More consumers may start returning to shopping in stores as we move past the pandemic, but that doesn't mean they'll be paying with cash. The last year of socially distanced economic activity has accelerated a trend toward cashless payments that had been gradually growing over the last decade.
A study from financial services specialist Square (SQ 0.51%) found that cash transactions at its U.S. merchants as a percentage of overall transactions fell from more than 50% in 2015 to around 30% today. That includes an 8.3 percentage point drop in the last year.
For investors expecting the cashless payments trend to continue, here are three ways to invest that take advantage of it.
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1. Payment networks
If you're not handing over actual banknotes, you have to use some other means to move money from your bank account to the merchant's account. Payments networks like Visa (V 0.49%) and Mastercard (MA 0.07%) are major players that help make the communication between consumers, merchants, processors, and banks go smoothly. When you insert your credit card, it's these companies that move the money from one account to another without a hitch.
Visa and Mastercard hold a duopoly on debit card transactions, and you can find their logos on around 80% to 85% of all payment cards. The two combine to take about 75% of all card transaction volume in recent history.
That scale is important because there are significant fixed costs to establishing a large payments network, but low marginal costs to executing more transactions. Visa and Mastercard already have all the partnerships in place to capitalize on the growing trend. So, as volume increases, it practically goes straight to the bottom line.
As a result, the two payment processors produce operating margins well above their competitors, such as American Express and Discover (who also run lower-margin banking services). The ongoing shift to more digital payment ought to have a significant effect on Visa's and Mastercard's bottom lines, more than other fintech businesses.
2. Merchant acquirers
A business can't accept digital payments without a way to work with financial institutions and process all those swipes, dips, and taps. Merchant acquirers provide the technology needed to process payments.
Two of the largest companies in the increasingly consolidated space are Fidelity National Information Services (FIS -0.49%) and Fiserv (FI 0.48%). And there's value in holding market share because there are high switching costs for the banks, merchants, and financial institutions that use these processors.
What's more, processing payments also involves high fixed costs and low marginal costs, so Fidelity National and Fiserv can offer better pricing while producing strong profit margins. As a result, the big companies keep getting bigger, and they're able to snatch up smaller competitors to increase their advantage.
Those industry giants face competition from newer companies acting as payment facilitators, like Square. These companies are attractive to small businesses due to their simple pricing, equipment, and software. Facilitators can and do, however, partner with acquirers like Fiserv and Fidelity National for payment processing, so that mitigates the threat to the older companies.
3. Consumer fintech
If you want to transact without cash, you need some sort of bank account. But millions of people remain unbanked or underbanked. Consumer fintech companies like PayPal (PYPL -0.27%) and Square are aiming to provide bank-like services (and more) to that demographic.
At PayPal's recent investor day, management talked about its plans to turn its digital wallet into a financial super app. The goal is to replace traditional banks for services ranging from high-yield savings accounts to electronic bill payment. It also includes a deeper push into in-store payments solutions, an area where it accelerated product launches in 2020.
Square, likewise, has ambitions of offering similar functionality as a traditional bank with its Cash App. Adoption of its Cash Card -- a debit card attached to users' Cash App accounts -- is growing quickly, and payment volume is growing even faster.
A growing number of cashless transactions should act as a tailwind for both fintech companies. It will enable them to grow their user bases and launch new products in their digital wallets, presenting new avenues for revenue growth. If the older fintechs at the core of cashless transactions don't appeal to you, perhaps the younger consumer-facing companies will.
