In my previous post, I highlighted how e-commerce, SaaS, and D2C businesses can improve customer traction by pricing in their customers’ native currency. This post delves into a comparison of 3 possible methods that businesses can use to collect customer payments in their native currency. In particular, I highlight how the adoption of virtual bank accounts to collect international revenues can allow fast-growing e-commerce and SaaS companies to rapidly enter offshore markets.
A fundamental element of proper localization is the choice offered to customers to not only view prices in their native currency, but also pay in that currency. In effect, while this should allow customers to simply make local payments, the seller has to put in place the required infrastructure to collect that payment in the buyer’s currency, convert that into its native currency, and transfer it into its bank account.
Current accounts by default only allow holders to hold money in native currencies. A UK business owner who maintains a current account with a UK bank, cannot receive or store US dollars in that account.
When that business receives a US dollar payment, the bank stores those dollars into a dollar denominated account of its own on behalf of the holder, exchanges those dollars for British Pounds in the currency market collected into a Pound denominated account, and then transfers that converted amount in British Pounds into the holder’s account. However, such a process could result in longer settlement times, and various kinds of fees and charges from the bank that could shave off quite a bit of your revenue:
- A fee to collect US dollars from the customer on behalf of the account holder
- A fee to convert US dollars into British Pounds
- A mark-up on the exchange rate to convert dollars to pounds
- A fee to transfer the converted amount into the holder’s account
Such fees can amount to up to 5% of the transaction’s total value, which adversely impacts profitability. Short term exchange range fluctuations can further reduce the credited amount. Ultimately, reconciling payments made by customers in foreign currencies with receipts in the domestic currency can complicate accounting, and increase internal operating expenses.
One option would be to open local bank accounts in the markets where the business operates to receive payments by local customers. This not only offers businesses the flexibility to time their conversions when currency markets are favourable, it also allows businesses to use non-bank payment providers (FX Brokers) when repatriating funds from offshore accounts into their parent bank account.
However, opening a local bank account requires businesses to incorporate locally, comply with a host of local regulations, and satisfy several continuing operational and financial requirements. While this can be viable for large, well established enterprises that have significant operational presence in various geographies, it can be highly onerous for SMEs or digital businesses that wish to target offshore markets without setting up offshore offices.
Are there better alternatives?
There are 2 alternate methods that are growing in popularity, that businesses can adopt (either separately, or in combination) instead of setting up offshore bank accounts. These methods are simpler, more efficient, and present much greater value for money.
- International Payment Gateways
- Multi-Currency Virtual Bank Accounts
International Payment Gateways
While local payment gateways are essential to help customers safely transact with merchants over secure and encrypted channels, international payment gateways offer the further capability to collect payments in multiple currencies, and convert the funds into the business’ native currency, if required, before depositing the funds into the business’ bank account. Stripe and PayPal are two popular payment gateways used by international e-commerce and SaaS businesses.
Multi-currency Virtual Bank Accounts
Traditional multi-currency bank accounts offered by high street banks allow businesses to maintain balances in different currencies to fund local operations, meet payment obligations towards vendors and suppliers in different geographies (especially useful for importers), satisfy pay-roll requirements, and access favourable exchange rate opportunities when funds are required to be converted. This vastly simplifies financial reconciliation, and confer greater autonomy upon cross-border businesses.
However, while opening a multi-currency account with your bank has always been an option, banks levy very high fees to maintain such accounts, impose high transaction and withdrawal fees, and even require you to maintain minimum deposits. Thankfully, financial markets regulators across prominent markets now allow non-banking financial institutions to offer virtual bank accounts.
Virtual bank accounts are electronic money accounts that are offered by regulated entities referred to as Electronic Money Institutions (EMI). While they aren’t interest bearing accounts, they allow account holders to collect and store payments received in multiple currencies without being required to convert them. These accounts are unique to businesses (they have unique account details for specified local currencies) just like regular bank accounts, but differ in the following key ways:
- Funds stored in these accounts don’t generate interest.
- These accounts cannot be used by the EMI for borrowings, loans, or overdrafts.
- While these funds are kept segregated by providers, they’re not guaranteed by domestic state sponsored insurance or compensation schemes (like the FSCS or the FDIC), as these funds aren’t utilized for borrowings or loans by the providers (this is not to say that they are riskier when it comes to safeguarding your money – your funds are always segregated or separately insured in accordance with guidelines from regulators).
How do they compare?
A simple approach for comparing these alternatives is to analyze how well they satisfy the use cases for businesses that wish to localize their pricing. Below is a list of factors that a business should consider before opting for an alternative:
- Quick checkout: Customers hate lengthy payment processes. They prefer using cards, wallets, or other domestic payment methods such as ‘buy now, pay later’, over wire payments that require customers to add beneficiaries to compete a transfer.
- Quick processing: While customers are habituated to long shipment periods, service process delays, and wait times for a host of other things, customers get very anxious when their payments aren’t instantly confirmed.
- Trust & Security: Customers worry about fraud, theft, phishing, and such other malpractices prevalent in e-commerce. As a result, they hesitate to pay into personal bank accounts, or account maintained in unfamiliar offshore markets.
- Refunds: Customers have become increasingly cautious about product & service quality, and therefore demand greater protection against their payments, such as the facility to seek a refund, or pay upon completion of delivery.
These considerations practically rule out the option to simply share bank accounts details with customers for wire transfers (which are cost-effective but cumbersome). This implies that the usage of a payment gateway is a must. However, the choice remains – should one work with an international payment gateway? Or are there better substitutes?
Constraints for the business
- Easy to set up: No business wants long man-hours wasted on lengthy account opening processes, onerous compliance requirements, complex integrations, or internal training. Owners prefer working with systems and tools that either combine multiple features into a singular interface, or a limited number of tools that integrate well wth each other using APIs.
- Predictable revenues: Receiving payments in foreign currencies can expose a business to sudden fluctuations in currency prices. An adverse movement can hurt profit margins abruptly before a business can effect price changes.
- Reconciliation: Business look for simple ways to reconcile customer payments with bank receipts. A business’ ability to offer a seamless customer experience, hinges on processing payments swiftly, and tracking defaults effectively. This process can be tricky when the accounts are maintained in different currencies, and result in long settlement periods.
- Quick settlements: E-commerce businesses have corresponding payment obligations to suppliers & vendors, and quicker settlements help them satisfy their working capital needs, and reduce reliance on borrowings. Cross-currency transactions can result in longer settlement times.
- Holding facilities: Businesses that need to hold on to funds on behalf of customers (refunds) or suppliers (commissions) often need access to neutral, interest-bearing escrow accounts or holding facilities that store payments, and settle them based on specific instructions.
- Minimize costs: This sounds obvious, but financial institutions have historically levied exorbitant processing fees to convert currencies, in addition to charging hidden exchange rate markups. While businesses are willing to pay for a great service, they prefer a service that offers transparent pricing and greater value for money.
- Borrowings: Business seek ready access to local credit lines to satisfy short-term working capital requirements. Credit lines typically require proof of stable historical revenue flows to indicate creditworthiness. To manage credit risk, banks typically refuse to offer credit lines, unless the business agrees to channel all revenue inflows into an account maintained with that bank.
How do our alternatives compare?
Determining an optimal approach
Businesses should now narrow down to their preferred choice based on how well these alternatives satisfy their needs, and that of their customers. To help with this decision, I have drawn a basic (directional) comparison on the metrics I referred to above. I’ve rated each value prop against the 3 popular alternatives on a 3-point scale with green being the highest, and red implying that the value prop is either extremely weak, or entirely absent.
It’s important to know, that businesses can also use international payment gateways to transfer funds into virtual bank accounts. However, this facility is limited to such virtual accounts that bear local details (the name of the account holder), which might be limited to a select few currencies (depending on your choice of virtual bank account provider).
However, this also means that businesses can very well choose to take advantage of the reach and capabilities of a global payments gateway for local payments, but maintain and convert currencies using a virtual bank account, which helps reduce risk as well as costs. As the above table indicates, in combination, all value propositions can be unlocked with this combination, with the exception of borrowings.
What does your business need today?
The ultimate choice would depend on the nature of the business, operational requirements, stakeholder related obligations, and the need to quickly enter & exit new markets. These needs evolve over time, as businesses grow from early-stage to maturity.
Large businesses that have both receivables and payables locally (payroll, suppliers, borrowings, interest payments) might find it useful or necessary to establish local bank accounts in the geographies where they operate. It is equally possible that certain geographies or currencies aren’t within the reach of well-known international payment gateways, or virtual bank account providers.
However, it is fairly evident that early-stage ventures or cloud-native businesses that want to swiftly capitalize on offshore demand for their products or services without incurring the high costs and lengthy processes involved in setting up local bank accounts, should prefer virtual bank accounts as a safe, quick, and cost-effective solution. These accounts are regulated, confer greater autonomy over managing currency risks, and enable businesses to be highly agile.
While virtual bank accounts are available in limited geographies today, with increasing harmonization in regulatory structures across the world, and with growing penetration of mobile and internet commerce in emerging economies, it is only a matter of time before these facilities are accessible in every major e-commerce market.