The ongoing COVID-19 crisis has been ruthlessly exposing fragile business models and weak balance sheets across a whole range of industries but perhaps never more so than in the travel business. In fairness, no one could have anticipated a global, government dictated total shutdown and no business models could ever be flexible enough to support such an improbable scenario. Still, it’s become clear that many travel industry companies are effectively broke and that the payments model they rely on is broken. Going forward we need a better and more sustainable approach to payments in the industry.
Most travel industry payments rely on payments cards so it’s worth starting by recapping on how most card payment models work. When a cardholder makes a payment to a merchant – either in store or, increasingly, on-line, this is routed to the merchant’s card acquirer. The acquirer has a direct relationship with the merchant in the same way that a card issuer has a direct relationship with cardholders and the acquirer will route the payment request to the relevant issuer – usually by sending the request to a payment scheme who uses the card number to identify the correct issuer. If the issuer approves the transaction then the response is routed back through the same path and the purchase completed. This is no different from any other card payment, although there are hidden complexities where the merchant is an online travel agent sourcing flights, hotels, etc from multiple underlying vendors. However, that’s a detail.
Liability in Card Payments
Where the travel industry is different from a lot of other businesses is that the majority of the purchases are for future consumption. I purchase flights and hotel rooms now and I fly and stay in the future. In the meantime many, although not all, of the travel companies will use the funds I’ve given them to pay for ongoing costs. Built into this is an assumption about a certain level of cancellations and refunds are often paid out of the incoming cashflow for future trips. Which all works, sort of, until a travel company goes bust. And, sadly, then tend to do this a lot – there’s a lot of competition in the space, margins aren’t great and business models tend to be fairly knife edge. And when a company goes bust then all of the future travel plans are at risk and where they can’t be delivered customers who paid by card can ask for their money back – typically, although not always, via a chargeback request to their card issuer.
The card issuer, however, is not liable. The rules of the card schemes mean that the acquirer is responsible for standing in for the merchant if the merchant is unable to refund. And the losses can be painful – when Thomas Cook went bankrupt in 2019 the acquirer losses in Europe we estimated at between €400m and €800m. Thomas Cook was just one of 23 airline operators that failed in 2019.
Can we imagine what would happen if every cardholder suddenly started demanding their money back from an industry that’s not earning anything?
Technically travel companies are legally obliged in most cases to refund on request but by and large they’ve been ignoring this requirement during the crisis and, by and large, regulators have been ignoring the problem, recognising that if they insist on customers receiving the monies they’re due we’ll see a swathe of companies going broke. Behind that, of course, is a systemic issue – if large parts of the travel industry go bust and acquirers have to stand in there’s every chance that some acquirers will find themselves unable to meet their obligations.
Where is the Risk?
Unsurprisingly acquirers are revisiting their risk models and reconsidering how much exposure they want to the travel industry. They have a range of options but none of them are positive for travel companies – they can increase their fees, demand larger deposits, widen the time period between them receiving funds and settling with the merchant or, ultimately, they can just offboard companies where the risk is too great. At best the travel companies end up with worse cashflow, at worst they can’t accept card payments. None of which is good for already stressed business models.
Of course, new players are looking at entering the market – but it’s not entirely clear that they understand the risks and, in any case, the fundamental instability of this payments model needs addressing. Fortunately we have the tools to do this, if we’re willing to use them. In the first place it’s clear that the model in which monies received today are used to forward fund costs needs to change. If the card payments industry isn’t able or willing to stand behind the liabilities this accrues then we need to look at other ways of managing the risks. Models that better balance the risk and reward between consumers and merchants are needed – and those will come out of a combination of prepaid, escrow accounts and underwriting.
Time for New Thinking
Beyond that, the industry needs to look at alternative payment solutions. The tools to deliver this are already in place – PSD2 Open APIs and, increasingly, real-time clearing systems are the basis for new types of payment instruments. However, this isn’t enough. There needs to be a proper scheme put in place to ensure consumers are protected: they are increasingly aware of their card chargeback rights so an alternative solution that doesn’t provide equivalent protection simply won’t work. Coming up with mixed solutions to ensure consumers are protected and travel companies don’t bear the brunt of the increased risk aversion in the payments industry is essential, if the current – hopefully short-term – crisis isn’t to turn into a long term trend.
Developing new business models and designing schemes to manage liabilities and risks is core to what Consult Hyperion do. We believe that the payment problems for the travel industry can be solved and can create a better basis for a long-term sustainable payment model for the industry. If you’re in payments or travel or just interested, drop us a line, we’d be happy to talk through the possibilities.