Apple Pay: Friend (and Potential Foe) to the Payments Industry Status Quo
Apple Pay combines NFC, TouchID, and HW secured “tokens” on its iPhone 6 to execute retail POS transactions, meeting the security requirements of the card nets (V, MC, AMEX) and issuing banks (JPM, COF, BAC, WFC, C) that will support it. AAPL gains rate parity with “card present” transactions, and a ~15bp fee for providing ID&V assurance and assuming some fraud risk. Alternative RF mobile payment options will NOT be allowed on iOS and Apple Pay will obscure the branding by card nets and banks, threatening the ambitions of many retailers, card nets and issuers. Adoption will be slow – an iPhone6 or Watch is required, just 17% of US stores support it, and the use case is NOT yet compelling. Competitive alternatives will strengthen – the MCX consortium will fight Apple Pay, investment will narrow AAPL’s technical advantage, and open Android provides far more brand flexibility to banks, card nets and merchants. The initial benefit to AAPL will be small –a 15bp fee would bring less than $300M in new revenue. The real benefit to AAPL is in strengthening its proprietary device-centered architecture against hardware commoditization and future cloud-based threats. For now, AAPL is content to leave interchange and network fees in place, preserving the status quo for incumbents, and deny interest in transaction data, assuaging merchants. However, with critical mass, AAPL could choose to monetize Pay more aggressively.
Special thanks to SSR Financials Analyst Howard Mason 203-901-1635, whose contributions were invaluable to this report. Please visit http://live.ssrllc.com/topics/research/financial/to find more of his insightful research on mobile payments
Apple Pay supports the status quo at POS. Apple Pay uses a fingerprint reader and card network issued “tokens” stored in a secure chip on an iPhone 6 to authenticate identity and specify a funding account, linking with secure POS terminals via NFC to execute transactions. This satisfies both the card networks and banks, relieving issuers of a bit of fraud risk and lowering AAPL’s mobile transaction fees to parity with chip-enabled cards. By abdicating financial disintermediation, AAPL gained the support of the major card nets and issuing banks, and by passing the fee savings to merchants and denying interest in consumer data, it hopes to build a critical mass of retail partners.
Adoption faces significant obstacles. Apple Pay will require an iPhone 6/6+ or an Apple Watch, excluding the current base of iOS devices and limiting it to an estimated ~40M US buyers over the next year. It will be available at 222K stores that support NFC, including many big name chains, but more than 80% of US retail locations cannot yet support it, and the 70+ merchants of the MCX consortium are pledged to oppose it. Moreover, merchants lack incentive to push Apple Pay – AAPL has no path to lower credit card fees and, thus far, has been hands off in helping with loyalty programs. Given that swiping a phone is not really easier than swiping a card and there is no $ incentive, it may be hard to convince consumers to change behavior – note that only 7% of iOS7 users use the SIRI app.
Merchants will need customer access. As Apple Pay offers no relief from 2-3% card fees, the primary benefit to merchants is access to the well heeled AAPL customer base. Retailers are not now able to push messages through Apple Pay, but such a channel would be intriguing IF a sufficient percentage of users opted in. AAPL has disavowed interest in transaction data, a plus for many merchants who see it as proprietary info. Merchants will be able to easily add Apple Pay to their apps to conveniently complete sales, albeit without available alternatives. The MCX retailers, with >$1T in combined annual purchase volume, are notably opposed to AAPL’s approach, which perpetuates fees.
Near-term benefit to AAPL is likely minor. The potential annual revenues from ~15bp credit scoring fees are tiny by AAPL standards, and are likely only a temporary advantage. Apple Pay may spur a few more iPhone 6 or Apple Watch sales, but the consumer benefits seem too ill defined to have much impact in the next year or two. The biggest immediate benefits to AAPL appear to be in a revamp of its retail operations, where mobile payments and iBeacon can be integrated with the on-line iTunes to offer an even more delightful customer experience that bridges online and in-store shopping. This could also serve as a model to draw in further merchant support.
Pay perpetuates the existing fee model but obscures card branding. Apple Pay emulates a card as an app, keeping issuing banks and card nets in place and supporting their fee structures. It reinforces a shift toward higher fee credit cards, benefitting banks and hurting merchants. However, it also buries the card net and bank brands, and blocks alternative wireless payments apps from iOS devices, dashing ambitions for strengthening brands with innovative mobile payments solutions of their own. Longer term, gaining a critical mass of transactions could give AAPL leverage to bypass credit cards, but we see this as unlikely, given the company’s strategic focus on devices and its institutional skill set. Instead, as it has with carrier subsidies, media purchases and app advertising, we expect AAPL to leverage higher fees from banks and merchants for access to iOS, happy to collect a toll rather than to disintermediate
Pay supports Apple’s proprietary device driven strategy. AAPL has isolated the secure elements of its solution on the device itself. Even online transactions are authenticated with credentials stored in the phone, not in the cloud. Because Apple tightly controls both hardware and software on the iPhone, this yields much greater identity security than is currently possible from the cloud or from traditional cards. However, we do not believe that this edge is permanent, and, longer term, see considerable benefit from a more flexible cloud-based authentication solution that includes biometrics but is not inextricably tied to a specific device. AAPL hopes that it can establish its device managed approach as the de facto standard for payments and secure documents, forcing smartphone platform rivals, which do not control hardware and are years behind in biometric authentication, to play serious catch up.
Too soon and too proprietary to dominate. Apple Pay is the most complete mobile payments solution to date, offering superior fraud security and wide industry support. Still, only new iPhone 6 and Apple Watch buyers can use it, merchant support will be slow to build and consumer fears, confusion and inertia will make it difficult to drive more than modest usage over the next few years, giving time for alternative solutions to gain ground. Most consumers do not see credit cards as a “problem” to be solved, and ultimately, we believe mobile payments will gain real success only as a part of broader initiatives to modernize the retail experience. The existing stake holders appreciate AAPL’s “hands off” approach to fees and data, but they also recognize the dangers in granting AAPL unchecked dominance. In the long run, we expect Apple Pay will be but one of several mobile payment alternatives to survive.
For our full research notes, please visit our published research site.