International money transfers (remittances) have also grown in importance, surpassing the $530 billion mark per year in 2016.
The UN has been putting pressure on transfer companies to reduce their fees, resulting in better value for consumers. How are the transfer companies responding to the pressure? What steps are they taking in order to differentiate themselves and stand out from the competition?
What has the evolution of the international money transfer market been like?
Sending money overseas has always been a difficult and expensive process, made more complicated by the endless chains of intermediaries and paperwork. Hidden charges are also common. Remittance companies have been able to offer a variety of services that are faster, cheaper, and more value-added for individuals and small to mid-sized businesses. All of these benefits were traditionally enjoyed by large corporations, banks, and governments who had direct access to the institution’s foreign exchange market. This market exchanges $4,8 trillion worth of transactions every day.
Money transfer operators are the facilitators of international payments. The IMF defines these entities.
Money transfer operators (usually not banks) are financial companies that transfer money across borders using their system or another banking network.
Due to the complexity of currencies and banking systems, sending money internationally is different than transferring funds domestically. Below is a visualization of the MTO’s role in international transfers:
This article will outline the main challenges facing the MTO industry and analyze the strategies of three major industry players to give a better understanding of how this sector is developing and the potential for investors to make money from it.
Remittance fees are Falling, and MTOs dominate
The international money transfer sector is also known as the remittances market. These transactions are defined by as follows:
Personal remittances include all transfers made between residents and non-residents, regardless of their source of income.
The World Bank reports that total remittances in 2016 exceeded $530 million and grew at a CAGR of 1 of 0.4% between 2000 and 2016. This represents a significant market for global services. In Q3 2017, the average cost of sending remittances was 7.21 %, which is in line with a downward trend.
The cost of remittances has been decreasing due to healthier competition within the industry and to the pressure of the G20 and UN, which aim to have an average cost of or for consumers. They pay special attention to this market because of its popularity among low-wage workers and also due to the important role that remittances have in the economic development of emerging markets. Banks face the greatest pressure to reduce fees as they are the most costly remittance service providers. Their average cost (World Bank, Q3 2017) is 11.0%. MTOs, on the other hand, are only 6.1%.
Charts 2 and 3 show the popular routes by which money flows. The US and India are the two countries that send and receive the most money. This pattern is a reflection of the general trend that cash flows from developed to developing countries. China is ranked high in both sending and receiving money. Both directional volumes are growing quickly relative to other countries. All of the countries ranked in this ranking are growing strongly, which shows that the $530 billion remittance industry hasn’t yet reached a mature stage.
MTOs are the dominant players in the market when it comes to remittances. Western Union holds a market share that is more than twice as large as its nearest competitor, the Exchange. In spite of the attention that fintech startups are giving to payments and remittances, there is only one newcomer amongst the top five providers based on volume, Transferwise. The chart below illustrates the competitive landscape in the market.
MTOs are being affected by the pressure to lower fees.
International organizations (G20, UN,etc.) have been putting pressure on remittance companies to lower the costs of remittances for users. Remittance companies are under increasing pressure to reduce the cost of sending money to their users. Banks are the ones who charge the most, so you would think they’d be the hardest hit by this move. However, banks have many sources of income and do not charge the highest price. Banks do not offer international payments as a core service, unlike MTOs, who make it their raison de tre. The revenue of global money transfer companies can be divided into two parts. A transaction fee and the foreign currency (“FX”) Spread that is charged to the customer. Western Union’s 2016 results, for instance, showed a revenue split between fees and foreign exchange spreads of 30% and 70%.
The remittance industry is becoming more competitive as new players enter the market. They use fees to differentiate themselves from incumbents. Their business models are built on digital platforms, which also reduces their fixed costs. They can also offer faster turnaround times to consumers with their newer, cleaner technology. Players are forced to innovate to stand out from their competitors as the industry shifts towards a commodities market. It can be done through services such as prepaid debit cards and payroll services for businesses, which offer the consumer more utility and choice. Below is a comparison of the main players’ services.
Let’s examine the results and strategies of three major MTOs to understand better how changes in the industry have affected its players: Western Union, Transferwise, and Xoom. The first is the dominant player in the market. However, the second and third have been emerging since the turn of the century. They have all left their mark on the industry. Both Transferwise and Xoom are examples that show there are opportunities for investors in this sector.
Western Union Fees are Under Pressure
Western Union is by far the largest MTO in terms of dollar volume traded. As a result, it’s a prime target to be disrupted by newcomers. The company’s dominance is due to its large and established network of brick-and-mortar affiliate branches. These provide physical convenience, brand awareness, and a steady introduction of value-added services that have drawn corporate customers. Edge is one such example. It’s a marketplace where customers can discover new clients and conduct transactions.
As can be seen from Chart 5, its revenue growth is stagnant, and its revenue lend has changed. Due to increased fee competition, the relative share of income derived from fees has decreased, falling from 72% in 2014 to 70% in 2016. In contrast, FX revenue has increased from 25% to 27% during the same period:
