Mobile Payments: From Cards, to Smartphones and the Cloud
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September 9, 2013
Mobile Payments: From Cards, to Smartphones and the Cloud
- After years of false starts, mobile payments are finally beginning to surmount the vested and conflicting interests of device platforms, wireless operators, and existing payments players to gain traction with merchants and consumers. These initiatives focus on the point of sale (POS) experience, simplifying checkout and/or integrating payments with merchant customer affinity programs. Most use near field communications (NFC) technology to connect and credit cards to fund, and will gain as merchants upgrade to NFC-equipped POS terminals to meet Visa’s 2014 PIN deadline. However, high carrier fees for NFC security and Apple’s refusal to support the standard remain obstacles. Longer term, we believe solutions that handle transactions in the cloud, and that tie payments with broader merchandising solutions and consumer e-wallets offer significant advantages – lower costs, superior convenience, closer relationships, more powerful marketing, and tighter security – vs. device-based NFC approaches. Moreover, as consumers gain comfort with mobile payments, on-line players and more sophisticated merchants/merchant consortiums may move to reduce high credit card fees via ACH bank funding, co-branded credit relationships, or taking credit risk directly. In the TMT sector, POS terminal vendor PAY and restaurant vertical solution OPEN should benefit in the near term, while GOOG and AMZN are positioned to lead as the opportunity shifts to the cloud.
- Mobile payments adoption has been slow. The idea of using mobile phones for payment has been in play for years, but the conflicting interests of the many stakeholders have yielded substantial obstacles to adoption. Credit card nets and wireless carriers have used oligopoly power to demand substantial fees and a starring role in early initiatives. Merchants have been slow to upgrade to the NFC capable POS terminals needed for many solutions, while Apple has, thus far, refused to support NFC in the iPhone. Consumers appear to have little awareness of mobile payments solutions, and early implantations have offered little incentive to change their behavior at POS.
- Conditions may finally be ripe for acceptance. Visa has mandated that its merchants install new POS terminals by 12/31/14 to comply with its PIN security requirements, or face liability for fraud. Most of these terminals will also be NFC (Near Field Communications) capable, and thus, able to support many mobile payments initiatives as well. At the same time, the share growth of Android smartphones, most of which support NFC, at the expense of the iPhone, which does not, increases the addressable market. Forward thinking merchants, like Starbucks, are tying mobile payments to more comprehensive customer affinity programs, giving consumers greater incentive to participate.
- NFC solutions are first, but cloud-based solutions will win. NFC solutions, such as Visa’s V.Me, Mastercard’s PayPass, and the AT&T/Verizon joint venture Isis, store data on a SIM card to manage security. This approach is expedient, but flawed. Wireless carriers can leverage their control of the SIM to demand fees, and the solution is tied to a single device. In contrast, payments systems that are secured in the cloud, can be available from any device, can be a common platform for on-line and POS transactions, and can be integrated into broader merchandizing solutions – e.g. linking advertising or promotions to single click checkout. In this, consumers can maintain a truly comprehensive e-wallet tied to an array of value-added merchant services (order ahead, no-wait automatic checkout, personalized price promotion, loyalty incentives, etc.), while merchants can efficiently find customers, build better relationships and reduce purchasing friction. Moreover, these cloud-administered payments solutions make carrier fees unnecessary, and could increase leverage on credit card nets.
- Big cloud players will battle big merchants/consortia for dominance. Companies with significant consumer cloud franchises have important advantages in the long run competition for electronic payments. First, there are significant functional synergies with on-line advertising, e-commerce, messaging, product search, media streaming, application hosting, and other cloud businesses. Second, big cloud players can leverage considerable economies of scale in brand reach, data processing infrastructure, and cash resources that give them advantage over all but the largest merchants and consortia. Third, web platforms have detailed profiles on hundreds of millions of regular visitors and unmatched ability to analyze and exploit that data to the benefit of merchants, their own franchises and consumers. Fourth, big on-line companies do not have to make money from payments – advertising and other merchandising revenues, hosting agreements and direct e-commerce sales would see positive effects from an integrated cloud payments platform. Finally, mobile platform owners – Google, Apple and Microsoft – can integrate their own payments apps directly into the operating software, offering unmatched convenience to users vs. 3rd party solutions.
- The final step: displacing credit cards. Cash and checks were 70% of all US consumer transactions in 2000, a percentage that dropped to 43% by 2010, almost entirely to the benefit of credit cards. Under the domination by Visa and MasterCard, credit card interchange fees have risen to 2% of the value of transactions with merchants nearly powerless to say no. The credit card nets are pressing their hegemony toward the nascent mobile payments market, and thus far, all major initiatives have included them as means of funding the mobile payments system. Still, as consumers grow more accustomed to cloud-based payments and consolidate more transactions, users could be given incentive to fund their e-wallets with direct ACH bank transfers, cutting the card nets and their fees out of the equation. More aggressive players could look to offer credit as well, partnering with, acquiring or even launching a bank.
- Winners may be different in 4-5 years. NFC solutions are set to win in the near term, credit card nets (V, MC, AMEX), wireless carriers (T, VZ), first movers (OPEN, EBAY) and POS terminal vendors, (PAY, NCR). Of these, we believe Verifone and Open Table are the best plays on mobile payments. Longer term, the growth of integrated cloud-based e-wallet solutions that enable more sophisticated merchandising (AMZN, GOOG, AAPL, EBAY) will crowd out more narrow device specific solutions. Here, we see Amazon and Google as far better positioned than their rivals, due to the strength of their cloud franchise, consumer reach and technology capabilities.
Here Comes That @#%$& Cloud Again
More than a decade ago, vending machines that allowed consumers to pay by sending text messages started to appear in mobile mad corners of the world like Japan and Scandinavia. Since then, the paradigmatic market shift to smartphones has spurred more sophisticated visions of mobile payments. The first smartphone payments solutions connect the device to retail POS terminals via secure low power, short distance NFC links, and accessing credit card data encrypted on the Subscriber Identity Module (SIM) provided by the user’s wireless operator. Transactions are completed by waving the phone near the POS terminal and entering a PIN code. The idea is simple, but there have been snags. Merchants didn’t have NFC-capable terminals and haven’t seen the value in upgrading. Mobile carriers decided to block access to the SIM unless they were given a cut. Credit card companies also insisted on a prime seat, and saw no reason to accept lower fees even if the new system reduced costs. Apple decided not to play in the NFC sandbox at all and refused to include the standard in its iPhones. Meanwhile, most consumers had no idea that any of this was happening and those that did, didn’t care.
Things look a bit better now. Visa is requiring merchants to upgrade their POS terminals by year end 2014, or else, face responsibility for fraud on their own. Forward thinking merchants, like Starbucks, are tying mobile payments to more comprehensive customer affinity programs. Consumers are gaining experience from hyper-efficient on-line transactions using Amazon Checkout, Google Wallet or Ebay’s PayPal, from e-ticketing at the movie theater and airport, and from retail concepts that use technology to speed checkout, like the Apple Store. The time may be right for NFC-based initiatives from Visa (PayWave, V.Me), MasterCard (PayPass), AT&T/Verizon (Isis) and PayPal to gain traction.
Still, while NFC solutions pick up steam, superior alternatives are emerging. Unlike device-based NFC mobile payments, cloud-based solutions are available to users from any device and can aggregate on-line and POS transactions on the same platform. The cloud can empower users to find what they want and pay for it quickly and easily – pre-order for pick-up, automatic self-checkout, comparison shopping, budget tracking, personalized promotions, etc.. The cloud can help merchants find customers and engage them – targeted ads, click to purchase, affinity programs bridging on-line and in store, etc.. The cloud can also reduce overall transaction costs – eliminating or reducing fees, improving retail employee efficiency, etc.. Given the resources of Amazon, Google, Apple and Ebay, it seems likely that effective security solutions will emerge and that cloud franchises like Amazon’s commerce platform and Google’s search and maps dominance, will prove synergistic with payments.
As consumers grow more confident with transaction aggregation platforms in the cloud, and if enough merchants accept these platforms, users may respond to incentives for funding payments directly from their bank accounts, bypassing the credit card nets and their fees. Some platforms may take the further step of providing credit in a co-branded relationship with a bank, or even eventually becoming a bank themselves. The timing of such an inflection point in consumer purchasing behavior at a time when credit card use is still on a hard upward slope is almost impossible to predict. In the short run, companies levered to NFC or well positioned verticals are still a good bet – VeriFone and Open Table stand out from the TMT universe. Nonetheless, the long term potential for Google and Amazon to prosper from cloud-based payments is another piece of support for their valuation.
The Minority Report Mall Experience
There is a scene in Steven Spielberg’s 2002 film “The Minority Report” where Tom Cruise’s character, pre-crime police chief John Anderton, walks into a mall and is greeted by a barrage of personalized video ads with messages building on his purchase of a pair of khakis the last time he visited The Gap. This technology, dreamed up by a team of futurists Spielberg had recruited to imagine the state of the art forty years from now, may be closer than it probably seemed a decade ago.
While big brother retinal scanners and holographic displays remain farfetched, retailers may soon be able to identify their best customers before they walk in the door based on location data provided from smartphones. The merchant may send a text with an e-coupon for a product that a frequent shopper had looked for on line as a lure to get him in the store. Another consumer may have pre-ordered an item, and she will find it pre-paid and ready to go, no searching shelves and no waiting in line to check out. Other customers are not sure what they want to buy, but the retailer can make helpful personalized recommendations via an app, and provide tools for researching product attributes and availability. If customers are “showrooming”, the store owner can match an on-line price, offer customized product bundles, or suggest alternative products that may be better suited to the customer’s needs (Exhibit 1). A shopper may “scan” purchases with her phone camera, authorize with a PIN, a facial scan, or fingerprint, and walk out of the store without waiting in a checkout line. Information about the store visit will be added to the customer’s profile, automatically crediting loyalty programs and allowing the merchant to follow up with the customer and informing future communications.
Exh 1: Top smartphone applications for product “showrooming”
Merchants will be able to tie the in store experience with their on-line presence. Purchases will be completed with a single click from a web site visit, display ad, search result, text message, or email from any connected device– delivery/pickup preferences and payment information held securely by the provider of a cloud-based e-wallet – reducing the friction between contact and completed sale. Fraud protection will be strengthened by biometric techniques, such as fingerprints or facial scans, or by improved PIN authentication via swipe patterns or two-stage passwords. Data from aggregated on-line and in store product search and shopping will help retailers find the best consumers to target with advertising and promotion, simultaneously improving the likelihood that users will get timely advertising that interests them. Consumers will use their e-wallets to aggregate payments, manage security, budget resources, track deliveries, collect electronic goods like tickets, coupons, and warranties, and to control the clutter of separate apps from dozens of individual merchants.
Exh 2: US Non-cash payments by transaction volume, 2000-10
How You Gonna Pay for That?!
Payment is THE critical step in the consumer retail process when sales are realized. The importance of payments is evident in the elaborate rituals that have risen around them. From the consumer side, executing payment involves an investment of time and effort – wait in line for checkout, get out the card and swipe, sign or enter a PIN, show an ID, take the receipt – and exacts costs of its own – ATM fees, higher prices, credit card fees, etc. From the merchant side there are also significant costs – register clerks, credit card interchange fees, investment in POS terminals, lost sales from impatient shoppers, fraud prevention efforts, etc. Improving the payments process – making it much faster, easier, cheaper and more secure – would be a win-win, but how.
Credit cards and debit cards have made a big move. In 2000, according to US Government statistics, 60% of all consumer non-cash transactions were completed with checks. By the 2010 census, the number was down to 34%, with card networks the big winners (Exhibit 2). Part of it was a big rise in convenience – clunky carbon paper forms, hand operated machines to take impressions, and fully physical processing of credit card slips were a major pain to both consumer and merchant. As a new process emerged – electronic swipes, e-signatures, and PIN codes – credit cards became a LOT more convenient than carrying cash or writing checks. Not surprisingly, usage took off (Exhibit 3).
Exh 3: Share of US retail purchases by form of payment, 1999 – 2017
Can I Leave My Wallet at Home?
Mobile payments – using a cell phone at the point of sale to complete a transaction – have been a wireless industry fascination for years. The first vending machines that allowed consumers to buy soda with a text message began appearing in Japan and Scandinavia more than a decade ago. More recently, the attention has been on solutions that use a short distance secure wireless standard called Near Field Communications (NFC) to establish a connection between smartphones and retail POS terminals. The user would enter a PIN on their phone and wave it in the vicinity of the reader and Voila! – transaction completed, charged to the credit card number in the profile held securely on the Subscriber Identification Module (SIM) stored in the phone. Multiple industry players jumped on the NFC/SIM bandwagon – Google Wallet, Visa’s Pay Wave, MasterCard’s PayPass, Ebay’s PayPal, the Verizon/AT&T joint venture ISIS, amongst others. PayPal abandoned NFC last year in favor of an app based approach (Exhibit 4).
Exh 4: Select Mobile Payments Offerings
None of the early NFC/SIM mobile payment solutions has really gained any momentum thus far. A big factor is the hesitancy of merchants to invest in the POS infrastructure necessary to complete NFC transactions. A second major factor is the control that wireless operators have over the SIM card – nothing goes on there without the agreement of the carrier, and the carriers have demanded fees and or participation as the price of consent. This opposition has particularly vexed Google, who’s Wallet App is blocked on smartphones sold through Verizon. Apple is a third fly in the ointment. It has not supported NFC in its iPhone or iPad products and is not expected to do so in the next iterations either. While the iPhone’s market share at just under 40% trails Android, it has disproportionate penetration into the most affluent demographics – ostensibly, the most attractive audience for mobile payments solutions (Exhibit 5-6).
Exh 5: US Smartphone OS Share, March 2009-June 2013
Exh 6: Android versus iPhone Demographics
Finally, the initial solutions offer only modest benefits to consumers and merchants. Shoppers still have to wait in line for a checkout clerk, saving a few seconds in the difference between swiping a card and waving their phone IF they download the app and learn how to use it. Merchants are still paying those clerks and must upgrade their POS equipment to accommodate the small handful of customers that want to pay by smartphone. This is not the degree of convenience or cost savings added by electronic credit card processing, and thus far, the population of consumers and merchants on board is far from the critical mass needed to drive mobile payments to a stable presence in the market (Exhibit 7-8).
Exh 7: Benefits of using a mobile wallet according to US smartphone owners
Exh 8: Awareness and Usage of Digital Wallets, February 2013
Gonna Break On Through to the Other Side
However, there are signs of movement that could bring mobile payments solution to the front burner. First, in 2010, Visa – which accounts for more than half of US credit card transactions – issued a mandate that its merchants upgrade all POS terminals to support PIN entry for security by December 31, 2014, or face liability for fraud. Adherence to the requirement has been spotty at best thus far, but with less than 16 months to the deadline, upgrade activity is likely to pick up dramatically (Exhibit 9). At this point, all of the new PIN compliant POS terminals also include support for NFC, meaning the infrastructure needed to support this initial wave of mobile payments solutions will likely be deployed.
Exh 9: Global installed base of NFC enabled POS terminals
Second, with the rapid growth of Android smartphones, the populations of US consumers equipped to use NFC-based mobile payments continues to increase, albeit skewed toward lower income demographics. Moreover, while Apple has given no indication of supporting NFC in its new products to be announced this week, it is entirely possible that it will include the standard next year once the merchant infrastructure gets closer to critical mass. Consumers are also getting used to paying for tickets on line and receiving electronic barcodes on their smartphones to be scanned on site, a step away from POS payments employing similar technology (Exhibit 10).
Finally, individual merchants are beginning to gain some traction with mobile payments tied into broader customer affinity programs that offer something of value to customers. Starbucks now sees 10% of its business at US stores coming via its mobile app, which does NOT use NFC, but rather completes the transaction by scanning a barcode on the users phone much like the experience of electronic tickets. Other chain retailers, like Jamba Juice, are experimenting with similar programs, which may include perks like pre-ordering and automatic loyalty bonuses. Open Table is piloting a program to allow diners making reservations at restaurants through its service to review and pay the check right from the smartphone app.
Exh 10: Global NFC handset shipments
Is NFC the Right Technology?
The success of Starbucks and the promise of programs like Jamba Juice and Open Table may be making the device focused NFC approach obsolete before it even gains traction (Exhibit 11). These app based solutions rely on the cloud for security, authorizing with bar code messages, or PIN entry. As a part of a cloud-based app, payment can be better integrated with customer affinity programs available from any user device and usable whether at a brick-and-mortar store or on-line. Shoppers can order ahead for pick up, self-checkout from their devices without waiting in line, find product information, seek sales assistance, all from the same app. Consumers benefit from faster transactions, more convenient shopping and more personalized advertising, promotion and service.
Exh 11: Starbucks – Key Digital Transaction Metrics: Q2 2013
Merchants can manage affinity programs tightly with payments, tracking purchases both on-line and in stores to better recommend products and identify likely buyers. Stores can push offers to nearby users, remember “usual orders”, and take advantage of app-based sales assistance and checkout to maximize worker efficiency. Moreover, NFC solutions add a new layer of fees from mobile carriers charging for use of the secure SIM card in the device. Add in that most of the NFC solutions lock in credit cards and their substantial transfer fees as the means of funding. As a result, accepting ISIS, PayWave, PayPass and the like will likely be more expensive for merchant on a per transaction basis than the old swipe system. In the end, cloud-based mobile payments solutions could deliver significant cost savings along with more completed sales and closer customer relationships.
Exh 12: Ebay/PayPal Payments Transaction Volume, 2005-2012
Go Big or Go Home
While Starbucks’ app-based system, designed in house with hot payments startup Square, is a stand-alone solution, we believe the future of mobile payments will be dominated by a handful of large-scale cloud platforms. These solutions will provided by massive Internet-based, consumer facing cloud businesses, like Google, Amazon, Ebay, Apple, and Facebook, or by retailers or consortia of retailers big enough and sophisticated enough to develop truly leading edge cloud apps on their own.
There are several reasons for this. First and foremost, payments systems have enormous synergy with the cloud businesses already dominated by the web leaders. For example: Ebay’s PayPal is an already well-established payment solution widely accepted for on-line purchases, and tied to Ebay’s on-line marketplace, through which consumers can shop and buy from retail partners like Toys ‘R’ Us, Target, BestBuy and Overstock.com. With 123 active digital wallet accounts in the cloud, driving $145B in annual transactions, PayPal is already a scale player in electronic payments with an aggressive plan to bridge into face-to-face mobile transactions (Exhibit 12-13). In 2012, 39% of its US customers paid for a product on-line and picked it up in-store, a process that is a step away from completing transactions from a mobile device at POS. Through its merchandising consulting arm, GSI Commerce, Ebay can bridge its on-line partnerships into the store, enabling programs like order ahead and service personalization, and drive transaction volume to PayPal.
Exh 13: PayPal Mobile Transaction Volume, 2006-2012
Ebay rival and global e-commerce leader Amazon is currently the number one tool that US consumers use to find products on-line and already represents hundreds of thousands of global retail merchants in its 3rd party marketplace program. Most of these partners already rely on Amazon to handle payments for on-line purchases, a capability bundled with customer acquisition, promotion, warehousing and distribution services, making it a small step for the e-tail giant to push its platform into brick-and-mortar POS if it were to so choose.
Likewise, Google has launched a “Buy with Google” initiative, giving on-line merchants a “two-click to purchase” solution directly from search and display ads. As Google controls nearly half of all web advertising, it is in a powerful position to sell this solution (Exhibit 14). Furthermore, Google is integrating comparison shopping tools directly into its dominant search platform, meaning consumers will be able to scan a bar code or even take a picture of a product and get competitive price quotes in the aisle of a store (Exhibit 15). Add in leadership in maps and location-aware apps, a growing social media presence with Google+, the increasingly dominant Android mobile platform and unmatched usage data/analytical capabilities, and Google has the blocks to build comprehensive merchandising programs for retail partners that could find promising potential customers, deliver timely and effective advertising and promotion, and eliminate “friction” in the selling process. Google’s first stab at the mobile wallet was a widely considered failure, tripping up on the inadequacy of NFC deployments and the interference of mobile carriers, particularly Verizon, which blocked Google Wallet from using the SIM card for security. Expect Google’s payment future to be big and in the cloud.
Exh 14: Global Measured Media Advertising Spend, 2010-2014
Exh 15: Product comparison shopping sites ranked by conversion rate, 2Q 2013
Apple has revealed little about its plans for mobile payments, but has been vocal in touting the potential value of the 450 million credit card numbers that it has on file through its iTunes/App Store business. Apple has also been a pioneer in retail payments, deploying mobile checkout from devices carried by all employees in the store – waiting in line is not necessary, just have a roving sales assistant swipe your card and go. It also has introduced its underutilized Passbook app to iOS6 a year ago, enabling iPhone users to contain electronic tickets and payments information in a secure folder on the device. With rumors that the company will include a fingerprint scanner on the iPhone 5S to be announced Tuesday, Apple could be on the verge of getting more serious about enabling mobile payments for its famously loyal installed base.
The other big cloud-based player is MCX, a consortium of nearly 50 well-known merchants, anchored by WalMart and including Dunkin’ Donuts, CVS, BestBuy, Bed Bath and Beyond, Shell, Sunoco, Target and Kohls (Exhibit 16). Together, the merchants claim to account for more than $1 trillion in annual transaction volume, obviously big enough to claim scale, with direct synergy to their own affinity and promotion programs. MCX is developing its own cloud-based electronic wallet built around downloaded barcodes for purchase authorization to be accepted at all consortium member retail outlets and on-line. The consortium would reserve all transaction data specifically for the individual merchants, and would link into the on-line merchandising programs being administered by each of the members. For consumers, MCX creates the convenience of a single, widely accepted, app for users, with a common procedure for funding and using it at all participating stores, integrated into value-added services (auto-checkout, order ahead, sales assistance, etc.) as provided by each of the merchants. The challenge for MCX is execution – it is not a world-class app developer or cloud service provider, and the difficulties in managing the varied interests of fierce competitors within a co-operative consortium are not trivial.
Exh 16: Merchant Customer Exchange Participating Merchants
But That’s Not All …
Not only do the big Internet franchises have substantial synergies between mobile payments solutions and their core businesses, but they will also leverage significant economies of scale. MCX is massive retail consortium, but Amazon, Ebay, Apple and Google are sizeable retail businesses in their own rights, each with hundreds of millions of regular customers, billions of dollars a year in electronic transactions, and, at least for Amazon, Ebay and Google, relationships with tens of thousands of retail merchants. All four players have billions of dollars invested in cloud data processing infrastructures, with Amazon and Google at the leading edge of processing cost and technology. Scale begets lower costs and stronger consumer awareness, driving wider merchant acceptance.
In the future, Google and Apple will likely integrate mobile payments mechanisms directly into their dominant software platforms, with their payments enabled electronic wallets installed as the default option for purchased initiated through their core applications. This is a huge advantage – imagine initiating a shopping query through Google Search or Apple’s Siri and being offered to complete the transaction with a single click based on funding information on file with Google or Apple, costs being equal, why open a separate app to make payment? History suggests few users will go to the trouble – advantage Google and Apple.
Moreover, the cloud players have captured extraordinary data profiles on the regular visitors to their sites, data that is invaluable to retailers looking to target the most attractive potential customers for advertising and promotions. The leaders here are obviously Google and Facebook, but Amazon and Ebay also have significant data assets. Not only do these companies have data advantages, but they also have abilities to analyze the data that go far, far beyond any traditional retail merchant. As transaction data is layered onto this rich information set, the value of broad payments platforms administered by these companies will be further enhanced.
It also helps that the big cloud platforms, including MCX, do NOT have to make big margins on payments to justify their investments in establishing their presence. Bundling payments into more comprehensive merchandising solutions can be a loss leader, eventually paid for by advertising, promotional programs, IT hosting, sales commissions, and/or warehousing and distribution agreements. Google and Amazon, in particular, have shown a propensity toward investing in similar low/no margin businesses as a means to end. Furthermore, the major internet players have the advantage of huge cash reserves to fund comprehensive payments initiatives along with the ambition and patience to allow the market to develop to their benefit.
Whether it takes 5 years or 10, we believe that the advantages of business synergy, scale, platform integration, big data, alternative monetization strategies, and deep pockets will win out, and that most merchant specific apps will tie back to these broader programs for payment. Merchants with sufficient scale and high repeat customer frequency, such as Starbucks, may be able to sustain their own successful independent programs, but the realities of app real estate dictate that only the most commonly used retail apps will stay on their customers’ smartphone home pages. MCX, may be able to sustain independence based on its scale, but the rest are better off rolled up into an electronic wallet integrated to the smartphone platform. We are also bullish on the potential for vertical solutions, in particular, Open Table’s plans to integrate payments at the table with its dining room management software and cloud-based reservations system, already adopted by 36% of all reservations taking restaurants in the US (Exhibit 17).
Exh 17: Open Table penetration metrics in North America, 3Q 2013
Exh 18: Sample U.S. Credit Interchange Fees
We Don’t Need No Stinkin’ Cards
Accepting a credit card as means of payment costs a merchant roughly 2-2.5% of the value of the sale in fees. The biggest fee, interchange, is paid to the bank that issued the customer’s credit card, and amounts to 1.54% of the transaction, plus a per transaction fee of $0.10. This fee is set as a standard by the credit card association (Visa, MasterCard, Discover, etc.), which takes an additional “assessment” fee of 0.11%, plus a $0.025 per transaction assessment, for itself. The card processor or acquiring bank, which manages the fees on behalf of the other parties, takes a negotiated fee for itself, typically around 0.2% of the transaction value plus another $0.10. These fees add up, and are often the highest expense for a retailer after COGS and real estate (Exhibit 18–20).
Exh 19: Sample U.S. Assessment Fees
Exh 20: Effective transaction fee rates by size of purchase
On the flip side, these fees are hugely profitable for the financial industry providers with the protection of a highly concentrated market with historically massive barriers to entry. The interchange fee plus credit card assessments are non-negotiable, with the only leverage on the processor’s mark-up. As long as branded credit cards are used to fund purchase through a mobile payments mechanism, this fee structure will be largely intact. However, there is another way.
If a mobile payments provider can motivate its customers to fund their purchases directly from their bank accounts, rather than using a credit card, the 2-2.5% fees can be avoided. While there are additional costs associated with completing transfers to merchants and managing fraud, these would not be expected to be more than a small piece of the savings, and the balance could be used to give incentive to promote consumer adoption and for profit. Consumers have been growing more familiar with ACH transfers through electronic bill paying and may be ready to shift their approach to funding, particularly if the incentives are appealing enough. For merchants and the MCX consortium, this would be a huge savings in their costs of doing business. For the internet giants, this could be a step toward using their powerful platforms to offer a wider range of financial services, including personal banking, directly. While this would require actually owning a bank and subject the parent company to the regulation and risks that the business entails, the idea of a virtual, internet-only bank may not seem as farfetched a few years down the road as it does today.
Now and Then
While we believe that the long term future of payments lies with cloud-based solutions spanning both on-line and brick-and-mortar POS, tied to full service merchandising solutions for retailers, and integrated tightly into mobile device operating platforms, the near term will look different (Exhibit 21). In the next year, the deployment of NFC ahead of the Visa deadline will reward POS terminal vendors, with VeriFone particularly well disposed to prosper. Over the next TWO years, NFC solutions from the card networks and carriers could pick up considerable momentum with merchants. However, we are concerned that these solutions offer insufficient consumer benefit to spur more than modest adoption. The exception will be well conceived merchant affinity programs, like Starbucks, that tie payments to real consumer benefit, the MCX consortium – if it can deliver an excellent solution in a timely way -and Open Table, where we believe that the obvious synergy of adding at-the-table payments to its comprehensive and dominant restaurant reservations solution is compelling. Ebay, which proposes to be a partner with merchants looking to establish affinity programs with payments solutions, should see strong growth, although financial industry fees may leave margins below water if the company cannot materially shift its consumer customers to direct ACH funding.
However, before the end of the decade, we expect cloud-based solutions from Google, Amazon and Apple to gain primacy with both consumers and merchants, helping to grow revenues from synergistic businesses – advertising, promotions, e-commerce, etc.. It is only in the latter half of this decade that the real and considerable threat to the credit card industry will be fully apparent.
Exh 21: Mobile Payments Winners and Losers