Are telcos smart enough to make money work?

Telco consumer financial services propositions

Telcos face a perplexing challenge in consumer markets. On the one hand, telcos’ standing with consumers has improved through the COVID-19 pandemic, and demand for connectivity is strong and continues to grow. On the other hand, most consumers are not spending more money with telcos because operators have yet to create compelling new propositions that they can charge more for. In the broadest sense, telcos need to (and can in our view) create more value for consumers and society more generally.

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As discussed in our previous research, we believe the world is now entering a “Coordination Age” in which multiple stakeholders will work together to maximize the potential of the planet’s natural and human resources. New technologies – 5G, analytics, AI, automation, cloud – are making it feasible to coordinate and optimise the allocation of resources in real-time. As providers of connectivity that generates vast amounts of relevant data, telcos can play an important role in enabling this coordination. Although some operators have found it difficult to expand beyond connectivity, the opportunity still exists and may actually be expanding.

In this report, we consider how telcos can support more efficient allocation of capital by playing in the financial services sector.  Financial services (banking) sits in a “sweet spot” for operators: economies of scale are available at a national level, connected technology can change the industry.

Financial Services in the Telecoms sweet spot

financial services

Source STL Partners

The financial services industry is undergoing major disruption brought about by a combination of digitisation and liberalisation – new legislation, such as the EU’s Payment Services Directive, is making it easier for new players to enter the banking market. And there is more disruption to come with the advent of digital currencies – China and the EU have both indicated that they will launch digital currencies, while the U.S. is mulling going down the same route.

A digital currency is intended to be a digital version of cash that is underpinned directly by the country’s central bank. Rather than owning notes or coins, you would own a deposit directly with the central bank. The idea is that a digital currency, in an increasingly cash-free society, would help ensure financial stability by enabling people to store at least some of their money with a trusted official platform, rather than a company or bank that might go bust. A digital currency could also make it easier to bring unbanked citizens (the majority of the world’s population) into the financial system, as central banks could issue digital currencies directly to individuals without them needing to have a commercial bank account. Telcos (and other online service providers) could help consumers to hold digital currency directly with a central bank.

Although the financial services industry has already experienced major upheaval, there is much more to come. “There’s no question that digital currencies and the underlying technology have the potential to drive the next wave in financial services,” Dan Schulman, the CEO of PayPal told investors in February 2021. “I think those technologies can help solve some of the fundamental problems of the system. The fact that there’s this huge prevalence and cost of cash, that there’s lack of access for so many parts of the population into the system, that there’s limited liquidity, there’s high friction in commerce and payments.”

In light of this ongoing disruption, this report reviews the efforts of various operators, such as Orange, Telefónica and Turkcell, to expand into consumer financial services, notably the provision of loans and insurance. A close analysis of their various initiatives offers pointers to the success criteria in this market, while also highlighting some of the potential pitfalls to avoid.

Table of contents

  • Executive Summary
  • Introduction
  • Potential business models
    • Who are you serving?
    • What are you doing for the people you serve?
    • M-Pesa – a springboard into an array of services
    • Docomo demonstrates what can be done
    • But the competition is fierce
  • Applying AI to lending and insurance
    • Analysing hundreds of data points
    • Upstart – one of the frontrunners in automated lending
    • Takeaways
  • From payments to financial portal
    • Takeaways
  • Turkcell goes broad and deep
    • Paycell has a foothold
    • Consumer finance takes a hit
    • Regulation moving in the right direction
    • Turkcell’s broader expansion plans
    • Takeaways
  • Telefónica targets quick loans
    • Growing competition
    • Elsewhere in Latin America
    • Takeaways
  • Momentum builds for Orange
    • The cost of Orange Bank
    • Takeaways
  • Conclusions and recommendations
  • Index

This report builds on earlier STL Partners research, including:

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Cashing in on the end of cash

Introduction

As the rapid expansion of the digital economy threatens to sweep away coins and notes, telcos could be one of the major players in the transition to a cashless society. In the emerging Coordination Age (see STL Partners report: Telco 2030: New purpose, strategy and business models for the Coordination Age), telcos are well placed to help consumers and companies interact and transact far more efficiently and effectively than they have in the past.

This report explores what the global shift away from cash means for telcos and their partners. It identifies the factors driving the transition from cash payments to electronic transactions, considering the perspective of governments, banks, merchants and consumers, before explaining why cash might cling on at the margins.

The report then outlines the progress mobile operators are making in payments and financial services, drawing on examples from Africa, Asia and Europe. It also considers some of the partnerships telcos are striking with Internet players to help overcome some of the obstacles curbing greater use of mobile payment services, before drawing conclusions and making recommendations.

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This executive briefing builds on previous STL Partners reports including:

Calling time on cash

Despite the widespread adoption of the Internet and the subsequent rapid growth of online commerce, almost 90% of global retail1 still takes place at a physical point of sale in a store or at market stall. Although many traditional high streets and shopping malls are struggling, the value of point of sales transactions continues to grow, as an expanding middle class spends money at everything from coffee shops and restaurants to leisure centres and theme parks.

As you would expect, growth in developing markets tends to be markedly quicker than in developed. In India, point of sale transactions (using all payment mechanisms) are set to rise from US$893 billion in 2018 to US$1.36 trillion in value in 2022 (growth of 53%), according to leading payment processor Worldpay. Whereas in the U.S., point of sale transactions are set to grow from US$7.96 trillion in 2018 to US$10.33 trillion in value in 2022 (growth of 30%), according to Worldpay.

Even with the expansion of the digital economy, many transactions worldwide still involve the face-toface exchange of coins and/or notes. Cash is used to complete almost one third of payments (by value) at point of sale worldwide today, according to payments technology company Worldpay. But it predicts that figure will fall to 17% in 2022 – a dramatic change in just four years. Worldpay projects “that cash will be supplanted by debit cards as the leading point of sale payment method in 2019, falling to fourth place in 2022 behind debit cards, credit cards, and eWallets.”

These trends reflect the fact that using cash is expensive, cumbersome, inefficient and opaque. Cash may eventually become an anachronism. At least, that is what many large stakeholders in the public and private sectors are hoping. There are multiple drivers steering governments, banks, merchants, consumers and banks away from cash.

Why governments don’t like cash

Governments have several inter-related reasons for wanting to reduce the use of cash:

  • Tackle the black market: As cash is untraceable, it can facilitate crime, such as the trading of illegal or smuggled goods, and even terrorism. Governments periodically try and crack down on people who use large amounts of cash. In 2016, the government of India, for example, suddenly announced it was replacing 500 and 1,000 rupee notes (US$7.50 and US$15 respectively) with new notes in an effort to identify black marketers. People could exchange the old notes at banks, but those with large holdings had to account for the source of their cash. However, such measures only work up to a point: eradicating cash won’t eradicate crime. If necessary, criminals can always store and barter goods (e.g. drugs or guns), rather than hoarding cash.
  • Reduce corruption: In some countries, cash payments to and from the public sector are often vulnerable to being siphoned off by unscrupulous officials or other middlemen. Conversely, the digitisation of government benefit payments creates an electronic trail that reduces the risk of fraud and theft, and thereby ensures the money goes where it is intended. In 2010, when the Afghan National Police began using a mobile money service to pay salaries instead of cash, they discovered that 10 per cent of salaries were being paid to fictitious police officers, while some officers were not receiving their salaries in full, according to a report by CNN.
  • Greater transparency and less tax evasion: Cash-in-hand payments can result in lost tax revenue, as the recipients fail to declare their income or don’t pay VAT.
  • Reduce costs: If governments can distribute cash digitally, it can save both the public agency and the recipients both time and expenses: In Niger, converting a cash transfer programme to mobile money saved recipients over 20 hours, as they spent less time travelling and waiting for their transfers3.
  • Digital leadership: Some governments want to position their countries as digitally advanced and see the drive to get rid of cash as a means to digitise services and drive adoption of digital IDs, which are a key enabler of the digital vision.
  • Increase state control: Some authoritarian states are likely to see the digitisation of payments as an opportunity to enhance state power, or at least enhance security.

However, in many cases, governments have to distribute or accept cash because many of their citizens still lack bank accounts. More than 60 million unbanked adults globally still receive government transfers, wages or pensions in cash, while 230 million unbanked adults work in the private sector and get paid in cash only, according to the World Bank’s Global Findex Database Measuring Financial Inclusion and the Fintech Revolution 2017.

Banks and merchants find cash costly

But the biggest driver behind the decline of cash could simply be the costs of the underlying infrastructure and merchants’ growing reluctance to accept cash. For a small retailer, bar or coffee shop, cash consumes time – it needs to be counted and taken to the bank. It also poses a security risk, whereas digital payments automatically end up in the merchant’s bank account and are very unlikely to go missing.

Cash is also a burden for the financial services ecosystem, which has to make ATMs and bank branches available. In the U.K., the Access to Cash Review, a report published in March 2019, warned: “As we stand, we have a cash infrastructure which is fast becoming unsustainable, with largely fixed costs, but where income is declining fast. Britain’s cash infrastructure costs around £5 billion a year to run, paid for predominantly by the retail banks, and run mostly by commercial operators. Much of this cost is currently fixed, whether in physical cash sorting centres or ATMs. But as cash use declines, the economics of the current cash model are becoming seriously challenged.”

Consumers’ mixed feelings about cash

Although some consumers may want to use cash to avoid taxes and maintain privacy, there are several reasons why they too might favour digital payments. Every deposit, withdrawal, transfer or payment made digitally creates a recorded financial history. These transparent transaction records can help protect customers’ rights – they can help prove that they have paid for a specific product or service. Moreover, using digital payments, rather than cash, can help individuals build a credit history, which could make it easier to get a loan. Digital records should also help consumers to monitor and budget their spending, although some studies have found that some forms of digital payments, such as contactless payment cards, can result in consumers spending more than if they were solely reliant on cash.

In the developing world, where credit scores are scarce, merchants are turning to digital mechanisms to help consumers pay in instalments for appliances, such as TVs, radios, lighting, cooking stoves and solar water pumps (all of which can increase household and agricultural productivity). In Kenya, for example, SunCulture enables farmers to pay for solar-powered irrigation pumps in instalments via a mobile money service. As a result, they can improve their productivity and, ultimately, their incomes. Farmers who use SunCulture have reported an average 300% increase in crop yield per year, according to a study by the mobile trade group GSMA.

A vicious circle for cash

While Worldpay point of sale data show cash is in steady decline, there are good reasons to believe it may actually be under-estimating the speed at which other payment methods will take over. In many markets, cash is approaching a potentially decisive tipping point. With consumers ambivalent and governments, merchants and banks all favouring alternatives, cash is in the grip of a vicious circle:

  • The deregulation of the banking system is increasing competition and putting pressure on banks to cut costs and close branches.
  • Small businesses find that the closure of bank branches makes it more expensive and riskier to handle cash. In some cases, merchants stop accepting cash or give people incentives to pay digitally.
  • As fewer merchants accept cash, consumers become increasingly reliant on digital alternatives.
  • As people use cash less and less, they make fewer visits to ATMs and bank branches.
  • Banks continue to close ATMs and branches, making it increasingly hard for anyone to keep using cash. Once the cash infrastructure in a specific locality has gone, everyone living in that area really much has to go digital.

If this vicious circle kicks in, providers of mobile payment services need to be ready for a very sharp fall in the usage of cash. In practice, that will mean upgrading back-end systems so they can handle large numbers of simultaneous transactions, while also preparing for a fresh competitive onslaught from new entrants hungry for potentially valuable transaction data.

 

Table of contents

  • Executive Summary
  • Introduction
  • Calling time on cash
    • Why governments don’t like cash
    • Banks and merchants find cash costly
    • Consumers’ mixed feelings about cash
    • The rise of the electronic wallet
    • A vicious circle for cash
    • The convenience economy
    • Why cash might persist
  • Mobile operators’ financial services
    • M-Pesa makes mixed progress in Kenya
    • The importance of interoperability
    • Telcos as banks
  • Conversational commerce
  • Partnering with Internet players
    • Learning from China’s Internet platforms
    • Other partnerships between Internet players and telcos
  • Conclusions and recommendations

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