Facebook is, through its WhatsApp subsidiary, expanding into London having picked the UK as its European headquarters, a move which is – as usual with tech reporting – causing not a little incorrect interpretation and analysis. Critiquing tech unicorns is shooting fish in a barrel and unworthy of us, but this move is highlighting an interesting notion about Facebook and financial services, payments especially, which is worth delving into. As the Yahoo Finance report ends:
The company’s chief executive Mark Zuckerberg has said WhatsApp’s move into facilitating payments via the app will be rolled out in several countries this year.
Recruitment has already begun, with senior engineers who were among WhatsApp’s founders reportedly sent to London last year to begin the search for talent.
It comes as new data shows investment in the UK’s tech scene holding up, despite a year of huge uncertainty over Brexit’s impact on Britain’s economy.
European investment in UK tech firms even hit a record high last year, with funds based in the EU piling £1.89bn into Britain’s tech sector in 2018.
Our main subject is how Facebook’s latest attempt to pivot its business model to payments isn’t at all new and isn’t without issues, but we’ll get to all that in a moment. But I can’t resist, and I hope readers will indulge me a little, in taking a side-swipe at the entire underlying premise of Facebook’s strategy. Yahoo Finance is an unrepentant tech sector booster and reluctant to get into matters of politics, but I have no such qualms here.
Firstly, I want to knock any notion that, post-Brexit, the UK (or, London as the UK’s financial centre, to be specific) can be a “Singapore on Thames” on the head as it is just silly. It’s merely the so-called “Swiss model” by another name – and the EU27 not only have said “no more Switzerland’s”, they’re not even happy with the existing Switzerland arrangements and are trying to wind those up via pressure on the Swiss. Let alone another one being created. The Swiss model, for those lucky enough to not have come across the term previously, refers to a notion that the UK can leave the EU without a Deal, but can, rather, come to individual arrangements for trade in particular areas. This is the arrangement which Switzerland has evolved with the EU.
So why can’t the UK copy the Swiss model? Because the EU has – rightly – concluded it was a form of cakeism which it should never have agreed to in the first place. While “thin end of a wedge” arguments can be logical fallacies, in this case, it is a valid argument because Switzerland has ended up with preferential access to the EU’s Single Market. It is enjoying the rights but backsliding on the responsibilities. The EU has had enough.
Now, the EU27 might not have everything all its own way in this, the deferral of the final decision in December last year gives a hint that the EU27 could still find it difficult to replicate the wide, deep capital markets which Switzerland hosts. The reasons are complex and aren’t the focus of this post but briefly, the unwillingness, in aggregate, of the Eurozone to run large trade deficits precludes a substantial pool of euros held outside the Eurozone itself which would then be available for reinvestment via the capital markets. They have, at the risk of a gross oversimplification, quasi-dollarised the Eurozone, at least where capital formation is happening. This gives an opportunity for non EU27 markets like Switzerland and the U.K. to muscle in. The EU27 is limited by an inviolable truth which is, while governments can restrict or even outright end international capital flows and commerce, they cannot force capital or commerce to flow merely by trying to order it to do so. Nationalisation is an option, but destroys pricing signals. If you kill price discovery, there’s no point anyway in having capital markets.
But the EU27 has signaled a clear, unmistakable direction of travel for Switzerland. It’s very hard not to come to the inescapable conclusion the Swiss model’s day’s are numbered. Yet this is supposed to be the exact same model which the EU27 will bestow on the UK? Maybe guests at the Mad Hatter’s Tea Party could believe this is likely to be a happening event, but even Caterpillar sitting on the magic mushroom smoking something pretty strong in his hookah would say “fat chance”.
So forget any fantasy about a post-Brexit U.K. financial services industry being granted the same or similar arrangements. Or, thus, any silliness about London being a Singapore on Thames, free to do whatever wheeling and dealing it takes its fancy to then selling it into the EU27 via sector-specific or market segment-specific deal-ettes.
Moving on, as we’ve more sensible things to look at.
Facebook is trying to set itself up as a financial services provider. But the latest attempt is not its first rodeo. Facebook first tried this in 2015, without any noticeable success. In late 2018, it had another go, to an overwhelming outbreak of apathy among both users and financial services providers. Try as they might, they can’t gain a foothold, yet still industry watchers keep predicting that Any Day Now, Facebook will suddenly manage to become a force in payments.
Why do analysts keep over-optimistically predicting how Facebook (and not just Facebook, other tech unicorns are given the same undue latitude) is just about to “disrupt” the payments system?
The payments system is an example of something that is superficially simple, because it replicates a previously simple system (handing over cash in settlement for a debt) with something else far more complicated (all the gubbins that go into keeping the payments system working). And because it has evolved organically over nearly 50 years of development, it is comprised of a largely-hidden framework of technical (IT systems), national law (regulation), private law (contracts) and commercial product components — all of which are designed to work together seamlessly and symbiotically.
So when system users hand over their credit card or use their PayPal app, they mistakenly think the credit card is the system or the app is the system.
Industry-watchers then make a category error in assuming that, if someone like Facebook comes along and offers a credit card or credit card-like product, or a new or replacement app, or a “pay a Facebook Friend” feature within their Facebook account, Facebook has created a new payments system. No, it hasn’t. Its tacked a teeny tiny new appendage onto the huge edifice which is really holding it all up.
Ah, but, say the analysis, what about the start-ups which have created an entirely new payments ecosystem in China? What the likes of Alipay (which belongs to Alibaba Group) or Wi-PAY in China have done is – at huge investment and with the massive advantage there were no incumbent players to fight them off, oh, and state sponsorship, too, which limits competition while they build a critical mass – to create from scratch the entire end-to-end payment system.
It is essential to understand how important the role of the Chinese government is in not only helping what are, in effect, State Owned Enterprises like Alibaba build out their financial services products and payments systems in the first place but also protect them from external competition while they establish their monopolies or oligopolies. As Forbes noted:
Since the early days, Alibaba, has been supported by the Chinese government which used Alibaba’s Taobao and Tmall sites to do billions of dollars of transactions between various government agencies which allowed Alibaba to post eye-popping revenues and growth in the early days.
The Chinese government still conducts a lot of trade between its various agencies using Alibaba platforms so as to ensure the continued scorching growth rates that Alibaba has been able to post year in and year out.
With China’s murky and archaic ownership structure laws and the fact that the government of China and/or the China Communist Party has huge control over almost single thing in the Chinese economy, companies and even society, means that Alibaba is the “golden child” at the moment.
Which is not at all what Facebook are doing, nor easily can do, because the Too Big To Fail (TBTF) banks, the card networks, the regulators, the merchants etc. are all quite happily using the existing system, so Facebook will need to either usurp that or agree to coexist with it, cooperatively. The former requires deep pockets, with no guarantee of eventual success. The latter precludes Facebook from establishing its no doubt intentional end-state: a monopoly with its toll booths around it.
Perhaps Facebook will, then, try to spend its way out of trouble and make the required investment to create a new, parallel, payment system? Then everyone can simply migrate their money transmission and transaction settlement onto Facebook’s new-fangled replacement. It doesn’t work like that. Payments is what is known as a “vertically integrated” system. You can’t establish an alternative to it incrementally. You have to replicate all the components and switch over all the user base in a big-bang implementation.
It’s no use, for example, launching a payment app if the people you get signed up for your payments service can’t use it with the existing merchant Electronic Point of Sale (EPoS) terminals in stores. You need to launch (with sufficiently wide coverage) the new EPoS hardware and have it available at the same time. But couldn’t Facebook make backwards-compatible or inter-operable EPoS terminals, ATMs, and eCommerce modules to embed in websites which work with both? This creates a complex and difficult to maintain software stack and hardware requirements because the existing payment system players set their own rules (here’s Mastercard’s as an example, all 130+ pages of it). If they don’t like anything about how Facebook’s EPoS equipment or processing apps work – they can refuse to licence them and block all transactions from such unauthorized channels. Facebook might be tempted to then cry foul and go running to the courts about restrictive practices.
But the incumbents are well used to getting lawyer-ed up and would like nothing better than to subject Facebook to a five year or more legal war of attrition. US courts in particular are very slow to get embroiled in cases which have even the merest hint of Godzilla-like company A trying to get the legal system to give them a competitive advantage over Mothra-like company B, with the courts expected to intervene and figure out who is right and who is wrong.
It is probably superfluous to add that, if Facebook’s existing business model is so great, why does it feel the need to try, try and try again to break into various aspects of financial services? Of course, financial services is, in effect, an administered income stream for the lucky TBTF banks which are the beneficiaries of their status as essential cogs in the economic machine, which need to be tended like exotic plants and given precisely the right conditions to be kept alive and (reasonably) healthy. Facebook’s current core income stream and operating model isn’t so lucky. Given Facebook’s many and varied woes, you have to at least consider the possibility it is living on borrowed time. In that position, becoming like a TBTF bank has its obvious attractions.