The Electronic Financial Ecosystem
Over the past two decades, corporate finance and treasury professionals have been inundated with marketing communications about the efficiencies
and cost savings of moving from paper to electronic payments. Although that message should be well-understood by now, most U.S. corporations continue to make and receive large volumes of paper payments and employ paper-intensive methods for processing payables and receivables.While these corporations may have understandable reasons for continuing to rely on paper, other businesses are aggressively intensifying efforts to move to electronic payments. What is driving this trend is not marketing but the recognition that a fundamental change is taking place in the way global financial ecosystems operate. Throughout the world, consumer electronic payment methods, which include credit cards, debit cards, automated clearing house (ACH) credits and debits, and Internet online payment services, are rapidly displacing cash and checks for retail purchases and remittances.
Even in the United States, one of the worlds most paper-based economies, the shift to electronic payments has become highly apparent. A Federal Reserve study of the volume and value of checks and other retail payments revealed that 40 percent of noncash retail payments in 2000-2001 were made electronically, a huge increase from the 15 percent share in 1979.
The study showed that credit cards were the most common form of electronic payment, with a volume of about 15 billion transactions worth $1.2 trillion in 2000. Debit cards ranked second in transaction volume, with 8.3 billion transactions worth $348 billion. ACH payments ranked third in volume but first in dollar value with 5.6 billion transactions worth $5.7 trillion, which represented 78 percent of the total electronic payment dollar volume in 2000.
Debit card continues to be the fastest-growing electronic payment type, reaching 11 billion transactions in 2001, an almost tenfold increase in volume since 1996. Federal Reserve statistical analysis indicates that the annual volume of check payments, estimated to be 42.5 billion in 2001, is now declining. If check usage continues to decline at 3 percent a year, electronic volumes will surpass check volumes by 2006.
The Nilson Report forecasts that in 2010 retail electronic payments will far exceed check payments, with projected volumes of 10.5 billion transactions for ACH, 28.5 billion for debit card, 31 billion for credit cards, and 29 billion for consumer checks.
U.S. corporations have not been so forward-looking. Businesses are the biggest makers and receivers of check payments in terms of dollar value. According to the Federal Reserve, checks written by businesses or governments represented 81 percent of the total value of check payments in 2001, with business-to-business transactions accounting for more than 42 percent of that figure.
Nearly half of the checks written by businesses and governments are income payments to consumers. More than half of all checks written by consumers are received by businesses for remittances and point-of-sale purchases, with bill payments being the single largest category of consumer check payments. For U.S. businesses in general, and those that receive consumer payments in particular, it is clear that this heavy dependence on paper payments will not be sustainable for much longer.
Well look at strategies that innovative corporations are now using to shape their electronic future and to take advantage of the numerous efficiencies and cost savings to be derived by ending dependence on paper payment methods. Because consumer payment behavior is one of the principal factors driving the shift from paper to electronic payments, well look primarily at electronic payment solutions that businesses can use to streamline retail collection processes. But well also highlight some emerging B2B electronic-collection strategies that are influenced by retail applications.
Electronic Check Conversion
Electronic check conversion promises to be one of the fastest and most efficient ways to remove paper from the collections-processing stream. With this solution, the check presented for payment becomes the source of payment information — not the method of payment. The MICR line information, including the bank routing transit number, the account number, and the check number, is captured electronically and then used to make a one-time ACH debit from the consumers account.
The check is imaged and then destroyed so that it cannot be reintroduced into the paper check-clearing process. The consumer receives a convenient record of the payment on the monthly checking account statement, which shows an electronic debit for the purchase amount, the check serial number, and the name of the business.
Provisions for electronic check conversion were incorporated into Regulation E, with mandatory compliance required by 2002. Check conversion is governed by NACHA Operating Rules. Checks eligible for conversion must be drawn on a consumer account, must contain a preprinted serial number, and must be drawn on a financial institution that accepts ACH debits. Ineligible checks include checks drawn on corporate or business accounts, third-party checks, credit card checks, cashiers checks, money orders, travelers checks, Treasury checks, and checks denominated in foreign currencies.
Check conversion provides significant benefits for businesses. Because the transaction is an electronic payment, funds are available faster, usually on a same-day or next-day basis. The business also receives much faster notification of returned items. Return notifications are provided the second day after settlement instead of the week to 10 days common for returned checks. In addition, corporate treasury and accounts receivable departments know exactly when ACH debits will post to the companys account. Since theres no guessing about when these items will clear, it is easier to determine daily cash positions accurately. Another major plus is that check conversion reduces the risk of fraud and the costs incurred to prevent check fraud. Finally, information reporting and account reconciliation for ACH transactions is much more straightforward than is the case for checks.
There are two basic types of electronic check conversion services available:
Conversion of commercial checks, although not currently allowed under NACHA Operating Rules, will become possible in the future. NACHA excluded business checks in order to give large businesses and financial institutions time to integrate their check and electronic payment processing systems with cash management and fraud protection services. However, the U.S. Department of the Treasury, which began piloting check conversion in 1999, is already converting business checks presented in person at federal agencies. So it is only a matter of time before check-conversion services become available for wholesale lockbox remittances and other types of B2B check payments.
Electronic Bill Presentment and Payment
This year, U.S. consumers will make over $800 billion in regular and ongoing bill payments to providers of essential services and merchants, with about 80 percent of those bills originated by the finance, insurance, telecommunications, and utilities industries. U.S. consumer interest in the convenience of electronic bill paying services has been steadily growing. A recent Visa survey found that one-third of U.S. consumers would use automatic bill-pay services if offered. Businesses that receive recurring consumer payments have discovered that electronic bill presentment and payment (EBPP) is growing in popularity as an online bill-payment alternative with todays technology-savvy consumer. EBPP uses the Internet to deliver bills faster and at a much lower cost than the mail system, and it enables the consumer to pay online using a choice of electronic payment options, including ACH debit, credit card, or debit card. According to the Tower Group, usage of online bill payment by U.S. households has grown from a mere 2 percent in 1998 to 13.7 percent in 2002. Since more than half of all U.S. households now have Internet access, sustained growth of EBPP can be expected.
For billers, EBPP means reduced printing and mailing costs, faster access to funds, and more efficient receivables processing, as well as more streamlined customer service with fewer calls for routine inquiries. The potential cost savings could be considerable as more consumers switch to the service. Currently, the highly paper-intensive method of bill presentment and payment costs billers and consumers about $80 billion a year. Billers internal billing and payment processing operations costs amount to $45 billion annually. Billers and consumers together spend $10.7 billion a year on postage. For consumers, EBPP provides the convenience of electronic payments with no need to remember to write checks and mail in payments. Consumers also benefit by having 24-hour-a-day, seven-day-a-week access to the service so bills can be viewed and paid at any time.
Billers can build EBPP functionality into their own Web sites or use a variety of EBPP solutions available from financial institutions and non-bank service providers that can design and host a custom-branded payment site. Another alternative is to use an EBPP service provider that incorporates a companys bill presentment information and payment links into a site that consolidates billing information from multiple billers. EBPP can also be combined with an electronic consumer collections service.
With this service, a financial institution or non-bank processor accepts payments from consumer bill-pay services, consolidates the payment information, and transmits the data directly to the companys receivables system. Exception items are automatically returned to the originator, so the transactions are corrected sooner. The result is that good funds are credited to the companys account more quickly, and there is no need to manually enter paper check and list data. As a result, reconciliation problems caused by key-entry errors are eliminated, and the cash application process is greatly accelerated.
Electronic Invoice Presentment and Payment
Electronic invoice presentment and payment (EIPP) is the B2B version of EBPP. With EIPP, a company presents invoices on its own Internet site or a hosted site, with email notification to trading partners when an invoice is available online. The trading partners then log on to the EIPP site, review the invoice, and initiate an online payment via ACH debit or a payment card such as a purchasing card or business card. Since EIPP electronically associates payments and invoice information, receivables processing can be greatly streamlined.
The business case for switching from paper-based invoicing and payment to EIPP is compelling. A Gartner Group study found that companies could save $7.15 per invoice by using electronic presentment over the invoice. Since large corporations issue an average of nearly 800,000 invoices a year, the cost savings that would result from presenting even a small percentage of invoices electronically would cover the expenses of implementing an EIPP solution. EIPP also gives companies much faster funds availability by eliminating the mail float associated with paper invoices and payments, which in turn means a reduction in working capital requirements.
E-Commerce Collections Management Solutions
Businesses that are moving from paper-based to electronics payments are ideally positioned to take full advantage of electronic commerce solutions for managing collections on an enterprise basis. Financial institutions and e-commerce service providers can consolidate electronic payment and remittance information from converted checks, online consumer payments, and electronic trade payments with lockbox data.This consolidated collections information can then be transmitted in a single stream to the company so that receivables and treasury systems can be automatically updated. An e-commerce collections management solution can deliver significant cost savings by reducing the amount of time that accounts receivable staff spends rekeying data and matching payments to invoice and remittance documents. Furthermore, by automating the flow of remittance data into the receivables system, the speed and accuracy of the cash application process is improved, enhancing the treasurys ability to track and forecast cash positions. More accurate and faster cash application also means fewer disputes over billing and improved customer service, again lowering costs.
The Electronic Financial Ecosystem
Global use of paper is an extraordinarily costly proposition that has had a major impact on our planets natural ecosystems. One-fifth of all the timber harvested in the world ends up in paper, which requires two to three-and-one-half tons of wood per ton of product. Pulp and paper producers are the worlds fifth-largest industrial consumers of energy. It takes as much power to produce a ton of paper as it does a ton of iron or steel. Making paper requires more water per ton than any other industrial product and results in high levels of air and water pollution. The paper industry is the third-most-polluting industry in North America. Disposing of paper, which is often used once and then thrown away, is also costly. In the United States, 40 percent of all municipal solid waste is paper.
For the U.S. financial ecosystem, the use of paper has been an equally expensive and wasteful proposition. The social cost of the nations payment system is estimated to be 1 percent to 1.5 percent of the total gross domestic product. This amount would be significantly reduced if businesses helped lead and accelerate the shift to electronic payments, which cost one-third to one-half as much to process as do paper-based payments. While many companies are hesitant to start re-engineering payables and receivables during a period of economic uncertainty; others recognize that the benefits far outweigh the risks. Check conversion, EBPP, EIPP, and e-commerce collections-management solutions can deliver significant cost savings and increased efficiencies in the short term, while laying the foundation for the infrastructure that will be required for survival in the electronic financial ecosystem that is now emerging.
Any company that intends to maintain competitive financial operations over the course of the current decade should consider shifting from paper-based to electronic payments. The business that takes a wait-and-see attitude today may watch from the sidelines in an electronic future that belongs to its more innovative competitors.
