Why Facebook Really Axed Credits

There was a lot of noise in the press last week about what Facebook’s Developer Blog post on the axing of Credits did or did not mean. Frankly, most of it missed the point.

In order to understand Facebook’s decision to wind down the virtual currency after dipping its toes into the space for the past 3 years, we first have to take a step back and look at what’s happening in the global payments industry. Driven mainly by the inability of financial services providers to differentiate themselves, historical integrated payments business models are being replaced by a disaggregated payments stack.

The base infrastructure layer makes up the industry’s rails, i.e. banks, schemes and processors. A critical component of the stack, the infrastructure layer acts as the basic toll road over which transactions travel, providing scale as the main benefit and presumably therefore cost efficiencies (cost leadership). In contrast with yesteryear’s integrated payments platforms, tomorrow’s highly specialized stack will be too competitive (on service leadership) for infrastructure players to properly cater to customer (merchant or consumer) needs downstream at the platform or application layers.

The application layer sits at the top of the stack, providing the differentiated touch points (service leadership) that customers demand, whether it be discovery, analytics or loyalty for an offline merchant or endless mind-numbing hours of FarmVille for a neglectful nanny. No one understands the consumer’s behaviors, habits or desires better than the specialized service providers at the application layer. These players have no business competing on cost leadership and frankly, that’s not where the margins are anyway, so eyes on the prize. Warning: many founders have been lured by the siren song of displacing an infrastructure player. The financial services market economics simply don’t support it – why waste resources rebuilding the rails? Look to the examples of Google and Apple in Mobile Telecom – go over the top.

Facebook’s decision to abruptly step back from Credits represented an acknowledgement of the above realities and the fact that its core strength (from a payments perspective) is at the platform layer. It cannot effectively be everything in the stack. Even ignoring the regulatory and political hurdles that would have arisen, why should Facebook have tried to be a bank – the rails already exist! Pay the toll and focus attention back on the key differentiating factor of any platform – distribution.

Don’t get me wrong – payments is still a massive opportunity for Facebook at the platform layer (as it has been for Apple’s iTunes store). I believe it will easily eclipse the company’s advertising revenue within 5 years. Facebook just needs to be prudent in where it focuses its energy because the payments game can be a slippery slope. Virtual goods (games and App Center applications) will still sell at 30% margins for now, but physical goods won’t return more than 3% when the company tries to convert the ubiquitous “Facebook Connect” button into “Pay with Facebook” (and that’s before the 1.8% owed to issuer banks for interchange fees and 0.2% collected by the card schemes). The margins will be no better if / when it attempts to follow PayPal Here into the O2O (online to offline) space, likely requiring the company to start collecting user bank account details to process using ACH and cut back on interchange fees to increase margins.

Suffices to say, before getting any further ahead of ourselves, there are potential opportunities and pitfalls for Facebook in the world of payments and axing Credits was a step in the right direction.


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