Apple Pay and the Mobile Revolution

Introduction

Apple Pay is positioned to revolutionize mobile payments, but probably not for the reasons that many think or the ways that many anticipate. In the week since Apple’s mobile payment play was announced, much has been written about what Apple Pay means for consumers and banks. I’ve spotted three common themes this week in the media, on tech blogs, and through my Twitter stream that are well-intentioned but miss the bigger picture:

• Android fans pointing out that Apple is “late to the party”
• An Apple “iBank” is only a matter of time
• Banks desperately need Apple Pay to blow up

Let’s take these one by one to explore why they miss the mark and, more importantly, what the real implications are for consumers and banks.

Apple is Late to the Party

If your only measuring stick is the presence of an NFC radio in a smartphone then yes, Apple is late to the party. The problem with this point of view is that an NFC radio in the smartphone is less than 50% of mobile payment’s problem. Even if every smartphone in the country were NFC-enabled, they would be useless without merchants accepting NFC transactions.

Google – to its credit – solved an important problem when they introduced Host Card Emulation (HCE) in the Android KitKat operating system. Prior to Android adopting HCE, getting a credit card to be stored inside a smartphone securely was a significant obstacle requiring the cooperation of banks, mobile network operators, and handset manufacturers. It was such a significant obstacle that it was never solved in a widespread commercial deployment in the United States. With the addition of HCE to Android, credit card storage became much easier.

Alas, provisioning credit cards in smartphones was only one of the obstacles to adoption. Other obstacles existed too: merchants didn’t have an incentive to deploy NFC-capable terminals in their stores and banks didn’t have an incentive to promote the standard. The credit card networks like Visa and MasterCard also lacked financial motivation to promote the capability. Google attempted to create demand for NFC transactions, but botched the message and the economics for merchants and credit card issuers they desperately needed on board. Despite Google’s significant investment in NFC wallets, the standard never gained traction in the United States.

This is the critical point that is missed when people complain that Apple is “late to the party”: there was no party before Apple showed up. Apple’s significant contribution to this story is not that it put an NFC radio into a phone – that is a technical challenge that has been solved for years. Apple brought the various parties in the payments ecosystem together in a way that provided incentives to everyone to make mobile payments possible. Apple fostered an environment that provided incentives to issuers, merchants and consumers to use a new payment method. This is similar in many ways to the role Apple played in an earlier decade with the various players in the recording industry.

Issuers reduce the cost of fraud because the credit card number stored in your phone is a token, not your real credit card number. If that token gets compromised, a new token can be issued without sending you a new physical plastic card. Merchants with NFC pay the same amount per transactions with this new system as they would if you swiped a physical card at the point of sale (the lowest cost of transaction). Consumers are provided an easy payment system that is integrated throughout the mobile operating system. Google failed at marshaling this diverse group of stakeholders in the payment process towards a common goal. Apple realized this was the critical component to making mobile payments a reality.

An Apple “iBank” is Only a Matter of Time

Could Apple “be a bank”? Maybe. Should they want to be? No.

Banking in the last 10 years has increasingly become a commodity. While banks do attempt to offer differentiated services, the realities of operating in a highly regulated environment make this incredibly difficult. Apple is in the business of providing its customers an experience. The vast majority of consumers do not perceive of a banking transaction as part of that experience unless the banking transaction doesn’t work. Try this thought experiment: The last time you bought something at a physical store, how much time did you spend actually think about money moving from your credit or debit account with your bank to the merchant? The last time you bought something from Amazon 1-Click Ordering, did you think about your bank as part of the experience? Probably not.

This is precisely why Apple does not want to be a bank. It’s incredibly hard to create the magical experience Apple provides with their products by being a bank. Apple Pay facilitates a significantly improved experience not just in stores but also inside iOS apps that just wouldn’t be possible if Apple didn’t participate in creating the experience. Maintaining checking or savings accounts, generating bank statements, and depositing checks isn’t part of Apple’s calculus on a great customer experience.

Apple may very well have other tricks up their sleeve that – superficially – seem like “banking.” My bet, however, is that these capabilities will be part of a broader vision of how Apple wants consumers to experience using their products. As an example, most people don’t think of Uber as a payments application. Payments just happen at the end of the ride. This is the way I think Apple and other successful companies will view the payments process. This is not about providing consumers with a mobile wallet or a payment app. Success is providing consumers with an exchange of value and having the payment recede in to the background to the point that the consumer forgets it is happening.

Banks desperately need Apple Pay to Blow up

It’s true that banks were a willing participant in Apple Pay. It’s also true that the banks probably need not fear Apple becoming a bank. Banks – in the short-term – stand to save more money from Apple Pay than it costs them. Many industry analysts have suggested that the banks pay Apple 15bps per transaction. While this is not a lot of money in percentage terms, it is material in a time when banks are seeing their margins compressed on credit and debit transactions. Banks may grumble at this, but Apple is providing a service that would not exist if they weren’t involved in the transaction.

Over the long-term, however, the story may be different. While I don’t believe Apple will ever want to be a bank in the traditional sense, it is likely that banks will see their customers increasingly disintermediated through products like Apple Pay. With Apple sitting in between the consumer and their bank, banks will see fewer options for differentiation. If Apple makes inroads in the loyalty and rewards spaces, banks will likely increasingly find Apple’s role to be part friend, part enemy. Banks have been losing control of their channels over the last five years and the tight integration of mobile operating systems to the payments process only furthers that trend.

What it all Means

Apple Pay is the most important development in the history of the mobile payments industry. Other technology companies, like Google, have made important contributions but lacked the holistic approach and appreciation for the dynamics of the payments ecosystem that Apple has shown. Apple isn’t interested in replacing banking services for the sake of being a bank, but they will work aggressively to create better consumer experiences with their product. In some cases, creating those experiences may disintermediate or replace existing banking relationships in ways that upset their recent banking partners. While Apple’s role in the ecosystem is likely to confound banks and merchants, consumers are likely to benefit.