PAYING WITH APPLE PAY

Any sufficiently advanced technology is indistinguishable from magic. ~ Arthur C Clarke

Apple Inc., the world's most valuable company with a market value of $668 billion, is used to making piles of money. If you were smart (or lucky) enough to own 100 shares of Apple Inc (APPL) on December 12, 1980 (which was then worth $411), and you wisely decided to hold onto them; your 5,600 shares – after 4 splits – now (as of 12/26/14) are worth $638,344. A beautiful example of an individual benefiting from capitalism. Nice going.

In October, Tim Cook presented Apple Pay to the world, in Apple's attempt to make more money. Apple Pay is Apple's ambitious version of a mobile payment or digital wallet system. Mobile payment systems that have been previously offered by Google, PayPal, Square and others have met with, at best, tepid interest on the part of retailers, financial services providers and most importantly, the paying public. But being Apple, its new mobile payment system is the talk of the tech and financial towns. The digerati are all over themselves saying that Apple Pay will soon lead to "the end of cash." Given its impressive success over the decades, it's prudent not to bet against Apple, but…

Perhaps it's a measure of my ever-lengthening separation from whatever the media and techno-cognoscenti decide is "the next best thing," but the attention given to Apple's endeavor to change how the public pays for stuff – via Apple Pay – defies reality in my mind. It's also possible that I'm a stick in the fiscal mud when it comes to salivating over yet another way to buy my Peets coffee. Oh well. Myriads of stories have been seen and heard about how Apple Pay will usher in the cashless society for everyone's benefit. The New York Times alone ran 2 dozen stories about Apple Pay since it was first presented on October 20th. The happy hype that the digerati are preaching is way ahead of what's really happening.

To begin with, last year consumers spent $1.6 billion using contactless mobile payments of the sort allowed by folks flapping their iPhone 6s with Apple Pay in stores, according to estimates from eMarketer, a market research firm. On its face, this seems like a lot of purchases (and it is), but $1.6B represents a mere 0.6% of all e-commerce spending and an infinitesimal 0.0037% of in-store retail purchases. Apple and its mobile payment system partners have a lot of ground to cover. The media buildup about Apple Pay precipitating the end of cash is impetuous. To paraphrase Monty Python, cash is not dead yet.

Any mobile payment system involves 4 vital sets of actors – the mobile software itself (here, the Apple Pay app on your iPhone 6), the participating retailers who have installed point-of-sale (POS) terminals that are compatible with the software, the financial institutions that process the transactions and the paying public. In order for Apple Pay to be successful, it has to lead a mobile minuet that each of these players want to dance to. The first 3 stakeholders need to strongly support and market the system so that the consuming public will be convinced to use the app to buy stuff. If there aren't enough retailers with compatible terminals (as is the case with Google Wallet, Square and PayPal), then there's not sufficient incentive for people to use the app and thus no real network effect to induce other stakeholders to adopt the system behind the app.

As one e-commerce payment systems analyst said regarding Apple Pay, "Apart from the cool factor, there’s really not a lot of value for the average merchant.” This is part of the reason behind Apple's initiation of a large advertising push to use Apple Pay. Together with MasterCard and Visa (the 2 biggest credit card payment processors), giant banks like Bank of America, Chase and Wells Fargo and prominent retailers including McDonald’s, Walgreens and Macy’s, Apple's advertising hopes to entice IPhone 6ers to buy stuff with their phones. But other major retailers like Best Buy and Walmart have stated they will not accept Apple Pay. These retailers, along with CVS Pharmacy, Rite-Aid, 7-Eleven and others are backing their own mobile payment system, CurrentC. If Apple et al. can't convince retailers to install Apple Pay compatible POS terminals, then it's not going to lead to success for Apple Pay.

For some perspective, let's see how we pay for stuff now, and learn what fiscal mechanisms Americans use to buy goods and services. Predictably, we purchase a whole lot of goods and services; in 2014Q3 annual consumer spending of all kinds was $10.97 trillion, which represents almost two-thirds of our GDP.   

The figure below shows the share of transactions people use for each payment type in late 2012 – cash, check, credit card, debit card, and electronic –by number of payments and value of these payments made by customers who buy everything from cappuccinos to vacuum cleaners.

 

Since 2000, the number of transactions using checks has steadily plummeted, dropping by half; so by late 2012 only 7% of all payments used checks. During this 12-year period, the number of transactions using debit cards mushroomed 9-fold. Credit cards' usage increased also and represents the 2nd most often used form of non-cash payment. After the first credit cards – BankAmericards – were issued in Fresno in 1958, they've become ubiquitous. [FYI, BankAmericards' name was changed to Visa in 1977. The first mention of the term "credit card" happened a very long time ago, by Edward Bellamy in his classic utopian treatise, Looking Backward, published in 1887.]

By 2012 the largest value of payments used either credit or debit cards, as shown in the above figure. However, cash (remember cash?) remains the single most often used payment type. Why? Because cash dominates payments for the multitude of small-value transactions; representing 40% of all transactions, but only 14% of the total value of these transactions. As seen in the figure, credit and debit cards and electronic payments ( which for the most part mean those made online, almost always using a card) account for much high-value transactions; checks also are used for higher-value transactions. Card and electronic payments account for 49% of the number of payments, but 61% of the total value share.

There are 3 "divides" present in payment preferences. First, from the above figure we can see there's an important value divide when it comes to how people pay for stuff. With small-value purchases, cash payments usually predominate; for higher-value purchases cards and electronic payments prevail. Next, there's a generational divide surrounding payment preferences. According to a recent survey, just 30% of folks under 30 said they'd use cash for smaller purchases. Forty percent of these people preferred using debit cards, but only 25% of people over 60 said they'd use a debit card.

Last, there's an income divide. Income exerts a strong influence on payment preference; folks with lower incomes use cash more frequently. From the San Francisco Federal Reserve Diary of Consumer Payment Choice study, 55% of consumers with household annual incomes less than $25,000 prefer cash over non-cash payment types, while those households making more than $200,000 exhibit a very strong preference for credit cards. The preference for cash declines sharply once household income exceeds $25,000 per year, with debit cards cited as the preferred payment instrument for all those in household income groups between the two extremes.

Consistent with these payment preferences, the highest-income earners use credit cards for more than 40% of their monthly transactions – much more frequently than any other payment option. This is likely because more affluent consumers tend to have better access to credit and financial services and can take advantage of the incentives card issuers offer for using credit cards. It's this group, together with younger people, that mobile payment systems' operators like Apple Pay are targeting.

Moreover, Apple's entry into retail payment systems may be banking on up-coming changes facing credit and debit cards. In October 2015 the fiscal responsibility for liabilities resulting from fraudulently-used credit and debit cards will shift from the card companies to the retailers themselves. This is no small matter, and why Apple and other suppliers of POS payment systems are loudly proclaiming their new systems' "enhanced security." This legal change will create significant incentives for retailers to replace their existing POS terminals – the "card-swipe" devices that retailers employ to authorize a customer's purchase. This change is why many newly-issued credit and debit cards have so-called smart chips in them, which creates an added level of security. New terminals will use the card's chip, not the strip, for authentication. As long as the retailers are changing out their terminals, Apple obligingly suggests, why not go whole hog as it were and use Apple Pay, with no card required at all. Nice timing.

There's also the issue that Apple Pay only works with iPhone 6s, Apple Watches and certain iPads. [The Apple Watch will be introduced in early 2015. And waving an iPad to buy a CFL at your local hardware store seems improbable, at best.] IPhones certainly occupy an important part of the smartphone market, but only a part. And that portion has been slipping as Android-based phones have captured a larger share of the market. According to Pew Internet, 56% of adult cellphone users have a smartphone. Apple expects to sell over 40 million iPhone 6s this quarter worldwide, so the share of this 40M who are American iPhone 6 purchasers is the underpinning of Apple Pay possibilities.

Finally, there's the issue of personal transactions data. If Apple Pay eventually comes into widespread use, then Apple will be privy to highly personal information about every Apple Payer's purchases that now only the financial institutions and credit card companies receive. These data are highly coveted and valuable. Apple already has access to multitudes of retail purchase information about their customers, through iTunes and their device sales, but Apple rightly expects Apple Pay transactions will be far, far broader should it become popular. Whether or not this further dispersion of retail  purchase data is appropriate or not is impossible to assess now. But I hope Apple's data security systems are being strengthened in anticipation of this possibility. Jennifer Lawrence, among others, would certainly suggest such strengthening is warranted after the September iCloud security breach.

Will most of us pay with Apple Pay in the near future? My bet for the future is that although cash may no longer be the high sovereign of the retail store counters, it will continue to be widely used for certain types of purchases, despite Apple's and the digerati's entreaties, as will debit and credit cards. If Apple can convince us that their app is both more secure and less troublesome than using a smart-chip card, then Apple Pay may become a prince of purchasing.

But the central challenge that Apple and its Apple Pay partners confront is that buying things with a credit or debit card is not nearly as arduous and burdensome a process as they make it out to be. It's actually quite straightforward and almost unconsciously used by millions and millions of people each day. And the prime mission of 2 key Apple Pay partners – Visa and MasterCard – is to promote the buying public's continued use of cards, not waving iPhones.

It's game on for the magic of paying with Apple Pay.