Interviewed By Emmanuel Daniel
Bernhard Kauer, founder and CEO of Puzzle2Pay, talked about the challenges faced by companies that want to enter the micropayments sector, the use of technology to achieve scalability and profitability, and the payments culture in Germany.
Puzzle2Pay, a payments platform set up in 2019 to fill the payment gaps in cash, banks and blockchains, aims to solve the dilemma of privacy, digitalisation, and universality.
Comparing Germany’s payments system with those of its European peers, Kauer noted that the payments sector had been marred by failure, and cash and debit card payments continue to dominate. He said, “We wanted to solve the new digital payment systems without throwing away all the benefits of the older systems. That’s one of the mistakes the other players were making, by saying that we do it digitally and if you have some problems, say you want privacy, then just forget it. It’s just more convenient. And this simply doesn’t work for the people”.
The following key points were discussed:
The following is the edited transcript of the full interview:
Emmanuel Daniel (ED): Today I’m going to be speaking with Bernhard Kauer, who’s joining us from Germany. I’m really excited to speak to you today because you are a pioneer and entrepreneur in the payment space. You are learning many things about what makes payments successful. I’m speaking to you from here in China where payments on the platform seems to be a done deal. In 2010, the social media platforms, WeChat and AliPay, pioneered payments as part of the overall platform infrastructure. Today you do not carry a wallet at all in China. Cash is exactly what becomes a problem when you present cash to a merchant, they don’t know what to do with it, because it means inventory immediately.
I’m very happy to meet somebody whose dream is to make this cashless future possible in Europe, in Germany. I’ve got a number of very important questions to test with you, in terms of what constitutes payments today in your view as a professional. You’re a technology person. And what do you see in terms of what it takes to succeed in retail payments today. And also in Germany, you already have some forms of digital payments for retail, giropay, Sofort, Bancontact – is in Belgium – and the Dutch have something called iDEAL, and so on. And then comes your business, which is Puzzle2Pay. Set for us the agenda for Europe and set for us the problem that you are out to solve in European payments.
Bernhard Kauer (BK): In Germany, lots of payments are still happening with cash, and there’s several reasons for that. One reason is privacy. People really like to have their anonymity when they pay. There are other reasons like high cost for card payments, and so on. Approximately half of the payments happen in cash. Then you have card payments and most of the cards are debit cards and they are given by the normal banks. You have 120 million debit cards that are given out by the banks. There is a German card scheme called girocard, which does 70% or 80% of the volume they are doing in Germany. You can pretty much pay with your bank card, and that’s it. And then we have some smaller Visa, MasterCard and other credit cards from the US, which were mostly used in the internet space. Then you have something like an internet PayPal as the largest payment provider there. Those are the big things you have.
Solving digital payment systems without throwing away benefits of older systems
People really want to have a faster and secure way and nobody has solved this problem yet. It was one of the reasons why we started Puzzle2Pay, we wanted to solve this puzzle, solving the new digital payment systems without throwing away all the benefits of the older systems. That’s one of the mistakes the other players were making, by simply saying, “Okay, we do it digitally and if you have some problems, say you want privacy then just forget it. It’s just more convenient”. And this simply doesn’t work for the people. The other thing, which you mentioned about, iDEAL, and Bancontact. In Europe, you have an interesting part, because you have a unified commercial area and with banking you have the ability to move or provide banking services pretty much in all European countries. But on the other hand, you have this still nationalised systems, like giropay and on so. It’s still outdated somehow. And on the other hand, it’s open, in some sense. There’s a real opportunity to look at the future and see what’s possible there.
ED: The funny thing about Europe is that by legislation in the EU’s activism in payment, you’ve got the Single Euro Payments Area (SEPA), and then you’ve got the payment legislations in place, and you have the participation, you’ve got open banking, so the APIs infrastructure. All the infrastructure has been created in Europe, more than in China, by the way. On top of that, for the traditional card payments, Visa and MasterCard, the regulators in Europe, the EU, has mandated that there is a ceiling in terms of transaction fees. If all the infrastructure has been put in place to make payments cheaper and more ubiquitous, what happened that Europe did not create that ubiquitous payment infrastructure that China has today?
Challenges of a ubiquitous payments system
BK: If you compare, say Sweden, you have this peer-to-peer payments system in Sweden, called Swish, where they can send payments, relatively small, it’s something like $0.10 (SEK 1). They can send between each other just by your phone, and this is provided by the banks. All the big banks in Sweden have approved such a system and they do peer-to-peer payments, and it works and its ubiquitous there. That’s something which will never happen in Germany for several reasons.
First, the banks do not like to work with each other. The last biggest one was they wanted to build a PayPal clone called paydirekt, and it failed spectacularly if you want to say it that way. They were not clear with what they want to achieve. If you do something new, you have to disrupt the old implements. And the banks don’t want to be disrupted. They want to take part in the new world, but they don’t want to lose their original money that they get from that. It’s the usual innovators’ dilemma they face.
ED: What happened in China was that the platforms quietly created the payment network. Before the legislation was even put in place, and then dominated, so wholly — in fact, when they were dominating the payment infrastructure, the pool that they had created in the digital wallets did not even touch bank deposits at all. So, the banks didn’t feel the pain. In a smaller country, the banks would feel the pain and say, “Oh, we are losing market share of our liabilities, we better do something about payments”. In developed and highly established banking systems, banks don’t feel the pain of all these small payment digital wallets coming into play. Now, then comes companies like yours. What is your overall goal? Is it to meet a gap in the existing system, or is it to, if possible, rewrite the landscape?
Using technology to achieve scalability and maintain profitability
BK: It’s pretty much both. We started with micro payments, so that was the original idea. It’s pretty much micro payments in the internet. We were doing a cloud storage start-up, where we were using SSDs, flash storage, for speeding up cloud storage. We built the system and the system was too cheap in the end. We had to charge something like $0.20 or $0.50 a month per customer. If you tried to do that with a credit card, if you tried to do it with even PayPal or something like that, it’s not possible. They take $0.20 or $0.30, even PayPal takes in Europe $0.10 per transaction. You pretty much end up with the payment provider getting all the revenue, which makes the whole system work like that.
We had the engineering experience and said, “Well, if it’s a problem on technology, we can solve that”. We know how to use the advantage we get from newer technology. We know Moore’s Law, we knew how to build a scalable system. So, we set out that goal, and what we came up with was a completely new payments stack where we can transfer single cents and still make money in the end. The gap is pretty much something like 100 times in cost reduction for payments from the infrastructure level. And when we finished that, we said, “Okay, we are done now, because we have a system and we can go to market”. Then we figured out, well, it’s not that easy.
There are several reasons why the micropayment system never took off. And one of the biggest reasons is the micro payment dilemma, as I call it, that if you make a payment with only small amounts of money, and if you take only a small revenue of that, then you end up with small fee, then you end up with a tiny revenue. And with a tiny revenue, you can’t build a big company, and if you have tiny revenue, you can’t do the customer acquisition, then you can’t go to market. If you don’t solve this business dilemma, you will never have a micro payment system. We looked a little bit around and figured out, if you have this nice payment system, then we can use it for more than just micro payment, it doesn’t matter whether you transfer $0.01 or EUR 100, it’s pretty much the same thing, right? It’s the same message, it’s the same procedure.
We figured out if we go outside and do payments for not only for micro payments, where we have small amounts, but do payments for everyday life, then we end up with a much larger volume. And with large volume, a small share, we still end up with the small, medium or large revenue. That was the idea to say, “Okay, we can build a payment system for everyday life that allows us to rewrite the current market landscape,” as we put it. The crisis now is how you can get into the market.
ED: The cost of processing payments has collapsed. Technically, it costs nothing to process a payment because a payment is an information on a string. If you can send a WeChat message, a Twitter message, or a Facebook message for free, then payments is also a message, therefore it’s free. That’s the basic idea. Of course, when you add on the cost of bank account, the cost of KYC and so on, then it starts adding up again. In fact, payment processing costs had also collapsed for the traditional payment companies like Visa and MasterCard. In fact, it’s in your country that there was a company called Wirecard, which was processing payments for Visa and MasterCard. But when the whole fraud took place, one of the things we discovered was Wirecard wasn’t processing payments either. It was passing on to smaller companies, which were taking bulk and so on.
This is happening in the payments world, and yet there are hundreds of startups like yours everywhere in the world that want to revolutionise payments. The first thing that you’re saying is that the cost of processing payments has collapsed, so you’ve got to look for a new revenue feed in what you do, and that the technology itself doesn’t distinguish between micro and large payments, so you can stop doing that. You can process any form of payment. So far, we’re talking domestic payment, or even SEPA, because within the eurozone, the infrastructure exists that you can plug into any of the existing payment network. Validate with me, what are some of the revenue models that you are thinking about to be a player in payments today? In China, for example, when the Chinese government closed Visa and MasterCard from accessing China except through China Unionpay, that created a lot of inefficiencies within the system, and that’s what also gave rise to WeChat and AliPay making their platform into a payment platform. That created an opportunity.
I want you to give me a sense of the revenue models that didn’t work in payments and the revenue models that you are looking at that makes it possible for a company like yours to function profitably. And one more thing is that when you think about the giropay network and the debit card payment methods, if they were standalone businesses, would they be profitable interbank payment networks, or are they subsidised payment networks?
Implementing a flexible cost of payment
BK: As I said, the physical cost of payment comes down, and the easiest explanation is Moore’s Law. In the last 20 years, we had something like 1,000 times improvement in CPU performance for the same price. The physical cost for sending a payment goes down all the time. So that’s the first answer. And the second thing about micro payment is, if you think what’s the most successful micro payment system in the world, and my answer for that is Google AdWords.
BK: No, Google AdWords.
ED: Google AdWords. Google Ad network. Okay.
BK: The Google Ad network is pretty much, on the websites, you have an ad. And if somebody clicks there, you get money for that. It’s a micro payment system, and you don’t get much money for that. And they do it in scale. So, there’s a lot of things.
BK: They have billions in revenue for that. That’s at least my point of view the biggest micro payment system we have in the world, and it works for very tiny amounts of money. There’s an example that micro payments have solved. You don’t need the system of Google, of course, and you don’t need to do advertising, but it’s already there. So that’s the proof that it’s possible. For the revenue model, if you think about what people are usually doing and they are usually doing something like, okay, we have a fixed cost and some percentage, though they do pretty much both things. If PayPal did something like $0.20 or $0.29 plus 1.9% or something like that, and if you do that, you immediately exclude micropayments. If you have a fixed cost, then you’re toast.
A similar thing was happening for a long time in Germany with giropay. They had something like $0.50 or so of fixed costs and then a percentage. It turns out that if you go into a shop, and there’s still some old shops with these old things that they would post a sign saying, “You can’t pay with card below EUR 10”. Because it’s too expensive for the people. And it took them a while to realise that’s not sustainable. If you want to pay everything, then we have to get rid of the fixed fee. Nowadays, giropay has something like 1% fee, and that’s it. That’s a model which works. If you want to have a business model, you need to have a percentage and nothing more for micropayment and to be flexible.
ED: Google AdWords is an on-us system. They own the network, therefore they absorb the cost or you don’t know the costs?
BK: It’s doing a small transaction on their system, which cost you a few cents, it’s possible for them. It’s nothing that they say, “Okay, there’s a minimum price for an ad, it must be at least EUR 1 or so”. No, it’s much lower. They don’t want to lose money on that. I don’t think that they would allow you to have cheap ads if the cost won’t be that low. For the revenue model, use a percentage and nothing more and you’re fine. And in our case, it’s possible or the question whether we can go below giropay because they are currently the lower bar in the market. And you have something like the 1% giropay, you have the 2% Visa, and then you have a 2.5% or 3%. And if you look at the WeChat pay in Europe, they do have a nice price list where they have something like 3.5% or something like that. From a pricing point, at least in Europe, it’s a little bit too expensive, so that it will never have a big market impact.
ED: Even in China, what happened was that they invested in their payment infrastructure for a few years to create critical mass. I’m sure that a part of their revenue comes from the ecosystem, the big merchants and so on, and from the deposits, which they need to park in different banks and so on. I think WeChat is trying to do that in new markets. So when they go abroad to Europe, number one, they bring the Chinese consumer who would pay for shopping and stuff. Number two, they subsidise the Chinese consumer to use WeChat pay. There’s this period where a lot of subsidy in order to create critical mass, and then the revenue model comes about. For companies like yours, or any payment entrepreneur who’s not a WeChat or AliPay, you don’t have that option. And then of course there are models like in Korea where the payment infrastructure was built, the digital payment infrastructure was the revenue stream for kakaopay, for example, a lot of that was foreign exchange because the foreign exchange market was underdeveloped in Korea. What is the model that you are thinking about that will work for you?
Using the customer-first approach as a go-to-market strategy
BK: The business model is something like having a percentage below giropay, something like the iDeal case, something like 0.5% of the transaction volume. That’s the thing which would work for micropayments. So that’s the revenue model and that’s the only thing which does two things, mainly getting micropayments on board and having an advantage compared to existing models. If you go for a merchant, they would say, “What’s my benefit?” And if you don’t reduce on price, for them it’s all the same because they have the same API in the end, and they simply flip a bit and say, “Is it that system or that system?”
Now, it’s a question, what’s the go-to market strategy for the customer? That’s much more complex because payment is a marketplace, you need both to work. And what we learned from retailers in that area was that they started on the merchant side. Paydirekt was something, there was a big project 10 years ago from Otto Group, which is a large retailer and e-commerce thing they wanted to build. They simply said, “Okay, we have a lot of money and we want to build a payment system. And we need both”. So, we go to the merchants and say, “Here’s some money, please use us”. And this obviously failed because the customer doesn’t care. If there’s a website, you have five different options, and there’s a sixth one, why should I choose the sixth one. And if I have to download an app, or do something like onboarding in this new system, then nobody wants to go there. They took the wrong strategy for go-to market. And it failed all the time.
ED: Are you saying here that there’s fragmentation in the market that is also a problem? Are there too many choices? Payment aggregation at the back end is still good old fashioned bank payment, right?
BK: Yes, it’s the interface to the e-commerce. If you look at e-commerce payments and the shop, then you have a choice. And because you have 30 different options and for different countries, you simply go to somebody who says, “Okay, I have to see you”, and you have to click, click, click, click, and add your account. And that’s what the success of Stripe and the other guys was. It was simply saying, “Okay, we have a simple API, just use it, and you’re free from any choices”. And at that point, if you have a new payment system, you’re pretty much lost. Because you have to have a real advantage that people will switch to your system. And the only reason we figured out was you have to come with a lot of customers. If you have a lot of customers behind you, then they will say, “Well, we can save some money”. And you have a million customers, yes, just try it. And then they see something in revenue or in costs. And they will say, “Okay, that was a successful integration of your system”. But if you do it the other way around and say, “Put my logo on your website and everything, the customers will come”, then this will fail.
You have to go for customers first, this was one lesson we had learned from the failed attempts. If you go for customers first, then you have the problem, you don’t have a merchant, and still you have to give the customer an advantage. Otherwise, they don’t want to use the system. We figured out that if you can plug into the existing payment systems, then we have the advantage that from day one, the first customer can use our system successfully everywhere. You raise your system not from building a critical mass, but there are other networks which have the critical mass and you plug into them and you pay. Maybe it is more expensive and it’s probably not that convenient, but it’s still an advantage for the customer because he can use it everywhere and you can give it some additional benefit. And he says okay, that’s a nice way to consolidate different things.
ED: Where are you in your business right now? When did you start your company? Where are you in terms of onboarding customers and building the revenue model as it were, and how are you funded to absorb the time it takes to build a revenue model?
Regulatory requirements for a payments system startup
BK: We started with the idea some three years ago, and we were funded two and a half years ago. We’re building the back end, which is very much invisible, if you show something. The next step was to make it usable, so we built an app for that and we built a prototype. Now we’re in the stage where we can test the whole system, and we can do some trials at the same time. We are looking for funding for doing the launch because the difficult part in payment, at least in Europe, is that you’re in a regulated industry.
If you do a normal e-commerce business, or you have a normal software business, you simply start. You write some code, you go have a minimum viable product (MVP), you go to your customer, and you get the first revenue. For payment, you’re a regulated industry so you have to get a licence, or you have to get a partner who has a licence. And then you have to do all this stuff, and it costs money. You have a barrier to entry, nothing like a normal start-up where you have an easy way to get your first customer.
ED: Where are you with regards to regulation, and where are you in terms of your licences? What has it given you? What do you have as a result of the licence? Do you have domestic access? Do you have access to interbank payment network and to SEPA?
BK: There are different parts on licences. The easiest licence is for open banking. We have something like payment information service, which you can build, and the payment initiation service. That’s pretty much you going to the banks and say I want to do a payment from your account to another account, but then you are only fronted, and that’s nothing which helps us. We have to go one level further, which is an electronic money institute, or electronic money licence. And then the last part would be a full banking licence where you can do lending and the sort of stuff. We need either directly an electronic money institute (EMI), or we have a partner, which gives us API access, and where we are an agent of such an electronic money institute.
ED: API access meaning you are an API to your partner?
BK: No, the thing is, he has the licence. And we are using his systems for getting into SEPA, for getting the regulation right, for uploading the KYC documents and so on. That’s the current state we are so we are working with the banking-as-a-service provider, which has an EMI licence and getting the whole system working, which is a shortcut compared to, okay, you need to put all the licensing requirements on the table, put a lot of money on the table, and then you’re going with a full line of electronic money licence.
ED: What do the licences allow you to do? And when you launch, what will you be able to do? Will you be able to create peer-to-peer networks? Can you work with whichever telco you want? Can you plug into other interbank payment network, which means that is everyone to everyone?
BK: With an electronic money institute licence, you can take deposits from public customers. We have three bank accounts in that sense. You can’t do overdraft and overlending part. And you can’t make money out of the deposits. But you can plug into the normal SEPA system, you can get credit cards or debit cards on top of that, and you can plug into the MasterCard and Visa card sphere. And then you can add your own system, you can do peer-to-peer payments, of course.
ED: That’s the technology and access part. What is the revenue model that you want to get into?
BK: If you look at how the current, the neobanks and even normal banks are in Germany at least following that up, they all have a subscription model. They have this premium thing where you have a minimal product, which is free for everybody, which you really can’t do much with that. And then you have something like EUR 5, EUR 8, EUR 10, for the normal standard account and then you have something like EUR 15 or EUR 20 for the premium account. The thing is, if that is there, it’s nice to model and it’s subscription so you get it every month and so on. But the problem is that it has a steep pricing increase, but people say, “I’m not sure whether I really want that product”. And you have a big step or say, “Okay, I am paying the EUR 5 a month or EUR 10 a month”.
What we figured out is, if you have from a payment side, if you want to have micro payments, there we have the percentage, and we can do the very same thing on the consumer side, and say, “If you use our system, if you use a little, you have a monthly throughput of EUR 100, then you paid EUR 1, or half a euro”, or something like that. And if you have EUR 1,000, then you pay EUR 10. We have a percentage on the price. And this gives you more incentives for the people who are not currently using the paid version. That’s pretty much a gap in the market we identified where we can have the little users, not the heavy users, but the users which want to use a little because they want to get in or they say, “Well, I just need it for certain use case, which makes the current offers simply too expensive for them.
ED: All of Europe is still struggling with the revenue model for payments. And the only way is to pass that cost directly to the customer, the banks are doing that. And you are saying that you will end up doing that too. What about ecosystems? What about when you create an ecosystem you create vendors or you create merchants who didn’t exist before, who would pay a premium to streamline the payment part or rather to complete the loop on the payments?
One of the reasons WeChat and AliPay are doing so well in the US right now is because many young Chinese people are now doing livestream shopping. In the US, you actually have merchants that close their merchant store for the whole day. I’m here in China, I’m actually watching young people buying clothes while they’re shopping, while they’re eating dinner at the restaurant and stuff like that. It’s an amazing phenomenon. It’s unique because of the rise of consumerism in China and so on. And that alone is creating a class of users that then gets the US merchants lined up for online payment. That’s the critical mass, the momentum that grows to make that possible. What do you think will be the momentum for Europe?
BK: The problem is Europe, from an outside point of view, it looks like this is Europe. It’s a big unified market, and it’s all the same. The problem is, then you end up with, Sweden is completely different than Germany, and it’s different than Italy, and that’s different than Spain. The cultural aspect is really hard to put into words.
ED: Very good point.
BK: What we figured out that, for example, the argument which we make is saying, okay, we started with a cash alternative because we can build a system that’s privacy aware. It’s perfectly fine for Europe, for Germany, but it won’t get much in Sweden, because they don’t have this problem. In Sweden, it’s something like 5% to 10% of the people, in Germany it’s more like 30%. It’s a much larger opportunity. Even if you look at a PayPal or something like that, it’s the same model for 20 years, and the environment has changed. The costs come down, the people want to have another thing, they want to have unified things that’s used for convenience, and so on. And this is not reflected in the products we see in the market today.
ED: In terms of technology, and coming back to your business model, your business model is potentially to be the technology engine for existing front, an organisation that has payment. Now, all of this is domestic payments, right?
BK: No, peer-to-peer is just getting to another customer, which is one thing people are using to start such payment systems. And another thing is then I want to exchange or extend that to the merchant, and then we have a normal payment system, and you do it in the point of sale and normal physical world, then you do the same thing in the electronic, internet, and online world. What we are doing is we start with a system where you can do all of these three things to impede peer-to-peer payments in our system, doing online and offline shopping at the same time, because we tap into the existing payment systems.
ED: Describe online and offline a bit more. What is offline?
BK: Going into a normal shop on the street, or going to supermarkets. How do you pay there? And the problem is, if you build a new payment system, then the people will say, “Well, we don’t support it”. But the people want it, they don’t want to have specialised payment systems. And that’s one thing people are trying in Germany, too. You have a specialised payment system for just paying at a small supermarket, using things like, okay, you get this nice app on the phone, and then you get all the discount codes for this particular supermarket chain. And you can direct payment within the app.
And if you think it sounds nice, because it’s more convenient, but people are not used to that because they don’t always go to the same chain. We ended up with those kinds of apps all allowed to pay something. And in the end, it gets fragmented. The user isn’t convinced anymore that this is a nice solution. But it’s just a special thing and it doesn’t gain enough traction. And it’s not used by the other supermarket chain, because it’s not the right product for them and so on. It’s another way of fragmenting that.
What we figured out is that we need a universal system, you have to pay everywhere, so that the user says, “Okay, it’s a choice for me to get rid of my wallet, it’s a way I can do all my payments, whether it’s for friends, whether it’s for the supermarket, or whether it’s for my e-commerce site”.
ED: Does the other party need to have your same app?
BK: Right. If you do a peer-to-peer payment, we plug into the SEPA system. You need to have the bank account number, the IBAN, for sending payments out, and the similar thing for getting or receiving payments from another customer or another human being would be to say, “Okay, you have a bank account somewhere just send money to that”. And it gets faster, it gets cheaper if you do it in our system, but it’s not a requirement. We are compatible to existing systems.
ED: Am I right to think that critical mass is important for you, having a critical mass, a momentum in terms of the number of customers is important for your payment platform to be considered successful?
BK: What we struggle with is getting a viral loop going on, getting the growth rate right. We don’t have the problem other payment systems have that if there’s not a million people in there, then the network is not dense enough. It’s not the number per se to say we are successfully we have 100,000 or a million or 10 million people, it’s the question whether we can convince a subgroup fast enough, that’s the thing. If you can convince all privacy aware people within three years or so, or five years, or a certain percentage of them, then it would be a success. And if you can do that, if you say, okay, this is a benefit for this subgroup, then the whole system will grow naturally.
ED: Final question, what do you think is the future of payments? What is the goal that you’ve set for yourself?
BK: Payments will be something which is much more convenient than we have today. It moves into one direction and the force is convenience in the end. Because it’s more convenient, people will use it. Because if they have less headaches, they will use it. Because it’s cheaper, they will use it. In the end, it’s the convenience for us that drives the industry for the future. And what I’m hoping for is very much that the puzzles we are solving for the puzzles that are currently in the obstacles that we can do away with that, that you are flexible, that they’re flexible, cheap, secure payment system, without having to compromise on one of the parts. That would be my dream.
ED: Bernhard Kauer, thank you very much for spending time with me. I make my own assessment as to the future of payments, by listening to people like you, by the technology challenges that you face, and also the challenge that you’ve given yourself to create the right ecosystem in which works for you in a very crowded marketplace, with many different options, many of them being historical with a huge legacy at the end, which you said is going to work through over time, and the new API payment models that are coming out. I want to thank you for spending time with me today.