Alternative payment methods – a proven payments imperative

To stave off competition and satisfy customer demand, payment providers need to act now on their alternative payment methods strategy.

Alternative payment methods (APMs) have experienced widespread adoption in many global markets, raising this question: Can APMs ever gain significant traction in the US, a market heavily dominated by card payments? An EY survey of large US merchants¹ reveals that more than 85% of merchants are planning to accept new APMs — defined as nontraditional payments, like digital wallets, account-to-account (A2A) bank transfers and buy now pay later (BNPL) — in the next one to three years. With digital wallets (funded via a card or bank account) now serving as the leading method of payment for North American e-commerce purchases,² the time may well be now for APMs to be at the forefront of the US payment roadmap.

Given the changing market landscape, issuers, acquirers, processors and PayTechs should consider investing in APMs as the following drivers become prominent:

1. Customers demand rich, frictionless experiences bundled with rewards

The pandemic greatly accelerated customer demand for frictionless digital payments, particularly when combined with differentiated offerings. BNPL and wallet players, for example, provide price drop notifications, targeted rewards and merchandise tracking as additional benefits beyond typical payment and lending services. Similarly, as customers are embracing new ways of paying that make their commerce journey simpler, J.P. Morgan Payments, as an example, is piloting biometrics payments, where a user can scan a palm or face for a secure and faster checkout experience.³ Merchant-owned apps are increasing digital engagement by including order-ahead and pick-up services, gamified loyalty points and seamless QR code-based checkouts.

2. Merchants are looking to simultaneously grow sales and reduce payment acceptance costs

Facing uncertain economic conditions and rising operating costs, merchants are increasingly looking to their payment providers to help them grow their top line and reduce costs of payment operations. In our merchant survey, over 70% of merchants recognized that failing to accept APMs could impact sales, putting pressure on acquirers to make them readily available. On the cost side, APMs, especially A2A or closed-loop payments, can offer a competitive edge by reducing typical payment processing costs associated with cards and supporting faster merchant funding via new instant-payment rails.

3. Payment providers are seeking opportunities to diversify payment revenue

APM payment volume reached $19t globally in 2022, meaning that processing fees alone may have approached up to $250b.⁴ While a portion of these fees are contributing to credit card interchange income since wallets can be funded via cards, that income could be at risk as A2A, BNPL and other payment methods grow in adoption. Further, as regulators continue to scrutinize late, overdraft and interchange income — with some recent regulatory proposals in the US seeking to cap swipe fees to increase competition — incumbents need to have a diversified payment revenue strategy while protecting existing income streams.

To capitalize on these changing dynamics and strengthen revenue streams, payment service providers should consider the following as they build out their investment strategy for APMs:

1. Examine customer needs and identify the most relevant business verticals and customer segments

Merchants and payment providers alike need to identify their target segments, understand the intended value-add for the customer and evaluate which incentives effectively encourage APM adoption. Younger generations, like Gen Z and millennials, have shown a high propensity to use APMs and are expected to continue that trend, with the demographic alone projected to have over 87 million APM users by 2026.⁷ Domains, like e-learning, gaming, online retail and wealth management, have shown promising indications to be the top verticals that are looking to offer APMs.

2. Strengthen back-office, risk and compliance operations

According to our merchant survey, fraud management and regulatory compliance capabilities were the key factors that merchants considered when choosing payment processors, with 87% of respondents claiming it as a priority.⁸ Payment service providers should focus on offering critical services, like fraud reduction, dispute management and compliance measures, for changing regulations, like Reg E, as a foundation for their full-service APM solutions, particularly when these value-added services are nonnative to the solution.

3. Evaluate strategic partnerships

Strategic partnerships should be built with PayTechs and other players across the payment ecosystem to offer specialized capabilities, like digital overlays, account validation, fraud monitoring and dispute handling while decreasing time-to-market and optimizing investment spend. J.P. Morgan Payments, as an example, has partnered with Mastercard to start offering simplified and secure Pay-by-Bank solutions to its merchants leveraging open banking capabilities.⁹ Banks building these services should collaborate with internal lines of business, like issuing/lending partnering with the merchant acquiring business to expand the market reach of their new APMs in a potential B2B2C model.