This is the first of a series of articles we will publish on B2B Payments. In this article, we take a deep dive into the US B2B payments landscape.
The Secular Shift to Cloud Has Continued Uninterrupted for 20 Years…
The secular shift to the cloud has transformed processes across the enterprise. Over the last two decades, this shift has accelerated globally in key areas from CRM to ERP to People Ops.
The COVID-19 pandemic will accelerate this shift as companies of all sizes think through how to increase automation, efficiency and seamless integration across the enterprise in a remote work/cost-conscious environment. As in other downturns, we expect overall IT budgets to come down. But one thing that is unique about this particular crisis is that it will accelerate and, in some cases even force, a broad shift to a more virtual work environment. This is a large reason why many publicly traded Cloud/Software companies have outperformed the broader stock market since the onset of the COVID-19 crisis despite dire macroeconomic data points.
According to Bessemer Venture Partners, the market capitalization of the Top 5 public cloud companies has surged by 44x over the last decade to $616B. It appears as if this market cap will continue to climb for the foreseeable future as public cloud companies crossed the $1 Trillion threshold in 2020.
Much of the innovation going forward, however, will likely come from the private market. As Bessemer Venture Partners also points out, there are now thousands of private cloud companies and almost 90 unicorns. The number and growth rate of these companies indicate that the shift to cloud will continue to transform the DNA of the enterprise.
…. But B2B Payments Have Lagged Other Areas of the Enterprise
We believe the Finance department is playing catch up to other key areas in the enterprise. As Seema Amble and Angela Strange of Andreesen Horowitz posit in their article “The CFO in Crisis Mode: Modern Times Call for New Tools”, many of the existing finance products are full of gaps. These include the lack of integration between key finance tools, general inaccessibility of forward-looking data and the need for manual processes. Nowhere are these problems more present than in business-to-business (B2B) Payments.
Despite the facts that B2B Payments (1) directly affect cash flow — a company’s life blood -, (2) is multiples larger than business to consumer (B2C) payments and (3) generates plenty of useful data across customers and supply chains, B2B Payments have remained stuck in the pre-digital age. Within the US, specifically, B2B payments are plagued with paper-based processes and a general lack of integration with other core systems. This stands in stark contrast to B2C, where the majority of payments are now digital.
Figure #2: Comparison of Digital Payments at Home vs Work
Although consumer payments have gotten a head start, we believe that B2B Payments is finally having its moment. The current crisis is forcing the CFO to adjust in real-time and make mission critical decisions that balance capital allocation, cash management and growth. On one hand, this is always the case for the CFO. On the other hand, an economic crisis transforms routine tasks — such as collecting receivables and managing spend throughout the enterprise — into existential imperatives. These are exactly the core issues that new, digital B2B Payment technologies address head on.
B2B Payments: A $100 Trillion Global Market
Let’s face it. B2B Payments isn’t sexy. It is hard for a headline on B2B Payments to compete with headlines from the sleek Apple Card, Millennial-focused Venmo or the rapidly evolving Facebook payment features. But that’s OK. What B2B lacks in public appeal, it more than makes up for by its sheer size and contribution to the broader global economy.
According to MasterCard, B2B payments represent a $100 Trillion opportunity globally and over $25 trillion in the US. By comparison, the total addressable market for US B2C payments (traditional retail payments for goods and services) was $11 trillion, according to the Nilson Report. The popular and growing segment of domestic C2C payments (peer-to-peer transactions through Venmo/Square Cash/Zelle), moreover, reached $219 Billion in 2018 according to eMarketer.
The US B2B market is more than 2X larger than the total B2C and C2C markets combined.
Figure #3: Payments Distribution by Segment
B2B Payments is Complex But Offers Multiple $100Bn Revenue Streams
There are key differences between B2C and B2B payments. In B2C payments, revenue models are more clearly defined (generally some derivation of a Merchant Discount Rate/Interchange Fees). In B2B Payments, the landscape is more complex. There are several business models, from traditional interchange-based models to SAAS license models to cross-border FX models.
In addition, B2B Payments automation needs to fit within the evolving relationship between the Finance and Operations teams of the enterprise. Today, businesses are increasingly managing customer relationships/contracts with a CRM system and key financial/operational data with an ERP system. But the actual payment/cash collection piece is generally missing. B2B Payment platforms thus have an opportunity to help enterprises manage the full customer sales cycle from the Contract to the Order/Invoice to the actual payment.
B2B Payments automation is complex, but it offers innovative companies an attractive TAM. There are 5 sub-segments in US B2B Payments space, each offering over $100 billion of revenue to both large incumbents and fintechs. According to Goldman Sachs, B2B Payments represent a $1 Trillion revenue opportunity, broken down by Cross-border payments and Domestic B2B Payments.
Figure #4: B2B Payments Revenue Opportunity
US B2B Payments Remain Stuck In Pre-Digital Age
Despite the innovation we have seen within the broader payments/fintech landscape, US domestic B2B payments seem to be stuck in the pre-digital era. Today, it is estimated that 42% of the US B2B payment volume is still paid via paper checks. To be clear, that percentage has been on gradual decline over the last couple of decades. According to The Association for Financial Professionals (AFP), as much as 80% of B2B transactions were paid by paper checks in 2004.
But checks remain the dominant payment mechanism for domestic B2B transactions, particularly with smaller and mid-sized businesses. According to a PYMTS.com study, as many as 81% of firms used checks to pay their suppliers. This usage was much higher than ACH (64%), Credit Cards (48%) and Cash (45%).
Figure #5: Popularity of Different B2B Payment Methods
That said, there is a sense that businesses continue to use checks out of necessity rather than preference. Only 51.3% of these firms said they were satisfied with this payment method (a gap of 30 percentage points). Part of the reason why paper checks continue to dominate B2B payments is the difficulty in changing both internal processes AND encouraging clients/vendors/suppliers to switch to digital payments. Checks on the other hand, are integrated directly into most banking system flows and there is a general path dependency among buyers-suppliers.
Figure #6: Satisfaction with Different B2B Payment Methods
The B2B Payments Revolution Is Underway…
The industry has begun to gradually shift away from these costly manual processes. In fact, nearly 80% of organizations said they are in the process of transitioning their B2B payments from paper processes according to the Association for Financial Professionals (AFP). Reducing costs, increasing efficiencies and combating fraud were cited as the key reasons for transitioning B2B payments.
Figure #7: Drivers of B2B Payment Transition
We expect small and medium size businesses (businesses generating up to $1 Billion of revenues) will drive the next leg of growth in B2B Payments automation. As we detail below, these are disproportionately paying high fees for manual, paper based processes. According to PYMTS.com research, businesses with $100M — $500M in sales (comprising the majority of the middle market) were most interested in digital innovation, with 73% of firms within that revenue range indicating interest in adoption of digital invoicing solutions.
In a separate study conducted by Suntrust, companies that adopted B2B Payments Automation have seen several benefits. These include a reduction in the labor portion of Accounts Receivable (62%), a boost to overall liquidity (62%) and overall faster speed in their payment processes (52%). These benefits no doubt led to a reduction in the costs (both direct and indirect) associated with processing paper invoices. We speak more about these costs below.
Figure #8: Benefits of B2B Payment Automation
… COVID-19 Is A Catalyst for Digital B2B Payments
The immediate challenges posed by the current COVID-19 pandemic will have profound and long-lasting effects on the B2B Payments landscape. We highlight the following factors:
1) Accounts Receivable: Number One Priority for CFOs Today
Cash trumps sales in a tough economic environment. Ensuring that outstanding receivables are collected is top of mind for today’s CFO. A joint PYMTS.com and Fundbox study, found that as much as $3 Trillion is owed to US companies in the form of Accounts Receivable on any given day. Not surprisingly, the report also found that 68% of the firms that received more than half their payments late experienced cash flow problems. But perhaps more alarmingly, more than a quarter (27.5%) of firms that received late payments were likely to pay their own suppliers late as well. In summary, not collecting on Accounts Receivable could have detrimental economics effects across the B2B supply chain. This risk is particularly acute for small and medium-sized businesses, which often don’t have the liquidity reserves or access to financial services as their larger enterprise peers.
Figure #9: Accounts Receivable Snapshot
2) High Costs of Paper Too Difficult To Ignore In This Environment
Manual processes, paper invoices and paper checks are very costly. And lowering costs is undoubtedly another top priority for CFOs in the current environment. In PwC’s COVID-19 CFO Pulse Survey, 80% of CFOs suggested that they are implementing cost containment measures as a result of COVID-19. The cost of paper invoices and checks could be particularly steep and we believe that CFOs will actively seek out ways to reduce them in the current environment. Direct and indirect costs of manual B2B payment processes include:
- Direct Cost: $17 average cost to process and pay a single invoice. According to the Federal Reserve Bank, small businesses spend $9 Billion a year on paper invoices alone.
- Time: Comdata estimates that it takes businesses at least 10 days to process a single invoice. This can push out the time to receive cash to as much as 30 days for a simple invoice.
- Risks: Manual processes always carry inherent risks. Companies report as much as 18% error rate in paper invoices and 75% of businesses experienced fraud.
The Federal Reserve estimates that the direct and indirect costs of processing paper invoices and checks total $150 Billion per year. These costs are particularly steep for small and medium sized businesses, where Goldman Sachs estimates that as much as 80% of paper invoices are still manual and paid by check.
3) Automation is A Must in the New Normal
CFOs are being forced to rethink the automation of the entire finance workflow, from invoice to payments to analytics. PwC found that 40% of CFOs are planning to accelerate automation and new processes post COVID-19. Another 40% of CFOs asserted that their companies are looking to make remote a permanent option for select roles (which is partly driving the need for more automation). Invoices that would have been paid with ACH or Paper Checks will migrate to digital solutions, like virtual cards as suppliers demand faster access to cash and large companies adapt their payment processes to ones that can work from home.
Figure #10: CFO Perspective on COVID-19
4) Health Consciousness Is A New Driver of Automation in B2B Payments
Businesses are as concerned as consumers about the health risks posed by traditional payment processes. On the MasterCard Earnings Call, the company noted a 40% jump YoY in the use of card and mobile contactless payments. MasterCard surveyed consumers, which confirmed that the key driver for this was cleanliness. This suggests that the COVID-19 virus remains top of mind for the average consumer. Importantly, 56% of survey respondents said they plan to continue using contactless payments post COVID-19, suggesting that wider adoption of contactless payments is part of a new normal.
Figure #11: Drivers of Increase in Contactless Payments
Similarly, according to a survey conducted by RTi Research, 30% of respondents used contactless payment methods for the first time since COVID-19 started. Of that 30%, the majority (70%) assured they would continue using this payment method after COVID-19.
Figure #12: Consumer Behavior Adjustment to COVID-19
Implications for Businesses’ Reliance on Checks
We expect COVID-19 to serve as a similar catalyst for B2B. In addition to the direct and indirect costs, we believe that processing paper invoices and checks now add an element of unnecessary health risks. Mastercard noted that half of the respondents in their survey said they wiped their credit card clean after usage since the onset of COVID-19. Unlike cards, it is very difficult to clean/sanitize paper checks and checks need to be handled by several people along the process as shown in the figure below.
Figure #13: Walkthrough of a Typical B2B Payment
Long-term Implications Could Be Profound
Just how significant can the shift to B2B Payments be? Using the broader US payments system as a potential guide, we believe check usage among businesses could decrease to low double digits in the next decade. It might be hard to believe, but checks represented 60% of all US non-cash payments in 2000. Since then, the percentage of checks has been on secular decline to just 8% of all non-cash payments in 2018.
Figure #14: Trends in Checks vs. Total Non-cash Payments, by number of transactions, 2000–2018
The role of checks in the overall US payment ecosystem has diminished. And that is overall a good thing. This is no doubt a result of tremendous innovation from banks, payment networks, point-of-sale technology providers and fintechs. However, it was B2C that led the shift away from checks over the last two decades. According to the Nilson Report, checks accounted for only 6.5 billion B2C transactions, down more than 60% since 2010 (when consumers used checks for 17 billion transactions). We expect B2B payments to carry the torch into the next decade.
Figure #15: Consumer Payment Systems in the U.S., by Purchase Transactions (in billions)
Our Investment in Paystand, “The PayPal of B2B”
There are multiple gaps — and thus investment opportunities — in the B2B payments space. Given the changing tide in B2B Payments, we expect to see a lot more innovation in the coming years. But the need for a widespread adoption of automated processes within the finance department of the enterprise has never been greater.
We are particularly excited about our investment in Paystand, which is taking a holistic approach to this large market. Like other rapidly growing fintechs in B2B, Paystand helps automate a company’s billing processes from invoice to payment to collections and integrates directly to a company’s ERP system. However, we believe that Paystand’s key competitive advantage is its ability to merge a modern digital payments infrastructure, with a SaaS architecture and delivery model.
Two decades ago, PayPal took the bold step to insert itself into the payment flow of B2C, effectively creating a hybrid payment network for the digital age that today continues to grow in importance for both their merchants (payees) and consumers (payers). Similarly, Paystand decided to insert itself into the payment flow of B2B, thus creating their own hybrid network for businesses (buyers and suppliers). As a result, in addition to eliminating the need for manual processes and paper checks, Paystand has adopted a SaaS pricing model that reduces the cost of receiving payments.
We ultimately invested in Paystand because we aligned with their vision that a digital payment rail for business transactions is necessary in order to truly automate the B2B payment stack. We believe that other companies in the space have added a useful layer on top of the existing payment stack. These AR/AP automation companies are enabling faster collections and easier reconciliation of payments compared to traditional paper processes. But by stopping short of a new digital payment rail, they have also limited the ultimate benefits of automation. A digital payment system will allow businesses to optimize the efficiencies of an end-to-end payment platform while lowering their overall costs of payments. Again, consider how PayPal addressed B2C payments by creating a new hybrid digital payments platform for the digital age.
Paystand’s unique model has significant positive implications for their clients, enabling CFO’s to (1) have quicker access to cash, (2) lower their payment fees by up to 50% and (3) — perhaps more importantly — to accurately predict the actual cost of payments. In the past, CFOs would need to “guesstimate” the cost of receiving payments as it would vary by volume, transaction, the mix of credit/debit/Bank wire or the mix of payment network (i.e. Visa/Mastercard/Amex). But Paystand charges one flat licensing fee based on the number of transactions, which allows the CFO to accurately model out the cost of receiving payments. We believe this shift in pricing, which Paystand calls the “Journey to Zero” will have even greater appeal to CFOs during this economic recession.
2020 Will Be An Inflection Point for B2B Payments
A 2019 study by Pymts.com and MasterCard found that over 80% of SMBs planned to implement automation within the next 3 years. And a significant number of enterprises have already begun digital transformation projects in finance and operations. However, the world changed in 2020 and these timelines will need to shorten drastically. The COVID-19 pandemic will change the way we do business. Businesses of all sizes — from SMB to enterprises — will need to accelerate their shift away from costly and inefficient paper based payment processes, which will unlock significant value for them and for the economy as a whole over the long-term. This is a tremendous window of opportunity for Paystand and the B2B space in general.