Mobile Payments: The Evolution from Loyalty Rewards to Branded Currency

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August 7, 2013

Mobile Payments: The Evolution from Loyalty Rewards to Branded Currency

  • Branded currency (store credit cards, gift cards, and loyalty cards) accounted for $325bn of purchase volume in 2012 versus $186bn for e-commerce. We expect these purchase volumes to grow dramatically with the rollout of mobile payments and digital wallet applications.
    • Starbucks provides a precedent: the 6 million members of the loyalty program accounted for 20% of transactions (as of March), and will grow to 9 million by year-end.
  • The difference between traditional loyalty points, such as airline miles subject to blackout dates, and branded currency is cash-substitutability.
    • Products such as Capital One’s “Purchase Erase” (allowing you wipe out the cost of a purchase from your account statement using accrued miles) close the gap; the online Chase-Amazon card (allowing you to use loyalty points at checkout – see Exhibit) eliminate it.
  • The rollout of mobile payments (see our August 5th note) and digital wallet applications will enable the evolution of loyalty rewards into branded currency at point-of-sale just as the Chase-Amazon card, for example, has done on the internet.
    • Digital wallets will allow consumers to carry multiple store cards in a way that would be cumbersome in a physical wallet; and
    • Applications, such as Apple’s Passbook, will make large digital wallets manageable by levering the capabilities of a smartphone to present context-relevant payment choices: so, as a trivial example, your Home Depot store-card when you are at Home Depot.
  • Retailers have strong incentives to promote branded currency as mobile payments infrastructure rolls out:
    • Reduced Visa/MasterCard fees to the extent consumers can be incentivized to fund store cards with ACH-accessed bank accounts rather than Visa/MasterCard accounts.
    • Electronic capture of “big data” enabling personalized offers based on purchase behavior and, hence, enhanced brand-engagement of consumers.

Exhibit: Integration of Loyalty Program and Payments on Chase-Amazon Card


Branded currency (store credit cards, gift cards, loyalty rewards, and coupons) together accounted for $325 billion 2012 purchase volume representing nearly double the $186 billion[1] in US retail e-commerce spending. This purchase volume is divided roughly evenly between store cards with pre-approved credit lines (see Exhibit 1) and store cards that are prepaid either through gifts, including “self-gifts” when the cardholder loads the card from another account, or through loyalty rewards[2]. Gift cards accounted for twice the volume of loyalty rewards, and the redemption of product coupons was small at $5 billion.

Exhibit 1: Purchase Volume on Store Credit Cards

Source: The Nilson Report

While retailers and brands have long tried to influence consumers through store-branded cards linked to loyalty programs, consumers can find them inconvenient to use: they create wallet clutter and may be left at home often creating more frustration than positive brand engagement. However, the adoption of digital wallets on smartphones will create important new opportunities for store-branded programs; at Starbucks, for example, there were 6 million members in the loyalty program in March (expected to grow to 9 million by year-end) accounting for 20% of transactions.

It is easy to dismiss Starbucks as a unique exception. Customers tend to be high-frequency visitors (so that it may make more sense to carry a Starbucks card at all times than, say, a Home Depot card) and the firm has had unique success with its digital wallet application which (extraordinarily) accounted for substantially all of the $500 million mobile payments in the US last year. However, we see Starbucks as an early-mover rather than an exception and expect purchase volume on store-branded cards to grow significantly as mobile payments roll out and as applications, such as Apple’s Passbook, make it easier for consumers to use the cards and easier for retailers to incentivize their use with loyalty programs.

From Loyalty Coupons to Branded Currency

In a paper-based system, you cut out your loyalty coupons from a newspaper and present them, along with cash, at checkout; it is slow, messy, and inconvenient. In a traditional card-based system, you accumulate loyalty rewards over time but they may not be cash-substitutes, with airline miles a frustrating testimony. Some card companies have introduced loyalty rewards that are closer to currency with products such as “Purchase Eraser” from Capital One (which allows you wipe out the cost of a purchase from your account statement using accrued miles).

However, it is online that loyalty rewards become closest to currency. On the Chase-Amazon card, for example, the customer specifies at checkout how much of the transaction amount is to be charged against loyalty points and how much against a Visa payment account (see Exhibit 2). In this case, loyalty rewards are as good a medium of exchange as Chase credit.

Exhibit 2: Online Integration of Loyalty Program and Payments on Chase-Amazon Card

Digital Wallets: Enabling Branded Currency at Point of Sale

The promise of mobile payments is that it will enable this substitutability of loyalty rewards for currency at point-of-sale; of course, the loyalty rewards will not be legal tender but, within the context of the relevant brand, will be just as good hence use of the term “branded currency”. However, if loyalty rewards are indeed to be used as currency at point-of-sale, the industry needs to address two issues which arise in any payments process: authorization and clearance.

One possibility is for the cardholder to carry two cards: a loyalty card attached to loyalty points and a payment card attached to a payment account; however, this is obviously cumbersome and slow at checkout. A second possibility is to make a card dual-purpose which is the approach Starbucks took with the Duetto card launched in 2003; the card carried two magnetic stripes one allowing it to be used as a store card linked to a loyalty program, and the other allowing it to be used as a Visa card either at Starbucks or elsewhere.

A third possibility, adopted by Starbucks in 2010 when Duetto was discontinued, is to ask customers to make the store card the primary purchase card. The risk of this third option is that a customer may resist the wallet clutter associated with using a Starbucks card at Starbucks, a Home Depot card at Home Depot etc. and the inconvenience of having to manage multiple cards. (For Starbucks, the risk is less than for other retailers because of the high frequency of visits for loyal customers so that it may make more sense to carry a Starbucks card at all times than, say, a Home Depot card).

A digital wallet addresses the issue of wallet clutter since a smartphone is no more cumbersome with a hundred uploaded digital cards than with two. And applications, such as Apple Passbook (and its Android clone, PassWallet) will address the issues of managing multiple cards.

Apple Passbook

The Apple Passbook application was released with iOS 6 in September 2012, and is opaquely named: “Apple Money” would be more suggestive of how it will be used by many consumers. The Passbook allows you to load[3] your branded-currency instruments (except store-brand credit cards), so loyalty cards, gift cards, and coupons, as well as event tickets and boarding passes (essentially branded currency with an expiry date) into a digital wallet. Apple refers to these loadable items generically as “passes”.

The key to the application is that the pass-provider can read and write information to the passes, and make use of the location- and clock-based abilities of iOS to push context-relevant information to your smartphone. So, for example, if the pass is for an event the pass-provider can detect when you arrive at the hotel, read the panel you are speaking at, update your pass for any schedule changes, and push you news about fellow panelists[4]. As it turns out, these context-relevant read/write capabilities and push-notifications match the requirements for the authorization and clearance of mobile payments, management of digital payment cards, and more general engagement of customers in store brands.

For example, a store-card provider can push you a notification that you are close to a store location and offer you a context-relevant inducement, based on your purchase history, to stop by (so, in my case please, a reduced-price cup of Earl Grey if I happen to pass within a few steps of Teavana around 4pm). At checkout, the store-card provider can post to your smartphone a screen or menu, different in form perhaps but functionally equivalent to that used online by Amazon in Exhibit 2, asking how to allocate your due amount between context-appropriate payment accounts including any loyalty account. Once you have authorized your payment bundle, and it has been accepted by the merchant, the store-card provider can update the balance on

your loyalty account (including a credit for any rewards arising from the purchase) and initiate the usual settlement and clearance processes for any payment amount on a Visa account.

Implementation depends on Mobile Payments Rollout

The above example is possible, but not current, because it depends on the rollout of mobile payments infrastructure. The communication between a payment card and the merchant terminal required for coordinated authorization and clearance on multiple payment accounts – a loyalty account and a Visa account, for example – cannot easily be implemented using magnetic stripe technologies. However, it can be accomplished using mobile payments by levering the processing capabilities of a smartphone and the information-exchange capabilities of near-field communications (“NFC”) technology. By 2017, we expect substantially all US smartphones to ship with NFC technology and over 80% of merchant point-of-sale terminals to be NFC-ready (see our August 5th report “Mobile Payments at the Tipping Point”).

Beyond this core payments functionality, the broader promotional activity including location-based push-offers, probably require WiFi for reasonable range and a cloud-based infrastructure: this, in turn, depends on pre-registration of the customer with the store which, of course, is the what membership of a loyalty program entails.

  3. In practice, the upload must be done via a “Passbook-enabled” application from the provider of the branded currency or via more general-purpose “Passbook-enabled” applications from third-party developers such as Gyft (to upload gift cards). Using Lemon, you can even upload a Visa card although, to make it work for mobile payments, you may need to tell the cashier the expiration date.
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