Jeff Coppolo
The COVID-19 pandemic has forced businesses to rethink how they accept and make payments. Paper invoices, checks and point-of-sale payments have given way to “corona-free payments” through mobile apps, electronic invoicing and ACH. Although significant, this is the sideshow to a more significant reshuffling of the payments industry.
Nearly $150 trillion in worldwide B2B and B2C transactions take place every year, but only a tiny portion are digital. A lot of technology companies want their piece of that massive pie. Until recently, though, only payment facilitators (aka, “payfacs”), gateways, banks and credit card companies had access to it.
That’s changing. Whether they know it yet or not, B2B tech platforms are becoming payments companies. Payfacs are competing to integrate their technology into these platforms, which drive an ever-growing number of transactions. Revenue-sharing deals are on the table, and payfacs are pushing the competitive advantages they can offer to the clients of these B2B platforms. Capabilities like cross-border payments, seamless customer onboarding, fraud protection, marketplace payments and B2B invoicing influence, which payfacs win in “integrated payments” (the jargon for this space) and which don’t.
B2B companies that use to leave the choice of gateway to their clients need to become savvy in payment technology, both to control the user experience and to tap this new business. There’s a massive amount of revenue on the table, and it’s just too easy to blow this opportunity and alienate clients in the process.
How we arrived here
A decade ago, the revolution in cloud computing led to a wave of B2B tech platforms promising to “disrupt” every industry. Gyms got gym management platforms. Hospitals got clinic management platforms. Retailers got commerce management platforms. Media companies got subscription management platforms. Many of these fill-in-the-blank management platforms — all independent software vendors (ISVs) — helped clients manage their operations and interactions with consumers or other businesses.
But ISVs didn’t get involved in payments, which was odd, given how complementary payments were to their platforms and how much money was at stake. Mastercard says there is about $120 trillion annually in B2B payments worldwide, and paper checks still dominate about half of the U.S.’s $25 trillion payment volume. Meanwhile, retail e-commerce sales account for $4.2 trillion out of $26 trillion in total retail, or about 16.1%, according to eMarketer. Less than 8% of global commerce is thought to occur online.
You’d think B2B software companies would find a way to generate revenue on some of that $146 trillion in transactions, but most did not. Payment processing is its own, messy, complicated niche. Payfacs go through a grueling underwriting process to provision a merchant account, which includes know-your-customer (KYC) and anti-money laundering (AML) checks. If a merchant defaults, the payfac is next in line to make good on the transactions.
When you run a venture-backed B2B platform, you have enough to worry about already.
So, B2B platforms stayed clear. They formed integrations with a basket of payfacs (Stripe, PayPal, Square, my company BlueSnap, etc.) and then let their clients choose which one to use. That’s a lot of integrations to maintain.
The wakeup moment
This situation was unsustainable because B2B tech companies realized how much money they were leaving on the table. The consulting firm McKinsey estimates that revenue from global payments totaled $1.9 trillion in 2018, split almost equally between retail ($1.02 trillion) and B2B payments ($930 billion). Eventually, major platforms started to have their wake-up moments.
Shopify, for instance, made a big deal of launching a payment system built on Stripe in 2013. Since then, Shopify has become a payfac in its own right in North America. GoFundMe, Klarna, Wix.com and Toast are all payfacs too, according to Mastercard’s list. They had the scale, revenue and funding to do it. More importantly, they had the incentive. Shopify recorded a gross payments volume of $61 billion in 2019. Why leave all the payment processing revenue up for grabs?
However, most companies can’t afford to become payfacs the way Shopify did. It takes a large team of developers, risk managers, product experts and legal and compliance professionals, all with payments expertise. When you’re taking people’s credit card information and other personally identifiable information, you can’t just “move fast and break things.” That’s a lawsuit and PR disaster waiting to happen.
Payfacs had a wake-up moment, as well. ISVs offer an access and distribution channel where payfacs can board merchants at scale. So, payfacs began to approach B2B platforms with a deal: we’ll let you white-label our technology and offer it as part of the platform. We’ll make onboarding and setup way easier for your clients and offer them a better payment experience. In exchange, you’ll get a cut of the revenue from every transaction. And by the way, we’ll assume all the risk of bad transactions, compliance, fraud and chargebacks.
This concept of “integrated payments” — as in, integrating a payfac’s payments solution into a B2B platform — took off.
Everyone’s in the payments business now
The implications for the B2B tech space are significant. For a long time, B2B tech platforms didn’t necessarily feel responsible for their client’s financial results or payment experience. The incentives for an average B2B platform were threefold: sign, retain and upsell (aka, “customer success”). Once the ISV has a stake in each transaction, however, there’s an additional incentive: help clients sell as many products and services as possible. For the B2B platforms, conversions matter, and so does optimizing their client’s payments solution to drive sales.
There are still risks for the ISV. Prior to integrated payments, merchants chose the payment gateway and merchant account provider that fit their business model best. Depending on a host of factors — their industry, where it’s headquartered, where customers are located and the average order value — the choice of payment provider could have a massive impact.
Some industries do tons of cross-border transactions and need to localize payment processing and offer payment methods that are popular in Brazil, China, India, etc. Some facilitate B2B rather than B2C transactions, so invoicing automation and ACH deposits are vital. Some platforms facilitate marketplace businesses, where revenues have to be split between the marketplace and its sellers in multiple countries. For other platforms, a subscription engine is going to be key for its clients.
For example, let’s say that the U.S. client of a B2B platform sells $10 million worth of goods and services, and half of its customers are located overseas. Assuming the payfacs processes those overseas payments in the United States, up to $5 million in revenue could be subject to cross-border fees, which average about 1%. So, the business might spend $50,000 on fees without needing to. Plus, an extra 3-6% percent of the transactions may be declined as compared to if those transactions were processed in the region where the payment card was issued.
The point is, B2B platforms that go into the payments business need to be smart about who to integrate with. The wrong PayFac has the potential to disappoint clients and hurt their businesses.
It’s all happening now
As you read this article, payfacs are competing to become the integrated payments system for the B2B platforms that dominate entire industries. This competition is moving fast in certain verticals (e.g. e-commerce, healthcare, education, etc.) because paper invoices are way too slow to process, and they’re exacerbating cash flow problems that began during the lockdown. The rush to get back to work is matched with urgency to get paid faster and more reliably.
If your platform is responsible for $1 billion or more in business, maybe it makes sense to become a payfac. You will take on the risk for default, fraud, non-compliance and the like. When consultants show up in your inbox talking about how easy it is to become a payfac, consider their proposition carefully and weigh the ROI of building a payments company within your software company. For 99.9% of businesses, becoming a payfac is too onerous, and partnering with a payfac for integrated payments is the way to go.
For readers who run B2B platforms or invest in them, now is an opportunity to tap a new revenue stream while potentially providing a better payments product and onboarding experience for your clients. My advice before you start this process: talk to your clients. Find out which payment providers they already use and what they like and don’t like. Try to figure out what parts of the payment process cause pain. Slow customer onboarding? Missing product features like digital wallets? Is it cross-border fees? Denied transactions? A choppy checkout experience?
Go into this search not just to increase revenue but to solve a problem for your clients. Remember, once you are integrated with a payfacs, you will have a direct financial stake in seeing your users do more business. Don’t botch this easy “win-win.”
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