Dreams of Glory: Business Payments and Network Fantasies
At Glenbrook we talk about “network fantasies” a lot. These are hopes that payments innovators, and incumbents, have about the so-called “network effect” in payments. Many a payments start-up has sat in our conference room and predicted the flood of transactions that will come their way due to the network effect.
The payments industry features a classic chicken and egg scenario: in a retail example, you need a lot of consumers to use your payment scheme in order to attract merchants, but you need a lot of merchants accepting the payment scheme in order to get consumers to adopt. That’s hard to do. But if you succeed in getting over the “hump” of initial adoption real momentum gets going. When it works, the network effect is very real and very powerful.
There is a strong tendency toward network fantasies in the business-to-business (B2B) payment world. Electronic payments in this domain are generally arranged by individual agreement between the payer (a business buyer) and the payee (a supplier). The allure of network fantasies is particularly strong due to a related concept, the notion that “the hub controls the spoke”. This is the number one myth when it comes to commercial transactions — it is hard to overestimate how much the industry has bought into this fallacy. Yes of course, powerful corporate buyers exert pressure on small or dependent suppliers. (And powerful suppliers can do the same with vulnerable customers.) But this represents the small minority of commercial relationships.
B2B purchasing is an example of the infamous pareto principle: 20% of customers that account for 80% of your revenue will be accommodated if they want or need something special. Buyer and supplier companies will invest IT time and resources in order to develop interfaces and processes to support business with key trading partners. Suppliers will even join the preferred B2B network of their counterparty. Thus paying enterprises find it easy to sign up their critical counterparties – the key 20% – for electronic payment (ACH or cards). But for all the rest – the other 80% – suppliers won’t bother. The relationship isn’t worth the hassle of doing something different in the back office.
This is the “long tail” problem, and many B2B payments networks and payments enablers are pursuing solutions to this issue. This is where the fantasy kicks in. If you are a B2B network, and you succeed in signing up another 20% of the suppliers for your customer (the payer), you figure you have an asset. “Hey!”, you say to yourself, “other enterprises will use my network in order to be able to pay those suppliers.” And those suppliers will perceive the benefit of reaching more buyers through the network! You start running the numbers and you get really excited. “Wow”, you tell your prospective investors, “pretty soon everyone is going to want to use my network”.
The problem, of course, is that the B2B commerce world is simply too large to be dominated by any one player. And so even the most successful of the B2B networks have only a small number of suppliers signed up and accessible to other payers.
To be fair, the network effect does occur – particularly in closely-knit supply chains i.e. chemicals, transportation, automotive, etc. – many of these industries adopted EDI back when I was an adolescent and now have thriving supplier hubs that manage the procurement, invoicing and payment processes. But for the most part, the B2B network fantasy remains elusive. We recently did some work to estimate the value and volume of commercial payments flowing through B2B networks and believe that less than 5% of U.S. commercial transactions are mediated through such a system, and an even smaller proportion of the payments are affected through B2B networks. After over 20 years of effort.
At Glenbrook, we believe that the right way to view B2B payments is as a “many to many world”. An over reliance on the importance of the big buyers has led to many dead ends in the industry, and heartache for many a network fantasist (and investor).