Beyond Payments for High-Risk Industries 

Today, most merchants looking to sell a product or service online can quickly get their payment system live with the help of a modern checkout platform. If the merchant works in a “high-risk” industry like games, sports betting, telehealth, travel, or cannabis, however, it’s more complex. Such industries lack viable out-of-the-box software products that help with payment-adjacent issues such as identity management (for games companies), payment reconciliation (for telehealth businesses), and logistics compliance (for alcohol and cannabis businesses). While there are a few big payment-acceptance incumbents to specifically serve some of these industries, there’s now an opportunity to couple payments with a vertical-specific software layer to offer better compliance, wallets, tools for identity management and fraud detection, reconciliation, and more. 

These industries are larger than you may expect, and they are also growing their online presence quickly. Games, cannabis, telehealth, and sports betting, for example, each represent billions of dollars in annual payment volume and spend (see the chart below for a few examples). Additional high-risk industries, like travel, online dating, and adult entertainment, also see billions of dollars of annual spend.

But first, let’s take a look at why high-risk industries have such painful experiences.

Historically, merchants in high-risk categories have had few options for payments. They have had to use either direct providers, horizontal industry gateways that have been open to serving high-risk merchants and high-risk specific gateways (e.g., payment gateways specifically for gambling), or indirect providers, publishers or marketplaces that require merchants to use their built-in payment products (e.g., Steam or the Apple App Store). Unfortunately for merchants, these options have tended to provide clunky experiences and limited capabilities, while requiring high take rates. 

Direct providers that specifically focused on high-risk merchants tended to have higher-than-normal payment declines, slow processing, poor support, unexplained charges, multiple credential re-entries by the consumer, and more. This ultimately hurt the experience and eroded merchants’ trust with consumers, who after multiple declines, may even have had a blanket block placed on their account—for which the dispute resolution process is a disaster. Most of these incumbent providers focus on payment acceptance, with limited software on top, all the while charging significantly high take rates (effective rates generally range between 6% and 10%, but 15% has been seen in some cases). The legacy (i.e., often built in the 1970s), more horizontal payment providers who served many industries were not friendly to work with from a technology and data perspective, didn’t provide any specific value-added functions for high-risk merchants, and many have been through so many acquisitions that the tech debt is hard to overcome.

The industry has also historically been littered by fly-by-night direct providers who are looking to grow quickly by masking the true nature of their transactions or business identities (i.e., by inputting incorrect MCC codes, changing addresses, names, etc.). While this has allowed merchants to get started quickly, banks and networks have since caught on. They now shut down providers due to non-compliance, leaving merchants without a provider, and in the worst case scenario, blacklisted by processors and on the MATCH list. 

When merchants are forced to work with an indirect payment provider via a publisher or marketplace to, for example, distribute products (i.e., mobile game developers needing to distribute their apps via the Apple App store for example) or comply with regulations (i.e., selling alcohol directly to consumers via a marketplace that has the required licenses), they are stripped of the ability to build direct relationships with customers and often have to pay take rates as high as 30% per transaction. This is a massive toll, especially for new companies that are innovating on the back of new platform shifts, increased digital adoption, and regulatory tailwinds.

These high take rates across both indirect and direct payment providers are typically either a consequence of the provider having pricing/monopoly power, like the Apple App store, a response to the elevated fraud rates these high-risk companies face, or a result of the providers themselves being charged richer margins by banks who underwrite their services due to their cost of compliance being higher. Online dating is considered high-risk because customers sometimes file chargebacks after they find a potential match—and essentially cyber-shoplift from the dating company. In travel, many customers file for chargebacks when they don’t receive—or feel as if they haven’t received—the level of service that was advertised to them on an online travel agency. Many incumbent providers argue they need to charge these “riskier” companies higher take rates to offset the lower fees they charge merchants in lower-risk industries; the latter group’s higher payment volume allows the payment company’s overall chargeback rate to be less than 1%, an important threshold for the card networks.

Direct providers often also have had to charge their merchants high take rates because their own banking partners have had higher compliance costs (e.g., SAR filings and AML screening) for serving high-risk industries. Banks serving these industries have to deal with more regulators such as reporting to both the state bank regulator and the state cannabis or gambling regulator for example–with audits being very cumbersome and the data that is passed back and forth not being uniform/in spreadsheets. Banks will then pass these elevated costs back to providers (who must then charge high take rates).  

Alternatives to these legacy providers were not great. One option was to become a payment facilitator (payfac) or work with a new provider to help them own more of their payment stack. But this can be an expensive and painful endeavor in terms of personnel, processes, and certifications required—and this trade-off likely only makes sense if processing over $100 million of gross merchandise value (GMV). Several payment platforms also tried to guide customers to off-platform payment forms like gift cards, which are unscalable workarounds.

Why Gaming’s Pain has Been Particularly Acute 

Gaming has had a particularly painful experience. In the past, when games were more console-based and bought in-store, retailers like GameStop would manage applications like gamer payments, identity management, cross-selling, and discounts. Now that consumers are buying and downloading games online and shopping in-game more often than they’re shopping at brick-and-mortar stores, game developers are dealing with elevated fraud levels and are often forced to rely on platforms that may take advantage of them. 

Looking at fraud, the games industry deals with higher rates of both accidental friendly fraud and intentional fraud than most other industries. This is because games have higher numbers of very young users, who are more likely to make “friendly” mistakes like accidentally paying for an in-game skin that their parents ultimately refute. Gaming also attracts fraudsters because it is easy for users to launder money by transferring and selling in-game currencies on the gray market. In other cases, gamers unknowingly buy items from illegitimate sources who claim to be legitimate developers.

On the platform side, most long-tail game developers rely on large-scale marketplaces (indirect providers) like Steam or the Epic Store to kickstart their customer acquisition. However, these platforms then force developers into using their payment products as well, and most providers charge 20%+ take rates, which causes many developers to question the economic trade-off. On the mobile front, Apple’s take rate has been so onerous for developers, to the point of lawsuits being filed. Not only do platforms charge high take rates, but they prevent the developer from getting valuable information about their customers. Developers can be blocked from seeing the direct identities of their game customers, where they are playing, and how much money they are spending in-game. This limits a game company’s ability to offer customers discounts and suggestions for similar games to try at opportune times.

If working with a legacy, direct payment provider, the experience is also fraught with issues. For example, payouts can be slower than desired and some providers in particular have a history of not being transparent with customers (e.g., retaining tips that were intended for the developers) and the user experience leaves much to be desired. In other cases, the traditional pricing model has stifled innovation for games companies that want to support microtransactions for their gamers, either for P2P or gamer-to-streamer payments. The typical flat fee per transaction (plus a %) makes charging for small in-game purchases uneconomic.

Clearly, the payments experience has historically been subpar, and several tailwinds are changing the payments and surrounding software needs for these industries. First, for regulated industries including skilled gaming, sports betting, and cannabis, states are continuing to push for legalization, given the dramatic positive impact such industries can have on state budgets, which were hit hard by the pandemic. Further legalization should result in more appetite from banks (and lower compliance costs) to serve these industries (Kentucky for example just legalized sports betting and medical marijuana), ultimately paving the way for more innovative payment solutions that sit on top of these banks to serve these riskier businesses.

On the games front, gamers have more choice than ever when it comes to which platform they want to spend their time in, regularly jumping between Fortnite and Roblox, for example. In an ideal world, the consumer would have interoperability of their money and status across these platforms. Another trend to track is the globalization of games like Free Fire, which, while developed initially for Southeast Asia, has become one of the most popular free-to-play games across the entire global south, including India and Brazil. As more games go global, developers will need payment orchestration products like Payrails to accept the preferred local payment method across these regions, especially in emerging markets where growth in gaming is strongest. Carry1st is an example of a company bringing global games to the African market, aggregating local payment methods across the entire continent.

In the mobile games world, all eyes have been on the Epic-Apple lawsuit. According to the latest April 2023 appeals ruling, Apple can no longer prohibit developers from sending consumers to third-party payment methods for in-app purchases. Apple has also been attempting to ease antitrust concerns by allowing “reader” apps like Netflix, Spotify, and Kindle to skirt their in-app payment requirements by linking to their own web stores–perhaps Apple will expand this to other types of apps such as games as well. Both of these developments could create a tailwind for third-party payment providers and enable games companies to build deeper relationships with their customers. Moreover, in a world where developers have to pay less onerous take rates, they can deliver more value back to their end gamers and potentially build greater loyalty with them as well.

Many other industries have benefited from a Covid-triggered increase in consumer digital adoption, necessitating better payment workflows. Telehealth companies, for example, must serve customers across multiple states, and patient payments must correctly be routed to medical groups in the same state as the customer—an accounting nightmare. Alcohol and cannabis companies, meanwhile, would prefer to stop relying on third-party marketplaces to expand their digital presence so they can build direct relationships with their customers, but are often forced to partner with them to satisfy logistics compliance rules because they lack visibility into their distributor and retail partner supply chain (e.g., consumers must receive an alcohol product from a retailer or distributor in their state). And sports-betting companies continue to face regulatory pressure to ensure their consumers are actually living and playing in a state where gambling products are legal—a difficult practice to track without solid KYC/compliance measures in place.

With these advancements, what can payment companies serving these high-risk industries provide? We believe successful companies building here will have vertical-specific, software tools that wrap the transaction and build-in fraud detection and streamlined compliance. These companies will likely not resemble traditional payment companies, but rather offer software products that include payment acceptance as one part of a broader feature set. 

Vertical-specific payment tools

Vertical-specific products will sit on top of the actual payment rail. They will use software to help the merchant improve their entire payment operations experience as well as gather additional data on their customers, improve the customer experience, and make payments more strategic to the overall business. In many cases, these additional tools also help drive down fraud. A few examples include:

• Identity Management for Games: Game developers want to be able to attach payment data to user profiles so that they can drive the right offers in-game; cross-sell via catalogs, storefronts, and marketplaces; and guide gamers to, or even create legitimate commerce channels within games. A modern payment platform for gaming would offer the developer access to this data and perhaps even allow this data to be shared across platforms.
• Wallets for Gaming: Game developers also want to build deeper relationships with their gamers, who at the same time crave interoperability between platforms. New payment companies here could help gamers set up wallets that enable them to hold currencies that could be used cross-platform, earn rewards from their favorite games, and store payouts that can then be re-used in-game.
• Geolocation for Sports-Betting: Sports-betting companies want built-in geolocation features and compliance checks such as age verification added into the checkout experience so that they can ensure they are compliant with regulators. Legalization has increased, but regulatory scrutiny persists. Modern payment platforms serving this category would thus have built-in compliance functionality, alleviating the need for merchants to juggle multiple providers for their payment stack.
• More Flexible Treasury Management and Payouts for Sports Betting: Sports-betting and skilled gaming companies want more flexible liquidity options given large sums of money typically cannot be moved over traditional rails on weekends, when most of the volume on these platforms occur. A new player can build a treasury management platform that helps these companies better manage the visibility of their cash flows (given the two-way nature of sports betting where consumers are constantly betting and getting paid), provide consumers with payouts whenever they need them, and potentially even provide liquidity for consumers via factoring type products.
• Compliant Fulfillment for Alcohol and Cannabis: Alcohol and cannabis brands want built-in logistics tools so they can provide a seamless checkout experience for consumers while meeting regulations on ensuring products are actually being directed from the state that consumers are purchasing the goods from. A payment platform that enables brands to go D2C could be a large opportunity, but this payment layer would need to be coupled with a deeper software layer that helps brands manage fulfillment.
• Reporting and Reconciliation Tools for Telehealth: Telehealth companies want better ways to reconcile payments between the different state-by-state entities to serve customers compliantly. A payment solution here could be payment acceptance with built-in accounting functionality that correctly helps identify and route payments from consumers to the correct medical group.
• Reconciliation & Dispute Workflow Tools for Travel: Travel companies, mainly Online Travel Agencies, want better ways to manage money movement between their counterparties and better payment failure/dispute resolution tools. A next-gen payment platform in this category could help OTAs and their counterparties (airlines, hotels, entertainment companies, etc.) reconcile payments more efficiently (via direct accounting integrations), get to the root cause of why certain payments might be failing, and provide for better dispute resolution (by helping identify the dispute occurred whether or not it’s valid).

Built-in fraud prevention and compliance

Many incumbent payment providers serving high-risk industries charge high fees as a response to high chargeback rates. However, almost none provide fraud prevention and management tools as complementary products to their customers as a means of reducing those chargebacks (which could lead to lower fees). This is a clear opportunity for new providers. Companies will need to get creative when it comes to preventing fraud in these industries given how hard friendly fraud is to stop, and KYC-ing users may prevent them from using these services. One specific value-add for customers is acting as the merchant of record so that customers do not have to build their own fraud tools. This would push the risk liability to that merchant of record though, and so a new provider here would have to ensure they have the fraud prevention tools to keep up with it. Fraud evolution has led providers such as Sardine to build better models around device identification and behavioral biometrics—which may now be relevant to serve high-risk merchants. Software providers serving high-risk merchants could also help drive down costs by streamlining compliance for their bank providers (for example with Seed to Sale tracking in the cannabis industry or built-in AML screening for sports betting), who could then pass on their cost savings to end customers.

The opportunity to serve companies in these high-risk industries is clear. New startups building vertical-specific tools could cover this whitespace or developer-friendly payment platforms like Stripe and Adyen could continue adding more software features for customers in high-risk industries. Payment providers building in this space could enable new companies to come to market, help existing companies launch new verticals (i.e., game studios without mobile games to launch them), and open up new opportunities to monetize. If you’re building in this space, we’d love to learn from you and share our insights in more detail. 

* * *

The views expressed here are those of the individual AH Capital Management, L.L.C. (“a16z”) personnel quoted and are not the views of a16z or its affiliates. Certain information contained in here has been obtained from third-party sources, including from portfolio companies of funds managed by a16z. While taken from sources believed to be reliable, a16z has not independently verified such information and makes no representations about the enduring accuracy of the information or its appropriateness for a given situation. In addition, this content may include third-party advertisements; a16z has not reviewed such advertisements and does not endorse any advertising content contained therein.

This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. References to any securities or digital assets are for illustrative purposes only, and do not constitute an investment recommendation or offer to provide investment advisory services. Furthermore, this content is not directed at nor intended for use by any investors or prospective investors, and may not under any circumstances be relied upon when making a decision to invest in any fund managed by a16z. (An offering to invest in an a16z fund will be made only by the private placement memorandum, subscription agreement, and other relevant documentation of any such fund and should be read in their entirety.) Any investments or portfolio companies mentioned, referred to, or described are not representative of all investments in vehicles managed by a16z, and there can be no assurance that the investments will be profitable or that other investments made in the future will have similar characteristics or results. A list of investments made by funds managed by Andreessen Horowitz (excluding investments for which the issuer has not provided permission for a16z to disclose publicly as well as unannounced investments in publicly traded digital assets) is available at https://a16z.com/investments/.

Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others. Please see https://a16z.com/disclosures for additional important information.