Payments are transactional by nature. The industry operates in close proximity to the process of money changing hands, requiring at least two parties. All businesses, whether in the payments industry or not, exist necessarily within a network of customers, collaborators, and competitors. All that is to say: no payments firm can exist in a vacuum, and it is neither desirable nor practical to develop business operations in a silo.
Nevertheless, there are payments firms – particularly those with an emphasis on Fintech – that may believe developing back-office architecture in-house offers a simpler and cheaper solution that is more attuned to their firm’s specific needs. But that is not always the case; one need only reexamine the interdependence of payments themselves to see that there is value in seeking outside support.
To learn more about how payments firms should rethink their back-office architecture, and how vendor partnerships can help build better reconciliation systems, PaymentsJournal sat down with Marc McCarthy, SVP of Sales and Reconciliations SME at AutoRek, and Steve Murphy, Director of Commercial and Enterprise Payments at Mercator Advisory Group.
They discussed key topics, such as:
The back-end fallacy
The payments process is at the heart of payment firms’ platforms. Part of the payments process is ensuring that payments have been transacted properly and that settlement takes place correctly. These are often referred to as “middle / back-office” functions, occurring behind the scenes and out of the sight of customers. In a non-payments industry, these accounting functions are generally deprioritized because they are not viewed as “core” to the business – but that is a fallacious stance to take.
As companies grow, business functions naturally separate out and become fragmented. “Back-office functions are seen as perfunctory, and therefore less attention is paid to them,” said McCarthy. “As time moves on, companies will obviously react to the pressures from their customer base, and more often than not, that is front-end rather than back-end focused. So, what we see is a mixture of capabilities for middle and back-office.”
Therein lies the issue. Conventional wisdom might seem to say that the best way to execute one’s business vision is to rely on a single team of engineers to build operations from end-to-end. This would include both back-end and front-facing operations. But solutions that are originally developed in-house are not necessarily designed to support the complexity of business growth, and this leads to manual workarounds for outdated systems, which in turn increases operational risk.
Life moves fast in the digital world
There is an old idiom that goes: If you want something done right, do it yourself. This individualist creed, while comforting to the self-confident and nitpicky alike, does not hold water when it comes to running a business. “Of course, every business specializes in their own niches,” explained McCarthy. “Therefore, it is a knee jerk reaction to say, I understand my base best, so I’ll build everything out from my own viewpoint.” The reality is that life tends to explode quickly, especially in the payments space, and any kind of sudden and massive expansion is bound to overwhelm companies.
Moreover, certain back-office business functions are similar across multiple industries. Vendors and consultancies exist for this very reason: to offer deep expertise in a specific area of business that is widely applicable across different fields. Companies should expend in-house time and energy on functions that are unique to business functions which are typically customer-facing. After all, it doesn’t make sense for a company to get bogged down in back-office problems that are easily outsourceable to a reliable expert vendor.
“I’m really surprised that so many companies are attempting to build in-house, given the solutions that are available [and the digitalization that has occurred over the last four to five years],” Murphy remarked. Whether out of ignorance or ego, there will always be proprietary companies that want to build everything themselves.
McCarthy offered an analogy: “Volvo has had their own proprietary voice activation software for years. But they’ve just now come to the realization that major companies like Google have much better voice recognition software than they as a car company will ever be able to build.” To avoid diverting attention from the core product, the smart move is to accept outside help.
Why back office architecture is a problem for payments firms right now
If we’ve said it once, we’ve said it a hundred times, and we will likely keep saying it: the world is undergoing an absolute explosion of payments at the moment. Embedded payments, IoT payments, micropayments, P2P payments, and more payment types are all increasing. “The proliferation of payment processing means that scalability becomes an increasingly important factor,” McCarthy pointed out. “And with scalability comes then the need for maintenance.”
There are three areas of risk for payment processors that payments firms should watch out for:
- Higher volumes have highlighted some of the underlying limitations of the in-house builds. If, say, less than 1% of transactions require a team to resolve some exception, and the total transaction volume reaches the tens of millions, unnecessary teams might be built that could be better served by technology that intelligently interprets or routs issues.
- Payments are now more global than ever, resulting in scenarios that include multiple currencies, a spread of banks, and local payment laws that need to be observed. There will be a need for greater regulation around data transparency, data protection, data control, chargebacks, settlement risk, and more.
- The U.S. government has realized that the current fragmented state regulation of Fintechs is no longer fit for purpose and that federal regulations are required.
- There has been only minor movement so far, with the SEC interacting with European regulators to learn best practices. The U.K. Financial Conduct Authority (FCA), for example, uses a sandbox where Fintechs can test products against regulations, both so regulators understand the technology and companies can be reassured their ideas won’t face regulatory friction.
Beneficial differences of engaging with vendors
At bottom, the reason to utilize vendors is the flexibility and expertise they can bring. There is a big difference between something that is built in-house at a single point in time and is inflexible to accommodate changes, and something that has been consistently built and upgrade over decades of collaboration with other financial organizations. “More often than not, it doesn’t matter if a vendor has worked in investment management, or in banking, or insurance – the problems are still the same,” McCarthy clarified. No matter where they go, vendors can bring best in breed products and services, often at a lower cost than one might expect.
High quality and malleability are also crucial assets, particularly because things can change very quickly in reconciliations. . If a data vendor makes a change to the format of a company’s bank statement, that company is not going to want to wait for an engineer to come and reprogram the back-office architecture to process new information. “What you want is a piece of software where you can very, very quickly make changes yourself,” McCarthy emphasized. Vendors can provide that kind of best-in-class software. “It is essentially to have the ability to react quickly to changes as and when they occur with the right level of expertise and confidence,” McCarthy continued, “and to make sure that those risks are mitigated as quickly as possible.”
One final key differentiator is that vendors are highly competitive with each other. “We all want to be at the forefront of innovation in these spaces,” said McCarthy. While payments firms are certainly going to compete with each other for customers’ business, that competition is around front-facing customer experience. For vendors, back-office architecture is their customer experience, so that is where vendors will devote time and energy.
Overall, the key is to be partnered to the vendor, rather than just a customer. “This allows for a good communication flow and ensures a better understanding of the data model,” McCarthy concluded. “It is hugely important to ensure that you pick the right vendor that is really going to tick all the boxes.” This is the best way to reduce manual in-house effort and increase streamlined automation for reconciliation and other back-office processes.
