Apple Pay:

Redefining the Digital Payment Architecture

Apple Pay

The surprising and exciting part of Apple’s announcement on Tuesday in my view is Apple Pay. Although many expected mobile payments to take off, the critical tipping point had not occured. The big question now is: Will Apple’s support for NFC finally tip the balance in favor of more secure mobile payments?

Points Worth Reflecting

First: security. To the extent that fingerprint-based TouchId is secure, Apple can raise the bar on security significantly beyond magnetic cards and even chip-and-pin system deployed in the USA. The secure element dedicated chip also ensures that the valuable information are not unsecurely transmitted. As Apple indicated:

Apple Pay will change the way you pay. When you add a credit or debit card with Apple Pay, the actual card numbers are not stored on the device nor on Apple servers. Instead, a unique Device Account Number is assigned, encrypted and securely stored in the Secure Element on your iPhone or Apple Watch. Each transaction is authorized with a one-time unique number using your Device Account Number and instead of using the security code from the back of your card, Apple Pay creates a dynamic security code to securely validate each transaction.

Second: convenience. It uses the established installed base of NFC terminals and the payment is simply through TouchID sensors built into iPhone 5S or the new models (iPhone 6 and 6 Plus). It will be interesting to track how we shift our payment behavior away from magnetic cards to phones.

Third: privacy. This is where Apple has scored a major point of differentiation. Unlike every other payment mechanism that relies on knowing the what, when and where of our purchases, Apple has made it very clear that it is not interested in capturing consumer data. The data is between consumers, the bank and the merchant. This is in sharp contrast to Google Wallet—that relies on adding this important set of informational attributes to better target the advertising. With Apple Pay, the focus seems to be on Apple earning fees from transactions from American Express, Visa and MasterCard without accumulating detailed data on consumer purchases.

Here’s a video where Apple CEO is making this point forcefully.

Apple’s monetization does not make use of invidual customer data

Four: Software API. Apple Pay Software APIs will be made available allowing every app to potentially make payments embedded within just as we do now with Uber. OpenTable app has already embedded the ability to pay at restaurants within the app itself. This is interesting as it shifts the onus of convincing restaurants to accept Apple Pay to app developers such as OpenTable.

Five: Apple Watch. This adds an additional pece of the ecosystem. We will have to wait and see how Apple builds security into the watch without the TouchID (perhaps with secure links to the iPhone or through other sensors built into the watch itself).

The dark horse: No mention was made of the IBM-Apple partnership obviously. But as we look at next-generation of enterprise applications (as opposed to consumer applications), could Apple (with IBM) streamline enterprise transactions?

Finally: the potential is big—indicated by the size of the installed base of Apple iTunes accounts with credit card numbers on file. The actual success of Apple Pay will be defined by (1) the pace of adoption of mobile payments by the consumers; (2) embedding of Apple Pay within iOS apps; (3) widespread installation of NFC readers as well as the (4) low incidents of security breach. The last thing Apple needs is the kind of publicity it has had with iCloud breach of celebrity personal photos.

Who is challenged by Apple Pay?

  1. eBay and PayPal: eBay has already announced that it will spin-off PayPal. Now the question is—who will buy PayPal? Samsung? Google? Amazon?
  2. Square. It has said that it wants to align with Apple Pay.
  3. Google Wallet—What next for Google and Android? Does PayPal add new dimension of value?
  4. Digital efforts underway within American Express, Visa (Visa Checkout) and MasterCard—They are not losing anything but what potential threats?
  5. Payment efforts of telecom operators (ISIS renamed as Softcard)—What should telecom operators do to be relevant and central in this arena?

It’s premature to know the shape and scope of impact of Apple Pay. What is clear is that we now have a new architecture for digital payments. Apple is architecting the new transacation landscape and is orchestrating this ecosystem through iOS8—much in the same way as it did in music with iTunes a decade back. Every company in the payment transactions space now have to define its position relative to Apple in this dynamic network of interactions. The landscape will be defined by dynamic web of competition and cooperation in the coming months.

Update: October 26, 2014

In 2012, many retailers including Wal-Mart and Target got together to launch an initiative—Merchant Customer Exchange—to enable mobile payments. That was before Apple Pay. Now, The Verge is reporting that the retailers are:

“building their own mobile payment app, called CurrentC. It’s expected to launch next year. In the meantime, these retailers have no intention to support Apple Pay.”

CVS, RiteAid, Wal-Mart, Target and others are actively shutting out Apple Pay hoping that the customers will embrace their system when it is launched sometime in the future (date unknown).

Retailers are jockeying with their mobile app.

This battle is not just between the retailers—who want detailed data on consumer purchases—and Apple that has clearly indicated that it simply wants a transaction fee but not the purchase data. The banks are in the middle: they are aligned with Apple. The payment networks—such as Visa, MasterCard and American Express—are in the middle and aligned with Apple.

The battles within the payment ecosystem are far from over. However, for the retailers to win, they need the cooperation of banks issuing credit cards (debit-based transactions are just niche). More important, in my view is that the retailers need to develop and master software and security competencies.

Will customers trust the retailers that have not been able to protect their data before? Can retailers master the competencies to deliver a payment app and seamless transactions that Apple has perfected over the last decade with iTunes and App Stores?

Can retailers band together to create a technology standard to win? Visa, MasterCard and American Express had their own internal experiments to dominate mobile payments but they seem to have realized the benefit of joining the Apple Pay ecosystem. TechCruch has a detailed discussion on how clumsy the process is for the consumers to use QR-code based mobile payment.

The telecom operators had their own initiative (Soft Card) but that also seems to not have the necessary traction. Are the retailers simply continuing their committed course of action—even though they know that their system is unlikely to win?

So, what’s the likely end-game?

  1. Retailers abandon their ambition and reluctantly accept Apple Pay.
  2. Retailers may fork their mobile app initiative and join Android payment ecosystem just as Amazon did with FirePhone and Barnes & Noble did with Nook (with samsung).
  3. Retailers actually succeed with their Mobile C app and block Apple Pay.

For now, #3 looks to be low-probability result.

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