Success and money-making in digital payments

PayTM, valued at $16 billion in its last funding round, is not making much money. Is that why it has bought a general insurance company?

On Monday, PayTM, one of India’s best known digital payments companies, bought a small general insurance company called Raheja QBE General Insurance.

According to regulatory filings made by Prism Johnson, Raheja QBE would be sold “to QorQl, a tech company with majority shareholding of Vijay Shekhar Sharma and remaining held by Paytm (owned by One97 Communications)

Paytm will acquire Prism Johnson’s 51 per cent and QBE Australia’s 49 per cent stake in Raheja QBE to become 100 per cent owner. The acquisition is expected to close by March 31 next year, subject to approvals from the Insurance Regulatory and Development Authority of India and other regulators

The total deal value comes up to ₹568 Crore (or $76 million). For watchers of the Indian FinTech landscape, this is no surprise. On the one hand, it is rather common for Indian fintech companies to buy legacy companies (this has been especially the case among marketplace lenders).

On the other, PayTM itself hasn’t been doing well (possible paywall) and needs to look for new sources of revenue.

Yet profits have been elusive. Paytm generates revenue mainly through fees collected from merchants. Some of Paytm’s businesses, such as the Paytm Payments Bank, travel and entertainment ticketing, and services for corporate clients, make money. But people familiar with the company’s operations said the profits from such businesses are far from sufficient to offset losses from the core payment business that accounts for the majority of Paytm’s revenue.

PPI runs into UPI

PayTM began life as a “prepaid payments instrument” (PPI) provider. It operated “mobile wallets” which people could recharge from their banks or credit cards, and use for purposes of digital transfers. The mobile wallet business got a fillip in 2014 when the Reserve Bank of India mandated two factor authentication for all credit and debit card payments (but not for mobile wallet payments). In its wake, PayTM tied up with Uber to enable the latter to seamlessly collect fares at the end of each ride.

PayTM’s next point of inflection came in November 2016, when Prime Minister Narendra Modi took ₹1000 and ₹500 notes out of legal tender. These notes accounted for 86% of India’s currency under circulation at that point in time, and in the following two months, Indians found it difficult to complete payments for their transactions.

The morning after Modi’s speech announcing the “demonetisation”, the front pages of most national newspapers that morning were plastered with this full page advertisement.

Demonetization- a lay person view -

In November 2016, the amount of money spent through PPIs was double the amount spent in October. Even after cash returned to the system, PPIs grew strongly, until they faced their first headwind in February 2018, when RBI required their customers to have full KYC documentation.

And then there was UPI. The Unified Payments Interface was a protocol launched by the National Payments Corporation of India (a consortium of banks) in 2016 to enable easy digital payments between bank accounts. Now, users didn’t need detailed account details for inter-bank transfers. Only a virtual payment address (VPA) was necessary.

UPI had two significant advantages over a PPI such as PayTM. Firstly, PayTM needed the creation of a separate account, requiring separate KYC documentation and essentially a bank account (in 2017, PayTM got a payments bank license). Secondly, UPI brought in interoperability - all one needed to transfer money to another person using UPI was the latter’s VPA. Two people could use UPI applications of their own choice and still be able to transact.

Interoperability meant that PayTM’s moat in terms of having built a two-sided market (acquiring customers and merchants) had been lost. In came specialised merchant acquirers such as BharatPe, and technology companies such as Google and PhonePe (the latter is owned by Flipkart, which is in turn owned by Walmart).

Apart from these intermediaries, customers can use their own banking apps to make payments using PPI. PayTM has been sidestepped. All this and other reasons as to why UPI had taken over digital payments in India were nicely summarised in a comprehensive PWC report (see attached article here).

(Notice in the above graph that the amount of money transacted using PPIs, which doubled upon demonetisation in November 2016, essentially stagnated since mid 2018, before dropping off this year. To put the graph in context, in May 2020, the total amount transacted using UPI exceeded ₹2 Trillion - 10 times that of PPIs)

In November 2019, PayTM raised an investment round from existing shareholders which valued it at $16 billion.

Paytm said on Sunday that it raised a fresh round of equity from existing shareholders such as Ant Financial, an affiliate of Alibaba Group Holding Ltd, and SoftBank Vision Fund. They were joined by new investors, including T. Rowe Price Associates, Inc. Discovery Capital, an existing shareholder of Paytm, also took part in the round. 

A month later, PayTM announced that it had applied for a license to turn from a payments bank to a small finance bank. This change in regulatory status would allow it to lend money as well. Given that PayTM processes payments for a large number of merchants, this seemed like a logical next step for the company. It is possible that the company is entering into the general insurance business as well by targeting the same demographic.

Success and money-making

The other day we spoke about Sanjiv Goenka’s acquisition of the right to distribute Fortune in India, where he claimed that while Open “is not making money, it doesn’t mean it’s not successful”. The same can be said of the entire payments landscape in India.

The ease of payments of the UPI protocol means that it has now largely taken over merchant payments as well. In May 2020, the total volume of money transacted through UPI was ₹2.2 trillion. To put that in perspective, the total money transacted through credit cards in the month was ₹322 billion, and through debit cards ₹480 billion. In other words, UPI is nearly 3 times as big as credit and debit cards put together (albeit in a covid-19 induced contactless environment).

While the amount of money moved using UPI is large, the payments industry makes no money off it. Since the beginning of the year, payments providers have been forbidden from collecting any “Merchant Discount Rate” (MDR) on UPI transactions.

And this has put the payments industry in a spot. “If you don’t pay for a product, you are the product” goes a popular internet adage. And payments providers, now not being allowed to charge for their payment services, have been forced to make money in other ways. This TechCrunch article gives a comprehensive view into the problems with India’s payment industry.

“They have no choice. Payment is the gateway to businesses such as e-commerce and lending that you can monetize. In Paytm’s case, their earlier bet was Paytm Mall,” said Jayanth Kolla, founder and chief analyst at research firm Convergence Catalyst.

But Paytm Mall has struggled to compete with giants Amazon India and Walmart’s  Flipkart. Last year, Mall pivoted to offline-to-online and online-to-offline models, wherein orders placed by customers are serviced from local stores. The company also secured about $160 million from eBay last year.

With PayTM mall not really working out, PayTM needs other means to monetise its large merchant base. Turning into a Small Finance Bank will allow it to lend to them based on the data. The data can also be used to offer them general insurance, which possibly explains the Raheja QBE acquisition.

Meanwhile, UPI might be eyeing a global expansion. Having become India’s largest digital payments provider with Google Pay, Google has now recommended UPI to the US Federal Reserve.

In a letter written by Mark Isakowitz, Vice President, Government Affairs and Public Policy, US and Canada, Google, the company said it worked closely with the National Payments Corporation of India (NPCI), the payment regulator government by the Reserve Bank of India (RBI), to build 'Google Pay' for the Indian market. NPCI deployed a real-time payment system UPI in 2016.

According to Google, UPI was thoughtfully planned and critical aspects of its design led to its success.

"First, UPI is an interbank transfer system (there are now over over 140 member banks, after initially launching with 9 participating banks). Second, it is a real time system. Third, it is 'open' -- meaning technology companies can build applications that help users directly manage transfers into and out of their accounts held at banks," Isakowitz wrote to Ann Misback, Secretary, Board of Governors of the Federal Reserve System.

While Google Pay has been the dominant digital payments provider in India, it has had its share of troubles. Last month, for example, there were rumours floating around that Google Pay’s licence had been cancelled (it was even a trending topic on Twitter). Finally, RBI had to step in and make a statement that Google Pay is indeed a part of the payments system in India.