Mobile Wallets: Structural Advantage of MCX over Apple, Google, PayPal, and Square
SEE LAST PAGE OF THIS REPORT Howard Mason
FOR IMPORTANT DISCLOSURES 203.901.1635
January 26, 2014
Mobile Wallets: Structural Advantage of MCX over Apple, Google, PayPal, and Square
- Mobile wallets are on the cusp of mass adoption: the WSJ reports that AAPL is looking to allow consumers to use iOS mobile devices to pay for physical goods outside Apple stores with their iTunes accounts; Google Wallet will by-pass carrier control by host card emulation (effectively a secure-element-in-the-cloud); and Isis is this month making available NFC-enabled iPhone cases.
- These wallets, along with those provided by Square and PayPal, will gain traction among small and specialty merchants by offering e-coupons and otherwise improving the shopping experience (e.g. pay-with-your-name by Square, skip-the-line and order-ahead by PayPal, and BLE “Beacon”-enabled location-based marketing by PayPal and Apple), but will run up against a structurally-advantaged MCX wallet at many mass merchants. These MCX advantages are:
- Low Acceptance Cost: MCX will not use the existing card networks (but rather a proprietary infrastructure in partnership with FIS). As a result, it will not pay interchange and premium network fees so that acceptance costs will be nearer 4 cents/transaction versus 1% of transaction value (so 40 cents on a $40 ticket) for PayPal, for example; savings will be recycled to consumers.
- Low Customer–Acquisition Cost: Cashiers will prompt consumers to enroll and use MCX wallets just as they presently do for Target Red cards.
- Access to In-Store, SKU-level Payments Data: Only merchants have access to these “hard” payments data which are valuable for targeting and personalizing e-coupon offers; indeed, a core objective of MCX is to protect these data from third-parties such as GOOG.
- Brand Benefits: MCX merchants can outbid competing mobile wallets for customer engagement because of brand benefits. For example, Target offers a 5% discount to customers using the Target RED card (versus an average acceptance costs for Visa debit and credit cards of less than 1.5%) because the brand benefits accrue to Target, not a third-party.
- As Apple and others build consumer awareness and trial of mobile wallets, we expect MCX members to act aggressively to shift transactions to the MCX platform. MCX sees the transition to mobile as a one-time opportunity to create a more merchant-friendly payments environment, and we do not expect members to squander it by accepting wallets that replicate existing bank-friendly rules and clutter the point-of-sale (see below): “The existing rules that are in place for card-based payments are not going to be acceptable for mobile-based payments” Jamie Henry, Payments Director, WMT.
In 2013, PayPal processed $180bn of payments volume, at an average of ~$1,300 per account across its 135 million accounts, generating net revenue of $4.2bn (see Exhibit 1). This revenue represents 2.4% of the payments volume based on a “take rate” (how much PayPal takes on each transaction) of 3.7%, a transaction expense (how much PayPal pays the payment networks such as Visa and MasterCard) of 1.0%, and a loss rate because of fraudulent transactions of 0.3%. It is important to note that the payment networks deem all PayPal transactions as “card not present” (even if the customer is using a mobile application in a face-to-face setting) so that PayPal, and not the issuer bank, is liable for fraud losses.
Exhibit 1 – Payment Volume and Revenues for PayPal
Source: Company Reports, SSR Analysis
The WSJ reports that AAPL, having recently filed a patent for a secure phone-based system using wireless technology (“a method to send payment data through various air interfaces without compromising user data”), is looking to allow consumers to pay with iTunes using iOS mobile devices outside Apple stores. It has ~600 million accounts on file compared with the 135 million at PayPal and 224 million at Amazon. However, it does not have the e-commerce platform of either (with eBay, for example, generating 30% of PayPal’s volumes).
The news on AAPL prompts this review of the digital wallet space which is becoming increasingly crowded and includes, in addition to PayPal and Square: the carrier-sponsored Isis (set to begin selling NFC-enabled cases at the end of the month so that it can be used with iPhones); Google Wallet (likely to gain more traction having by-passed carrier control with host card emulation that puts a secure element in the cloud); and Amazon Payments (allowing customers of participating e-commerce companies to purchase goods and services using their Amazon account information).
Different Business Models
There is an important difference between pass-through digital wallets, such as Isis, and staged digital wallets such as PayPal, Amazon, and Google. In the case of Isis, the customer does not open an Isis account but rather provisions a qualifying card into the wallet; the transaction is processed and experienced by the cardholder (in terms of statements and rewards) just as if the card had been swiped at point of sale. In the case of a staged wallet, the customer opens an account with the digital-wallet provider (e.g. an iTunes account in the case of Apple) and links that account to a suitable debit or credit card. The impact of this account is to hide the end-merchant (except for large merchants) from Visa or MasterCard; from the standpoint of the networks (and hence cardholders statements), the merchant-of-record is the staged digital wallet operator (“SDWO”) which is referred to as a payments “aggregator”.
Unlike Isis, which makes its money from the issuing banks (WFC, Chase, and Amex) who pay to provision their cardholders’ cards onto the secure element of an Isis-ready mobile phone, SDWOs look to earn a spread between the fee charged to merchants and the fee due to the payment network (including the interchange portion that is ultimately passed through to the bank issuer). PayPal was the first payments aggregator and, in 1998, filled a market niche by enabling e-commerce merchants who were too small or too risky for servicing by traditional acquirers (such as Paymentech) to accept payment cards. The networks had concerns around monitoring the transactions and risks of the end-merchant but saw PayPal as a way to extend online acceptance of payment cards among smaller merchants by overcoming consumer resistance (for security and convenience reasons) to providing card credentials to multiple web-sites.
In the event, and with the support of WFC as its acquirer, PayPal became a standard for online payments by developing tools for managing online risk (which, as an aside, are meaningfully enhanced by the data available from customer activity on eBay). The cycle repeated when Square was founded in 2009. Its value proposition was to enable bricks-and-mortar merchants who were too small or too risky for servicing by traditional acquirers to accept payment cards using dongle-equipped mobile phones. The networks had concerns around monitoring the transactions and risks of the end-merchant but saw Square as a way to extend acceptance of payment cards among smaller merchants by overcoming merchant resistance to the costs and procedures involved in establishing a merchant account with an acquiring bank.
In the event, and with the support of Chase as its acquirer, Square has become a model for onboarding micro-merchants and is being imitated by traditional acquirers (such as Bank of America and First Data) who want to be able to migrate those micro-merchants that are successful to acquiring accounts. In addition SDWOs with roots in e-commerce (AMZN, GOOG, and PayPal) are looking to emulate Square by extending their brands from online to e-commerce, and likely have data advantages that will support advantaged fraud costs.
Integration of Payments and Marketing
The initial value proposition to consumers of PayPal in the online space was relief from the having to enter card credentials on to multiple web-sites. Given a card swipe in a face-to-face environment is so straightforward, there is no equivalent value proposition to SDWOs in the physical world; as a result, they have looked to add value to consumers (and merchants) through integrating payments and marketing. The most common form of this is through e-couponing to make personalized and targeted offers and to facilitate consumer redemption of offers at checkout. Over time, the integration of payments and marketing will likely change the way merchants think about the pricing of payment cards.
LevelUp, for example, undercuts Square and other wallet by charging a flat 2% payment processing fee (versus 2.75% by Square) but makes up the difference by charging 25 cents on the dollar for incremental sales delivered through e-coupon campaigns offered through its wallet; the firm offers analytics to support the design and measurement of these campaigns which, aside from driving merchant sales, can build customer loyalty for both the merchant and LevelUp. Increasingly, we expect SDWO’s to compete based on their ability to support merchants through e-coupon campaigns and the large online players, such as GOOG and AMZN, will be able to leverage their knowledge of customers to gain advantage by personalizing and targeting offers.
PayPal and Apple are exploring broader ways to improve the customer shopping experience and merchant checkout times including, in the case of PayPal, order-ahead and skip-the-line. Both are also exploring the use of wireless technology (Bluetooth low-energy) for geo-fencing (indoor navigation) and location-sensitive offers and information (for customers at a particular aisle in a store or even just passing by). While this technology, branded Beacon by PayPal and iBeacon by Apple, is capable of enabling payments and may be used in this way for some specialty stores, we believe it will be need to be complemented for mass-market stores with NFC at checkout if only because most of these merchants will have in-place NFC-capable POS terminals (because of the shift to EMV compliance) but will need to make incremental investment for BLE.
The proliferation of digital wallets, while embraced as a marketing and differentiation opportunity by some specialty retailers, is causing alarm among many large merchants. There is concern about the costs of enabling point-of-sale (POS) terminals for multiple wallets and the complexity of the customer experience, and concern about how mobile aggregators will use the customer data generated from payments activity:
- “Trying to get a POS project through at any merchant practically takes an act of God. So to make a business case for five or six payments systems is just not going to work. We don’t want our point of sale to look like the side of a NASCAR racecar covered in logos for a variety of different payment providers. That level of complexity is not palateable for our environment” Jamie Henry, Payments Director, WMT.
- “What would those wallets be doing with that data? Would they use it to steer customers to competing stores. The control and ownership of the data is really important to us retailers” John Manna, vice-president, Lowe’s Corporation.
In part to address these concerns, a group of merchants (accounting between them for ~$1bn of US consumer spending) have formed the MCX consortium with the objectives of controlling and protecting customer data, reducing the costs of card acceptance, and streamlining the customer experience. Indeed, MCX asks its members not to accept new competing mobile wallets. News of a possible launch of an Apple wallet will increase pressure on MCX to roll out its alternative and on merchants to offer attractive rewards to encourage its adoption by consumers. In the competition for wallet adoption and usage among digital wallet providers, MCX will have important advantages:
- Data: Member merchants have access to customer’s in-store, SKU-level payments information. Indeed, a key motivation of MCX is to control and protect these data from third-parties (including fellow consortium members).
- Cost: Unlike digital wallets that leverage the Visa/MasterCard/Amex infrastructures, MCX wallets will not pay interchange to issuing banks and will pay meaningfully lower network fees (perhaps 2 cents/share
- to FIS for PayNet transactions and an additional 2 cents/share if these are settled over ACH rather than by BIN-routing versus 6-7 cents for Visa debit and double that for credit). In contrast, PayPal is paying an average of 1% across both network fees and interchange (amounting to 40 cents on a $40 transaction). Furthermore, MCX will have low customer-acquisition costs since cashiers can prompt consumers to enroll and use MCX wallets each time they checkout.
- Branding: US merchants collectively spend ~$550 billion/year on branding and merchandising, and will likely divert a meaningful portion of that to digital channels that support merchant brands rather than bank brands (as in the case of acceptance fees on Visa/MasterCard cards) or digital wallet brands (as in the case of, say, GOOG and AMZN. This is why Target is prepared to offer customers a 5% discount for paying with a Target Red card even though the fee for accepting a Visa credit card is at most 3% (and closer to 1.5% on non-rewards cards) and 24 cents (or 0.6% on an average $40 ticket) on Visa debit cards.
- Under network rules, a merchant with payments volume of more than $100,000 annually must open a merchant account. In this event, the SDWO will operate as a payments gateway (interfacing to the merchant account) rather than an aggregator (acting as the merchant-of-record). ↑
- For large aggregators, such as PayPal, MasterCard assesses a SDWO fee of ~30 basis points of transaction value unless the regulator lifts the veil on the end-merchant by passing a merchant ID, along with the wallet’s ID, as part of the acquired transaction record. ↑