mckinsey on payments

As we have argued previously, continued re-duction in cash payment volumes will re-quire better alignment among variousstakeholders in the payments business. Ear-lier articles have examined the high cost ofcash to merchants (“Mission impossible?The cashless payments proposition for‘small-ticket’ merchants,” McKinsey onPayments, February 2008) and suggestedthat banks, merchants, consumer groupsand governments should work together toimprove electronic networks (“FightingCash not SEPA,” Payments: Charting aCourse to Profits, December 2005).

ATMs contribute significantly to the cost ofcash, and we urge banks to target thesecosts side-by-side with cash volumes. Out-lined below are the ATM strategies cur-rently available to banks for this dualattack. The precise strategy any bank fol-

lows will vary according to the maturity ofelectronic payments networks and con-sumer payments behaviors in the marketsthe bank serves. To identify a winning strat-egy, banks must understand both theirbranch and ATM costs, as well as the fac-tors influencing their customers’ paymentpreferences. If they act aggressively, banksin Europe stand to reap €11.5 billion in re-duced costs.

Cash is expensive

Reducing cash volumes is essential to lower-ing the economic burden of cash to society.Europe1 spends an estimated €60 billion to€100 billion each year processing 237 bil-lion cash payments out of a total volume of313 billion payments transactions. Thisamounts to 0.5 percent to 0.8 percent of Eu-rope’s gross national product (GDP).2

12 McKinsey on Payments November 2008

1 Our analysis in this article includes theEU 27 excluding Luxembourg, theBaltics, Malta and Cyprus and includingNorway and Switzerland.

2 Based on total costs of cash to allstakeholders, i.e., merchants, consumers,banks, government. These costs includefully loaded direct costs, such asprocessing, theft/fraud, security,transport, time, cost of producing notesand coins, etc. They do not includesecondary effects, such as lost income forthe government due to the grey economy.

ATMs: Complex weapons in the war on cashAt the very moment when cash payment volumes have started a gradual decline,many countries face an unexpected rise in the absolute cost of cash processing. In 2006, European banks spent a total of €28.2 billion on cash operations, eightpercent more than in 2002. In the same period, cash payment volumes declinedby six percent. This article examines the dynamics driving these divergent trendsin four distinct European “theaters” and recommends strategies for reducingbanks’ costs in the “war on cash.”

Olivier Denecker

Florent Istace

Mieke Van Oostende

For merchants in Europe, the cost of cashequals, on average, 1.3 percent of the valueof each cash transaction. Levels of cashusage vary from country to country, as doesthe absolute cost of cash to merchants. InFrance, for example, where consumers usecash less frequently, the average “small-ticket” merchant with annual sales of€400,000 pays cash processing costs of€2,900 each year. A similar merchant inGermany pays €4,100.

Banks in Europe pay €28.2 billion annu-ally for cash-related operations, whichamounts to 30 percent to 50 percent of so-ciety’s total cash costs and represents 0.23percent of GDP. This expense comprisesthe fully loaded direct costs of cash opera-tions, including the processing of cash atthe front office and back office, teller time,installing and maintaining the ATM net-work, security, fraud and theft, transport,etc. The impact to banks is a 3 percent to5 percent charge against their cost-to-in-come ratio (Exhibit 1).

Cost of cash is increasingThe reduction in cash volumes raises logicalexpectations of lower absolute cash costs,but, perversely, the total cost of cash has ac-tually risen. As shown in Exhibit 1, branchand ATM costs represent the lion’s share ofbanks’ cash costs. Allowing a customer toaccess cash through branches is expensive,and banks can substantially reduce theirbranch costs by making ATMs the primarychannel for cash distribution.

But ATMs are complex weapons in the waron cash. Consumers in many countries pre-fer to access cash at the branch, despite thewidespread availability of ATMs. Conse-quently, the expense of building and main-taining ATM networks, added to alreadyhigh branch costs, drives the total cost ofcash upward. Even in some of the countriesthat have sharply reduced cash transactionsin the branch, the cost of cash has stillrisen, primarily due to the expansion ofATM networks at a faster pace than growthin ATM usage.

13ATMs: Complex weapons in the war on cash

Exhibit 1

Network costs, namely ATM and branch costs,represent over 90% of the total cost of cash

Source: McKinsey Payments Practice

Back officecosts

Network costs(ATM and branches)

6

7

Administrative costs

Transport to/from branches

Cash processing costs

Float in branches

Other branch related costs

24

10

44

91

9

Percent

Another trend pushing cash costs higher isthe gradual increase in the number of with-drawals. We have found that in many Euro-pean countries the number of cash deposits

and withdrawals is increasing and the aver-age transaction value (relative to the cost ofliving) is decreasing. Consumers are with-drawing cash more frequently to spend rap-idly.3 Absent incentives (and penalties),simply increasing the availability of ATMscan actually enable the “cash habit.”

It is a perverse phenomenon: Gradual de-creases in cash payments in Europe are gen-erally accompanied by rising costs to banks(Exhibit 2). These increases are erodingbank profit margins across Europe, and insome countries, including Spain, Irelandand most of Eastern Europe, banks’ cash

costs have risen by over 3 percent annually,for the period 2002-2006.

Best practices point the way to costreductionTo be sure, some countries (The Nether-lands, Switzerland, Scandinavia, Belgiumand France) have managed to reduce theiroverall cost of cash at an annual rate of 1.5percent for the same period.4 These coun-tries, which together account for around 20percent of European banks’ cash costs, paid€5.6 billion for cash processing in 2006. Byfollowing the best practices of these “costbusters,” banks in other countries can re-duce their total cost of cash by at least€11.5 billion, cutting the total cash cost forEuropean banks from €28.2 billion to €16.7billion (0.14 percent of GDP).5

If they have not already done so, banks needfirst to attack cash costs by implementinglean structures in branches, streamlining theflow of cash through the branch networkand shifting the balance of cash transactionsfrom branches to ATMs. These measures


Exhibit 2

Despite decreasing cash usage, the cost of cash keeps rising

* EU27 excluding Luxembourg, the Baltics, Malta and Cyprus and including Norway and Switzerland

Source: McKinsey European Payments Profit Pools

237243251

2002 2004 2006

Total Cash Transactions Europe*€ billions

-1%

57%

43%

26.1

2002

55%

45%

26.8

2004

55%

45%

28.2

2006

Branch

ATM

+2%

Total cost of cash for banks in Europe*€ billions

3 The Average Transaction Value (ATV) hasrisen nominally, but when corrected forinflation and GDP growth, ATV has decreasedin real terms relative to the cost of living.

4 Weighted average of 2002-2006 CAGR forall countries except France for which we takethe 2004-2006 CAGR.

5 In most of Europe, the cost of cash to banksranges from 0.16% to 0.43% of GDP. Byreducing cash costs to 0.14% of GDP (theamount paid by banks in the “cost buster”countries), European banks can eliminate€11.5 billion in costs.

It is a perverse phenomenon: Gradual decreases in cash payments in Europe are generallyaccompanied by rising costs to banks.

typically result in a 15 percent to 25 percentreduction in banks’ cost of cash. To reap thebiggest cost reductions, however, each bankneeds to rethink its ATM strategy and alignit with an overall offering of value-addedpayment services.

Whether the goal is to reverse an upwardtrend in cash costs or ensure the continuationof a decline in cash transactions, the strategicoptions available to banks in the ATM busi-ness are determined largely by the paymentsenvironment within which the bank operates.

Four theaters in the war on cashPayments systems differ greatly by country,but our observations suggest that the funda-mental dynamics driving the cost of cash tobanks are consistent:

• ATM penetration and growth• Share of cash transactions in branches

compared to ATMs• Share of cash in total payments volume.European countries fall into one of four cat-egories, based on the growth rate of the

ATM network and the share of cash transac-tions in branches (a reflection of how suc-cessful banks have been in pushing cash outof branches to ATMs). While our analysisfocuses on Europe, countries in other re-gions will likely find themselves in one of thefollowing four groups: “infrastructurebuilders,” “cash addicts,” “cost busters,” or“convenience seekers” (Exhibit 3).

What follows is a description of the pay-ments infrastructure of each group and thepropensity of consumers in each group touse cash, or electronic payments.

Group 1: Infrastructure buildersGreece and most Central and Eastern Eu-ropean (CEE) countries are beginning todevelop robust, multi-channel payments in-frastructures. However, consumers andmerchants in these countries prefer cash,and total electronic payment volumes re-main low.6 ATM distribution is sparse, andbranches are the main channel for cashwithdrawals. Consequently, the cost ofcash for banks is exceptionally high (over


FI

FR

DE

IE

IT

NL

NO

PT

ES

SE

CH UK

CZHU

PL

SK

0 10 12 14 16 182 20 25 454 6 8-2-4

AT

BE

-6

Growth in number of ATMCAGR 2002-2006, Percent

DK

10

35

40

45

5

0

Share of branch transactions Cost of cash to banksPercentage, 2006

15

20

25

30

70

“Convenience seekers”“Cost busters”

“Convenience seekers”

“Cash addicts”

“Cost busters”

“Infrastructure builders”

CAGR2002-2006

% of GDP

6.2%0.43%

1.8%0.28%

–1.5%*0.14%

1.5%0.16%DE

IT

ESATT CZ

HU

PL

SKSSK

IEUK

Exhibit 3

Four theaters in Europe: countries grouped according to ATM growth and reliance on branches for cash transactions

* Weighted average of 2002-2006 CAGR for all countries except France for which we take the 2004-2006 CAGR

Source: Retail Banking Research (RBR); McKinsey European Payments Profit Pools

FI

FRNL

NO

SE

CHBE

DK

CountriesAT Austria

BE Belgium

BG Bulgaria

CH Switzerland

CZ Czech Republic

DE Germany

DK Denmark

ES Spain

FI Finland

FR France

HU Hungary

IE Ireland

IT Italy

NL Netherlands

NO Norway

PL Poland

PT Portugal

RO Romania

SE Sweden

UK United Kingdom

“Cash addicts” “Infrastructure builders”RO

BG

6 However, at 30% CAGR, growth rates for electronic payments volumes in groupone are high.

0.4 percent of GDP) and rising rapidly(often over 5 percent CAGR), as banksincur both high branch costs and the ex-pense of building the ATM network.

Group 2: Cash addictsWell-established ATM networks and strongconsumer preference for cash over electronicinstruments distinguish this group, which in-cludes Germany, Austria, Italy and Spain.These countries have adequate — and, insome cases, highly developed — electronicpayments systems, but consumers and mer-chants persist in their “cash addiction.”ATM networks are strong but underlever-aged compared to branches, as most con-sumers go more frequently to branches forcash transactions than other Europeans.Consumers in these countries also tend towithdraw higher amounts of cash for theirroutine expenditures. The heavy use ofbranches, combined with the expense ofmaintaining robust ATM networks, is themain factor in the steady rise in banks’ cash-related expenses (increasing by nearly 2 per-cent CAGR). The overall cost of cash relativeto GDP among “cash addicts” (0.28 percentof GDP) is double that in other Western Eu-ropean countries (0.14 percent of GDP).

Group 3: Cost bustersCountries that are reducing costs in Eu-rope’s war on cash include The Netherlands,Belgium, Scandinavia, Switzerland andFrance. For most “cost busting” countries,the downward trend in banks’ cash costsbegan in 2002; in France, it started in 2004.

“Cost busters” demonstrate best practicesfor banks in other markets to follow. BothATM and electronic payments networks are

well developed, and banks have taken im-portant steps to optimize their ATM net-works, sometimes (as in Norway) incoordination with independent ATM deploy-ers (IADs).7 ATM growth is slow and out-paces transaction growth only slightly. InFinland, the ATM network is even shrinkingrelatively quickly (-6 percent CAGR between2002 and 2006).

Convincing consumers to withdraw cashfrom ATMs instead of the branch increasesthe likelihood that they will use cards forpoint-of-sale (POS) purchases. Further-more, banks in “cost busting”countriesconsistently promote the use of the most efficient instruments (ATMs, cards andelectronic transfers) with low or no fees forelectronic payments and light pricing forcash withdrawals and paper-based transac-tions (Exhibit 4 ).

Additionally, the cost of cards to merchantsin these countries is among the lowest in Eu-rope, and both consumers and merchantsview cards favorably. Finally, thanks in partto flat fees, cash-back at the POS is verypopular, which opens the door to furtheroptimization of ATM networks.

Thus, “cost busting” countries buck the typ-ical trend of rising cash expense. The cost ofcash to banks in these countries is signifi-cantly lower (0.14 percent of GDP) and stillshrinking in most countries (-1.5 percentCAGR). They can, however, do more. Banksin “cost busting” countries can push theircost of cash even lower by tailoring pay-ments services, including optimized ATMfunctionality, to serve the needs of distinctconsumer segments.

Group 4: Convenience seekers“Convenience seeking” countries (Irelandand the U.K.) have several features in com-mon with the “cost busters.” They have ma-ture ATM and electronic payment networks,the balance of cash transactions has shiftedfrom branches to ATMs, and both con-sumers and merchants show a high level ofcomfort with electronic payments.


7 IADs, as non-bank operators offeringpayments services, are similar to third-partyprocessors and independent salesorganizations (ISOs) in the U.S.

Banks in “cost busting” countries can push their cost of cash even lower by tailoring payments services, including

optimized ATM functionality.

“Convenience seekers,” however, differ sig-nificantly from “cost busters” in the detri-mental role played by IADs in the Britishand Irish theaters of the war on cash. Nowcontrolling 40 percent of ATMs in the U.K.and Ireland, IADs have increased the totalnumber of ATMs rapidly, not only encour-aging consumers’ “cash habit,” but also rais-ing the cost of cash to society.

IADs have a highly profitable businessmodel in the U.K.: Making a “convenienceplay,” they install cheaper, cash withdrawal-only ATMs in high-traffic locations or wher-ever the need is immediate and the customerless sensitive to high fees (e.g., in restaurantsand pubs). IADs in the U.K. enjoy an

estimated profit margin of 20 percent to 25percent on annual revenue of €600 million.

Despite the sharp growth in ATMs, banksin “convenience seeker” markets have notbeen able to leverage IADs to optimize theirown networks. In the U.K., withdrawals atbank-owned ATMs are free or priced verylow, and IADs charge for cash withdrawalsat “convenience locations.” This forcesbanks to maintain their own networks inorder to serve their customers. In Ireland,the pricing at IAD machines, which areowned by banks but operated under a dif-ferent brand, is comparable to pricing atbank-branded ATMs. However, Irish bankshave not leveraged their IADs to optimizetheir networks, as they have in Norway. Ifbanks in the U.K. and Ireland do not opti-mize their networks, the wide availability ofATMs will continue to feed the “cash habit.”

Remarkably, the cost of cash to banks in “con-venience seeking” countries is comparable tothat in “cost busting” countries (0.16 percentof GDP versus 0.14 percent of GDP), but thiscost is rising steadily (1.5 percent CAGR).


50

55

60

65

70

75

80

85

90

95

0 4 8 12 16 20 24 28 32 36

AT

BE

DK

FI

FR

DE

IE

IT

NL

NO

ES

SECHUK

CZ

HU

PL

SK

Exhibit 4

Using cards to withdraw cash leads to higher card usage at point-of-sale

Source: Retail Banking Research (RBR); McKinsey European Payments Profit Pools

Share of card payments in retail paymentsPercentage, 2006

Share of ATM in cash withdrawals and depositsPercentage, 2006

“Cash addicts” & “Infrastructure builders”

“Cost busters” & “Convenience seekers”

CountriesAT Austria

BE Belgium

BG Bulgaria

CH Switzerland

CZ Czech Republic

DE Germany

DK Denmark

ES Spain

FI Finland

FR France

HU Hungary

IE Ireland

IT Italy

NL Netherlands

NO Norway

PL Poland

PT Portugal

RO Romania

SE Sweden

UK United Kingdom

In the U.K. and Ireland, IADs have increased thetotal number of ATMs rapidly, not onlyencouraging consumers’ “cash habit,”

but raising the cost of cash to society as well.

While IADs also operate in some “cost bust-ing” markets, their business model has con-tributed to the optimization of ATMnetworks, particularly in the Nordic coun-tries. Caution, however, is in order. Low fees(to consumers or between banks) for trans-actions at bank-owned ATMs may leadIADs in some “cost busting” countries to

charge significantly higher fees than banksdo (as with the “convenience play” in theU.K.). As a consequence, banks would notbe able to push customers to IAD machinesas a substitute for their own ATMs. Banksin “cost busting” environments, therefore,need to be careful in their ATM strategy soas not to join the “convenience seekers.”

Position payments as value-addedservicesWhile the “infrastructure builders” and“cash addicts” vary in level of infrastructuredevelopment, consumers in both groups aresimilar in their preference for cash. If the“infrastructure builders” increase consumeruse of cards and electronic payments, whilealso leveraging ATM growth to reducebranch costs, they may leapfrog the “cashaddicts” and join the “cost busters.” Weoffer banks in both groups the followingrecommendations for joining the “costbusters” in the war on cash:

• Expand and improve electronic paymentsystems as needed. Increase the number ofcard-holders in the consumer market andoffer incentives to increase consumer usageof cards for POS payments. Work withmerchants to increase their ability and

willingness to accept card payments (e.g.,the delay of payment makes merchants inGermany hesitant to accept cards).

• Avoid the “commodity trap,” wherewithdrawals and deposits are free at bothbranches and ATMs. Poland and Bul-garia have successfully avoided this trapby charging for cash transactions at thebranch, and they rank among the highestin profitability of cash, even when com-pared to Western European countries.Pricing cash transactions at branches isnot an isolated measure, but should beone of several features in payments pack-ages differentiated according to con-sumer needs.

• Position electronic payments instrumentsas value-added services affording con-sumers control over expenses, securityagainst fraud or theft, and availability ofresources whenever desired. Boost the ap-peal of cards and electronic paymentswith innovative technology (e.g., RFIDand biometrics) and sophisticated fea-tures like optimizing return, receiving re-wards or even displaying status (as withgold or platinum cards).

• Expand ATM functionality according toa hierarchy of consumer needs in differ-ent locations: (a) First-level machines of-fering cash withdrawal only, (b)Second-level ATMs adding bank-tellertransactions (e.g., credit transfers/directdebit, balance inquiry, etc.), and (c)Third-level ATMs including value-addedservices (e.g., lottery tickets, as in Portu-gal, or loading mobile phones).

Rethink ATM strategyIn the “convenience seeking” U.K. and Ire-land, IADs have increased the availabilityof cash through strong expansion of ATMnetworks, and this expansion has occurredwithout coordination with bank networks.By contrast, IADs operating in some “costbusting” countries have enabled banks toreduce their networks, resulting in low


Position electronic payments instruments as value-added services affording

consumers control over expenses, securityagainst fraud or theft, and availability of

resources whenever desired.

growth or a decrease in the total number ofATMs. We observe four ATM strategies inthese markets, and banks should weigh theadvantages and disadvantages of each strat-egy carefully as they rethink their gameplan for ATMs:

• Rationalize the network and optimizethe usage of each ATM. Retire under-uti-lized ATMs to reduce costs (44 percentof ATM expense is fixed cost) and pro-mote alternative ways to access cash(e.g., cash-back at POS).

• Position ATMs against the “conveniencegame” of IADs. Optimize the networknot simply through capacity manage-ment, but primarily by increasing thepayment services available at ATMs.Value-added features (e.g., lottery ticketsas in Portugal and mobile phone uploads)in bank-owned ATMs make it more diffi-cult for IADs to enter the market.

• Make room for IADs to play the conven-ience game. Take advantage of IADs, asbanks in Norway have done, to optimizethe bank-owned network, with fullawareness that some fees will leak out ofthe bank’s network.

• Following the example of banks in Ire-land, join the “convenience game” bybuilding a network of ATMs with cash-only functionality (operated under a sec-ond brand). Charge a fee for cashwithdrawals to control consumers’ “cashhabit” and sustain a steady decline incash volumes.

* * *Reducing the volume of cash payments doesnot, in and of itself, reduce the cost of cashfor banks. Defining their ATM strategiescarefully, banks need to leverage their ATMnetworks to reduce the number of depositsand withdrawals in branches, while alsopromoting electronic payments alternativesthat beat cash on security, convenience, so-phistication and cost.

Olivier Denecker is a Payments Practice senior knowledge expert, Florent Istace is a Payments Practiceknowledge specialist, and Mieke Van Oostende is an associate principal, all in the Brussels office.


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