By Rick Ferguson
[Editor's note: This article is Part I in a multi-part series. Read Part II here and Part III here.]
In business, companies have historically created value for themselves by developing business processes that harness and exploit friction. For example, consider the humble credit card transaction.
In the U.S., credit card transactions operate on a four-party payment system, where the merchant discount fee is divided up among the merchant acquiring bank, the card issuing bank, and the payment network. When a cardholder presents a credit card to a merchant for payment, the various parties to the transaction each take a piece of it in the form of additional fees. These fees, in effect, convert the kinetic energy of the transaction into thermal energy in the form of revenue taken from the transaction.
It’s been this way forever. Does anybody really think system this benefits the customer?
Credit card transactions don’t represent literal friction, because the whole transaction takes place instantaneously in real-time. But the transaction does represent business friction, in that the interchange fee takes away a piece of the transaction amount. Issuers and payment networks love this system, because that’s how they make money. Consumers love it because of the convenience of paying with credit cards and the rewards often funded by a portion of interchange fees.
The only involved party who doesn’t like the system are merchants, who have to cough up a sizable portion of their revenue in processing fees. But they accept credit cards because the ease of the transaction results in more customer spend. These fees are then often passed on to the consumer in the form of higher prices. So the friction in the system has a positive impact to issuers and payment networks, and a mixed impact on consumers and merchants.
Because of this friction inherent in the current electronic payment system, third-party developers, big tech companies, and mobile start-ups have arisen to find ways to remove some of that friction. Some of these solutions charge lower merchant transaction fees than the big credit card companies. Others aggregate transactions to help merchants avoid swipe fees. Some promise faster transactions. Some promise to replace plastic cards with mobile payments. Some aggregate payment, stored value, and/or loyalty rewards in a single mobile app. Some allow you to link credit and debit cards to an app. Others bypass credit card networks altogether, allowing you to send payments to friends or pay via text or email. Some of these payment systems are becoming FDIC secured, just like traditional bank accounts. Some systems even leverage blockchain technology or allow you to pay with bitcoins.
What these mobile and e-commerce payment platforms have in common is that they all, to varying degrees and with varying levels of success, attempt to remove friction from the payments ecosystem. They remove friction for merchants with lower swipe fees. They remove friction for consumers through faster, more secure, or more rewarding transactions.
In fact, the entire banking industry is talking about the frictionless future. At the 2015 Money 20/20 conference, PayPal CEO Dan Schulman said that the future of banking is about "taking basic human interactions and making them faster, easier, more secure and less expensive."
Why is the banking industry so focused on the frictionless future? It’s because we now have close to 20 years of evidence to demonstrate that, if an industry isn’t focused on removing friction in customer relationships, then the intersection of technology, entrepreneurship, and consumer behavior will do it for them. In industry after industry, we’ve seen it: the traditional gatekeepers, who make money off of increasing friction, are destroyed by technology and companies that reduce this friction. We’ve seen it in the music industry and the publishing industry. The sharing economy, represented by Uber and Airbnb, has eliminated friction in transportation and in hospitality.
The idea of a frictionless payment future is even extending to wearables, with the launch of the Apple Watch, as well as MasterCard’s recently announced initiative to extend mobile payments to designer rings, key fobs, and wrist bands. And you can bet that connected dresses and driverless cars will soon become part of the payments ecosystem as well.
These initiatives are the vanguard of the Internet of Things (IoT) – the hyper-connected world where every device from the phone to the washing machine will be connected to the internet. According to Cisco, there will be 50 billion connected devices worldwide by 2020.
Technology is, of course, rapidly accelerating the pace at which friction is removed from consumer interactions. It’s not that consumers themselves have changed; change is happening because technology is allowing consumer behavior to flow from friction-laden environments to frictionless ones. Consumers don’t naturally move at the pace of continental plates shifting over eons; consumer behavior moves like water. Like water, consumers always seek the easiest path. Like water, their behavior is driven both by predictable micro-forces inherent in their behavior, and by very large macro-forces that are difficult to predict and understand.
The impending disruption of the payments and banking industry is indicative of a larger seismic shift in the broader loyalty industry - and by the "loyalty industry" I’m referring both to the global community of practitioners and programs, and the global industry of providers, platforms, agencies, and consultants that collectively deliver solutions to these practitioners. The confluence of technology, consumer behavior, and macroeconomic forces threaten to disrupt the very idea of a "loyalty industry."
If we continue to believe, as I do, that building long-term, value-added, profitable relationships with best customers is essential to business success, then the question begs: how can the discipline of loyalty marketing adapt to the frictionless future? This topic will be the subject of next week’s article. We’ll continue the conversation there.
Rick Ferguson is the CEO and Editor-in-Chief of the Wise Marketer Group.