Payments Part of OS: What does that mean?

Payments in the OS is perhaps best described as the intersection of the 2 major disruptive forces at work: Connectivity of Consumer and Merchant during shopping and purchase, Authentication. As I outlined in Cloud Wallet, it makes little sense to store anything in the mobile phone. If everything is connected, I should just need to authenticate my identity and payments, promotions, reminders, receipts, … everything else could happen in the background. If everything is connected, the nature of payment settlement risk changes (see credit push).

28 July 2013

Continuation of Friday’s Blog BIG Changes to NFC: Payments Part of the OS.

In 1996, I remember launching the first Client Server application for FirstUnion (Smalltalk, OS/2, Win 95).  I had left NASA just 2 yrs prior, and having a Sun Sparc, connected to Arpanet on my desk since 1987 had spoiled me..  The Win95/LAN environment was not designed for engineering… it was a poorly assembled toy for business. It didn’t have native TCP/IP in the OS, actually Microsoft itself didn’t even offer the protocol, I had to install a third party vendor stack on over 2000 PCs around the bank.  Hard to believe this was just 15 yrs ago.. MSFT seems to have embraced a few changes since then, and what was “outside” its platform is now part of it.

The same platform “integration dynamic” can be seen in: video boards, laptops (remember the external slots), mobile phones (Cameras, Bluetooth, Wifi,…), and now NFC from a dedicated NXP chipset to Integrated chipset (ex Broadcom BCM43341, plus firmware).  Most of my readers are not hardware people, so in layman’s terms.. dedicated hardware and software are merging into integrated “platform”.  Mobile phones are thus evolving. from telecom, to Toy, to entertainment, to COMMERCE CAPABLE, connected, devices beyond the browser.  For those interested in reading further, one of my top 10 business books is PLATFORM LEADERSHIP, a tremendous read.

The title of the book above is a great transition into the meat of this blog: Platforms require leadership.  Apple needs no lessons here, as they view stewardship of hardware, design, OS, app store, experience as core to their company. The “distributed” innovation model is akin to WINTEL, where generic industry standards were set, and again we see a core group (this time Google/Samsung/MOT) leading definition of a new platform, against a vision of MNOs (who customize and subsidize Android).  As hardware becomes a commodity, differentiation shifts to orchestration and network applications, this requires a central “orchestrator”.   MSFT itself shifted into this role in PCs, but Orchestration success is dependent on the number of nodes you touch.. and MSFTs nodes are still PCs, thereby allowing Google and Apple to more rapidly gain on their already advantageous positions.   

One way of look at the chaos in payments is to see existing players attempt to create an orchestration role across platforms. Google did this in PC search in 02. Payment Clusters attempt to leverage old nodes (Cards) and current market position to form a new orchestration role (or platform) where others will coalesce (ex: See Network War). Examples: Telecom and ISIS, Visa, Amex, US Banks, Retailers and MCX, Google, Apple, Qualcomm (old),  (links for each of my blogs discussing).  For example, existing beneficiaries of current interchange model are working to retain their 2% tax on commerce (in consumer credit). Among Payment Players, Amex is furthest along here, as they can uniquely help merchants know who their customers are … and market to them.  Visa is working to build services around cards to increase “stickiness” and barriers to entry/change, Banks and retailers are working toward the same goals. All participants realizing that payments in and of itself is a rather ubiquitous service with many different options. The central problem for all of these initiatives: a SUCCESSFUL PLATFORM must deliver value to ALL participants. For Payments, the problem to be solved is COMMERCE.. a rather long process of which payments is only the last, easiest part.  Network Clusters

Focusing on payments, the NFC “platform” provided a way for a telecom/TSM to “control” a user’s data, and a radio on the phone. NFC is great “walled garden” strategy for the MNOs.. but why would anyone want to support an MNO holding the “Key” to mobile commerce? MNOs created a great technical solution without a supporting business model (see Carriers as Dumb Pipes). Mobile is uniquely positioned as the point of confluence between the virtual and physical world, a platform of untapped value to date.

Commerce Services

As I stated Friday, Mobile Platforms (Apple/Google/?MSFT?) recognize the key to margin in an undifferentiated hardware world is in Orchestration/Services. Platforms can’t afford to give the keys to this Platform away to anyone, and are thus integrating all commerce functions into the platform.  Take for instance the service of AUTHENTICATION, this function is critical to both physical world commerce and virtual world (cloud access, pictures, music, online services). Commerce services from advertising, to in-store marketing, and obviously to payment. Thus Google/Apple’s M&A and R&D activity in the space.  Diagram_android

Many of my own “bets” are locked up in the “other services bucket” within the platform, and therefore I’m not able to comment much further here. But as an example, think of the primary categories: infrastructure HW/OS (legacy telecom, embedded SIM/HW mgmt, authentication, location, connection management, secure storage, data management, authorization…), Platform Services/APIs (Administration, Service provisioning, data access, hardware access, service access, location, preferences, payment, …), Core Platform Apps (ie Passbook, Maps, Wallet, …), 3rd Party Apps,

Example Future View – Transit

Today, the top success stories in Transit are Octopus/HK, Oyster/UK, EZ-Link/SG, and Suica/JP. All have a version of mifare compliant interface in transit station gates, with a dedicated card (Japan/Suica  can do mobile top up/reload).  Today all are experimenting with NFC/TSM model. In future “platform” all will be able to create an app on phone to access radio capable of MiFare communication, simplifying the creating and testing process without a hardware NFC dependency or TSM.  A GREATLY simplified development process. Further, given that Platform’s like Apple have existing payment instruments stored, funds could be either transferred into a dedicated stored value account prior to ticket purchase, or authorized on the underlying payment instrument at time of purchase. NFC solves NONE of these funding problems.. it only solves a single secure “presentment” problem.

Example: Store Checkin

Today with Square, Foursquare and others you “check in” to a business, either though GPS, wi-fi or QR code scan.  Similarly Target, Macy’s and other retailers have developed custom apps to enhance in store experience. Its hard to imagine loading an app for every retailer you deal with, or even using the app for any one of them. With future platform services, consumers could publish rules for merchants and store applications leverage a broader set of “platform” services which may include customer insight.  When you walk into any store, a future retail application would give you relevant information depending on your preferences. Platforms will support store branding and communication, enabling a much broader reach (no app install) and capability (insight, payment, ). In this future, the “Platform” is taking on an orchestration role independent of the store you are in. The platform is a working on your behalf, but also transparently supporting retailer objectives. Today, we see Target mobile delivering a price comparison application that doesn’t compare prices. Is there any wonder that usage suffers.. ?

Not Mobile Payments…  CLOUD PAYMENTS

Payments in the OS is perhaps best described as the intersection of 2 major disruptive forces: Connectivity of Consumer and Merchant during shopping and purchase, Authentication. As I outlined in Cloud Wallet, it makes little sense to store anything in the mobile phone. If everything is connected, I should just need to authenticate my identity, allowing requestors cloud access to: payments, promotions, reminders, receipts, … everything else could happen in the background. If everything is connected, the nature of payment settlement risk changes (see credit push).  iPhone-6-Fingerprint-Detection-And-Apple-Release-Date-Rumors

Payments in the OS presents a disruptive opportunity for banks. If there is going to be a PAN (“number”) in the iCloud or iOS why on earth would Banks want to make it a Visa or Mastercard? This is yet another reason they are working on Tokens.. to ensure control of the process.  Problem is that for a new “token” scheme to gain adoption, is must deliver increased benefit to: merchant, consumer AND to the Platform. Bank token advocates will say that the benefit of mobile payment is that the consumer would never need to see the PAN, and thus Consumers do not need to be incented.  Even if this is the case, they must still incent merchant and Platform, particularly when Apple ALREADY HAS the PAN.  In their tokenization efforts, Banks are attempting to resurrect the TSM role, to justify their payments revenue.

However, my view is that IF authentication is owned by the platform, there is very little that banks can do to retain their fee. Just imagine a world where the retailer could proactively offer store credit based upon an individual’s data and behavior (accessed through platform). Where open loop cards displaced store credit 25 yrs ago, the forces could be easily reversed, enabling a new breed of consumer credit companies which support merchants. Banks are working to add value to their existing 16% interest premium credit product which costs merchants 250bps. Merchants may be well positioned to capture all of this revenue, if they had the data (and platform) to make this a seamless experience.  My personal bet is that we will first see a new credit card product which will offer a greatly enhanced value proposition to both consumer and merchant in exchange for consumer data sharing. This product would completely disrupt existing cards.

POS –> CRM and Digital Marketing

We can also see the new opportunities for Payment Enabled CRM when a platform can work with retailers. Leaders here are Square, Levelup and Fishbowl.   The “platform” works before the checkout.. here the key is consumer insight for targeting and relevance. Consumers will only pay attention to “items” which deliver value.

Closing Thoughts – Commerce a very BIG and Broken Market

Commerce is a very, very big market (see $1.46T non-grocery US retail sales, 2013 Deloitte Global Retail Study). US eCommerce sales last quarter were $61.2B, or an annualized $245B, making eCommerce just 17% of non-grocery and 5.5% of total Retail Sales (see US DOC).  Digital Ad Spend is over $100B globally, with the US taking about 40% of that. Google alone accounts for over 40% (eMarkter) and over 50% of mobile (eMarketer), with self reported revenue of $14.1B for 2Q13, (US 45% of Rev).digital ad spend

Looking at US numbers alone, there is ~$750B in total marketing spend (see Chart). Why is digital marketing only 5% of total non grocery sales? Note that this figure is off by 2x as a very large portion of online spend is by service providers (banks, tree cutting, accounting, ..) and restaurants. These 2 categories are not part of Retail sales.

My view on why more marketing spend is not digital:

  • There is no CROSS CHANNEL marketing.  Online ads are most effective when there is an online purchase (or at least most effectively tracked).  Advertisers typically don’t advertise online when products aren’t sold online.
  • Amazon/eBay and other large companies have locked up a substantial portion of eCommerce.
  • Digital advertising is fundamentally BROKEN (when was the last time you clicked on a banner ad).
  • Madison Ave is bypassed as most companies go direct, or use specialized agencies. “Brand Advertising” is big and sticky… big corps like to spend about what they did the year before.. independent of what value it is providing to the organization

 

US Marketing Spend

 

 

Battle of the Cloud – Part 2

Where are the cloud battle lines? Well most significantly the battle lines are forming away from NFC. The Cloud battle is complex, as the strategies are about MUCH MORE THAN PAYMENT. Payment is the ubiquitous service that is the last phase of a successful marketing, engagement, shopping, selection, deliver, retention, loyalty process.

29 August 2012

Previous Blog – Part 1 – May 11, 2012

Let’s update the Cloud Battle story and discuss events since my last post on the subject

Square, Visa, Google, PayPal, Apple, Banks, … have recognized the absurdity of storing your payment instruments in multiple locations. All of us understand the online implications, Amazon’s One Click makes everything so easy for us when you don’t have to enter your payment and ship to information. (V.me is centered around this online experience). Paypal does the same thing on eBay, Apple on iTunes, Rakutan , …etc.   But what few understand is the implication for the physical payment world. This is what I was attempting to highlight with PayPal’s new plastic rolled out last week (see PayPal blog, and Target RedCard). If all of your payment information is stored in the cloud, then all that is needed at the POS is authentication of identity (see blog).

The implications for cloud based payment at the POS are significant because the entity which leads THE DIRECTORY will have a significant consumer advantage, and will therefore also lead the breakdown of existing networks and subsequent growth of new “specialized” entities. For example, I firmly believe new entities will develop that shift “payment” revenue from merchant borne interchange to incentives

Since May, the following “significant” events “in the battle” have occurred:

  • Retailers have launched MCX with Wal-Mart’s Mike Cook as the lead. I want to emphasize, this is not “mobile payments” but rather a low cost payment network (Cook talks about $0.05/payment). Some retailers will seek to integrate their loyalty card, others will create plastic (see Target RedCard), others will certainly couple with mobile. WMT will likely integrate with a virtual wallet that manages digital coupons (Coupons.com likely leading)
  • Apple has rolled out Passbook in June.. See my Blog, and hardware analysis from Anandtech of why there is no NFC.
  • PayPal had a marketing announcement with Discover. Why would you announce something like this with no customers? Paypal is expanding its network… but merchants are just laughing.. MCX wants a $0.05 payment, Durbin gave them a $0.21 payment and Paypal wants to get 180-250bps. As you can tell, I don’t think much of this, as the Merchants are still in control of their payment terminal. This is also not an exclusive deal with Discover. I expect 2 other major players to partner with Discover in next few months. Paypal just wanted to run with this announcement before the other products come out. I also want to emphasize that DFS is a BUY. They will be a partner of choice as they run a subscale 3 party network that can adapt much more quickly than V/MA. As a side note,  Paypal will likely expand distribution of their own plastic.  See related blog.
  • Google rolled out Wallet 1.5 on August 1 (see blog). This is one of the biggest moves in payments and provides an enormous retailer value proposition (aligned to MCX). Google didn’t follow PayPal, Passbook, or Microsoft.. they rolled out product that was 1.5 yrs in progress.  Google’s new cloud wallet allows the consumer to select any payment method, and provides the merchant with a debit rate (Bancorp non-Durbin 1.05% + $0.15 (note Google/Issuer can lower this for merchants, as any issuer could, this is a MAX rate). Google is CURRENTLY loosing money on the payment side of the business in hopes of making it up on the advertising side. This is no marketing announcement like Apple, Microsoft and Paypal.. this is a product announcement.. it is working today in my new Galaxy phone. This is also the first PRODUCTION cloud wallet for the POS. Apple, Amazon and Paypal dominate cloud wallets in eCommmerce and mCommerce. Google and Amex’s Revolution money are the only one’s doing it at the POS.
  • Square acquired all 30M Starbucks mobile payment customers (see Blog). Square has done a great job acquiring merchants.. but was hurting on the consumer side. Square wants to build network and needed a pop on the consumer side. Square’s business is pivoting toward marketing and consumer experience. Within the next year, the little Square doggle will be a thing of the past. Starbucks is committing to the Square register experience, and Square is relabeling “card case” to “Pay with Square”.
  • LevelUp is making payments “free” for merchants as part of a loyalty value proposition. This is an example deal.. expect more to follow. Issue is that different merchants have different priorities. LevelUp is focused in QSR/Casual Dining and is operating as part of a loyalty play. I’ve outline their revenue in this blog, don’t think it is sustainable unless they can move into acquisition.
  • ISIS has lost key executives in its product area, AT&T is rumored to have a NFC/Wallet RFP of its own out and even Verizon is planning to let Google go ahead and put its wallet on the Samsung Galaxy III phones.. after all what choice does it have?
  • Card linked offers and incentives in the cloud. No one is making money in this space, large retailers are not participating, hyper local merchants (who are interested) are very hard to sell to, and consumers don’t see relevant content (thus redemption rates under 2%).

Where are the cloud battle lines? Well most significantly the battle lines are forming away from NFC (as I stated in January). Even my old friends at Gartner have caught up and placed NFC in the trough of disillusionment. To restate, NFC is not bad technology.. but it delivers no “value” in itself beyond control. Mobile operators have consistently failed to build a business around a “control” strategy (see my Walled Garden Blog). In the  ISIS example they mandated use of credit cards only, as this higher credit interchange was the only way to make revenue. Well guess who pays the freight here? Yep the merchants…  Wal-Mart and its peers were not thrilled at giving issuers and MNOs 3.5% of sales for the privilege of accepting a mobile payment.

The Cloud battle is complex, as the strategies are about MUCH MORE THAN PAYMENT. Payment is the ubiquitous service that is the last phase of a successful marketing, engagement, shopping, selection, deliver, retention, loyalty process. Leaders from my vantage point:

Payment Networks:

  • Mastercard focused on acting in supporting role globally.
  • Discover similar to MA, but with much greater flexibility as it operates in a 3 party network and is both issuer and acquirer.
  • MCX – Not a leader yet, but has CEO mindshare of every top US retailer. They seem overly focused on the cost side. There is a very big whole in their customer acquisition strategy. MCX is bidding out its infrastructure now, my guess is that Discover or Target will win it.. and the the RFPs are just a way of keeping Banks “in the tent” to keep them from changing ACH rules to kill it like they did to Scott Grimes at Cap One (decoupled Debit).

Physical POS:

  • Google – has more consumer “accounts” than any company on the planet. Can it convert them to accounts with a linked payment instrument? Google also “touches” more customers, more times per day than any other company, its heavy influence in the shopping process positions it well with retailers. Also has the best retailer sales force of anyone on this list, as they bring in customers to retailers every day. Android/Google Wallet….
  • Square – Best customer experience hands down (register). It also has the most traction among small retailers

eCommerce/mCommerce:

  • Apple – expect Passbook to dominate mCommerce. It will be the killer app.
  • PayPal – Challenged in market adoption beyond eBay/GSI customer base. Top ecommerce sites like Amazon and Rakuten have their own integrated payment, also 50% of eCommerce/mCommerce goes through Cybersource which Visa acquired. Paypal’s future growth driven by international
  • Amazon – leading eCommerce/mCommerce player. When will it take one-click beyond Amazon? Amazon’s experience is best from end-end…. PayPal/Apple will operate around the periphery of non-Amazon purchases.
  • Rakuten – “Amazon of Japan” who now also owns buy.com. Fantastic experience and leading eCommerce loyalty program.

How many places do you want to store your payment credentials? Who do you trust to keep them? What data do you want providers to know about you?

From a macro economic perspective, total payment revenue for all major participants is just under $200B in the US. Total marketing spend in the US is over $750B. Total retail sales in the US is $2.37T (not including oil/gas, Fin services, T&E). Marketing is fundamentally broken… payments is not. Retail sales gross margin has been compressed from 4.2% in 2006 to 2.4% in 2010. Who is best able to execute on the combined retail and marketing pain points? Who can be retailer friendly? Consumer friendly? Marketing friendly?

I start my analysis with #1 the consumer value proposition, and #2 the merchant value proposition. Entities like Google, Paypal, Apple already have tremendous consumer relationships and traction. They thus have very few “acquisition” costs. However, these entities do bear the costs of changing customer behavior. There are many approaches for changing customer behavior:

  • Incent behavior – direct/indirect/merchant
  • Customer Experience (ex Square)
  • Service integration (reduce effort or # of parties)
  • Reduce risk – financial (security/anonymity…)
  • Reduce risk – purchasing (social, community reviews, …)
  • Value proposition in commerce process (indirect incentives)
  • Marketing
  • ..etc

Other groups like MCX and ISIS bear the cost of both customer “acquisition” AND behavior change for: Consumer, Merchant or Both. As I state previously. one of my favorite arcane books I’ve ever read was “Weak Links” I’m almost reluctant to recommend it because it is so good you may jump ahead of me on some of my investment hypothesis. One my favorite quotes from the book

Scale-free distribution (completely open networks) is not always the optimal solution to the requirement of cost efficiency. .. in small world networks, building and maintaining links between network elements requires energy…. [in a world with limited resources] a transition will occur toward a star network [pg 75] where one of a very few mega hubs will dominate the whole system. The star network resembles dictatorships in social networks.

Networks like V, MA, PayPal, Amex and DFS are working to participate in this new Macro economic opportunity. But established networks are hard to change

“The network forms around a function and other entities are attracted to this network (affinity) because of the function of both the central orchestrator and the other participants. Of course we all know this as the definition of Network Effects. Obviously every network must deliver value to at least 2 participants. Networks resist change because of this value exchange within the current network structure, in proportion to their size and activity.”

The implications for cloud based payment at the POS are significant because the entity which leads THE DIRECTORY will have a significant consumer advantage, and will therefore also lead the breakdown of existing networks and subsequent growth of new “specialized” entities. For example, I firmly believe new entities will develop that shift “payment” revenue from merchant borne interchange to incentives (new digital coupons).

The current chaos will abate when an entity delivers a substantial value proposition that attracts a critical mass of participants. Today most mobile solutions are just replacing a card form factor… this is NOT VALUE. I am currently placing my bets on solutions that merchants support (Square, Google, MCX, LevelUp, …) as this is a key “fault” of almost every other initiative.

Comments Appreciated (as always sorry for the typos…)