Quick Thoughts – Apple Pay and the Convergence of Physical and Digital Commerce


Apple Pay is an EMV-compliant, NFC-enabled payments solution that will work: (i) at physical stores with EMV-compliant contactless terminals (currently activated at less than 5% of US retail stores but likely to reach 25% by end-2015); and (ii) through apps to make online purchases. As an EMV-compliant solution, it will attract card-present rates for in-store transactions although, of course, card-not-present rates for in-app transactions. Merchants will be drawn to the security features of Apple Pay which uses a static device-identifier to authenticate cardholders and dynamic tokenization to keep raw card credentials out of the phone and merchant systems; and merchants will be reassured that, unlike GOOG, AAPL will not look to capture payments data for an ad business.

While Apple Pay will launch with iOS8 in October on the iPhone 6 and 6 Plus, it will also be available on the iPhone 5 series through tethering to the NFC-enabled Apple Watch scheduled for release in early 2015. This backward extension of Apple Pay to the large iPhone 5 customer base provides additional incentive for merchants to install contactless terminals (although we note that, independently of Apple Pay, member-merchants of the MCX merchant payments consortium, including TGT and WMT, have committed not to activate NFC terminals given their plans for a barcode-based mobile payments solution, as used by SBUX, in partnership with FIS).

Apple Pay essentially extends the Passbook app, which currently works for gift cards with QR codes as transport, to include network-branded cards with NFC as transport. Among the four major networks, only DFS is excluded but this is likely temporary. The top-6 issuers (JPM, C, COF, WFC, BAC, and AXP), representing over 80% of US card payment volume, will participate in the launch with other banks, including USB and PNC, expected to follow shortly thereafter. Banks are giving up fees since they will reportedly pay Apple per-transaction amounts, of up to 25 basis points, in return for fingerprint risk-scores generated by Touch ID that will tend to reduce fraud losses (although these fees will presumably not be paid for transactions initiated on Apple Watch which does not have Touch ID).

JPM has suggested the biggest impact of Apple Pay may be for online shopping rather than in stores because consumers will not need to input card numbers and shipping addresses for purchases using Apple Pay-enabled apps; AXP comments more broadly that “Apple Pay is the kind of innovative thinking that brings the worlds of online and offline commerce closer together”.

As a catalyst for contactless-terminal demand, Apple Pay is positive for market-leader Verifone and, as a competitor to PayPal (with a fee-advantage for in-store purchases given card-present rates are typically 50 basis points lower than the card-not-present rates of PayPal’s solution which is not EMV-compliant), a negative for EBAY. For now, Apple Pay works with, rather than around, the branded networks. However, once consumers have loaded in cards with the iSight camera (or become used to using cards registered to iTunes), AAPL is in a position to enable Apple Pay for barcodes thereby extending its reach to merchants that have not upgraded to NFC and may offer compatible payment solutions that disintermediate the branded networks as in the case of the partnership of MCX with FIS.

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