Entry of FinTech Firms and Competition in the Retail Payments Market

• Author: Eunjung Yeo,Jooyong Jun
• DOI: http://doi.org/10.1111/ajfs.12126
• Published date: 01 April 2016
• Date: 01 April 2016

Entry of FinTech Firms and Competition in

the Retail Payments Market*

Jooyong Jun

Economic Research Institute, the Bank of Korea

Eunjung Yeo**

School of Business, Chung-Ang University

Received 31 August 2015; Accepted 15 February 2016

Abstract

We investigate the effects of entry of financial technology (FinTech) based firms on competition

in the retail payments market. With a model of two-sided market with vertical restraints, we

derive the following results. When only the entry of a vertically integrated (or end-to-end ser-

vice) provider is allowed, either all merchants opt for multi-homing or no entry occurs, regard-

less of the regulatory requirement. On the other hand, if the entry of a downstream-only (or

front-end service) provider is allowed, a partial multi-homing equilibrium could emerge under

certain conditions, in which the entry of an end-to-end service provider does not occur. With-

out regulation, however, the vertically integrated incumbent does not voluntarily provide the

back-end service to the entrant in general. This suggests the need for proper regulatory mea-

sures to reach a socially desirable outcome from the new entry in the retail payments market.

Keywords FinTech; Entry; Retail payment; Front-end; End-to-end

JEL Classification: G23, G28, L11

1. Introduction

Recent advances in information and communications technology (ICT) have led to

the rapid development and expansion of new and innovative financial services, often

termed FinTech. According to Accenture (2014), worldwide investment in FinTech

has grown threefold over the past 5 years. While innovations are occuring in various

*An earlier version of this paper (Bank of Korea Working Paper 15–19) was circulated with

the title of “Entry of non-financial firms and competition in the retail payments market.”

The authors thank Woon Gyu Choi, Jin Jeon, Byoungki Kim, Juwon Kwak, Inho Lee,

Kyoung-Soo Yoon, and anonymous referees for their valuable suggestions and comments,

and Hyung-Kwon Jeong and Bokkeun Yu for their support. This paper does not necessarily

reflect the opinions of the Bank of Korea. All errors are our own.

**Corresponding author: Eunjung Yeo, Associate Professor of Finance, School of Business

Administration, Chung-Ang University, 84 Heukseok-Ro, Dongjak-Gu, Seoul 06974, Korea.

Tel: +82-2-820-5542, Fax: +82-2-815-7001, email: ejyeo@cau.ac.kr.

Asia-Pacific Journal of Financial Studies (2016) 45, 159–184 doi:10.1111/ajfs.12126

©2016 Korean Securities Association 159

areas of finance, retail payment has become an extremely competitive area because (i)

non-cash payments have increased rapidly,

1

(ii) payment acquisition has emerged as a

key area for innovation in FinTech (Capgemini and Royal Bank of Scotland, 2013), and

(iii) front-end services provide additional strategic value for payment service providers

owing to their proximityto consumers (Busch and Moreno, 2014).

The retail payment landscape is characterized by a wide diversity of payment

instruments

2

and activities at different stages of the payment process.

3

To provide

retail payment services to consumers, a payment platform needs to complete all

stages of the payment process. On the other hand, owing to the tiered structure of

that process, the platform may not need to own all the necessary facilities and

related licenses to provide payment services to consumers, provided it can access

and use the facilities of other platforms.

Taking into account the stages of the payment chain, type of service provided, and

predominant types of relationships with banks, CPMI (2014) classifies non-financial

payment service providers into four categories: (i) front-end providers, (ii) back-end

providers, (iii) operators of retail payment infrastructure, and (iv) end-to-en d provi-

ders.

4

We specifically focus here on the competition between the front-end and end-

to-end providers, which are the types that interact directly with consumers.

Front-end providers, including ApplePay and KakaoPay in Korea, offer some or

all aspects of front-end services, which include pre-transaction, authorization, and

post-transaction. They often rely on the back-end services and infrastructure pro-

vided by others, possibly rival end-to-end providers in the market, and pay fees for

doing so. End-to-end providers, on the other hand, include banks, credit card com-

panies, and other payment platforms such as PayPal and Alipay.

5

These providers

1

From 2009 to 2013, the world’s annual growth rate of non-cash payments (excluding credit)

was 7.4%, and is expected to have risen to 8.9% in 2014 (Capgemini and Royal Bank of Scot-

land, 2015). The trends are stronger in the Asia-Pacific region where the growth rate was

more than 20%. Table 1 in Appendix B shows the detailed data of recent trends.

2

We do not present the details here, but they can be found in many articles (e.g. Reinartz

et al., 2011; Busch and Moreno, 2014; Mariotto and Verdier, 2014; Capgemini and Royal

Bank of Scotland, 2015).

3

CPMI (2014) categorizes the payment process into five stages: (i) pre-transaction, (ii) autho-

rization, (iii) clearing, (iv) settlement, and (v) post-transaction. A more detailed list of the

different activities in each stage can be found in CPMI (2014). DeGennaro (2006) also pro-

vides a detailed analysis of the payment card process and associated risks.

4

In CPMI (2014), back-end providers include back-office services like data centers, security

firms, and audit or compliance entities. Operators of retail payment infrastructure are defined

as specialists in clearing and settlement services. We use “back-end” in a more abstract sense,

to indicate every service other than those from front-end providers.

5

Visa and MasterCard, unlike American Express and Discover Financial Services, can be clas-

sified technically as operators of retail payment infrastructure. They provide only networks

between acquirers and issuers, mostly financial institutions. Considered from the perspective

of a consumer’s perception, however, they can be regarded here as end-to-end providers.

J. Jun and E. Yeo

160 ©2016 Korean Securities Association