Tech Giants Are Entering the Payments Industry with NFC Chips
Written on April 18, 2011 by Milton Reyes
Phones are hardly phones anymore: they’re very small computers that happen to have a Skype-like method of communication. Smartphones are making forays into the world of payments, with merchants like Starbucks experimenting with mobile prepaid cards and scrappy startups like Silicon Valley’s BlingNation piloting smartphone-only registers.
Apple and Google are also now jumping on the mobile payment bandwagon, using near field communication (NFC) chips that would enable customers to pay simply by waving their phones over a register. Apple will probably have NFC chips ready by the iPhone 6, but Google is one step ahead: it already supports the technology in Android phones like the Nexus 5 and will begin testing mobile payment systems in New York and San Francisco.
But will it ever happen?
TechCrunch’s Erick Schonfeld wrote a piece recently arguing that NFC chips will never reach the critical mass needed to become actually useful. He cites four reasons: not enough phones are NFC-enabled, not enough retailers have wave-and-pay registers, the entrenched behavior of paying with plastic, and the opposition of credit card networks.
Really, though, those obstacles can all be overcome. A company with cash to spare that’s willing to invest in research and development can afford to develop a technology that won’t be immediately profitable (few have deeper pockets than Google; Apple is also sitting on something like $50 billion in cash). The long-term payoff is great enough that the tech giants have already introduced NFC-capable phones, and are fully capable of both subsidizing retailers’ registers, and launching extensive marketing campaigns, in order to create this new market.
Apple and Google are already taking care of the new and as-yet-not-fully-adopted technology problem, and have the means to expand their efforts. The last two obstacles are the most interesting, and they come back to an issue that we’ve covered extensively: merchant interchange fees.
How will this impact swipe fees?
In the absence of regulation by the Durbin Amendment, or in the unregulated credit card market, consumers and merchants pay for the lion’s share of payment processing fees. Merchants see the “swipe” fees take a chunk of their profits, losing at times up to 3% of the transaction. Customers then pay higher costs for the goods they purchase, whether or not they use plastic, because with the exception of gas, few merchants can afford to differentiate their prices.
If done correctly, mobile payment systems can address this pain point. NFC chips have the potential to lower prices for consumers and costs for retailers by upsetting the current Visa/MasterCard duopoly, and allowing lower interchange fees.
Apple and Google already have payment systems in place: mobile carriers. Apple could charge a purchase through AT&T or Verizon, and set its own interchange fee. In fact, AT&T, Verizon and T-Mobile have already joined forces to do just that. They are building a payment network known as ISIS that will allow customers to charge purchases though a cell phone. Barclays US will be the first card issuer to join the network, and Discover will handle the transactions. Discover already charges lower interchange fees than its behemoth competitors, Visa and MasterCard.
If a tech company were to charge lower swipe fees, merchants would gladly install NFC-capable registers even without a subsidy, because the fee differential would quickly pay for the new register. Of course, merchants will be unwilling to invest in the registers as long as the technology is not widely adopted. So how can the new network encourage early-adopters to get on board? The same way Visa and MasterCard did – with rewards.
The future of rewards cards?
The big guys have long known that rewards are what sell consumers. This is how they were able to convince so many people to sign up for premium airline rewards cards, or to sign for debit purchases instead of using their PINs, even though these charge substantially higher swipe fees. So if consumers were offered immediate cash back rewards through ISIS for not using traditional plastic, they would probably be willing to switch.
In 2008, the interchange fee at a restaurant for a Visa Signature card, which commands some of the steepest fees, was 10 cents plus 2.4% of the transaction. Then the issuer would kick back up to 2% of this to the cardholder. Now imagine that Apple is able to charge a lower fee through ISIS. They wouldn’t need to use these fees to subsidize rewards because Apple is in the business of selling much higher margin hardware and digital media. By offering iTunes credits as rewards for purchases, they could take a small loss and chalk it up to marketing for iPhones and iPads.
Google could potentially offer something similar through its advertiser relationships, and the two companies could pitch the product as a plastic-free rewards debit card. If they then charge no fees for use, they could distinguish themselves from traditional banks who now typically charge monthly fees for rewards checking and debit.
The restaurant, in this case, could see up to an additional 1.0% on each transaction. Assuming a $600 unsubsidized register, the restaurant will profit on its investment after processing $6,000 on the new system, which a typical restaurant could conceivably make in days. As Schonfeld points out, “merchants only care about two things: speeding up their checkout lines and cutting costs.” The effect of mobile payment on checkout lines should be negligible, and the savings are clear.
Schonfeld argues, lastly, that credit card companies would be unwilling to relinquish control of transactions to Apple or Google. But ISIS was created to do just that. Plus the tech companies could potentially work around them by connecting iTunes or Google Checkout accounts directly to users’ checking accounts (similar to Paypal). In this case, NFC chips could bypass credit cards entirely, creating a parallel system that is more favorable to both merchants and consumers.
The largest obstacle to mobile payment systems is security: consumers must be able to trust that their information will be kept secure over a wireless network. This may be the biggest deterrent to a change in consumer behavior. However, if Apple and Google solve the security problem, they could reduce the cost of fraud prevention and thus charge lower interchange fees. The success of NFC chips, in the end, may depend less on consumers’ unwillingness to switch from plastic to providers’ ability to create a safe and cheap transaction mechanism.
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