Consumer Payments Strategy: The Monetisation Shift (#46)

Industry focus shifts away from cashback-led user acquisition to monetisation

Welcome to the 46th issue of Unit Economics. In today’s write-up, I highlight the shift in payments strategy for the industry away from cashbacks, discounts towards monetisation for favourable unit economics. Let’s jump straight in!

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The last few months have quietly changed the questions investors ask of payments. Traction and scalability of businesses remain important factors for success. But with retail investors occupying a larger part of the table, and critics getting more material to build their arguments on – the private investors have reacted with tough, traditional business questions to founders.

How do you plan to make money? And once you do, when and how would you breakeven?

The murmurs of this shifting investing focus are more pronounced in South-East Asia given how some of the IPOs have progressed. But, what do these developments mean for the industry?

1. Primarily, this adds weight to a filter for investors when evaluating companies, which lowers the chances of a startup at the median to get funded.

2. The bag of private capital chasing payments is, however, hardly lighter. This directly implies that the same money would now be chasing fewer companies that would belong to the top-bucket, which should result in more aggressive funding rounds and larger cheque sizes for the few.

3. Moreover, the investor attitude has a domino effect on how companies approach their business strategy. This, I imagine, would make P&L discussions a much higher priority for many a business heads.

4. Lastly, with the P&L in focus, we can also expect a relative deceleration in aggressive customer acquisition, which should perhaps open up discussions on smarter and more innovative forms of creating similar acquisition viral loops.

These implications put across an interesting challenge for the industry, especially given the standard for the last decade.

The 2010s: Cashbacks, discounts, and mass-market focus

In India, the latter half of the last decade was highly influenced by digital payments. And with UPI, the likes of Paytm, PhonePe, and Google Pay tussled in a continuous battle for customer acquisition over this period.

Gimmicks of scratch cards and other little games aside, at the most fundamental level - all the B2C payments apps relied on merchant discounts and transaction-based cashbacks for customer acquisition, spending more than a billion dollars on advertising, marketing, and promotional expenses annually.

Over time, the products had all gained feature parity and appeared commoditized, which meant that as users multi-homed, i.e. users used multiple competing apps – not only the acquisition, but even the daily engagement of activated users relied on cashbacks and discounts. Some of this standardization of features was no doubt due to certification requirements, but the lack of strategic focus on differentiation had an equal role to play.

The commoditization put increased focus on distribution as the only strategy to win. As years went by, the competition switched from acquiring a million to hundreds of millions of users. Consequently, spending on discounts and cashbacks continued to grow in high double digits year-on-year for all those competing.

Capturing the era of high cash burn for acquisition in payments; Source: Bloomberg

Since the investors agreed with the business focus on acquisition, the money continued to pour in despite little to suggest long-term sustainability of the strategy. The cashback and discount-heavy culture also put some of the traditional business principles in the shadow, with the companies going mass-market for acquisition, offering almost uniform rewards across user cohorts.

Now, with the questions being asked, the strategy seems to be slowly drifting away from the rewards and mass-market culture.

Monetising Payments

Slowly, payments apps had diversified to insurance, investment, and lending products to monetise their growing user bases. However, the promotional expenses comfortably towered any gains from cross-selling. This has, over the last couple of years, meant that while there is a focus on cross-selling higher-margin products, the expenses had to come down too.

For Paytm, this has translated to a more than 50% YoY reduction in marketing and promotional expenses. In FY21, the figure stood at INR 532 Cr as compared to INR 1397 Cr the year before.

This points to an industry-wide trend that draws resemblance with the last few years of the telecom industry in India. History tells us that fighting a price war makes sense if you can outlast others in the market. For Airtel, this was improbable against Reliance, and Airtel chose rightly to shift strategy and focus on a more premium segment, cutting out a big part of its existing user base.

For payments, it appears to have become a collective understanding to slowly stray away from the cashback wars. Given that almost each of the big four competitors (PhonePe, Paytm, Google Pay, and Amazon) have heavy pockets, the price war would last for many more years.

For now, the focus is beginning to shift from gross volume to unit economics in payments. If we are to break down the problem, the question then becomes one of maximising take rate for a unit of cost across payments. This is challenging given that few, without the network effects of card networks or processors, have done this well in B2C space. But I briefly suggest a few directions that might make business sense.

Loyalty Programs

Dedicated loyalty programs can help drive cost-effectiveness by directing the promotional expenses from the masses to a segment of engaged users, who are willing to spend and transact more on the application.

Given that the big payments platforms today offer services ranging from payments to investments & lending – the benefits of the loyalty program must be closely tied with the services within the ecosystem to drive higher involvement. This would:

1. Churn out a set of low quality acquired users as more rewards are directed to those part of the loyalty program

2. Increase switching costs for frequent users since they will be tied to the loyalty benefits accrued on usage

3. Allow apps to charge a premium for any value-added services, which could include PFM insights, investment advisory, better lending rates, reward points boost, etc.

There are few better examples in the ecosystem of a well-functioning rewards program than the Amazon Pay ICICI card that has tied millions more closely to Amazon.

Improve Transaction Economics with Cards

Following up on the previous suggestion, cards offer an ideal medium for building a loyalty program. They equally allow a way to earn through relatively higher interchange share, and favorable interest / late fee charges if credit risk is managed well. Moreover, cards have been found to drive better recall with the personalized plastic. So if your card CVP is well-thought out, it’s a win-win.

Manage Risk using Transaction Data

I have written previously on the potential of transaction data to facilitate digital lending, which offers a high margin play to payments providers. Increasingly, this trend is more apparent in the risk policies of the payments credit products, which are shifting reliance from external bureaus to internal transaction monitoring.

Transactions offer a host of behavioral data that can be used to assess purchase preferences, channel usage, net-worth, risk averseness, all of which can help inform the repayment behavior of users.  Presently, the risk models driven by transaction data are in infancy and will only be able to manage smaller ticket loans. As the models are iterated upon given the market behavior, there is potential for them to serve payments companies profitably by informing the credit behavior better than the static bank statements or oft-outdated credit bureau scores.

Final few thoughts

The write-up is meant as a short note to highlight the quiet industry movement away from cashbacks towards monetisation, which is no doubt to the benefit of many stakeholders.

The trend also raises the stakes for founders and puts across a challenge that hardly anyone in B2C has crossed successfully in payments. Going ahead, lending – as it appears – will need to be closely tied with the product roadmap, and cards & loyalty programs will have to be in fashion for some of the businesses to make sense.

If the reading of the trend is right, this will be a decade where some of the giants that are unable to crack for unit economics will have to fall. For those that are able to, a bigger market will be waiting to be captured.

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If you have any views or feedback to share on the topic, feel free to add a response below or to share your thoughts with me over Linkedin. In case you feel your friends or family would be interested in reading about payments, feel free to share the blog with them as well. See you in a couple of weeks!