New Delhi: Avinash Kumar runs Blumox Technologies, a Delhi-based company that develops websites, mobile apps and applications for enterprises. For five years, he used the services of Razorpay, a payments company, for his everyday transactions with customers online. However, a few months ago, he switched to PhonePe. At $12 billion, it is India’s most valued fintech startup today.

The reason? An offer too good to pass—or so he thought.

“PhonePe committed to me an offer of 1.75% transaction discount rate (TDR) on all cards and next day settlement. I was saving almost 0.25%, which was a major factor for me to jump,” he said.

TDR is the fee that a merchant pays for every transaction processed using a payment gateway. The industry standard is to charge 2%.

Blumox Technologies makes a revenue of ₹5-6 lakh a month. A saving of 0.25% may appear paltry to many of us but for a small business, every rupee saved matters. In a year, Kumar can theoretically save ₹15,000.

Similarly, many other small businesses have been offered a low TDR—at times even 0%—by PhonePe.

Behind these offers are PhonePe’s growing ambitions of becoming a larger, well-diversified fintech company that is known both for offline and online payments. PhonePe is currently popular for its digital wallet and online payment app that allows one to make instant money transfers with Unified Payments Interface (UPI). However, its merchant base is almost entirely offline. These businesses use the company’s QR codes to accept payments or its point of sale (POS) devices.

But Blumox Technologies is an online merchant with no physical presence. PhonePe is offering this company its ‘payment aggregator’ platform. Such aggregators offer merchants many online payment options—pay options using credit cards, net banking and UPI, among others—and handle the money. Aggregators are different from payment gateways, who just offer the technology platform and don’t get involved in the settlement of funds.

Pushing the payment aggregator business is now the fulcrum of the company’s effort to diversify the business, away from simply facilitating UPI transactions that make no money. As of today, the Government of India doesn’t levy any charge on UPI services.

PhonePe started offering payment aggregator services earlier this year, and at an opportune time.

After issuing guidelines to regulate payment aggregators in 2020, the Reserve Bank of India (RBI), India’s banking regulator, granted in-principle approval to several companies to operate in February 2023. Apart from PhonePe, this list included PayU India, Razorpay, Cashfree, Paytm, Billdesk, Amazon Pay, Google Pay, Innoviti Payment, Pine Labs, Reliance Payment Solutions and Infibeam Avenues.

Nonetheless, four top payment aggregators—PayU India, Razorpay, Cashfree, and Paytm—despite receiving the in-principle approval, were barred by the regulator from onboarding new clients.

The reason isn’t clearly known, even to those in the payments industry. “There is no official communication (from the RBI) in this regard. They wanted these companies to complete the system audit report within six months and relook at the onboarding process. This was done earlier this year. The companies are awaiting further communication,” a person in the know, who didn’t want to be identified, said.

The system audit report is a compliance mandate to ensure appropriate security measures and data localization controls for payments-related data.

This ban is a god-sent opportunity for the new aggregators. PhonePe is one company that is trying to make the most of this opportunity, aggressively going after the acquisition of small and mid-sized merchants.

The question is if this is a sustainable strategy. How is PhonePe funding the discounts? And is there enough money to be made in the aggregation business?

The company, it appears, has a larger game plan.

What numbers say

PhonePe, founded by Sameer Nigam and Rahul Chari, started in 2015 as an UPI-focussed app. Within a year, the company was acquired by Flipkart, India’s largest online retailer. Meanwhile, in 2018, Walmart picked up a 77% stake in Flipkart. And in 2019, the board of Flipkart agreed to hive off the payments unit, PhonePe, and also cleared plans for it to raise external funding independently.

In December 2022, Flipkart hived off PhonePe as a separate entity in a deal that involved existing shareholders of Flipkart Singapore and PhonePe Singapore purchasing shares directly in PhonePe India. PhonePe also became an India-domiciled company—its businesses were registered in Singapore and it moved all the subsidiaries of PhonePe Singapore, including its insurance and wealth broking businesses, to PhonePe Pvt Ltd. The speculation was PhonePe wanted to list in India.

While UPI transactions remained the mainstay of its business, PhonePe did try to diversify earlier. It forayed into financial services in 2017 with the launch of gold investments, providing its millions of users with an option to buy 24-karat gold. The company also launched silver on its platform. This year, it started offering several other financial services, including investments and loans for merchants.

PhonePe hasn’t disclosed its profit and loss statement for 2022-23 yet. However, in a filing with India’s ministry of corporate affairs, the company reported revenue of ₹1,913 crore in the first nine months (January-September) of 2022. The loss before interest and taxes stood at ₹410 crore during the period. In 2021-22, its losses were far ahead ( ₹2,010 crore) of its revenue from operations ( ₹1,646 crore).

So, where does the payment aggregator business fit in? While margins in the business are small, this is a volume game. The total payment volume (TPV) processed by the older aggregators gives us a sense of the market size. Billdesk claims to have processed TPV exceeding $119 billion in 2022-23; Infibeam’s TPV touched $53.9 billion. Razorpay’s TPV, as of April 2022, was $80 billion. During 2021-22, PayU India’s TPV totalled $43.8 billion, while Cashfree processed $40 billion worth of transactions last year.

The older aggregators have acquired a sizable number of merchants already. Razorpay, for instance, claims an online merchant base of 8-10 million while PayU India has over 450,000 merchants.

Paytm and PhonePe have a larger base of merchants at 31.4 million and 35 million respectively, but like we mentioned before, they are mostly offline—the neighbourhood grocery seller or the owner of a small tea stall, for instance. PhonePe, therefore, now has the difficult job of finding new merchants who have an online presence. While the base of merchants transacting online is small today, India’s digital economy is rapidly expanding. Online aggregators, therefore, are hoping that more and more small businesses will set up commerce websites or apps and start transacting.

Math behind discounts

That brings us back to PhonePe’s aggressive tactic— over the last couple of months, PhonePe has been running ads offering 0% TDR.

Here’s how the cost economics work.

Like we mentioned earlier, a payment aggregator usually charges 2% TDR, in addition to the goods and services tax (GST), to any merchant using its platform. Overall, TDR plus GST totals around 2.5% of a transaction. The cost of running the business—expenses incurred on manpower, travel, technology, advertising/marketing, etc—is estimated between 1% and 1.5% of the transaction. This implies a rather thin margin for the payment aggregator, of about 0.5%.

In PhonePe’s case, at 0% TDR, it is footing the entire expenses bill (1.5%) from its own pocket rather than passing it on to the merchants.

“It’s a promotional offer that they are running to grab market share aggressively. They have the money to do that,” an executive from a payment aggregator company, who didn’t want to be identified, said.

PhonePe, amid the funding winter, recently raised $100 million from General Atlantic at a valuation of $12 billion.

While the company has the money to fund the discounting, industry participants don’t see the tactic as a sustainable game, particularly when it comes to large merchants.

“2% of the order value will be a huge cost if its a large merchant. For instance, if PhonePe processes ₹100 crore a month for one merchant, then shelling out ₹2 crore from its own pocket is a huge cost to bear,” the executive quoted above said.

According to some industry executives closely following PhonePe’s strategy, the fintech firm is only targeting small merchants—those with a turnover in the region of ₹5 lakh—with such tempting offers. According to one merchant Mint spoke to, the 0% TDR offer does come with certain terms and conditions. For instance, the offer is valid for the first ₹1 lakh worth of transactions.

In response to a detailed query from Mint, a PhonePe spokesperson stated: “PhonePe had plans to launch a full-fledged payment aggregator offering and the embargo on other players did not change our roadmap in any way. We are targeting the entire gamut of merchants right from enterprises to MSMEs (micro small and medium enterprises) for this offering. As a part of enabling MSMEs to start accepting digital payments in a seamless manner, we may run offers in a time-bound manner and will continue doing so, depending on business needs.”

Data games

Let’s dive into the other services PhonePe has started offering recently.

In April this year, the fintech firm launched digital lending pilots for merchants and in June, it launched a merchant lending marketplace. During its pilot, about 20,000 loans were processed—the company claimed that it achieved an annual loan disbursal rate of ₹1,000 crore. In August, PhonePe entered the stock broking market with a new app called Share.Market.

A top executive from a payments company Mint spoke to believes that for PhonePe, diversifying into stocks, mutual funds and insurance makes more sense as the margins are more lucrative. But the payment aggregator business is an important piece of the whole diversification puzzle. How so?

Because the payments business is a customer acquisition strategy.

“Being a payment aggregator, you can monetize your payments but being just an UPI app, you can’t at all. In that sense, more money can be made by becoming an aggregator. But, still, the margin is thin,” another executive, who is working closely on PhonePe’s fintech strategy, said. “Higher margin can be generated when you add more products on top of the aggregation business, especially credit,” the executive added. Both the executives quoted above didn’t want to be identified.

Once PhonePe builds a large online merchant base through the payment aggregator business, the data it generates can be helpful in building a lending business.

This strategy sounds good in theory but carries risks that can upset the applecart.

Not a cakewalk

With the top four payment aggregators being barred from onboarding new merchants, PhonePe has less competition as of now. Nonetheless, these companies would make a comeback at some point. PhonePe, therefore, may not have much time to establish itself in the business.

“All the four companies are constantly in talks with the regulator. The RBI will have to take some action since it will start impacting all of us,” a top official from one of the barred companies said, declining to be identified.

Apart from PhonePe, Infibeam and Billdesk are also trying to grab the share of small and mid-sized merchants for its payment aggregator businesses.

Infibeam (popularly known as CCAvenue), which offers digital payment solutions and enterprise software, has witnessed record growth in the last few quarters. In 2022-23, Infibeam’s topline grew 56% to ₹2,033 crore on the back of client additions. The BSE-listed entity claims that it is adding over 9,000 merchants on a daily basis and for the first time, crossed the 10 million-mark by June-end. Billdesk, which has a monopoly in the large merchant segment and the government sector, has recently turned its attention towards smaller businesses.

However, the co-founder of another top payment aggregator believes that the ban on the top four players has made no difference in the market. “First, the number of good merchants is limited. Second, no matter how many merchants these payment aggregators claim, the base of the transacting merchants is small,” he said.

PhonePe surely has the money muscle. But flexing it alone wouldn’t work in the aggregator business. Apart from operational bottlenecks, the regulatory scrutiny could make it tougher for the new players to gain ground, going ahead.