Apple Pay may finally turn our smartphones into wallets and, if it does, banks and the credit card industry could face a tricky future.
By Elizabeth Fry
When Apple announced its payments-enabled iPhone 6 hardware and Apple Pay software last year, the global payments industry immediately knew it could be a game-changer. Over the next year, as the technology rolls out across markets and consumers update their iPhones, we’ll find out whether Apple can really win at payments.
At the time of writing, Apple Pay works only in the US. Adoption has not been instant: most US merchants lack the point-of-sale hardware the iPhone needs, and iPhone 6s are still making their way out into the market.
And the industry is used to seeing new electronic payments schemes appear, fail and die. Many firms have enabled payments using near-field communication (NFC) technology, the same technology used in the iPhone 6. None has yet taken off. Payments systems need more than technology; they need to solve security issues, get hardware in customers’ hands, and convince retailers to embrace their system. They need, above all, to make the whole experience pleasant for consumers – which is Apple’s speciality.
So as Apple prepares its plans for markets beyond the US, the global payments players are still trying to figure out how much the consumer giant will change the business of moving money around.
"Apple is on track to have the world's biggest user base in the mobile wallet market."
But Apple Pay certainly has their attention. It has the broad trust of its user base and 800 million credit cards on file through iTunes. Even the existing US rollout makes Apple Pay the world’s fastest-growing payment method.
If someone is going to make phone-based contactless payments happen, and shake up the world payments system, that someone may well be Apple. And if that change is going to start anywhere, it may happen first in markets outside the US.
Australia, for instance, is “the biggest in the world” in contactless cards, says MasterCard president of international markets Ann Cairns. Australia, Canada and Sweden have a history of payments innovation and a large base of consumers and merchants who are used to tapping and going – users who have abandoned the ageing magstripe swipe technology that still dominates the US.
The usual Apple assault
The payments landscape is dominated by card scheme operators, led by Visa, MasterCard and American Express. Apple’s CEO, Tim Cook, notes that these three businesses process more than 90 per cent of global purchase transactions, and Apple has been working with them all. With their help, Apple Pay has been able to reach critical mass in the US very quickly. With brand power to burn and a massive following, Apple is on track to have the world’s biggest user base in the mobile wallet market – a market where everyone has been waiting for an explosion. This is typical of Apple.
CSC Australia director of banking Simon Millett says Apple has a history of successfully entering markets only when people are primed and ready to take up a new technology. And the company likes to position itself as being at the pinnacle of innovation while bringing the population along with it. “That means being selective about how it positions itself, taking the path of least resistance,” Millett explains. “It generates new revenue streams literally without upsetting the applecart.”
Joining forces with the card schemes is a highly strategic move in the long game of financial services. Ben Robinson, chief marketing and strategy officer of Swiss-based banking software supplier Temenos, believes that Apple Pay is a “lifeline” for Visa, MasterCard and Amex as they work to defend their respective futures in a changing system.
Paying for a purchase using Apple Pay simply requires holding the iPhone near the contactless reader. Apple Pay sends coded payments data to payments terminals. Once a purchase is made, the iPhone wirelessly transmits a secure digital token along with encrypted customer data – but not credit card details.
Visa, MasterCard and Amex helped drive the development of secure technology to store cards on phones, now the card companies believe these technologies will be a long-lasting standard for store payments. It will not only enable more secure payments but also allow for global interoperability – something that competing standards from the likes of MCX, PayPal and Starbucks are not able to offer.
At first glance, the card schemes are doing very well out of Apple Pay because of the robust growth in transactions that it will drive. As Apple Pay becomes more popular and volumes skyrocket, everyone in the transaction chain sees benefits – merchants, processors, networks, and issuers.
So is Apple Pay really shaking things up? After all, when we use Apple Pay we’ll still need a card number, we’ll still pay the card issuer schemes (Visa, MasterCard, Amex and the like) and we’ll still need an issuing bank.
"In the digital world where is the value in even having a credit card?"
The prominence of cards in the process will diminish. The first problem for the card schemes is that the biometric ID or fingerprint scanner on iPhones may make Apple Pay relatively safer and more secure than cards. And protection against fraud helps justify card fees.
Robinson from Temenos sees a good chance that MasterCard and Visa fees will get “hammered” over time as fraud rates drop. Visa and MasterCard will still have a healthy business for a while, he predicts, but their long-term future is “massive” disintermediation, as middle-man companies are removed between lenders and borrowers to streamline processes and reduce costs.
The banks may also have good reason to be scared. By joining Apple Pay’s network, the banks that issue the cards pay Apple just 0.15 per cent per transaction, about a tenth of what they typically make from cards. The banks also pay extra fees to the card networks for the use of the digital token. If the banks lose that direct relationship with the card customers (and the opportunity to cross-sell or up-sell services), they may be relegated to the low-margin work of payments processing and deposit taking.
The banks could develop mobile payment apps with their own tokens supported by alternative funding sources such as personal loans, as UBS analysts suggested in a recent note. That would let the banks bypass Apple Pay, MasterCard, Visa and Amex. But control of the hardware gives Apple and other smartphone makers a unique edge. They can easily limit the functionality of any bank apps if they choose.
Peer-to-peer payments bypass cards
Putting the card into the phone does not just get rid of the plastic in our wallets. It uses new technology to transport payments data in real time. The UK, Mexico, Singapore and Sweden all operate real-time payment systems at the bank end, and Australia’s central bank will force its use next year. With real-time payments, an individual can make a mobile payment and the merchant gets instant value.
The merchant doesn’t have to use a merchant acquirer service or pay fees to the credit card scheme operator.Brett King, the founder and chief executive of US digital bank Moven and author of Bank 2.0, notes that in the medium term MasterCard and Visa have another advantage: interoperability. “You are going to need to be sure that you can use your phone everywhere,” he observes. “And that requires the network.”
Of course, the major credit card schemes are trusted brands. They’re so ubiquitous that their eclipse is hard to imagine. They control the payments flow; the big banks have the deposits.
But in a digital world, especially one where banks offer customers credit or an overdraft, where is the value in even having a credit card? “It is difficult to see how, long term, these real-time peer-to-peer payments won’t supersede credit card payments,” says Robinson.
This payments future will not be welcomed by credit card companies or banks looking for super-profits. With Apple’s distribution power behind it, Apple Pay stands a real chance of becoming a mainstream solution. If it strikes the right chord with shoppers, Apple will add financial services to the list of industries it has helped transform.
Death of the loyalty scheme?
Moven’s Brett King sees real-time payments transforming the customer rewards game, too. In a real-time world, rewards will have to be available immediately and in the store to be relevant, he says.
Waiting until the end of the month won’t make any sense. In such a world, the old airline frequent flyer rewards may quickly lose value.
King predicts that credit cards will quickly give way to instant credit options in the store for either emergency cash or in-store financing, essentially becoming all about the phone. “Traditional card schemes won’t be valued or differentiated in the way they used to be,” he predicts.
Value moves to transaction
In a world of smartphone payments, much of the money may be in transactions data that enables better marketing. Apple Pay doesn’t store data on the iPhone itself, and at Apple Pay’s launch the message was that Apple won’t track or store purchase data or pass it on to other retailers. But there’s no doubt such information could be worth a fortune. And Apple Pay could easily link a person’s Apple ID to where you shop, and the date and time of the transaction.
Soon Apple will be able to suggest third-party products and services to customers, help them manage their finances better, and eventually offer a marketplace for financial services without having to provide the actual services themselves.
None of the new entrants in the payments industry really wants to get into the heavily regulated, low-margin aspects of banking. As Brett King has noted, financial technology start-ups don’t want the massive capital requirements that would come with being a bank. And Google would rather not repossess your house if you don’t pay your mortgage – that would cost money and hurt its reputation.
Rather, these new payments players hope to direct and mediate your banking transactions. They want to suck the margins out of banking. King can see a scenario where Apple takes control of the in-store buying experience and the banks just hold deposits or offer credit.
This article is from the May 2015 issue of INTHEBLACK.
INTHEBLACK wrote last May that if Apple’s payment solution Apple Pay struck the right chord with consumers, the company could help transform financial services.
We also noted that new electronic payments systems had a history of failure. So far, Apple Pay has failed to beat the odds.Even among consumers carrying Apple Pay-enabled iPhones, just 5 per cent of transactions use Apple Pay at merchants that accept the system’s NFC technology – and that number isn’t increasing. A study late last year by fraud consultancy Trustev found only about one in five people who could use Apple Pay had ever done so.
Regular surveys by payments industry website pymnts paints a similar picture: more consumers are trying Apple Pay, but they are not sticking with it.
The site argued that US consumers’ unwillingness to change habits had triggered a cycle of indifference where “merchants don’t support it yet, consumers don’t remember to use it, and you know the rest of that story”.
“Apple has now rolled out Apple Pay in China, where its bigger iPhones have sold well.”
The problems have surfaced despite enthusiasm from consumer technology experts and support from dominant card scheme operators Visa, MasterCard and American Express.
Apple has now rolled out Apple Pay in China, where its bigger iPhones have sold well. The company is up against established Chinese solutions such as the Alibaba-affiliated Alipay and Tencent’s WeChat payments. However, at least plenty of Chinese merchants have the NFC-enabled terminals that Apple Pay needs if it’s to end its unvirtuous cycle.
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