19. How Payment Aggregators Make Money?

The main purpose of a business is to make money… not just revenue but also profit… and payment aggregators are not exception to that.

A payment aggregator relies on backend banks to enable payment services to merchant so the aggregator has to pay to those banks. Top line and bottom line of an aggregator depends on how it manages commercials with merchant and cost with banks and other payment providers

Typical cost structure for e-commerce merchants:

• Debit Cards (below Rs.2000): No Cost
• Debit Cards (Above Rs.2000): Differential pricing for On-Us and Off-us cards (in percentage, %)
• Credit Cards: Differential pricing for On-Us and Off-Us cards (in percentage, %)
• Amex: in % and higher than other cards
• Net-banking: Either fixed cost in percentage (%) of value or revenue sharing (60:40 or 50:50)
• Other payment methods: in percentage (%) of value

The cost structure will vary from sector to sector. Example: Net-banking cost is percentage (%) of transaction value for e-commerce sector but for Insurance sector, the cost will be flat fee per transaction.

Pricing Principle

• Wherever it is fixed cost, charges should be higher than cost (Example: If fixed cost is 1.50% then charge to merchant should be 1.55% or more)
• Wherever there is revenue sharing arrangement, don’t worry about making loss but try to keep top line intact (Example: On 50:50 revenue sharing model if you close commercials at 0.50% instead of 1% then you won’t make a loss but revenue will be reduced to half)

Note: To stop aggressive pricing for net-banking transaction (revenue sharing) some banks set a floor cost. Example: 50:50 revenue sharing with minimum 0.40% of transaction value. This forces aggregator to give rate of 0.80% and above.

How pricing impacts bottomline?

Example A: Standard commercials with healthy margins

On processing INR 10,00,000 per day, aggregator will make profit of INR 605. i.e. INR 2.2 lakh profit per year. Imagine the profit if aggregator processes INR 1Crore… Awesome !!!

Example B: Super competitive pricing (Say… to win the merchant)

I dropped rates of credit cards below bank cost and end up making loss of Rs.140 per day which translates into loss of Rs. 51,100 per year.

Now let’s do what we did in last example… imagine the loss on processing 1crore amount per day… from awesome suddenly it becomes gruesome… right?

This is the beauty of volume game… a small margin translates in huge profit over the period but with a small mis-pricing, merchant will end up losing huge money.

So how to keep making profit?

As explained earlier, it is very simple !!! The charges offered to a merchant should be higher than cost. But remember two more additional points

• What is transaction split across payment modes
• What is the GTV

These numbers will give you good idea, for which payment method you can drop price with minimal impact of bottomline.

Refer to Example B: What would be profit or loss, if I had reduced rate on net-banking transaction but not on credit cards? Calculate yourself and you will know how the loss will turn into profit.

Is transaction processing the only way to earn revenue for a payment aggregator? Or is managing back-back cost is the only way to make profit?

Aggregator’s other avenue for revenue and profit

Aggregators’ have other avenues to earn revenue as well.

1. Debit Card Transaction of less than Rs.2000:

As per Govt. rule there is no charge on debit card transactions below Rs.2000. But Acquiring bank gets subsidy (up to 0.25%) from the Govt. So an aggregator can strike deal with acquiring banks to receive few basis points (5bps or 10bps) against volume commitment

Note: Above model was applicable in 2018–19 and not applicable anymore after GOI changed the RuPay and UPI pricing in 1st Jan 2020

2. On-Us rates:

Say aggregator has differential rate for On-Us and Off-Us from multiple acquiring banks then process On-Us transaction for respective issuers and thus can optimise the cost

Illustration of On-Us combination

Here is the example of how such routing optimises the cost of processing.

In above example, the profit margin is maximum if aggregator uses two acquiring banks and take advantage of differential pricing offered by both acquiring banks.

3. Subvention:

Banks like to enjoy the float and banks often work with payment aggregators and give subvention of few basis points against volume commitment.

Banks doesn’t work on this model all the time with all the aggregators. Example: Bank A has given subvention to aggregator A for merchant A. But same bank will not enter subvention deal with aggregator B for same merchant as there is nothing additional gain a bank will get by moving the engagement.

4. Nodal Account benefits:

Aggregator’s nodal account is quite lucrative for any bank as huge amount moves through the account. Although aggregator cannot earn interest but banks can use this amount to increase ‘the leverage’. So banks are ready to plough back some amount to aggregator against the float or provide better costs or give priority in partnership deals/RFPs etc.

Where does an aggregator loses money:

a. Auto-refunded cases

As covered earlier chapter, merchant who need instant gratification would want aggregator to configure auto-refunds if transaction status is not definite (Success/failed) within specified time.

When transaction is successful then aggregator will mark refund and won’t give settlement to merchant. But as acquiring bank has marked the status successful so it will deduct the charges from aggregator’s settlement. As there is no merchant settlement for that transaction so aggregator end up losing that amount

Example: Transaction Amount = 100, Charges: 1% + GST. Then aggregator end up losing 1.18 for the auto-refunded case

b. Surcharges (bad configuration)

Earlier we covered the surcharge model, where PG Charges + GST Amount is passed on to the customer. Typically used by merchants from Utility, Government, education and B2B.

But banks do not distinguish between transaction amount and surcharge amount, for bank’s point of it is one single amount. So bank applies its rate on total amount not just transaction amount.

Aggregator collects = 11.80 (i.e. 1% of Rs.1000 + GST)

But Acquiring bank deducts = 11.94 (i.e. 1% of Rs. 1011.18 + GST)

So aggregator lost = Rs. 0.14

(If you remove GST component from calculation, then the loss would be INR 0.12). And as payments is a volume game so more the transactions, more the loss

c. Chargebacks where aggregator couldn’t recover money from merchant

We discussed this earlier in chargeback section, a mismanaged chargeback will end up wiping large profit as aggregators work on thin (or zero) margins.

Example: PG Charge: 2%, back-to-back cost = 1.90%

so aggregator has to process Rs.10,00,000 value (2,000 transactions of Rs.500 each) to make profit of Rs.1,000. And one mismanaged chargeback of Rs.1000 will wipe out that entire profit.

d. Fraudulent transactions:

Aggregator has to compensate banks or merchant if a fraudulent transaction is attributed to it and such cases impact merchant’s revenue /margins badly.

Imagine if there is fraudulent transaction of Rs.10,000 then aggregator has to process INR 1Crore GMV to compensate that single loss.

e. Main reason for loss is ‘bad commercials’

Pricing is major differentiator and entry point for new aggregator to get transaction share of large merchant. And an aggregator has to beat not only other aggregators but also acquiring banks, wallets (who also can directly integrate with merchants).

Subvention and plough back doesn’t happen every time, so the aggregator has to undercut other’s rates and many times the rates will be lower than actual cost and thus start losing money.

How to beat the price war:

• Create a niche segment (won’t work always as payments is volume game)
• Differential pricing strategy for small, medium and large merchants
• Choose which battle you want to fight (decide for which merchants you will undercut the cost)
• Deliver the value (performance, operation support) for long run engagement
• Tighten back-to-back cost with unique processing arrangements (on-us routing) and fix revenue leakages (due to surcharge model or auto-refunds)
• Better engagements with banks to avail privileged rates
• Diversify product portfolio and thus create stickiness

Note: Entire article is written based on assumption that infrastructure, admin and support costs are considered as sunk cost. If you factor those costs then entire calculations will be different.

If most of the aggregators are losing money then why compete on price? The idea of price war is simple, knock-out the opponent with your deep pocket (funds) and then be dominant player. If competition is for valuation but not for value creation then price will be the only differentiator.

A quote from movie ‘A Beautiful Mind’ summarises what these payment aggregators are forgetting…

“…the best result will come from everyone in the group doing what’s best for himself and the group” — John Nash