Here's why Apple Pay will shake up consumer payments, even if it gets lost amid the iDevice frenzy
Mobile payments may have gone from a nice-to-have to a must-have today, thanks to Apple’s announcement of its Apple Pay platform.
Replacing physical wallets and payment cards has been attempted by countless companies over the last decade, but never with much success. The big problem has been the inability to drive the widespread adoption among both consumers and merchants necessary to move this beyond a niche, early adopter technology to one embraced by the mainstream.
If Apple has proven anything, it’s that the company has the ability to reinvent and relaunch existing product categories and achieve newfound success. The company did this first (in recent memory) with the MP3 player, then with the smartphone, and later the tablet. Sure, a large part of Apple’s success has been the elegance of its product and software design, but an equally significant factor has been the company’s reach and credibility among mainstream media and consumers alike. When Apple says a category matters, people tend to sit up and listen.
Apple is also better than any company around at lining up the right strategic partners ahead of entering new categories – think music labels for iTunes, cellular carriers ahead of the iPhone, and now banks and large retailers in payments – in such a way that these products and services simply “work” right out of the box. In the case of Apple Pay, Apple announced integrations with Macy’s, McDonald's, Walgreens, Staples, Disney, and several other major retailers, not to mention its back-end partnerships with Visa, MasterCard, AMEX, and the six largest issuing banks that it says collectively represent 83 percent of all credit card volume.
We heard a lot of big promises today from Apple around its entry into payments. Tim Cook introduced Apple Pay with a demo video that was just a few seconds long that showed a consumer touching their new iPhone 6 at checkout to a NFC payments terminal. He said something to the effect of, “Did you see that? That’s it. Did you blink? Did you miss it? Let me show you again.” It’s classic Apple to make the mundane and familiar seem revolutionary and new. And yet, it works, more often than not. NFC payments aren’t new, and have existed in the Android ecosystem for several years. The same is true of mobile wallets that store user payment credentials, via PayPal, Venmo, and previously, Google Wallet and Lemon. Cook ended the segment with a prediction: “Apple Pay will forever change the way all of us buy things.”
Where Apple believes its solution is different than these predicessors, beyond the above mentioned partnerships – which shouldn’t be overlooked – is in the security and privacy technologies that its brought to bear on this category. As I've written previously, Apple’s TouchID biometric sensor – which is widely considered best-in-class – gives it the ability to secure mobile devices and authenticate payees better than its competitors. But Apple added a new feature called the Secure Element to its iPhone 6 line that takes this a step further. Like many other apple features, secure elements have been around for a while, most notably as part of the old Google Wallet platform. But combined with Apple's hardware advancements and business development muscle, could finally change the way consumer payment security is handled.
Unlike many payments competitors, Apple does not share user payment credentials like credit card number, expiration date, security code, and billing address with merchants. Instead, the company stores those details in encrypted form within the Secure Element and at the time of payment converts those details into what it calls a device-specific one-time payment number and a dynamic security code, often called a "token," that is passed to the merchant. In this way, merchants never have access to the payee’s credit card information and thus cannot lose it should their security systems be compromised. (This would have been nice around the time of the Target security breach and other major hacks over the last few years.) IPhone users can also suspend all their payments credentials remotely using the Find My IPhone app or website, meaning that if the device is lost or stolen, credit cards don’t need to be cancelled. Cook described it as security married in hardware and software that only Apple can deliver.
Perhaps most interestingly, given how accustomed we’ve grown to large technology companies viewing consumers as endless sources of data, Tim Cook told the audience today that “Apple doesn’t know what you bought, where you bought it, or how much you paid for it. That transaction is between you, the merchant, and your bank.” In other words, Apple is rolling out a new payments railway between the consumer and the merchant, but will not be looking to replace the incumbent payments networks. This should come as little surprise given the fact that Apple partnered with, rather than attempted to replace the large credit card companies and banks.
The two big questions walking away from this announcement are, what impact will Apple Pay have on payments competitors like PayPal, Stripe, and Square? And, secondly, what impact will Apple Pay have on Apple’s bottom line?
A shot across the bow of the payments industryTackling payments competition first, today’s Apple Pay announcement was not good news for any of the modern payments technology companies – Visa, MasterCard, and AMEX, on the other hand, got a welcome reprieve from Apple-led disruption – but it's worse for some than for others. With over a billion iOS users and 800 million iTunes account holders, Apple has an enormous installed base, many of which will eventually upgrade to NFC and Apple Pay enabled devices. And with the typical breathless coverage of Apple product announcements and the launch partners announced, the vast majority of this user base will be aware of Apple Pay in short order.
When it comes to driving adoption, a few key ingredients are awareness, existing customer relationships, and brand trust. Apple has those ingredients in spades – questions about the recent iCloud celebrity photo hack notwithstanding – which means that it can quickly catch up to payments market leader PayPal in terms of installed base among consumers. The company has also proven that it will have no problem enticing many of prominent merchants to support Apple Pay. That said, notably absent among the list of launch partners are the world's largest retailers like Wal-Mart, Safeway, and CVS which have fought heavily against recent attempts to regulate interchange fees under the Durbin Amendment. If Apple wants Apple Pay to become truly ubiquitous, both in-person and within mobile apps, it will eventually need to convince these holdouts that it adds more value than it takes away (through any fees), perhaps by increasing transaction volume through reducing friction.
If Apple ushers in a world where consumers no longer carry physical credit cards, Square and other NFC-less payment terminal providers could be dramatically impacted. The company has already tried and failed to drive adoption for its own mobile wallet app, pulling Square Wallet from the app store earlier this year. And for small and large merchants, the appeal of having a mobile-device powered register is dramatically diminished if that register doesn’t also support NFC. Future versions of the iPad and select Android tablets may offer NFC functionality, but as of right now, plugging in a simple Square payments dongle won’t allow merchants to support in Apple Pay.
Stripe, like Square, lacks any kind of meaningful relationship with the consumer which will make it difficult for the company to take advantages of the benefits of mobile payments, like biometric security and NFC-powered payments.
PayPal (via Braintree) offers its own One Touch mobile payment solution, but as described above, finds itself in many ways at a significant disadvantage in terms of driving adoption of this technology among both merchants and consumers. According to a company spokesperson, todays announcement won't impact PayPal and Braintree's existing merchant relationships or the income it generates. For example, the Apple Pay partnership with Uber announced from stage will simply mean that payment tokens rather than actual credit card details will be passed from the AppleDevice to Braintree and process as usual.
With Apple partnering with banks and credit card providers, rather than disintermediating them, PayPal's position in the payments hierarchy appears safe for the moment, while Square and Stripe seem more vulnerable. That said, the Apple Pay we see today looks a lot like a wedge that the company has inserted into the industry, and one that could use to continue to pry open the market, should Apple decide that it wants to take more of the payments pie for itself.
Apple Pay: A user acquisition tool or a profit center?Unsurprisingly, Apple made no mention today of the economics of Apple Pay. Put another way, we have no idea if this platform is meant to drive cash to the bottom line or simply to give consumers another reason to buy Apple hardware. Wall Street analysts have been speculating about the rumored “iWallet” in recent weeks, and the common conclusion has been that this is more about ecosystem lock-in than direct profits. With so many constituencies taking a piece of the relatively slim payments margins, it’s unlikely that Apple can generate the kind of income that would be required to meaningfully affect its bottom line. A JP Morgan analyst, for example, predicted that in the best case scenario, the addition of Apple Pay could add just 0.5 percent to Apple’s earnings per share. With Apple generating nearly $40 billion in 2013 earnings, this is no small sum – on the order of $185 million in additional earnings – but, given the scale the company operates at would not be enough to move the needle.
Another wrinkle in this still opaque payments picture is the terms of the partnerships that Apple negotiated with its banking and credit card partners. Rumors leading up to today’s announcement suggested that the company had used its enhanced security and anti-fraud features to negotiate unprecedented discounts on the already low “card present” rates applied to traditional in-person credit card transactions. If true that could impact the above conclusions slightly, but still not enough at the outset to truly move the needle for Apple.
Then again, iTunes started out in much the same way as a vehicle for selling iPods, and later iPhones and iPads, but has grow into its own meaningful profit center. Even the so-called “hobby” Apple TV now generates non-trivial revenue and earnings for Apple. It’s far too early to predict just how ubiquitous and thus how financially impactful Apple Pay could be. In the early going, it’s likely that it will contribute far more indirectly by driving purchases of iPhones and the newly-announced Apple Watches, rather than through payments-specific profits.
The question payments industry insiders will be asking themselves today is, is Apple looking to further split the existing pie, meaning taking a cut for itself, or grow the pie in some form by increasing transaction volume. If it's the former, whatever profit Apple takes for itself will come out of someone else's pocket. Given rumors of the sweetheart deals it reportedly secured with issuing banks, it would appear that this is where that cut will first appear. But if history tells us anything, it's that any haircut banks take on one end of a transaction, will quickly be passed along to either merchants or consumers on the other end.
If this is the case, it could be one reason we don't see Wal-Mart and other Durbin opponents represented in today's list of launch partners. Another related issue is that large merchants have been fighting tooth and nail to reduce processing fees by driving more debit card transactions – much the same way as PayPal prioritizes the use of ACH transfers. If Apple Pay leads consumers consumers to designate credit cards, rather than debit cards as their primary payment mechanism, this could swing that pendulum in the opposite direction and surely wouldn't earn Apple many friends among the largest merchants.
We don't have enough information at this stage about the specifics of Apple Pay's merchant-facing terms, but expect those details to emerge in the coming weeks. Depending on what they reveal, we could be in for an entirely new round of fireworks around Apple's entry in to the payments game.
A new era in mobile paymentsThere were more leaks leading up to this year’s Apple product keynote than in many years past, and yet, the company still managed to wow the crowd and those watching from afar. Apple Pay will likely be lost in the initial buzz about Apple’s new giant iPhones and Jesus wearable, but its a significant development for the already competitive payments industry.
Consumers may be more skeptical than at any point in recent memory about the security of Apple's cloud, and that will surely weigh on the minds of some as they decide whether to trust Apple with their payment credentials. But what many naysayers fail to realize, is that some 800 million consumers have already given Apple this information, and it will be as easy as a single click to integrate this existing iTunes payment data into Apple Pay. That alone means that uptake should be swift and broad, not to mention the appeal of finally leaving your physical wallet at home.
Much like Peter Thiel likes to lament that “We were promised flying cars, but all we got were 140 characters,” consumers have similarly been promised for years and years a fully-digital payments experience and gotten little more than glorified toys. Large and otherwise impressive companies like PayPal, Google, Amazon, Square, and Stripe, have all tried to tackle this problem before with limited success. But as is the case in most categories it enters, no one like Apple has tackled payments before. Which is precisely why you should expect Apple Pay to take hold like nothing we’ve seen in the past. There will be losers among existing payments players, but it will take some time for that market to fully shake out. With convenience and security at the center of today’s announcement, the biggest winner of all will be the consumers.