Carpadium Consulting

There have been rumours for a while now that @jack from Twitter was working on a new payments venture. Well, it seems that those rumours are true with today’s announcement of SquareUp.

The home page has some information about what they are doing, but the service is in soft-launch / invite-only mode at the moment so full details are not yet available.

Straight away, SquareUp looks cool, and from what limited information is available on the site, it looks like it has the potential to shake-up the way small businesses work with credit cards to accept payments.

Two things stand out. Firstly, it looks like it is designed only for card-present transactions (as far as I can tell), and secondly, it uses a magnetic stripe reader to acquire the card details. The first point means that its not likely SquareUp can be used for online payments, and the second point will probably mean that it does not handle chip cards.

However, this does not mean the system is without a security overlay. One neat feature is that it supports a form of photo id check. When a merchant accepts a payment, the iPhone application shows them a photo of the cardholder, which they can use to verify against the payee. I have to assume that this only works for cardholders that have pre-registered a photo with SquareUp.

To some extent (but certainly not all), this gets around the need to use a chip card, although I wonder what the card schemes will have to say about this as they roll out chip cards and readers everywhere.

One final note about SquareUp that is specifically relevant to the Australian market (although I have no information about plans to roll-out the service here) is what it might look like against the proposed MAMBO payments service.

Is this another payments innovation that the big banks should take notice of, or something with a limited niche for use by small businesses currently lacking in ability to work with credit card payments?

My first impression is that it will certainly be successful in that niche, however you have to wonder what they might have up there sleeve. If we have learnt only one thing from the history of Twitter its that they understand how to build a platform.

M@

Update 1: Here’s some words from the Man himself. Pretty much confirms my initial thoughts. Still no CNP option, as far as I can tell.

Today’s Sydney Morning Herald has an article about how Murdoch’s The Times in the UK will start charging web readers for news. You can see the (amusingly headlined) article here: Times are a-chargin’ for web browsers.

Along with many, many, (many!) other commentators, I’ve blogged about this topic before.

Apart form the beautiful irony [2] in this article from the Herald, I am pretty sure that this whole paywall argument is a dead-end for newspapers. Why? Because readers have never really paid for news. It’s the advertisers that pay. I could be wrong, but trying to make readers pay for something that can quite easily get elsewhere for free seems crazy.

The problem that newspapers face is not that readers (or aggregators) are stealing content, its that the business model upon which 20th Century newspaper journalism is based has collapsed. Advertisers chase eyeballs, and have simply followed the punters online. Not to mention the fact that their other major revenue stream – classifieds – has also left the building.

This is good and bad. If newspapers can’t generate revenue at their traditional scales, then neither will they be able to generate quality news. This will create opportunities for others (eg ABC) but it will almost certainly see a shake-up in the business of news making. And to be perfectly honest, it really does need a bit of a shake-up given the quality of “news” in some of the major dailies around this part of the world.

The underlying effect at work here is what I refer to as “the end of distribution”, which I blogged about some time back. The fact is that traditional newspapers assume their businesses are a scale play founded on the distribution of physical newspapers. The Internet removes distribution as a factor, and so almost self-evidently, traditional newspapers must struggle as their founding assumptions crumble.

Unless of course, they can change. But charging your readers for something that they have essentially always taken for free [3] when those who really pay your bills are running away seems like a pretty dumb idea.

M@

[1] If you want a really insightful analysis of this whole debate (without the vested newspaper interests) check out Mike Masnik’s blog: TechDirt. It’s a fantastic read.

[2] If it’s not obvious, the clear irony is that we have one newspaper (SMH) reporting on a story in another newspaper (The Times). There is little difference between this and what bloggers and other web commentators do on a regular basis, yet it is precisely the kind of thing that newspaper publishers call “stealing”, and then put forth as the motivation for establishing their paywalls.

[3] Or at the very least, heavily subsidised.

More and more banks and financial institutions are looking at Electronic Verification (EV) as a way to improve their customers’ online experience, while at the same time improving the efficiency and accuracy of customer enrolment to tackle the ever-increasing threats of online crime.

EV is coming up more and more often in our consulting activities, so we thought it would be useful to provide a quick introductory overview of the basic concepts for anyone wondering what it is all about.

What is Electronic Verification?

Electronic Verification (EV) is a process that verifies the identity of a new customer to a bank or financial institution using a combination of publicly and privately available electronic data sources.

EV is the electronic equivalent of sighting a physical identity document to verify the correctness of information provided by a customer. EV is attractive to financial services organisations because it can remove the need for a new customer to present physical identity documents in person or via certified copy.

In general, the EV process works as follows:

• An individual’s identity information finds its way onto a government or private sector database through an existing identity collection and verification process.
• The individual provides identity information to the financial services organization as part of a customer or product origination process, typically performed by the customer using the financial institution’s web site.
• The organisation tries to match that information against available government or private sector databases to verify the customer’s identity.

It is important to note that any rejection via electronic means does not exclude the customer; it only excludes them for this type of verification. Traditional paper based identification is still available, and so EV is typically used in conjunction with other forms of identity verification.

At its best, Electronic Verification:

• Is a very cost effective way of complying with the identity verification component of anti-money-laundering/know-your-customer (AML/KYC) requirements,
• Removes the need for new customers to produce paper-based identification documents face-to-face or via mail as a certified copy, and
• Removes human error and provides a separation between customer-facing staff and the original identification due-diligence process.

However, EV is not perfect. It can also:

• Open the door to the creation of many fraudulent accounts,
• Expose the Australian public to an increased threat of identity takeover,
• Lead to a downward spiral in the value of existing identity credentials, and
• Result in contracts and agreements becoming unenforceable in court.

Balancing these risks and rewards as Australian financial services organisations roll out EV programs is critical to acceptance of the approach by the general public.

The Electronic Verification landscape

There are five main elements to the EV landscape in Australia:

• The Legislative Environment is the combination of the Australian anti-money-laundering/counter-terrorism financing (AML/CTF) and Privacy legislation, including how it is applied and interpreted.
• Data Providers are those Government and Private entities and organizations that allow access to data for identity verification purposes.
• Service Providers allow access to identity data, including the ability to verify and score it against an identity scorecard.
• Businesses (also known as relying parties) are the entities that use this data for the purposes of verifying the identity of new customers.
• Private Individuals are people living in Australia that have physical or electronic identity information.

The Legislative Environment

Part B of the Australian Government’s AML legislation provides for a “risk-based approach” to customer identity collection and verification, along with guidance on minimum requirements. In addition, the legislation also provides for a second level of identification collection and verification called “safe harbour”.

The extent to which the Privacy Act influences the EV landscape is limited to the Government’s agreement on access and disclosure of new sources of identity verification data. The most contentious part of the legislation to date is the provision and use of consumer credit data. Part IIIA of the Privacy Act expressly excludes the use of credit information for the purposes of accessing transaction history. At this point in time the debate continues without official guidance.

Data Providers

Existing Sources of EV Data

Data providers are those government and private entities that hold data and make it available for the purposes of identity verification. There are two principal sources of this kind of identity data in Australia:

• Government sanctioned data sources including the Australian Electoral Roll, OFAC, DFAT, Department of Immigration and Citizenship Visa Verification Service.
• Privately held databases including Sensis White Pages DirectAccess™, Public Number Database, Historical Public Number Database and the National Homeowners File.

Future Sources of EV Data

Existing identity verification companies are actively trying to unlock new data sources from both government and privately held sources. In Australia there are six other government data sources that remain essentially untapped:

• Electoral Roll, including date of birth information
• Birth Deaths and Marriages, including full name and date of birth
• Tax File number, including full name and address
• Drivers Licence, including full name, address and date of birth
• Passport Office, including full name and date of birth
• Medicare, including full name and date of birth

Other Sources of EV Data

Credit data is explicitly restricted in its uses by the Privacy Act. There are two major sources of credit data in Australia: Veda Advantage and Dunn and Bradstreet. While there has been significant rhetoric from financial services organisations and data providers regarding the use of credit data as a safe harbour mechanism for electronic verifications, to date there has been little or no regulatory guidance.

Service Providers

Electronic Verification service providers offer the ability to verify identity credentials against a list of both publicly and privately held databases. This takes the form of a technical interface that allows data to be matched and/or compared.

For the most part, these companies act as a data hub, allowing a relying party to verify against multiple sources with a single call into the Service Provider’s technical infrastructure. Some Service Providers also offer an identity scorecard that allows a relying party to make a risk-based decision to either accept or reject the EV data.

EV Service Providers create their value by gaining access to and aggregating publicly and privately available databases. Their success in matching an individual’s identity details depends entirely on the quality and breadth of the data held in the databases they access.

All Australian EV vendors offer access to similar public databases, and they all claim to be able to verify to a satisfactory level according to the AML/CTF legislation, including the safe harbour provisions.

Businesses

Businesses that make use of EV service providers typically do so to reduce the risks associated with original identification and customer or product enrolment processes. Before embarking down this path, it is important that businesses understand the risks and rewards of EV.

Risks worth considering include:

• Compliance risk, including their adherence to AML/CTF rules, impact on the future value of identity credentials, and how their implementation approach aligns with the organisation’s existing audit and compliance regime.
• Legal/privacy risk, including product terms and conditions and existing privacy principals.
• Fraud risk, including understanding how attacks happen and how to mitigate them.

Rewards to consider include:

• Better customer experience, including removal of the need to be physically present to enrol, which can then enable straight through processing.
• Capture of market share, by removing time delays involved in customer and product enrolment process.
• Cost reduction, by removing the need for face-to-face identity verification and handling physical identity documentation.

Experience shows that the benefits of EV can outweigh the risks, as long as the program is properly executed.

Individuals

Private individuals are potentially the most impacted by changes in the EV landscape because it is their detailed, personally identifying information with which relying parties and service providers transact. This raises two significant issues that individuals need to consider:

• The validity of personally identifying information depends entirely on an individual’s ability to maintain the correctness of their credentials on the various databases in which their data resides.
• The decision to EV (generally) lies with the individual. However, if a fraudster chooses to EV, then it is very unlikely that the defrauded person will have any idea – at least until is too late. This raises the question of just who is responsible for protecting individuals’ personally identifying information.

Individuals are most at risk when problems in the EV process manifest, yet it can be argued that they derive only marginal benefits. This misalignment between risks and rewards means that there is a very strong role for Government and regulators to ensure that relying parties and service providers do not exploit their positions at the expense of the individual.

The Top-5 Issues Hindering EV Adoption in Australia

Based on our experience with EV programs, we think that the Top-5 issues hindering EV adoption in Australia are:

• The validity and availability of current sources of identity for the purpose of identity verification
• Lack of a secure centralised identity verification service.
• Any degradation of identity credentials on any one part of the system degrades the whole.
• Ensuring that individuals keep their identity credentials up to date
• Understanding who is ultimately responsible for protecting the public from identity fraud: individuals or Government?

Addressing these issues is something that we are well placed to help our clients with over the coming years, because developing elegant solutions is a pre-requisite for further EV adoption in the Australian financial services marketplace.

Andrew

There are a few agencies reporting today on the news that Visa is mandating that credit cards will need to be chip-and-pin enabled by 2013.

While it’s obviously a good thing to improve card security, Australia actually has pretty low card fraud by World standards (although it is on the rise, and in some areas more than others). Because of these relatively low levels of fraud, our Banks have been a little slow to fully roll out new security measures. What has been standard in the UK for some years is only now just becoming standard in Australia. The reason for this is simple: Banks only ever spend on fraud reduction an amount less than they are losing in fraud.

What I find particularly interesting about this announcement is that it won’t really do too much to stop one of the main pain points: card-not-present fraud. Chips are great when you have a chip reader at the point of sale, but they don’t do too much when you don’t. The obvious example of card-not-present transactions is Internet commerce. Chip cards don’t help much to stop fraud here, unless you have some extra countermeasures. And that starts to get a little tricky in terms of cost, and not least of all in terms of the end user’s experience.

So, while this is a good step forward, it’s definitely not a panacea for all credit card security.

M@

I was reading a piece linked from DaringFireball yesterday and something really leapt out at me. Check out these two quotes pulled from the linked article, one from Tim Cook, Apple’s COO, and the other from Steve Ballmer, Microsoft’s CEO.

Here’s Cook’s quote:

“Windows 7, from our point of view, is just another opportunity to remind everyone to switch to a Mac,” said Apple Chief Operating Officer Tim Cook. “People are sick of all the headaches that go along with Windows.”

And here’s Ballmer’s quote:

“Let’s face it, the Internet was designed for the PC. The Internet is not designed for the iPhone,” Ballmer said. “That’s why they’ve got 75,000 applications — they’re all trying to make the Internet look decent on the iPhone.”

I really don’t understand Ballmer’s point. Leaving aside for a moment that there are 2 errors of fact and an irrelevance in the space of 3 sentences – what is he trying to say? It just does not make any sense. It even has an air of the Chewbacca Defence about it. Just what is their message? I have noticed this coming up again and again in recent Microsoft comments and not just from Ballmer. I guess if the message is confused at the highest levels, it’s difficult to see how it can get any clearer down the chain.

On the other hand, the message from Cook could not be clearer. And not only is it clear, but it’s said in a completely positive way. It’s a brilliant piece of communications that uses Microsoft’s own weight against it. It’s 31 words without a skerrick of weasel. It’s a piece of PR jujitsu.

M@

It appears like NAB is continuing to put downwards pressure on fees, with the recent announcement that it will further lower fees on accounts and card products.

Along with earlier announcements by NAB and others, this is all very welcome news. However, you can start to get a sense of the scale of the fee regime here in Australia when we see one of the big banks foregoing an alleged $110 million per year in revenue at what has routinely been called the worst financial crisis for a generation. Quite clearly, things are not so bad that they can’t afford to take a lazy $110m of the bottom line.

Now that this fee reduction program has really kicked off in earnest with the major banks, you are starting to hear them using “low fees” language in their communications, so it is obviously something that is resonating with consumers. There is still quite a long way to go, but it certainly seems like things are moving in the right direction. Unfortunately, there has not been much movement on fees and charges for businesses – a fact that is just now starting to get some public attention.

I imagine that we will see all of the Big 4 come more or less into line over the next 6 months or so on fees for retail customers. It remains an open question if any one of them will blink and start reducing fees for business customers.

M@

The Australian is reporting that CBA is in the process of rolling out contactless payments, apparently with a view to shortening the lines for pie and chips and your next footy match.

I think this is a good move, because I believe that it can have a real impact on the way people make purchases. If you can cut down the time it takes to make a payment, then you can obviously cut down the time taken waiting in line. This will obviously be really good at the big venue scenario, where you often have to wait a very long time in huge queues.

However, there is another angle where it could be very useful: public transport. There has been a long running effort to try to roll out a stored value transport card system here in NSW. This is similar to existing systems around the world, with the exception that our Government has not been able to make it work as yet. Perhaps an alternative to building a new stored value system specifically for transport would be to make use of one of these emerging contactless payments mechanisms? If done properly, this would obviate the need for a dedicated stored value card system altogether.

It will also be interesting to see how the fees and charges work. In the past, this is something that the banks would have placed a whole bunch of new fees onto from the outset, but my sense is that there is a bit more competitive tension these days between the Big4 banks on fees, so I’m guessing that there will not be too many (at least in the short term).

M@

I just spent a few minutes answering an Apple email survey, and it contained a very interesting question.

It asked me if I would be interested in “cloud based business applications including hosted email, CRM, accounting and storage solutions”.

I wonder what they are up to? I guess it could explain this, this and this.

M@

John Gruber from DaringFireball has great article today about the way business models are changing for newspapers. This is something that I have been following very closely recently because I have some good friends who work in the media business, and we have been having an ongoing conversation about this exact topic over the last year or so.

In the article, Gruber describes his own one-man-show, DaringFireball, an operation “where nearly every employee is working on producing actual content”. I think that what he describes here is the inevitable consequence of the end of distribution. When distribution is free, then there is simply no need for whole layers of business operation that have been required in the past. I’m also reading Chris Anderson’s Free right now, which is not a bad read, but I get the same sense as Gruber: some of it feels so obvious, that it’s a little hard to get excited. However, I suspect that the real point is that so much of it is not obvious to the likes of our current generation of newspaper publishers, in particular, Fairfax’s John Hartigan et al.

Newspapers are a great example of this principle: you need to manufacture a wad of paper to hold the news, and you need to manufacture a significantly large wad of paper to make the production economics work. Then if you want to chase more profits, you have to grow, grow, grow to extract scale efficiencies from the various production processes. However, when someone comes along and starts competing against you who does not have these same production burdens, you end up in an entirely different economic battle. One that it is difficult to see the traditional players winning.

I think it’s fascinating how this trend has played out in music, and now newspapers, and I can see it being repeated in books (if it is not already occurring) and also in television and movies over time. One of things that distinguishes these different forms of media is the cost of production and distribution. Arguably, music is the cheapest and easiest to produce (ignoring quality), and so it was first to experience the disintermediating effects of the end of distribution. You could probably also argue that the large music businesses added the least value for consumers, and so ended up being the low hanging fruit of the disintermediating effects of this process.

Newspapers are clearly next. They have taken slightly longer to fall victim than music because whereas music is subjective and personal, news is more expensive to create because it is (supposed to be) objective and correct. This takes time and research to get right. And although we could argue about their relative values, it’s not hard to make the case that news is more expensive than music to produce and distribute. For evidence, look no further than less advanced cultures who make music in abundance, but do not have the resources to create news, at least in the Fourth Estate form that the Western world is used to.

Television and film will follow. I hear all of the same arguments being made today about why this will never happen. In the end, all of the reasons seem to boil down to the same thing: it’s too expensive to produce and distribute. Well, that was true for music and newspapers not too long ago as well, and the end of distribution for them is already upon us. Television and movies are expensive to produce and distribute today, but my strong belief is that precisely the same pressures that have been brought to bear on music and newspapers will also be brought to bear on television and movies. Perhaps not this year or next, but it will happen over the next 5 years or so. YouTube is an obvious example (quality issues aside) but take a look at something like Vimeo, which specialises in hosting very high quality content, and I think you will see in it, at least some of the future of visual media.

Books are probably the odd one out in my list because they have a fascinating dual quality: they are of course the written words they contain, but they are also objects of beauty in and of themselves. People have books just for the sake of having them (I do this!) because there’s something really special about a book. People used to do this with vinyl records, but it’s not done so much with CDs, and not at all with digital music. Interestingly, vinyl is having a resurgence (a friend of mine just bought a USB turntable!) and I would argue that at least some of that resurgence is due to the collectability of vinyl albums.

In economic terms, what is really going on with the end of distribution is that we are seeing a massive increase in efficiency – an efficiency discontinuity. This occurred with agriculture at the turn of the last Century. It happened (and is still happening) with information right now. And here’s a way-out prediction for free: next in line is an efficiency discontinuity in manufacturing. However, this first requires humans to invent nano-technology based desktop manufacturing, which although still sci-fi today, it is certainly on the horizon for my lifetime (I hope).

As Gruber points out, his business has a single person working in it, and there is no room for anything other than highly efficient content generation. Businesses of this type simply cannot support the magnitude of operation of existing news organisations. I think that the ultimate outcome will be a complete reboot of the underlying business model for the entire Fourth Estate. DaringFireball, Crikey and The Eureka Report are great examples of what the new model will look like. Unfortunately, Fairfax is an example of the old model. And I think it has already been checked in for palliative care.

Although I am probably out on a limb, movies and television are equally susceptible to these pressures. Since the end of the Studio Era in film we have seen a reversal of the power structures in Hollywood to the point where a very small number of Stars are paid excessively large (and increasingly larger, it would seem) amounts of money, often without regard for the profits generated by, or the the quality of, the products they are making. This model is unsustainable in the long term, because someone or something will come along and radically change the cost base in precisely the same way that they changed the cost base for newspapers and music: by effectively eliminating the costs of distribution. As soon as scale becomes an unnecessary component of the operating model, it becomes increasingly difficult to sustain large production and distribution costs.

Who knows, perhaps the future of acting is on stage, where actors make YouTube or Vimeo versions of their live performances, and publish them on their own web site, complete with notes and background information on their interpretation of the role. They might even sell T-shirts to subsidise the costs of the performance! This sounds cartoonish, but apart from a very small number of uber-successful music performers who make money through recording contracts, this is the way the vast majority of musicians make money today. They perform live in front of an audience that either pays the band for a ticket, or the venue for their drinks which subsidise the band, as well as by selling merchandise directly to them either at the show or over the Internet.

If you go back into history, this was precisely how artists made their way – by going on tour and getting directly in front of their audiences night after night. If journalists and actors are to continue to be relevant, then they are going to have to get a lot closer to their respective audiences because distribution is disappearing. Unfortunately, this leaves very little room for anyone not directly involved in producing or consuming content.

M@

BTW: if it wasn’t obvious, the end of distribution is really only about the end of distribution for digital goods. As populations grow and environments deteriorate, it will become increasingly difficult to produce enough good quality food and collect clean drinking water for peoples’ requirements. We will also – at some point this is inevitable, even if it occurs too late – have to integrate the true cost of carbon into the production and distribution of food. For example, transport costs will rise, making local production of food the only economic alternative. The consequence of these trends over the next 20 years or so is that there will be a renewed focus on localised food production, and the places that can produce good quality food will be in a position to reap the rewards as prices rise.

Update 2: 21-July-2009: TechDirt is also pushing the boundaries of the new media business model. Check out the CwF+RtB=Business Model post. A brilliant analysis.

Update 1: 21-July-2009 – Here’s a follow-up by John Gruber on yesterday’s piece on newspaper business models. Interestingly, the article that Gruber references (by Mark Bernstein) agrees with his conclusion that newspapers are big, but disagrees with the premise that they are bloated because of management bureaucracy, rather suggesting that newspapers are big because of technology and distribution. Precisely! And if distribution has changed to the point where it is now essentially free, then there’s a whole lot of fat that can come out of these existing businesses, or perhaps more likely, a whole lot of lunch to be eaten by businesses that just don’t have these costs in the first place.

This article from the Age represents an interesting development for payments regulation in Australia.

For some time now, there has been a regulatory dance between banks and the RBA. As with many situations of this nature, the regulator has asked for the banks to make interchange fees more transparent, and to make it easier for new entrants to enter the market, but not surprisingly, the banks (in most cases) have really only done what was absolutely necessary. I expect that will continue.

There was a move earlier on the year to make fees more transparent by allowing direct charging at the ATM. This was supposed to open things up and give the customers more information about fees, but I am not entirely sure the outcome has been what the regulator was hoping for. Following these changes, any time a customer uses an ATM from another bank, they are hit with a direct $2 charge. In some cases, the charge is even greater. There has been some consumer outcry over this.

Also, it was revealed yesterday the extent to which Australian banks make money from non-spread revenue such as fees. All up, it was about AU$12b across the banks, which is a staggeringly large number, and an 8% uptick year on year. Most of the fees were charged to business, but about $5b was charged to consumers.

These factors are probably contributing to a slightly more bellicose position from the regulator as it becomes increasingly difficult for banks to justify these types of fees and charges as “cost recovery” when they make so much money from them. I think that everyone from the regulator to the public has long since realised that fees are really a very big source of revenue for the banks, and not just cost recovery for expenses incurred providing services. It’s a prickly issue, especially politically, and I expect that it will get pricklier as the year progresses.

What makes this issue even more interesting is the fact that since the GFC, the Australian Government has provided banks with a wholesale borrowing guarantee (effectively giving them all a AAA credit rating) as well as a guarantee for retail funds on deposit, which has put them all in a very strong position. There is starting to be some public questioning of this given the fees and profit results, and people are asking if the Government should not also be able to exert some pressure of the banks given the privileged position that it has afforded them.

How this will play out is anyone’s guess, but I can definitely anticipate some more political machinations over the coming months, because just about everyone loves to bash the banks.

M@