMENT-SPECIFIC SOLUTIONS Industries vary in their payment product needs, and some industries are significantly more predisposed to use card network payments solutions than others (Fig. 6). A good next step following the successful integration of commercial payments lines of business is the development of segment-specific solutions that take in all commercial payments products. These might include combinations of products to meet the needs of corporations with large overseas operations (i.e., F/X products, export payment solutions, and foreign currency cards) or industry-specific packages. FIGURE 6: PERCENT OF TOTAL SPEND VIA PURCHASING CARDS (BY INDUSTRY TYPE) 4.89% 2.83% 1.75% 1.61% 1.02% 0.87% 0.79% 0.70% 0.67% 0.41% 0.39% 0.38% Doe Cont Finance Trans Util Pharma Petro Semi- Construction Conduct Aero/ Def Indust Manuf Chem. Manuf Metal/ Mine Source: The Center for Advanced Purchasing Studies (capsresearch.org) July 2012 Report of Cross-Industry Benchmarks. START WITH QUICK WINS The fastest way to gain alignment between card and treasury services solutions is by focusing on quick wins. Work with both of these groups to identify customers who are eager for integrated solutions or other opportunities for cross selling. Once you ve identified quick wins, team up relationship managers and card specialists to execute. By taking these newly formed teams through the sales-to-implementation process early and with motivated customers, you gain insight into how integration can be rolled out across the two organizations. MONITOR AND REWARD PROGRESS If you ve gathered the right data and are comfortable you know your customers potential, building out a system for monitoring progress (i.e., sales pipeline, account management goals) should be relatively easy. Ensure that whatever you use as your dashboard looks at customer performance from the perspective of customer profitability, using your model for holistic profitability. Over time you can monitor program performance to build a more accurate understanding of metrics such as net present value and long-term profitability. The fastest way to gain alignment between card and treasury services solutions is by focusing on quick wins. Work with both of these groups to identify customers who are eager for integrated solutions or other opportunities for cross selling. With this level of monitoring and the more accurate revenue forecasting it allows, you should also be in a good position to reward progress against goals. Rewarding quick wins will help your whole team to understand the commitment to making this new alignment succeed. 8

CONCLUSION As card payment networks seek to drive still greater volumes of payments traffic through their networks, banks and their customers can expect investments in new value-added services to continue. While card networks once offered a one-size-fits-all solution for payments products, recent investments in new technology have allowed for more customized pricing, data delivery, and other value-added services that make using these networks for B2B payments viable for more purchase types than ever before. Moving away from their beginnings as an offshoot of the consumer cards business, card network commercial payments solutions have now taken their place among the most profitable treasury services products. However, the banks that are benefiting most from these new solutions have realized they need to be integrated with more traditional payment offerings. Leading commercial payments providers are taking a data-driven, collaborative approach to migrating these products from the consumer lines of business that created them to the commercial banking lines of business where they re best suited to reside. Author Hugh Thomas Hugh Thomas has worked as a consultant to the payments industry for more than 15 years, providing expertise in areas such as product and concept assessments, acquisition assessments and long term strategy development and planning. Prior to joining Advisors, Hugh led projects for other payment networks, and numerous issuing banks in North America and Europe. Hugh has also consulted extensively on technologies such as EIPP, SRM and supply chain finance. Hugh is a graduate of the University of Manitoba and resides in Toronto, Canada. For additional insights, please visit insights.mastercard.com and mastercardadvisors.com. 2013 MasterCard. All rights reserved. Proprietary and Confidential. Insights and recommendations are based on proprietary and third-party research, as well as MasterCard s analysis and opinions, and are presented for your information only..