September 4, 2016
In contract to cash, cash-replacement has an extensive value chain. In its most simplistic form, it is a four-party model. In reality, there are many more entities involved from the point a product is issued by the issuer to the consumer, transacted between the consumer and service provider, and settled across the entire ecosystem. Where some products may require an upfront payment, there are others that are paid for by the consumer at the end. Prepaid cards primarily function as cash-replacement products. Credit cards can also be leveraged as an inexpensive short-term loan, or as a fairly expensive line of credit.
Given the fact that there is a delay between issuance, transaction and settlement, fraud is inevitable. With fraud comes risk, with risk comes insurance, with insurance comes arbitrage, and with arbitrage comes speculation.
Cash-replacement has a complicated business model. Clearly, while there are advantages with replacing cash – which, in most instances, directly and indirectly, lead to an increase in sales – its cost-saving benefits specifically related to the handling of cash are typically offset by the additional costs related to the risk of their acceptance. While there is a perceived benefit of not having to carry cash around or to effectively leverage a small short-term loan, there is clearly a cost involved for the same.
Which brings up the most fundamental point of consideration: while cash is a state-backed utility driven by socioeconomic and geopolitical factors, cash-replacement is an undertaking by private enterprise, albeit regulated in most instances but driven entirely by market efficiencies. While cash-replacement is clearly an evolution of cash strictly from a transactional perspective, and effectively they both share several points of convergence specific to the consumer and service provider, they fundamentally could not be more different.
The biggest point of divergence is the inability of cash-replacement to transfer the complete value from debtor to creditor. Simply put, the face value of a cash-replacement instrument does not reflect its real value, and hence, the debtor will have to bear an additional cost to facilitate a transfer to the creditor. Sometimes, this cost is obvious and at other times, not so much.
It is absolutely fair to price a service, especially one as dear as facilitating a transaction, not to mention the myriad of related value-added services. That said, what constitutes a fair price for this service is the topic of heated debate amongst analysts, open war in the marketplace and legal action in the courts.
Pricing aside, cash-replacement was clearly designed to solve a problem. This is not a bug looking for a windshield. It provides a very important transactional service, and possibly even more profound is the impact of its various value-added services from providing credit to facilitating payroll to the distribution of social benefits to enabling virtual commerce between consumers, businesses, and government.
With every new cash-replacement product coming into the marketplace, the focus is less on its transactional capability but on the value added services, both in terms of scrutinizing its value proposition as well as flushing out its hidden profiling features. With every new cash-replacement program, what is of great interest is how many points can be earned and redeemed, as well as, who else is going to have access to the data and related analytics.
Which effectively sets up the question – has cash-replacement gone from being a Philosopher’s Stone to a Trojan Horse?
Check out Mehul Desai’s August of Money.