Cash was king, who’s next?

“The king is dead, long live the king”

Cash/cards are dead, long live mobile payments. Many commentators have declared that cash and credit cards are on their way out. The future is in mobile payments. Five years from now, many of us may not even carry wallets, they say.

So should I start buying up wallets given that they may be a collector’s item soon? A Business Insider report paints an interesting picture. It estimates that cash use will decline at a CAGR of approximately -1% in the future, while in-store mobile payments will grow at a CAGR of 154%. How will that happen, you may ask? Well, commerce is going mobile. And who likes pulling out their credit card to pay on their mobile? I certainly don’t. The screen is small, typing 16+ digits is not fun. And you are not always purchasing from retailers that have your information stored under a sign-in. Once I start using an online payments service, I will start doing it in-store, particularly if the merchant allows/encourages me to do so. The next thing you know, the only thing I need to pay in-store is my smartphone. There is merit to this argument. After all, online payments giant Paypal processed $180bn in transactions last year. And only 30% was on eBay!

And so the story goes. But the jury is out on whether consumers will jump in to pay with their mobile. Is it really much more convenient to pay with your phone in store when you can just swipe your card? How much time does it really save you? And perhaps most importantly, does it feel secure?

Enter Apple. CEO Tim Cook doesn’t just want to play your music and send your texts; he wants to be your wallet. Apple Pay could be a game-changer in the world of mobile payments. The reason is that because Apple is trying its best to make it as secure as possible. First, iPhone6 allows you access only after a fingerprint match. A “secure element” in the device also encrypts your account numbers so that they can be stored safely. Apple Pay itself uses a technology called NFC – Near Field Communication. The technology uses low power signals to communicate with a reader that is a few inches away. The cool part is that the iPhone will communicate with the reader in code. So unlike a typical credit card transaction where your card number is fully visible and available, Apple Pay will send a secret code to the reader. The reader will unlock this secret code and then communicate with your bank to get authorization for funds. So even if your phone was hacked, all the hackers will get is unintelligible code, not your actual bank account/credit card number. Sounds good, no?

But cards are fighting back. If its speed you want, they have a product for you. This summer in London, I often paid for my lunch with “contact-less payment” using my debit card. I would just wave my card in the general vicinity of a reader and lunch was mine. No pins or signatures required. As we discussed in class, consumers have incentives to use credit cards, such as rewards, cash-back, etc. If Apple Pay means I have to pay for my flights, then forget it. Apple will probably have to do more to win in this space. They will certainly need to get partners on their side and understand the motivations for consumers to use certain payment methods.

Not to mention that Tim Cook still has to convince merchants to adopt the reader. This is the real question. Will merchants want to invest in the reader? Many small merchants in the US already have Square, which lets them use the traditional credit/debit card in a mobile fashion. Larger merchants may want their own barcode-enabled system – Starbucks is an incredible success story in this space. In a recent earnings call, the CEO mentioned that in 2013, 11% of Starbuck’s US and Canada transactions were done through the mobile app. Users are reported to find the app very engaging. An app with an in-built payment system could be a great way for a brand to directly engage with the customer. The Starbucks app connects to your credit/debit card or PayPal account. It remains to be seen if large global brands will want to give up direct engagement for Apple Pay.

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But the gauntlet has been thrown. PayPal seems to be nervous. Apple Pay is credited with eBay’s recent decision to spin off PayPal. Their first response was to take a cheap shot. They ran an ad reminding consumers that Apple was recently a part of a massive data breach that involved naked pictures of celebrities being hacked and released on the internet. Want your naked pictures on the internet? No? Then don’t use Apple Pay.

But they will have to try harder than that. Apple has grand ambitions to convert 600m ITunes account holders to Apple Pay. Some good-old fear-mongering probably won’t do the trick. Many will be watching this space with great interest. I know I will. Maybe Google will learn a lesson or two and bring back a new and improved Google Wallet?

P.S. PayPal is also trying make moves into the global remittances market. Every year, immigrants send $542bn in remittances home. PayPal is angling to get a piece of that market. You can now use PayPal in Nigeria and South Africa, for instance. Personally, I would like to see companies like Apple and Google make an effort to create products for consumers in emerging markets. Companies like Mpesa have done amazing work to help the global unbanked access financial services like never before. With their collective knack for innovation and engineering prowess, Apple and Google could have a meaningful impact in this space. I suppose at this point its more important for me to have a marginally better smartphone every few years.

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 Mobile technology is driving towards an all-encompassing device that will consolidate your communicator, payment system, house key, car key and identification.  We aren’t there yet, but there is a lot of the effort focused on enabling payments from a smartphone; worldwide mobile payments is a $172B business and is expected to grow to $617B by 2016.[1]

There are dozens of companies already chasing after this market and every few months, a new entity seems to jump in – each with its own business model, proprietary technology and merchants.  What are the key requirements of a successful mobile payment platform? At the risk of over-simplifying, the four critical ingredients are:

  1. Security to protect access and transaction payments – often executed with a password, PIN number, photo or distance limit.
  2. Financial institution support – access to finances, whether it be a bank account, credit card or something else.
  3. Communication technology between the customers’ mobile device and the merchants’ transaction device – could be physical, radio or cloud-based.
  4. Widespread merchant acceptance – customers need to be able to use their mobile payment platform at a sufficient number of stores and services.

 There is lots of sprinting to grab first mover status because this is an industry with network effects that is destined to tip towards one platform, at least in the United States.[2]  The real challenge of winning the platform war is to execute especially well on points three and four: Communication Technology and Merchants.  (Note: that is not to say that the first two points are less important, but rather they are table-stakes to even be at the Mobile Payments table).  Surveying the leading platforms, it appears that there are two major customer-focused paradigms that mobile payment entrants consider:

  1. Hardware play – require customers to buy the device with the special hardware that enables payments.
  2. Software play – require customers to download the app that enables payments.

The hardware paradigm typically refers to the NFC chip (near field communication) inside of a smartphone as the authentication and security mechanism.  The benefit of NFC is that it is quick to process a sale and works only within a few inches of the sensor, so it is safer.  This is the system that has been adopted by Google Wallet[3] (via Android phones) and Isis[4] (the recently announced joint venture between AT&T, T-Mobile and Verizon).  The main downside for consumers is that the most popular handset does not include an NFC chip; the iPhone is 33.4% of all smartphones compared to Samsung’s Galaxy S3 representing significantly less than 25.6% of the market.[5]

The software paradigm traditionally just requires the customer to open an app and display a barcode of sorts for the merchant to scan or capture.  The benefit of this system is that it can work on any smartphone as long as the customer downloads the app.  This is the payment system that has been adopted by Square, Paypal, LevelUp, and perhaps one day: Apple’s Passbook.

With both paradigms, there is also a merchant-side challenge: it is expensive to install NFC terminals and barcode scanners – even if it is just an iPad – into every checkout counter of every McDonalds (14,000 US restaurants), Gap (2,550 stores) and Walmart (4,300 US locations).

 It is premature to predict which paradigm will win out – much less which company’s platform – but if I had to guess, it would be the software paradigm.  The reason: it is challenging enough to convince merchants to adopt this new payment system (even if the terminals were given away for free), but it may be even more difficult to sell customers an NFC-enabled smartphone.

In this highly competitive battle for market share, there have been many interesting strategies to onboard customers and merchants alike:

  • LevelUp – attracts merchants with their 0% payment processing (as opposed to 3-4% for standard credit cards)[6].  They also have built both NFC and QR-code scanners into their merchant hardware.[7]  LevelUp claims it has 3,600 merchants as of September 2012.
  • Square – got deeply intimate with Starbucks by taking in $25m in strategic financing and adding Starbucks CEO Howard Schultz to its board of directors.[8]  No surprise, before Christmas 2012, Square will be accepted in all 7,000 US Starbucks locations.[9]  As of August 2012, Square boasted 2M merchants.[10]
  • PayPal – recently invested in a national TV campaign – starring the endearingly-paranoid Jeff Goldblum – to raise awareness of its availability  (watch the commercial here).  This past May, the company announced 15 new merchants including Toys R Us, Abercrombie & Fitch, Barnes & Noble and Home Depot.[11] PayPal claims it reaches 40m point-of-sale systems as a result of a partnership with Ingenico payment terminals.
  •  Apple Passbook – just launched as part of iOS6 and the iPhone 5.  Passbook enables barcode scanning for loyalty cards and airplane tickets, but no mobile payments yet.  If that day comes, the tens of millions of iPhone owners will be an influential buying force.

The race to be the ubiquitous mobile payment platform will explode in the coming months and years.  We will likely see bitter rivalries, confused customers, frustrated merchants, and tumultuous failures before a winner is finally crowned.

[1] “Gartner Says Worldwide Mobile Payment Transaction Value to Surpass $171.5 Billion.”  Gartner Research.  May 29, 2012.

[2] The two sides of the platform are consumers and merchants.  While there are somewhat low multi-homing costs for consumers (at the app level), the costs for merchants are considerably higher: multiple hardware apparatuses, accounts receivable to manage, etc.  As such, the market will tip because merchants do not want to simultaneously support multiple technologies.

[3] Google Wallet FAQ.  October 24, 2012.

[4] “Isis Announces Its Pilot Programs Are Now Up and Running.”  Mobile Payments Today.  October 22, 2012.

[5] “One in Three U.S. Smartphone Subscribers Use Apple’s iPhone.”  Apple Insider.  September 27, 2012.

[6] “LevelUp for Businesses.”  Website.  October 26, 2012.

[7] Empson, Rip.  “On a Mission to Be Mobile Payment Agnostic, LevelUp to Roll Out NFC-Capable Terminals.”  TechCrunch.  September 6, 2012.

[8] Ha, Peter.  “Square Partners with Starbucks, Raises $25M for Series D.”  TechCrunch.  August 7, 2012.

[9] Perez, Sarah.  “Starbucks’ Square Rollout Gets a Launch Date.” TechCrunch.  October 5, 2012.

[10] Kim, Ryan.  “Why Starbucks is Betting on Square.”  Gigaom.

[11] Perez, Sarah.  “PayPal Rolls Out to 15 More National Retailers.”  TechCrunch.  May 25, 2012.


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While I’m bearish on many of the loyalty programs and restaurant promotion companies out there today, I’ve become increasingly excited about LevelUp. They just might have integrated the missing component to the equation. The general idea is simple. The user links a credit card to the LevelUp app on her iOS or Android device. She can then use her phone to scan a QR code to pay using funds from her credit card while collecting loyalty rewards at the same time[1]. This might sound pretty similar to other start-ups competing in this space, but these are the reasons why I think LevelUp might be doing it right.

Tracking! As we have discussed before, one missing component in the restaurant promotion equation is reliable downstream tracking. Can Groupon definitively tell the merchant that a campaign improved long-term sales? Can demonstrate the customer lifetime value of a single customer acquisition? While that analysis should be simple, the data gathering is incredibly difficult. LevelUp cleverly integrates the loyalty program offering with mobile payment technology. Users are incented to pay with LevelUp because they are able to get double the rewards: (i) native credit card rewards and (ii) the loyalty program rewards. With this regular use of LevelUp as a payment option, tracking the impact of any one campaign becomes much easier – making the job of the LevelUp sales force easier as well.

Merchant Incentives! The sales pitch for many of the existing loyalty programs is simple – but questionable. The promise to generate repeat customer sales without a reliable way to derive the ROI for a given campaign seems fundamentally flawed. LevelUp seems to have not only circumvented the analytics hurdle, but it has also changed the merchant’s incentive to adopt in the first place. ‘Revenue growth’ is not their opening line; ‘zero interchange fees’ is. Merchants across the US spend over $40 billion on interchange fees a year[2]. The charges per transaction are typically 2.5% for SMBs[3]. Assuming a merchant has $1 million of revenue that is charged through credit a year, they pay $25,000 in swipe fees per year. Even if only 10% of that volume is moved to LevelUp, they immediately save $2,500 – and that’s without signing up for a loyalty program yet.

And if the merchant wants to drive more traffic to this free interchange fee option? Well, that’s one reason to sign up for LevelUp’s loyalty programs. Clever right? While some of the competing start-ups need to convince a merchant of the potential revenue lift their campaigns will generate, LevelUp’s job is much easier. So long as more existing credit card revenue shifts to LevelUp’s free option, the merchant wins because of the lower interchange fees – even if gross revenue remains flat. Revenue lift is just icing on the cake.

Mobile Payments Positioning! LevelUp has been training its 200,000 users[4] to become accustomed to the behavior of reaching for their phone – and not their wallet – when they want to settle their check at a restaurant. While the technology they have chosen to use today is the QR code – of which the sustained use of has been called into question by many – this simply serves as a basic method of proximity payment. Just in the last month, LevelUp has already unveiled new merchant payment docks that will accept both NFC and QR codes. As soon as the rest of the mobile ecosystem is ready, LevelUp will have a base of users who have already adopted mobile proximity payment behavior.

Profitability Model? While I’m excited about how LevelUp has found a nuanced value proposition to offer merchants, its money-making strategy is bold and fraught with risk. More traditional loyalty programs sell the idea that their  campaigns will bring the merchant more business in the long-run. If the merchant believes them, they pay for their services and hope for the best. But the company gets paid either way.

Instead, LevelUp is putting its money where its mouth is and will only do well if its loyalty programs do well. While the zero interchange fee scheme is clever, it also builds up an incredibly large base of expenses. I view these to be analogous to a fixed cost base that a traditional business would incur. LevelUp must build this expense base up in order to even have a chance to sell its loyalty program services. Once the merchant is signed up, LevelUp will make a hefty fee on the loyalty programs themselves, charging 35% each time a consumer redeems loyalty rewards[5]. If LevelUp gets its loyalty program right, they could scale quickly and become a very profitable business. However, building up such a large cost base will not allow it much room for error or experimentation.

I hope that LevelUp believes its analytics as much as they claim to. If so, I’ll be excited to see how they continue to navigate the complex mobile payment landscape in the future.






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