Mobile payments in the West, a primer

Oct 14, 2014
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Last week Square raised a new $150m in equity financing led by the Singapore government fund, valuing Jack Dorsey’s mobile payments juggernaut at a rumored $6 billion. Also recently, Amazon launched a Square competitor, Tim Cook announced the iPhone 6 and Apple Pay, and Paypal reclaimed its independence from eBay. And that is just in America.

mobile_money_transferAt my fund we see a truckload of European startups attempting to tackle the mobile payments and money transfer space, and my senior partner at Truffle even has a few pet projects in this area. In France alone there’s Leetchi’s MangoPay, BuyBoxPaylib, Paymill, not to mention a variety of student initiatives like Skimm and MyBee. Even the Banque Populaire & Caisse d’Epargne announced a money transfer capability on Twitter. European players gunning for the French market include: The Currency Cloud, iZettle, TransferWise, CurrencyFair, Payleven, SumUp, Flashiz, Adyen, Klarna, to cite just a handful.

Although mobile payments is not one of my own core investment themes these days, I thought it would be interesting to make a brief assessment of the current state of the marketspace.

Apparently, in 2014 Visa and Mastercard will process $3.5 trillion worth of credit card transactions in the U.S. alone. So it’s no surprise that such a sizeable market opportunity attracts a broad array of technology innovators at several stages of the value chain. And we are only at the beginning. Take mobile payments. Despite the enormous transaction volume, payment from smartphones still represent less than 0.5% of market.

Why the slow adoption ?

With smartphone penetration exceeding 40% in most developed countries, why is the uptake of mobile payments still so low ?

The key lever that drives adoption of mobile payments is winning over the merchants. And at first blush, this should be fairly straightforward. Merchants generally feel held hostage by the card processors like Visa/Mastercard who charge fees of around 200 basis points (2%) on every transaction. Amex assesses merchant fees that can be even 1.5x higher. Here in France, incidentally, many merchants refuse to accept Amex due to the card’s higher merchant fee.

So one would think that merchant should be eager to try new innovative solutions which will help them drive down their merchant fees. Why the slow adoption ?

In reality, processing billions of credit card transactions is quite difficult. Tracking them. Clearing them. Detecting fraud. The credit card issuers have the robust back office systems to handle such complexity and perform the processing efficiently. Accordingly, when tech companies enter the payments business, they tend to partner with Visa et al, or build their payment platforms on top of the existing infrastructure. Since Visa/Mastercard remain involved in the process, there is not any direct reduction in the merchant fees. On the contrary, the new tech solution may actually increase total merchant fees if their business model involves taking a cut of the transaction too, alongside Visa/Mastercard.

Hence the slow adoption, as merchants are understandably reluctant to engage the costly expenditures of upgrading their credit card terminal equipment without a clear financial case for doing so. Why should a merchant invest in new near-field communication terminals (NFC), for example, without a resulting cost saving in transaction fees? NFC technology has existed in Android smartphones for a while (deliberately avoided by Apple), yet the absence of compatible terminals on the merchant side explains the lack of widespread NFC payment in most of the West (unlike Japan, I might add).

So how can a new technology company navigate this jungle ?

One way is to focus on the segment of the market that is not using credit card terminals: such as small businesses or online businesses whose transaction practice does not involve handling the physical credit card. Similarly, sole proprietors and individual consumers are more likely to embrace such technologies as it opens up a new payment channel. Square, for example, addresses this segment in part of its strategy.

Another way is to persuade forward-looking merchants to integrate the new payment workflow at their own expense in hopes of increasing revenue. While this business case is difficult to justify at a retailer like Wal-mart, franchises with a high-touch component on the transaction may be more open-minded to new trials. The Square deployments of “iPad point-of-sale systems” at Starbucks and Whole Foods are great examples.

Ideally, the technology company can convince the credit card issuers to share a portion of their merchant fees. Apple, for instance, with its new iPhone 6 and Apple Pay, has struck such a deal with Visa/Mastercard by offering better fraud detection.

Half of global credit card fraud occurs in the U.S. Part of the reason for this is due to the sheer volume of credit card transactions in the U.S.; however, another reason is the antiquated system of magnetic strips. Europe, and most of the rest of the world, uses chip-and-pin technology (EMV), which is far more secure. Although rumors of very few merchants in Europe accepting magnetic strip U.S. credit cards are overblown, I do know of a handful in Paris that will not accept cards without a chip.

Every once in a while, however, there is a tectonic shift in the market that can open up vast new opportunities for shrewd thinkers. This is happening in the U.S. following Visa/Mastercard’s bombshell: beginning in October 2015, liability for fraud will become the responsibility of the merchants on credit card transactions not involving chip-and-pin. By shifting the burden of fraud to the merchants, the business case for upgrading the merchant terminals quickly becomes financially worthwhile.

I do not believe that it is pure coincidence that Apple now adds NFC capability and introduces Apple Pay in its new iPhone 6. As Adam Nash astutely pointed out, the timing of Apple’s release ingeniously occurs during a year when merchants will most likely upgrade their terminals en masse.

The mobile payments savannah in Europe is set to excite over the coming years in an interesting dynamic among powerful lions, fleet-footed gazelles, crafty hyenas, and skittish zebras.

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