Communications of the ACM

Communications of the ACM

Cutting Checks: Challenges and Choices in B2B E-Payments

By Mark J. Cotteleer, Christopher A. Cotteleer, Andrew Prochnow
Communications of the ACM, June 2007, Vol. 50 No. 6, Pages 56-61
10.1145/1247001.1247006
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Changes in the marketplace for business-to-business (B2B) payments increasingly demand executives' attention. Growing numbers of e-payments, decreasing paper check volumes, and new legislation in the U.S. are the main motivators. Businesses are beginning to realize they must add new payment options to a process still dominated by paper checks, wire transfers, and automated clearinghouse (ACH) transactions.

What started in the 1990s as a consumer push for e-payments has influenced new thinking in the B2B market. Financial institutions and businesses alike must closely monitor this trend because current payment options fall short of changing business expectations. For banks, ignoring market demand could result in disenfranchised customers and decreasing revenue and profit. For businesses, failure to adopt new payment options could result in lost value, as well as lost customers.

The future of electronic banking depends on the development and adoption of new technologies. The promise of e-payment technologies has been that they ease payment and lower transaction costs [11]. This promise is being realized in the area of electronic B2B payments. Here, we investigate the B2B e-payments industry and the technologies that will shape the future of B2B transactions.

Historically, the paper check has served as the key settlement method for financial transactions between businesses in the U.S. market. However, evolving technologies have created new possibilities within the payments supply chain. To date, the fastest-growing sector of the electronic bill payment market is business-to-consumer (B2C) transactions. For instance, 2003 marked the first year that the majority (53%) of in-store consumer payments were conducted electronically, according to a 2005–2006 study of consumer-payment preferences by the American Bankers Association and Dove Consulting. Similarly, from 2001 to 2003, automatic e-payments and online bill payments increased from 17% to 29% of the consumer bill payment mix [3]. Businesses have been less aggressive in their adoption of e-payments. As of 2001, 86% of B2B payments in the U.S. were still executed through paper checks, with the remaining 14% using a variety of e-payment options (see Figure 1) [10], a percentage that has changed little in the ensuing years.

Industry research into e-payment trends suggests a near-term increase in B2B e-payment volume [5]. The rationale behind this transformation lies with improvements in e-payment cost, timeliness, and reporting accuracy relative to paper checks. The 2004 Check Clearing for the 21st Century Act, also known as "Check 21," is indicative of the changing business mind-set regarding e-payments. Check 21 legalized the substitute check, or a check printed from an electronic image of the original check. The legislation allows financial institutions to process payments more efficiently because electronic check images can be transmitted electronically. Although Check 21 technologies may be a minor process enhancement, they still rely on manual intervention and provide little in terms of the cost of processing a payment to the extent provided by a true e-payment process. True e-payment systems continue to evolve as an attractive solution because they allow bundling of payments with related transaction data, along with integration of accounting and enterprise resources planning systems. This means that businesses expend fewer financial and human resources processing payments, reconciling payments with invoices, and entering information into databases.

According to a 2000 study conducted by the National Automated Clearing House Association, companies in the U.S. pay from $2 to $5 to create and deliver a single paper-based invoice. Another $10 is spent on the other side of the transaction for processing and payment [4]. Estimates suggest that a typical large business, sending approximately 792,000 invoices per year, can save nearly $5 million per year by eliminating costs related to processing paper payments [9]. In light of these potential savings, business executives are starting to recognize the value of moving to an e-payment solution [12]. The result is that approximately 61% of all B2B payments in the U.S. are forecast to be conducted electronically by 2010 (see Figure 2) [5].

Four main challenges confront businesses interested in adopting e-payment processes: systems integration; the absence of remittance standards; security; and uncertainty in the return on investment; in addition, candidate technologies must be considered in light of their ability to deliver value in multiple dimensions.

Systems integration. The most daunting barrier to the adoption of e-payments is a lack of integration across the many systems needed to support the process [1]. B2B payments involve up to five distinct components:

• The buyer purchases goods and services;
• The buyer's financial institution provides banking services to the buyer;
• The supplier provides goods and services;
• The supplier's financial institution provides banking services to the supplier; and
• The Federal Reserve or other check-clearing institution facilitates the check-sorting process.

Figure 3 outlines the traditional B2B check-clearing process in which a buyer writes a check that subsequently flows through the supplier, the supplier's bank, the Federal Reserve (or other check-clearing institution), the buyer's bank, and finally back to the buyer. This process is supported by human intervention throughout the supply chain, including manual entry of check amounts and associated transaction data.

Shifting payment processes to an electronic format requires an IT infrastructure to route payments and related data through an integrated network. Using such end-to-end infrastructure poses a significant adoption challenge because users' technological sophistication with regard to the payment supply chain is so varied. Creating uniformity in the e-payment infrastructure is further complicated by the fact that the standards of the Federal Reserve infrastructure apply to Fed products but not to products outside the Fed's domain. Therefore, building the infrastructure necessary to securely and reliably transmit e-payments and related transaction information among a large group of diverse users is a significant obstacle and expense. However, the result of an improved payment network, as in Figure 3, is a streamlined process supporting the continuous exchange of information and funds.

Remittance standards. Complicating these challenges is a lack of even minimum standards pertaining to e-payment data. Although the Federal Reserve has long promulgated standards to guide the type and format of information associated with both paper- and ACH-based payments, invoices, and receipts, the related guidelines do not exist in the world of e-payments. Consequently, different types of e-payment systems have evolved to integrate and support three levels of transaction information:

• Level 1. Standard purchase information, including merchant name, transaction amount, and date;
• Level 2. Summary detail, including point-of-sale codes, sales tax amounts, and accounting codes; and
• Level 3. Line-item purchase detail, including sales quantities, product codes, product descriptions, and shipping data.

Early adopters of e-payment technologies still complain that inconsistencies in remittance standards have resulted, in some cases, in the corruption of important remittance data, including invoice numbers, and other information, including payment amounts and payer identification [8].

As e-payments become more widely accepted, niche players in the e-payment industry must coordinate and agree to facilitate efficient networks. E-payment users want information formatted so it can be processed "straight through" to internal systems. Recently, the Clearing House Payments Company, the first and largest U.S. payments clearinghouse, released a plan to help catalyze standards convergence. Collaborating with bank owners and payment technology vendors, it adapted the traditional EDI 820 file—the standard EDI payment file format—trimming it down to 10 essential fields. Before this modification, EDI 820 files included hundreds of fields, creating problems for some trading partners if senders used too many or too few of them. The simplified e-payment network 820 format was approved by the American National Standards Institute (www.ansi.org) and is today broadly accepted by industry participants. This coordinated effort or one like it should hasten the acceptance of e-payment systems [12].

Security. Since B2B transactions involve multiple parties, they flow across diverse technology architectures. Each party in an electronic transaction is subject to the security procedures of other members in its financial supply chain. Arguably, paper-based payments are subject to similar security challenges, though they are well understood and have long been accounted for.

An added complication with e-payments is that they are potentially subject to a larger pool of anonymous attacks. Consequently, existing security tools (such as encryption technology) may need to be supplemented by third-party vendors to protect information as it passes across diverse networks. Improving business confidence in B2B e-payments might be achieved by building B2B payment solutions into financial networks already operating with a high degree of security.

Value proposition uncertainty. E-payment networks (like other networks) are subject to "network externalities," so the value of participation is contingent on the size of the network itself; that is, the greater the number of participants, the more valuable the network is to each participant. Given that the technical aspects of e-payment networks are still evolving, it has been difficult for potential participants to estimate the value of joining and assess the appropriate level and speed of the related investment. Investment decisions in this context are influenced by businesses' perceptions of the likelihood of agreement on the issues related to standards and integration [7].

The value proposition of e-payment networks is further clouded by the realization that connecting accounts for only a portion of the total cost. After the initial capital investment, businesses must invest significant financial and human resources in training employees to use the system. Moreover, banks and businesses cannot simply abandon their old check-processing infrastructure, as not all B2B transactions immediately migrate to e-payments. Businesses thus have an incentive to wait for others to go first, watching as they build the value of the network prior to joining or waiting to join until they are compelled to do so by competition or regulation [7].

Value dimensions. In addition to surmounting key adoption challenges, businesses must also consider e-payment technologies in light of their ability to deliver across multiple dimensions of value. A clear understanding of the value drivers of e-payments enable participating businesses to better address challenges to e-payment adoption. In 2004, Charter Consulting, a management consulting firm, surveyed businesses across multiple U.S. industries, ranking 10 attributes based on their perceived value to B2B e-payment users [2]; in order of importance, they were:

• Offer direct savings vs. paper-based check processing. The direct cost per transaction decreases for e-payments compared to paper payments;
• Facilitate reconciliation and dispute management. Finding and retrieving data is simplified in e-payment systems;
• Provide global coverage. Payments can be sent and received outside the U.S. market;
• Improve control of payment timing and cash flow. Payment is initiated and sent at precisely the time the business intends;
• Increase visibility of cash requirements. Payees can see scheduled payments and anticipate cash flow;
• Reduce fraud and credit loss potential. Payments are sent through a secure and reliable global network;
• Possess remittance data. The system is able to handle Level 3 remittance data;
• Offer low implementation costs. Up-front investment is relatively minor for all users, and costs are clearly defined;
• Integrate data and payment information. Payments are bundled with transaction data for simplified integration into accounting systems; and
• Offer a flexible fee schedule. Transaction fees are negotiable.

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E-Payment Options

Three notable e-payment technologies promise to simultaneously address key adoption challenges, accelerate B2B e-payment adoption, and deliver across multiple value dimensions:

• ACH-based bank proprietary e-payment platforms;
• Enhanced purchasing card technology; and
• Open network systems.

For businesses, they offer potential financial, human resources and time savings, along with streamlined processes that have long been promised from revolutionary payment systems. Financial institutions will find that providing them to business customers can strengthen their product portfolios, provide an opportunity to expand relationships with existing customers, and attract new customers who seek e-payment efficiencies (see Table 1).

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ACH-Based Bank Platforms

ACH-based transactions (such as for direct deposit of employee salaries) have existed in one form or another since the early 1970s. Bank proprietary systems are e-payment solutions built on the ACH network. In the past decade, banks have invested heavily in developing software packages that have improved the functionality of B2B ACH transactions. They now combine financial processing and electronic data warehousing capabilities into one comprehensive service. Buyers and suppliers send complete trade information (including contracts, pricing, orders, receipts, and invoices) to bank systems; the information is then stored in a document available to both parties. These platforms seek to provide comprehensive electronic bill payment and presentment from the beginning to the end of the payment cycle.

From the standpoint of value attribute comparisons, ACH-based payment systems meet many of the requirements identified by B2B transaction participants. The importance of these attributes is the foundation of historical ACH popularity in facilitating relatively small recurring financial transactions between businesses and consumers. One particularly troublesome issue is the relatively high implementation costs of ACH-based platforms, particularly for small- and medium-size businesses. This issue further complicates systems-integration problems. Another significant issue plaguing ACH-based solutions is that they rely on bilateral closed networks. This means that businesses must share sensitive financial information, in turn increasing the risk of fraud. Global coverage is another concern with any form of ACH-based payment, as ACH systems are typically built for domestic use in the U.S. Due to the foregoing, along with the lack of other desired characteristics, as in Table 1, ACH-based e-payment systems have not gained significant traction in the B2B e-payment market. Despite this, bank proprietary solutions are well suited for large corporations and government agencies that execute relatively low- to medium-value recurring payments within the U.S. (see Table 2).

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Enhanced Purchasing Cards

Enhanced purchasing cards, or p-cards, (such as MasterCard's e-P3) are e-payment solutions that offer management services for B2B purchasing, presentment, and payment. This e-payment strategy is the result of collaboration between outside software vendors and existing p-card issuers to provide businesses with customized end-to-end e-commerce. P-card solutions allow buyers and sellers to collaborate within a common environment, streamline payment processes, and use p-cards for payment. Businesses transmit orders electronically, view the status of orders and invoices online, control the initiation of payments, and integrate data into existing financial systems.

Enhanced p-cards share many of the positive characteristics of desirable e-payment networks. They are typically Web-based and relatively easy to integrate with legacy software and hardware environments. This ease of integration greatly reduces the cost and complexity of implementation. Another p-card benefit is reduced potential for fraud and credit loss, due to enhanced settlement processes. P-card transactions settle through an online "credit gateway" associated with the p-card issuer that allows institutions to exchange encrypted information for authorization purposes. These systems provide a secure environment for payments because sensitive account information is not exchanged directly, and transactions are easily traceable and challenged when disputes arise.

One significant disadvantage of enhanced p-cards is that interchange fees typically still apply. This means that suppliers may be averse to accepting the enhanced p-card for medium- to large-value (more than, say, $1,000) transactions, as fees increase as the dollar value of the transaction increases. Given these benefits and limitations, the enhanced p-card represents a good way for current users of p-cards and prospective e-payment-orientated businesses to conduct low-value nonrecurring transactions, as in Table 2.

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Open Network Systems

Open network systems, like Visa's "Visa Commerce" platform, are rules-based e-payment systems that utilize open, secure, global-settlement networks to process buyer-initiated payments. Open networks interface directly with front-end procurement and accounts-payable systems to provide buyers and suppliers alike with a seamless, integrated corporate payment solution. Open networks also enable buyers to initiate and settle payments based on preestablished terms with suppliers.

Unlike enhanced p-card and ACH-based platforms, open networks employ a flexible fee schedule, allowing for the minimization of fees for relatively high-dollar-amount transactions. In addition, open-network solutions may be easier to integrate with legacy environments. For example, Visa Commerce was designed to integrate with existing procurement applications, regardless of their sophistication. This integration strategy means that financial institutions, buyers, and suppliers that want to use an open network can do so with minimal up-front investment. Finally, open networks typically offer global coverage, a major consideration for moderate-to-large-size firms. Open network payments appear to be best suited for relatively large-value, multiple-invoice directed payments, as they circumvent interchange fees and support robust transaction data.

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Conclusion

The volume of e-payment activity has risen steadily since 1979 and shows no sign of slowing down [6]. Motivating this trend has been consumer willingness to submit payments electronically. Increasingly, businesses have sought to improve their understanding of the value of e-payment systems. Studies have begun to illustrate in greater detail the specific value afforded and risk incurred to businesses by e-payment systems [4]. Along these lines, newer e-payment technologies possess attributes (such as systems integration, remittance standards, security, and an uncertain value proposition) that promise to help overcome past obstacles. That will be done through technologies that can be implemented by a greater number of entities (lower up-front investment costs), incorporate improved data capabilities (permitting varying degrees of data remittance), and be built on existing networks (more certain return on investment).

Financial institutions and businesses must therefore evaluate their e-payment product portfolios, coordinating and comparing them against organizational needs and goals. Financial institutions offering an appropriate e-payment product mix can expect to enhance existing client relationships, attract new clients, increase revenue, and decrease costs and the risk of fraud.

Businesses that identify and adopt effective e-payment strategies are more likely to realize streamlined business processes and significant bottom-line savings compared to their peer organizations that don't. Those seeking to implement e-payment technologies must consider not only their emerging technology options but evolving payment needs as well. Although ACH-based systems, enhanced p-cards, and open networks have different characteristics, a business may implement a combination of technologies. However, the long-term goals of an organization, from both a business and process perspective, should be analyzed and agreed upon before a new payment regime is implemented. The future of B2B payments surely resides in an electronic format. Organizations that embrace the flexibility of open network e-payment systems will realize benefits beyond their peers that embrace traditional ACH- and enhanced p-card-based e-payment systems.

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The Digital Library is published by the Association for Computing Machinery. Copyright © 2007 ACM, Inc.

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