The Great Payments Engine

The Great Payments Engine

By Banking & Payments Group and Blueflame Consulting

The number of payment transactions in the US has grown by 5.1% per year, on average, over the past 20 years. Through recessions and a pandemic, the payments market has proven to be remarkably resilient, easily outpacing GDP growth. This point-of-view explores what’s powering this incredible payments engine.

We discuss four important considerations with respect to the overall US payments market:

  • The rear-view mirror: reflections on the industry’s growth
  • Payments’ outsized growth
  • The factors driving outsized growth
  • A forward-looking view: will the good times continue?

We conclude that, with considerable runway left in each of these industry’s key drivers, the payments business is poised to continue to enjoy above-market growth for many years to come.

1. Reflections on the industry’s growth

Exhibit 1 shows the number of non-cash payment transactions performed in the US every year, starting in the year 2000.1,2 In 2000, the US payments industry processed 72.6 billion transactions; by 2021 (the most recent year where data are available), the industry had grown to over 204 billion transactions.3

It’s easy to forget just how far the industry has come.  Less than 20 years ago, paper checks were the country’s most prevalent payment method (in 2003 Congress passed the “Check 21” legislation to create the legal basis for processing check images).  From 42.6 billion checks in 2000, today fewer than 11 billion checks are written.  Yet, despite dropping by 74%, the total number of payments expanded.

Similarly, 20 years ago, few people would have predicted the runaway success of debit cards, growing from 8 billion transactions in 2000 to almost 88 billion transactions in 2021, and now representing the most commonly used payment method, by far.

    Exhibit 1: Number of Non-Cash Payments
    Billions of Transactions, 2000-2021

    Source: 2022 Federal Reserve Payments Study, Initial Data Release, April 21, 2023

    While there’s a fascinating story behind every line on this chart, that’s not the focus of this article.  Instead, here we take a step (or two) back from individual payment products and year-over-year trend lines in order to look at the macro picture.  The overall message over the past two decades boils down to:

    • Growth: The number of payment transactions has expanded by 5.1% per year (on average), every year, for the past 21 years (2000-2021). The sector’s growth, combined with the strong margins and recurring cash flows enjoyed by payment companies, help explain private equity firms’ interest in the industry.
    • Migration: between 2011 and 2021, the number of “batch” transactions increased by a total of 5.5 billion transactions.4 By contrast, the number of “electronic” payment transactions grew by 79.7 billion in the same time period.  In other words, 94% of the industry’s net growth in the past decade has come from cards (debit, credit and prepaid).

    2. Payments’ outsized growth

    A twenty-year period of uninterrupted growth is pretty remarkable.  Which raises the question, what’s driving this growth?  Does population growth or economic growth explain the expansion of the payments market, or are other factors at work?

    • Population growth: More consumers will translate directly into more people making payments. The US population increased by 0.8% per year (from 281.4 million people in 2000 to 331.4 million people in 2020), so this isn’t the primary source of payments’ growth.5
    • Economic growth: Another possible explanation is economic growth. As GDP expands, so the velocity of commerce may increase as consumers and businesses buy more goods and services more frequently.  US GDP has grown by 3.7% per year, from $10.3 trillion in 2000 to $21.1 trillion in 2020 (and $23.3 trillion in 2021).6  While sustained economic growth of 3.7% per year is noteworthy, it does not capture the full 5.1% achieved by payments.

    Exhibit 2: Growth in Payment Transactions vs. Population and GDP Growth
    All values indexed to 100 in base year (2000)

    Source: BPG Analysis

    The change in these macroeconomic factors is shown in Exhibit 2.  Our analysis suggests that economic growth accounts for about two-thirds of the growth in the number of payment transactions.  In the next section, we discuss three multipliers that have contributed to payments’ outsized growth.

    3. Factors driving outsized growth

    Payments’ outsized growth is broadly explained by three multipliers: cash-to-card migration, two-stage wallets and the rise of commerce platforms.

    A. Cash-to-card migration

    The most important contributor to the industry’s growth over this time period is a payment method that’s not included in Exhibit 1, namely cash.

    The Fed’s payment survey is of all non-cash payment types.  All non-cash payments go through (at least one) an intermediary, simplifying the market sizing effort.7 Cash, on the other hand, does not have any such intermediary – person A gives cash to person B who pays company C – none of which is easily tracked.  Nevertheless, the migration of cash-to-card is evident from multiple vantage points:

    • More card acceptance: Square revolutionized the ability for merchants to accept card payments. Historically, acquirers’ combination of expensive POS terminals, opaque pricing and complex underwriting requirements served as a barrier to payment card acceptance for many small merchants.  By contrast, Square offered a simple card reader with transparent pricing, allowing millions of formerly cash-only merchants to begin accepting credit and debit cards.
    • More verticals accept cards: many ‘life events’ that previously were cash-only have been upgraded to accept electronic payments. Driving on toll roads, paying at parking meters, buying snacks at vending machines, and purchasing a ticket on mass transit represent just a few of the venues where cash was the norm and now card acceptance is commonplace.
    • Growth of online commerce: In 2000, online shopping represented 1% of total retail sales (and Amazon was the 66th largest retailer in the US); today ecommerce accounts for 15% of retail sales (and Amazon is now #2 in sales, behind Walmart). Since cash and checks are not payment options, the expansion of online shopping created an enormous tailwind for card-based payments.
    • Societal acceptance: even if a venue accepted cards, there may have been societal norms about when and where to pay – or not pay – with a card. In the past, it would have been unusual to use a credit card to pay for a cup of coffee; now it is unusual to not use a card.
    • Growth of merchant apps: merchants encouraged customers to pay with their proprietary apps, offering rewards for app-based purchases to incentivize a shift away from cash. Starbucks was an early leader in this regard, but now most large coffee chains and QSRs offer an integrated payment and loyalty program.  In a sign of how far habits have changed, over two-thirds of Starbucks orders now come from its mobile app, drive-thru, or delivery (and just 28% of customers enter Starbucks and place their orders with baristas – where payment with cash remains an option, albeit little used).
    • New capabilities for person-to-person payments: another major use case for cash was for person-to-person payments, such roommates splitting the rent or a family transferring money to a child in college. With the widespread adoption of Cash App, Venmo and Zelle, the need to carry cash to accommodate these payment requests has dropped considerably.
     

    Exhibits 3 illustrates how cash is steadily coming out of the system, helping to propel growth within the processed retail payments ecosystem.  While the ‘average’ purchase made with a debit card is for $43, this average hides the reality of actual use.  Today, one-third of all debit card transactions are for purchases of less than $10 – a purchase that historically would have been made with cash (or not at all).

    Exhibit 3: Debit Card Purchases, by ticket size

    Source: BPG Analysis

     

    B. Two-stage wallets

    The second factor contributing to payments’ above-market growth rates is wallets.  Not leather wallets with plastic payment cards, but digital and mobile wallets with tokenized payment credentials.  Visa reports issuing over six billion unique payment tokens and the rate of issuance is accelerating.

    The most commonly used general purpose mobile wallet, in the US, is Apple Pay.  A consumer registers their payment card, the card number is converted into an encrypted payment token, and this token is stored locally on the phone.  Whenever the consumer uses their iPhone at the point-of-sale, the terminal and the phone utilize near-field communication (NFC) technology to transmit the token from the phone to the POS – and then the transaction is processed from acquirer-to-network-to-issuer as any other transaction (with the added step of a secure token vault).

    In other words, a card-based credit or debit card purchase and a phone-based wallet purchase are each counted as one transaction.  Changing the form factor, from card to phone, does not alter the underlying trend line in the number of payment transactions. 

    But some digital wallets, namely “two-stage wallets,” function differently.  PayPal is a prime example of a digital wallet where one purchase can produce two transactions. Two-stage wallets generate two transactions:

    • Purchase transaction: a PayPal user initiates a purchase online. This purchase, ecommerce site to PayPal, is transaction #1.
    • Funding transaction: Simultaneously, PayPal initiates a funding transaction to move money from the user’s funding account into their PayPal wallet, via the ACH or a debit or credit card; this account funding is transaction #2.
    apple-pay
    paypal-1
    As PayPal has grown, so the number of one purchase for two payment transactions has also increased.8

     

    C. Commerce platforms

    The past decade has seen incredible growth in the number of commerce platforms – the rise of the gig economy (e.g., Uber, Lyft, DoorDash, Instacart and many more) and marketplaces (eBay, Etsy, Poshmark, etc.) has transformed the traditional buyer-to-seller model.

    Historically, card payments at a particular retailer are processed one-by-one but settled into the merchant’s account as a batch.  However, in the world of marketplaces, the default model is one payment from the buyer to the platform, plus one disbursement from the platform to the seller (in other words, two transactions for one purchase).

    The best platforms make the payment experience as seamless and frictionless as possible.  In the process, it’s easy to overlook just how many payment transactions have been created out of what was previously a singular purchase.  Two examples illustrate how easily payment transactions can multiply:

    • Uber: a consumer requests a ride with Uber and their card-on-file is authorized for the estimated cost of the trip. At the end of the ride, the card is charged (transaction #1).  The driver wants to be paid as quickly as possible and requests a push payment from Uber for their share of the ride revenue (transaction #2).  The next day, the consumer opens the app and adds a tip (transaction #3).
    • Instacart: a consumer places a grocery order with Instacart, paying the platform (transaction #1). The platform funds a virtual commercial card for the Instacart shopper to use in the store; the shopper pays for the groceries with this account (transaction #2).  Instacart pays the shopper (transaction #3).  The consumer adds a tip for good delivery (transaction #4).  One of the delivered items is spoiled and the consumer complains; Instacart issues a refund for that particular product (transaction #5).
     

    As digital commerce continues to grow, we are likely to see even more use cases for how money is moved into or out of the system.  Each represents a distinct payment transaction, further expanding the overall payments universe.

    4. Will the good times continue?

    Payments have had an incredible run, with the total number of transactions almost tripling from 2000 to today.  As we look forward, product managers and investors are asking, will this growth continue?

    At least for the foreseeable future, we believe the answer is yes.  Our confidence in the sector’s growth prospects reflects: strong industry fundamentals, a return-to-basics for established payment methods, and market expansion with the rollout of new payment technologies.

    A. Strong industry fundamentals

    The vitality of the US payments market is reflected in the Federal Reserve’s payments data.  Between 2018 and 2021, the industry added 30.7 billion payment transactions, up slightly over the growth from the previous three-year period (see Exhibit 4).

    A maturing industry would begin to show signs of tapering growth, as adoption and usage reach saturation points.  The data give no indication of this dynamic.  In fact, despite the headwinds created by the pandemic, while usage of some payment methods slowed (notably credit cards), utilization of other payment methods accelerated (ACH and prepaid cards) as vehicles to distribute various forms of government stimulus.

    Exhibit 4: Change in the number of payment transactions (BN)

    Source: BPG Analysis

    B. A return-to-basics

    At different times over the past twenty years, there’s been lots of noise about the potential for significant disruption.  Will merchant wallets cannibalize issuers’ card volumes?  Will decoupled debit cards restructure the prevailing transaction flow?  Will blockchain and distributed ledger technology eliminate the need for centralized payment networks?  And many more.  Yet, none of these potential challengers to the status quo gained any traction.

    Perhaps learning from these lessons, today the focus within payments is USE – Ubiquity, Simplicity and Embedded.

    • Ubiquity: electronic payments are inexorably extending into every conceivable venue and use case
    • Simplicity: in-person payments are becoming faster with tap-and-go; new methods of managing guest checkout for online shopping are streamlining card-not-present transactions
    • Embedded: increasingly, consumers and businesses make and receive payments that are integrated into other propositions, further reducing friction
     

    Business-to-business payments will be a major beneficiary of this renewed focus.  Younger employees increasingly expect the same speed, security and convenience for B2B payments as they enjoy as consumers.  This latent demand is supported by the rollout of Request For Payment (RFP) functionality.  As a result, batch AP processes for B2B are shifting toward Purchasing and general purpose card payment, while vertical market payment networks build out for supply chain and embedded payments.

     

    C. Rollout of new payment technologies

    Last month (July 2023), the Federal Reserve launched FedNow, a new real-time payment system.  Aside from the card and ACH networks, the US now has two dedicated faster payment rails: FedNow (operated by the Federal Reserve) and Real-Time Payments or RTP (operated by The Clearing House).

    These are capabilities; it will by the network participants, and their customers, that determine uptake and usage.  That said, there are already early signs that these new payment technologies are opening up new use cases and, in the process, further expanding the addressable payment market size.

    • Real estate closing: when buying a house, buyers and sellers use an escrow agent to help manage the movement of money. Given the large sums involved, a trusted third-party ensures that good funds are transferred at the agreed upon time.  With real-time payments, both parties can have immediate confirmation of funds availability, with finality, at a fraction of the cost.
    • Car buying: car dealerships typically require buyers to provide a certified check. A bank check verifies that the funds are good, and does not carry the acceptance costs associated with credit or debit cards.  However, adding a visit to a bank branch (during business hours) to collect this certified check adds considerable friction.  As an alternative, dealerships are implementing RTP’s request-for-payment functionality to allow car buyers to initiate a real-time push payment from their bank account directly to the dealer.
    • Account-to-Account immediate transfers: Current account-to-account transfer services have several limitations, which can be directly addressed with newer real-time money movement systems. Before a business (or a consumer) can send a wire transfer, they need to complete cumbersome paperwork, adding friction for the sender and cost for the originator.  Consumer money movement apps are more convenient, but dollar limits make them ill-suited for high-value urgent transfers.  As instant payments take off, we expect these – and other – use cases to expand.
     

    Better products and services that deliver more value, more quickly, inevitably win in the marketplace. This truism certainly holds in payments where, over the past 20 years, the speed, convenience and superior economics of electronic payments over paper payments has powered the great payments engine.  Nowadays, younger consumers rarely write checks or carry much cash, preferring payment cards.  These consumers, together with more tech-savvy businesses, will drive the next wave of industry growth, utilizing a range of newer payment technologies.  It should be an exciting ride.

    Tony Hayes is the Founder and Managing Partner of Banking & Payments Group. He can be reached at tony.hayes@bankingandpaymentsgroup.com

    Ed Bachelder is the Director of Research with Blueflame Consulting and Research, LLC, specializing in consumer & business market research and electronic bill payment.  He can be reached at ed.bachelder@bflame.com

    1 A number of organizations estimate the size of the US payments market but the Federal Reserve is generally regarded as “the gold standard” in terms of accuracy. The Federal Reserve began collecting these data via triennial surveys, contracting with Global Concepts for the check sizing and Dove Consulting for all of the electronic payment methods (ACH, debit, credit and prepaid cards). The authors previously worked at Dove Consulting.

    2 Note (directly from the Federal Reserve): “All estimates are on a triennial basis, except that card payments were also estimated for 2016, 2017, 2019, and 2020. Credit card payments include general-purpose and private-label versions. Prepaid debit card payments include general-purpose, private-label, and electronic benefits transfer (EBT) versions. Estimates for prepaid debit card payments are not available for 2000 or 2003. The points mark years for which data were collected and estimates were produced. Lines connecting the points are linear interpolations.”

    3 An alternative methodology is to measure the market size in dollar terms, not the number of transactions. By this measure, the total value of non-cash payments made in 2021 was $128.5 trillion. In most cases, we prefer the ‘number of transactions’ approach since (a) one transaction reflects one payment made/one payment received, thereby removing the effects of inflation and (b) most entities pay on a per-transaction basis (with the notable exception of cards where interchange and network fees typically utilize ad valorem pricing).

    4 For this article, we consider check, ACH debit and ACH credit to be “batch” transactions.  While in the vast majority of cases, the transaction is processed electronically end-to-end, at the time of payment initiation, the parties do not have visibility into funds availability and the transactions are therefore not “pre-authorized.”  By contrast, card transactions are processed individually and, in most cases, the balance or open-to-buy is verified at the time of purchase.

    5 As a sidenote, population growth is the primary driver for retail banking growth (at an industry level).  Since the percentage of the population that is unbanked or underbanked is reasonably stable, the only source of new consumer customers for a retail bank is net population growth.  Banks that are growing their customer bases faster than population growth are gaining share at the expense of competitors.

    6 Another measure is Personal Consumption Expenditures (PCE).  PCE is the component of GDP that tracks spending by households.  Over time, the growth rates for PCE and GDP generally move in lockstep.

    7 Payment cards (general purpose open-loop payment cards and most ACH transactions) are processed by a network, providing a defined entity for data collection.  Private label cards, and check and ACH transactions that are processed on-us, introduce additional complexity and necessitate some level of sampling and estimation.

    8 PayPal processed 22.3 billion transactions in 2022, up 188% over the past five years (7.8 billion transactions in 2017)