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Bud Bhattacharyya Nicholas Flanders Andrew McCarthy Richard Ung Transit payments: The open-standards advantage 31 Transit

Bud Bhattacharyya Nicholas Flanders Andrew McCarthy Richard Ung

Transit payments: The open-standards advantage

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Transit payments:

The open-standards advantage

Americans will take more than 10 billion rides on trains, trolleys, buses and ferries this year—38 percent more than in 1995. Other markets rely even more on public transit. Moscow and Tokyo each now support 2.4 billion trips annually, and in Hong Kong nearly 90 percent of people use public transit daily.

Public transit systems have long relied on fare payment instruments such as tokens, tickets and magnetic-stripe cards. This started to change recently as several major transit operators began to capitalize on emerging payments technology by introduc- ing proprietary contactless “smartcards” de- signed to expedite fare payment and add customer convenience. These systems, how- ever, are not the last stage in the evolution of fare collection. New technology and busi- ness rules are creating fresh opportunities for transit operators to reach beyond propri- etary smartcards and adopt a new approach:

open standards. We expect open-standards systems will deliver unprecedented flexibil- ity, convenience, operating-cost savings and interoperability between transit systems – from Paris to Rio de Janeiro. As public tran- sit and open-standards payments converge, many opportunities will emerge for both the transit and payments industries.

Open-standards fare systems allow riders to pay directly at turnstiles and fare boxes using a wide range of credit and debit cards, thus eliminating the need for other types of

intermediary instruments. In recent years, open-standards systems have become in- creasingly attractive to operators around the globe. New York, Paris and Moscow, for example, are testing systems that accommo- date contactless credit and debit cards. Op- erators in other major markets, including Chicago and Rio de Janeiro, are adopting them as well (Exhibit 1, page 32).

Open-standards payments systems differ sig- nificantly from proprietary closed-standards systems. London’s Oyster Card and At- lanta’s Breeze Card, for instance, may use the same technology and provide a similar customer experience, but the cards cannot be used interchangeably because the respec- tive cards, readers and encryption codes are unique to each city. Conversely, open-stan- dards systems draw upon a global set of di- verse and publicly available payment technologies that are sustained via collabo- rative, consensus-driven processes. Prime examples are today’s general-purpose credit and debit cards which consumers use to purchase a wide range of goods and services almost everywhere they go.

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McKinsey on Payments

In the transit environment, open-standards technology clearly presents a compelling al- ternative to proprietary closed-loop smart- cards. Account information in closed-loop smartcard systems is stored on each card’s embedded microchip, while fare processing logic is stored in the system’s card readers. Open-standards systems, by contrast, are server-based, so cards merely identify the cardholders’ accounts that actually reside on remote servers, along with the fare logic. This remote data storage has distinct advan- tages for operators, such as the ability to segment and revise fare schedules almost limitlessly (e.g., senior discounts, family rates), offer multi-user accounts and multi- ple account access modes, and maintain su- perior security at scale.

Open-standards systems can be designed to accommodate swipe or contactless cards; however, the high frequency of swiping that transit cards typically endure significantly increases the wear on both cards and read- ers, thus adding to operating costs. This

March 2010

gives contactless cards an important cost ad- vantage. Data transmission between con- tactless cards and readers ranges from 300 to 600 milliseconds, depending on the secu- rity level. While this is longer than the 200 to 300 milliseconds for closed-loop cards, the difference may be offset by open-stan- dards’ many advantages.

Basic requirements of an open-standards sys- tem include: a broadband communications infrastructure, ample market penetration of contactless credit and debit cards, the adop- tion of business rule changes to permit aggre- gation of micropayments for settlement and clearing, and the development of risk-sharing arrangements between card networks, issuers and transportation authorities (Exhibit 2). Importantly, each of these requirements is relatively new to the transit industry.

Advantages for transit operators The benefits of open-standards fare systems over closed-loop smartcards for transit op- erators are significant, and include:

Exhibit 1

Open standards are getting on track

Transit operator

Recent developments

New York Metropolitan Transportation Authority (MTA) Collaborating with other regional transit authorities (PATH and New

New York Metropolitan Transportation Authority (MTA)

Collaborating with other regional transit authorities (PATH and New Jersey Transit) in second phase of pilot for contactless credit and debit card acceptance

Chicago Transit Authority (CTA) Re q uested proposals for developing open-loop contactless credit, debit and

Chicago Transit Authority (CTA)

Re q uested proposals for developing open-loop contactless credit, debit and prepaid cards for transit use, with implementation planned for 2012

Utah Transit Authority (UTA) Began accepting credit and debit cards on buses in January

Utah Transit Authority (UTA)

Began accepting credit and debit cards on buses in January

2009

Régie Autonome des Transports Parisiens (RATP) Preparing to test acceptance of Visa PayWave and MasterCard

Régie Autonome des Transports Parisiens (RATP)

Preparing to test acceptance of Visa PayWave and MasterCard PayPass cards, in addition to Navigo (its own closed-loop transit card)

Transport for London (TfL) Planning launch of open standard payments in 2011

Transport for London (TfL)

Planning launch of open standard payments in 2011

Moscow Metro Teamed up with Citi and Mastercard to pilot contactless credit card acceptance in

Moscow Metro

Teamed up with Citi and Mastercard to pilot contactless credit card acceptance in subway

Source: McKinsey analysis; Interviews with transit operators

Rio de Janeiro Metrô (Metrô Rio) Announced in November 2009 planned acceptance of contactless CrediCard

Rio de Janeiro Metrô (Metrô Rio)

Announced in November 2009 planned acceptance of contactless CrediCard MasterCard cards in the near future

Transit payments: The open-standards advantage

Scalability and interoperability. Most transit systems comprise multiple transportation modes and often link to other transit opera- tors that use different fare payment systems. Open standards would enable riders to use the same card on different transit systems, and potentially to even use them on toll road fare systems, such as E-ZPass in the U.S. And customers could also pay fares with the same card whether they were trav- eling in New York, Paris or Rio de Janeiro.

Increased fare flexibility. Because fare pro- cessing occurs on remote servers, fare poli- cies can be easily modified and include many variations to maximize the value to customers (e.g., capped daily rates and fam- ily discounts) and to transportation authori- ties (e.g., peak-hour and distance-based fares). While fares can certainly be modified in closed-loop systems, variations are lim- ited by card reader memory.

Enhanced security. Recent breaches of closed-loop transit smartcard systems have raised legitimate security concerns. Open-

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standards systems enable operators to share risk and draw on the substantial re- sources and expertise of established pay- ments industry players – including card companies, banks and governments – that have vested interests in assuring their open platforms remain secure.

Reduced operating cost. While overall credit and debit card interchange costs will in- crease significantly, they will be offset by cost savings which can occur in many forms, including those generated by faster fare pay- ment (e.g., reduced bus dwell times), as well as the reduced collection, servicing and card issuance costs that bankcard acceptance brings (Exhibit 3, page 34). For large sys- tems, this could mean operating-cost savings of as much as 20 to 30 percent.

Lower capital cost. Open-standards systems typically use commonly available hardware, such as card readers, servers and vending equipment that many providers sell and support competitively. Transit operators can therefore expect significantly lower

Exhibit 2

Open-standards payment systems use new technology and business rules to enable real-time and secure transactions with 20-30% in cost savings for transit operators

Source: McKinsey analysis

1 Account 234 Initial Fare processing Authentication and authorization identification security screen Credit/debit
1
Account
234
Initial
Fare processing
Authentication and authorization
identification
security screen
Credit/debit card
Hotlist access manager
Card network
Fare processing
platform
Card
reader
Authorization, clearing
and settlement (via
merchant processor)
Transit-specific card
account processing
platform /account
manager
Transit-issued card
Rider taps reader
with either a
general purpose
payments card
(e.g., credit, debit)
or transit-issued
card
Customer allowed
to board or enter if
card is not on
hotlist of invalid
cards (e.g., lost or
stolen cards)
Fare type (e.g.,
peak versus
off-peak) and
amount is
determined after
customer enters or
boards
General purpose transactions authenticated
against hotlist access manager, which
screens against larger remote hotlist
Valid transactions are stored, aggregated
and authorized via networks
Transit card transactions authenticated and
authorized against transit account processing
platform
Requires customers
Requires risk
Requires broadband
with contactless
sharing
communications
Requires broadband communications and
micro-payments aggregation
cards

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McKinsey on Payments

equipment costs relative to a proprietary smartcard system.

Forward compatibility. As mobile and other open-standards payment platforms evolve, their flexible non-proprietary na- ture will make system updating faster and more economical.

Non-transit revenue potential. Transit op- erators can collaborate with card issuers to develop branded or co-branded general- purpose cards that could generate incre- mental revenue.

Added customer convenience. A transit rider could take a bus to the grocery store, pur- chase goods, and return using a single open- standards card. Commuters would no longer have to frantically reload a separate closed-loop card at a transit vending ma- chine while their train leaves the platform.

The challenges of conversion The transition to an open-standards system can generate significant value for customers, transit operators and payments players.

March 2010

However there are also unique challenges. In particular, conversion will require:

Ensuring that riders have sufficient access to contactless credit and debit cards

Providing public transit to people who do not have such cards

Funding and integrating the requisite in- frastructure

While most U.S. consumers still use mag- netic-stripe cards, we estimate that 10 to 20 percent of urban U.S. cardholders actually have contactless credit or debit cards (al- though few may realize they have them). Card issuers have yet to aggressively market contactless cards and the value proposition for merchants to accept such cards remains weak. For instance, while contactless cards would increase customer checkout speed, merchants can gain the same benefit by eliminating the signature requirement for small ticket purchases. Additionally, many merchants are hesitant to invest in contact- less readers until interchange or other fees

Exhibit 3

Operating cost increases are more than offset by savings

Source: McKinsey analysis

Sources of operating cost increases

Interchange Increased use of bank-issued cards will raise overall interchange costs for transit

Bus wireless Enabling real-time transactions on buses will re q uire wireless service

Chargebacks Chargebacks may increase slightly

Float Interchange and network fees are a larger part of costs and must be paid sooner

IT staff/management More resources will likely be needed to manage more sophisticated payment system

Net savings
Net savings

Sources of savings

Revenue collections Fewer cash payments means leaner operations (e.g., reduced station-by- station collections, less cash counting, fewer armored cars)

Fare equipment maintenance Open standards e q uipment can be serviced by multiple vendors at lower prices than proprietary systems

Card issuance Increased use of bank-issued cards reduces need for transit operators to issue their own cards

Customer service Customers using bank-issued cards will rely more on banks to resolve transit payment issues

Faster boarding Tapping cards, rather than depositing coins/cash, results in faster routes and leaner operations

Transit payments: The open-standards advantage

are lowered. While achieving market pene- tration for contactless cards has been diffi- cult, a major event could become the catalyst, much as preparation for the 2012 Olympics is becoming in London.

In any case, transit operators must also serve riders who do not have contactless credit or debit cards. These customers typically in- clude people whose banks have yet to issue such cards, as well as unbanked riders. Im- portantly, some customers will always prefer not to use credit or debit cards for transit. Is- suing or reissuing contactless credit or debit cards will require investment that varies by region. In Europe, for example, cards must have both radio frequency identification (RFID) and EMV chips as well as an inter- face, all at a cost of $3 to $4 per card. In the U.S., most cards have a magnetic stripe that is less technologically sophisticated, so the cost per card is only between $1 to $2.

As the open-standards approach becomes increasingly viable for transit operators, payments industry players will have new opportunities to collaborate with them in ways that meaningfully differentiate their own core payments businesses.

Given the large numbers of cards involved, funding a conversion sufficiently to achieve critical mass is a concern.

Infrastructure requirements for open-stan- dards include advanced communications and data management networks. Where these al- ready exist – perhaps for surveillance or other reasons – the investment needed could be modest. Moreover, the wide availability of open-standards equipment will enable op- erators to procure equipment for as little as one-third of the cost of proprietary hard- ware. A notable challenge will be integrating the components and relatively complex tech- nologies from multiple vendors – an area in which most transportation operators have limited experience.

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As the open-standards approach becomes increasingly viable for transit operators, payments industry players will have new opportunities to collaborate with them in ways that meaningfully differentiate their own core payments businesses.

Building value-creating partnerships With annual worldwide revenues of $50 billion to $100 billion, public transit is a relatively modest payments category. Nonetheless, payments players can unlock significant value and acquire important first-mover advantage by partnering with transit operators to address key challenges. Here, we identify several such opportuni- ties. Because attractiveness will necessarily vary by country, each should be evaluated within the context of the respective transit and payments market.

Joint marketing of cards. In Hong Kong, Japan and other markets, transit has been the catalyst for rapid penetration of con- tactless open-standards cards. High-fre- quency use of these cards for public transit creates a halo effect that extends to other types of traditionally cash-based purchases. Joint promotion of contactless cards by payments players and transit operators could intensify this effect, thereby benefit- ing both parties. Issuers would also need to issue more contactless cards to take full ad- vantage of such a partnership.

Facilitate access to prepaid cards. In many markets, most riders lack access to bank-is- sued contactless cards. Transit operators will therefore need to issue and support their own prepaid contactless cards to as- sure access across all customer segments. These cards would also be open standard, and could be either transit-specific or gen- eral purpose. Because they are open stan- dard, they would rely on equipment available from multiple vendors and thus would still cost less than a proprietary smartcard system.

Prepaid cards are primarily marketed to un- banked consumers who tend to be frequent transit riders, so payments players and tran- sit agencies could increase card usage by

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McKinsey on Payments

jointly marketing and distributing general- purpose prepaid cards to the transit agency’s captive market of unbanked and under- banked riders. In the U.S. and other mar- kets, the profitability of prepaid cards has been mixed due to high customer acquisi- tion costs, rapid customer churn and incon- venient options for reloading the cards’ stored value. Daily use of these cards for transit and other purchases would boost overall usage, payment volumes and cus- tomer loyalty while extending the lives of the underlying accounts. Meanwhile, transit operators would save on card-issuing costs and could generate incremental revenue through co-branding.

It should be noted that in most western Eu- ropean countries, Mondex and other re- loadable prepaid card schemes have yet to enjoy widespread success. However, in the U.S. and many other markets these cards are gradually gaining traction. The Los An- geles County Metropolitan Transit Author- ity, for example, is piloting a co-branded prepaid card with Visa.

March 2010

Establish card reload networks. Providing prepaid card users with convenient ways to replenish their cards’ stored value is es- sential. In some markets, customers can re- load their cards through multiple channels, including bill payment and remittance net- works and at selected merchants. Reload- ing may be either clerk-assisted or self service (Exhibit 4).

Rather than build new reload networks, transit authorities could partner with pre- paid card issuers who already have exist- ing reload infrastructures in their respective markets. If the issuers can also market to transit riders and extend their networks to include transit locations, they would thereby expand their reload net- work’s reach for other prepaid products, as well. In markets where reload networks do not yet exist, or have yet to be success- ful (as in some European countries), opera- tors could partner with banks to provide an automatic reload feature.

Leverage ATM technology. Many banks have replaced their ATMs with new models

Exhibit 4

Customers can add or replenish card value in multiple ways

Source: McKinsey analysis; Interviews with payments network/technology providers

Interface type

Customer experience

 

1 Account identification

2 Fare selection

3 Payment

Clerk-initiated

Clerk-initiated

Walk-in bill pay

Walk-in bill pay
Walk-in bill pay

Transit-specific

proprietary terminal

In-store reloads

Clerk swipes/taps card

Customer informs clerk of desired fare product

Customer pays clerk reload amount

Remittance

Customer-driven

 
Customer-driven  
Customer-driven  
Customer-driven  
Customer-driven  

Envelope-less ATM

Envelope-less ATM

Retail kiosk

Customer inserts card

Customer chooses

A.

Customer inserts cash into deposit slot

product on

ATM/Kiosk screen

 
cash into deposit slot product on ATM/Kiosk screen   B. Customer chooses direct transfer from bank

B.

Customer chooses direct transfer from bank account

Card reloaded for immediate use
Card
reloaded for
immediate
use

Transit payments: The open-standards advantage

that use document scanning to accept cash and check deposits. These machines can be adapted to also reload prepaid cards – a fea- ture that could benefit banks by increasing the ROI on their ATM assets, improving customer retention rates, and providing new customer prospecting opportunities.

Open-standards payment systems present significant customer service improvement and cost savings potential for public transit. In many metropolitan areas, the capabilities and much of the requisite infrastructure may already be in place.

Provide card exclusivity. In an open-stan- dards system, merchants can choose whether to accept cards from all or a select group of issuers, as seen in restaurants that accept certain cards but not others. A card issuer or network could, for example, offer infrastructure support to a transit agency in exchange for exclusive acceptance of its cards for fare payment. (Note: transit-issued prepaid cards must always be accepted as well, and be reloadable through convenient channels.) Some transit operators have al- ready signaled their willingness to consider such exclusivity on a short-term basis. Doing so could potentially generate strong visibility, more frequent card use and top- of-wallet status for the card issuer or net- work in some of the world’s most densely populated markets.

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The foregoing examples illustrate some of the many opportunities open-standard systems present for building partnerships capable of generating significant mutual value. Opportu- nities will naturally vary by market, but they can only be fully exploited through a sus- tained, dedicated collaboration by both sides.

* Open-standards payment systems present significant customer service improvement and cost savings potential for public transit. In many metropolitan areas, the capabilities and much of the requisite infrastructure may already be in place. In any case, the de- velopment of strong collaborative relation- ships between transit operators and their payment industry partners will be essential to maximizing the inherent value of these new systems.

More specifically, it will require a robust ability, willingness and commitment to col- laborating closely in the design and imple- mentation of transit-oriented solutions built on more compliant business rules to facili- tate payments aggregation and risk sharing. And it will demand a commitment to imple- menting contactless fare payment systems – including the issuance of cards and building broad merchant acceptance. As the pay- ments industry continues its rapid evolution, we expect new technologies to present nu- merous growth opportunities for the transit and payments industries alike.

* *

Bud Bhattacharyya, Nicholas Flanders and Richard Ung are consultants, in the New York office. Andrew McCarthy is an alumnus of the New York office.