Future of Phones.. Good Enough?

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16 Sept 2012

Quote of the week

It’s not clear that NFC is the solution to any current problem…

Apple Senior VP Marketing – Phil Schiller

A few months ago I was in Hong Kong speaking with institutional investors at CLSA’s annual event. One of my more memorable meetings was with James, a chief investment officer with a top 5 investment bank. The heart of the discussion was on the future of telecom. Although I’m not a telecom expert, James was interested in finding “the next killer app” in mobile. Was NFC it?

His investment thesis was that phones are starting to become commodities: screens, LTE connectivity, cameras, battery life, applications, …etc are all reaching a point of good enough. His time with me was spent drilling down into payments and NFC in order to see if I had any new data which would alter his view.  I did not….

What will happen in a world where handset hardware is no longer the basis for competition?  The same thing which occurs to any manufacturing area where a “good” becomes a “commodity”: margins compress for the commodity and migrate to the new area which is basis for differentiation/competition. Yesterday I outlined the implications, and investment opportunities, for the mobile operators.

This week we saw the launch of the iPhone 5.. better, brighter, bigger, lighter, clearer, faster, lasts longer, crisper, sturdier, takes better pictures, more tightly integrated to applications that Apple controls, …etc. A great new product.  An Evolution… not a revolution.  What Apple understands better than almost any consumer product company is: consumer experience matters.  While some handsets already exceed those of  Apple’s iPhone in feature/function (Samsung’s Galaxy S III)…  none can match it on consumer experience. Experience is where Apple is focusing its efforts, and the major shift in iPhone capabilities is NOT in hardware features.. but on orchestrating value in ways it can control.

Apple takes a Clayton Christensen approach to the iPhone: what problems does a customer have, and how do I solve them? For example, I hate typing in my name and address on a little mobile browser to order a good from lets say Gap.com.  Apple’s passbook will resolve this by allowing Gap to integrate to passbook to pull all of the “iTune’s account” information over .. so I don’t have to fill this out anymore.   Apple is moving to solve real consumer problems…  It is looking to orchestrate value delivery.. moving the “hub” of coordination from the phone to iCloud.

This is what I refer to as the Stage 4 Value Shift (see April Blog). Theoretically, an open innovation model (ex Google/Android, Java/Oracle, …) should be able to quickly surpass Apple, as 100s of small companies invest larger amounts (cumulatively) in expanding capabilities of a “platform” (see platform leadership). However, Apple has learned its lessons from its Mac days and has defined competition along the lines of “consumer experience”. In this model, it does NOT CARE about interoperability or standards… rather Apple is maniacally focused on delivering value to consumers with usability, reliability, intuitiveness, …  being core measures.  Apple’s brilliance is multi-faceted, but by defining product focus along the lines of consumer experience, the iPhone’s closed model of innovation can not only effectively compete, but win easily against open systems. In other words, while open systems compete more effectively in a feature/function war.. they loose in the qualitative measures of “experience”.

Apple will obviously monitor the environment for effective new features, to ensure that the core product hardware remains competitive. For example, the real world transaction data for NFC based payments is a complete joke. There are no phones, there are few terminals, and there is no consumer or merchant value proposition. Sure there are exceptions like Japan, but only closed systems with a monopoly leader have proven the ability to push the solution out.

Apple does see a need to improve device-device communication, as well as shrink the hardware footprint. With these drivers, and given the prototypes in market, I fully expect Apple to redefine phone hardware architecture with a new integrated chipset that would encompass functionality of: controller, radios (wi-fi, BT, 14443, …etc), secure element that would also enable the SIM to be virtualized and placed within the SE. If this is indeed Apple’s direction, it will not be a new basis for hardware competition on feature/function, but rather: battery life, footprint and control (ex. virtualized SIM).

Other players also have unique strategies and assets. For example, Google’s strategy: orchestrate value based on consumer data. In assessing investments I look for one key answer: what problems are platforms trying to solve and in what marketplace?

All about Commerce… and Entertainment

My major issue with Apple’s strategy is the degree to which other entities can participate. I see mobile phone revenue streams in 2 major buckets: Commerce and Entertainment.  Entertainment is not a focus for me.. Commerce is. Businesses operating within the retail sector are undergoing fundamental transformation. For 1000s of years, local merchants survived based upon distribution and availability. Today they are left trying to sell a commodity product at a higher price to consumers in a marketplace with near perfect transparency.

What is the roll of any intermediary in commerce? Not just in the selling, and purchasing, but in marketing, product selection, distribution, service, support, … What does the new face of retail look like? This is the focus of Amazon… they are the leader here from a “virtual commerce” (e and m) perspective.

As an investor, I believe we will see a massive new wave of companies redesigning retail. Five years ago I had a camera, an iPod, a PDA, GPS, phone, … today I have one device.  What will the bundling (or unbundling) of retail look like? What are the problems to be solved? In the past 15 years mobile has grown up along side of commerce, operating primarily as a replacement to fixed line and then migrating to a replacement for online. We will start to see phones leap into commerce in new ways.. but my firm position is that this leap does not start with payment (the last phase of a commerce) but with marketing (the first phase). Why? Because marketing and retail are fundamentally broken, and Payments is NOT.

It is in this context that I laugh at NFC solutions. My favorite quote on this topic was from head of strategy of top 5 retailer

“Mobile Operators know how to run dumb pipes, not create business platforms for marketing… their current wallet initiatives are akin to a toll bridge, NFC is their toll booth where they stop me before reaching my customer..  to cross their NFC bridge I have to wait in line and when I arrive at the gate they don’t want $0.50 toll.. they want 3.5% of what I’m carrying in my truck, and a copy of the shipping manifest (customers’ names). This model doesn’t work for me. “

Commerce will find another path… one of least resistance … of better “experiences”. This is what Apple is enabling in Passbook, and why Amazon is succeeding in commerce. NFC is just a radio… one who’s standards are largely controlled by banks, mobile operators and card networks. Why would retailers want to participate here at all?  We should not act to enrich the complexity of payment networks, or wireless ones, but rather form new networks.

Sorry for the typos.. and re-hash of past blogs.. hope it was useful.

Mobile Operators – Where to Invest?

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13 September 2012

Mobile Operators should be quite happy with 2012.. it is turning out to be a good year for them. Wireless data revenues are climbing by around 20% YoY and 4G phones are just coming to market. This means your LTE investments should really start to pay off (if you get your data plans right). Motorola indicated that median usage of a 4G device is 11x more than a 3G device – 89MB/ day vs. 8 MB/ day. Also, 4G users are 62% more likely to check their phones than their 3G counterparts… As Jim Patterson notes, more checks mean more opportunities to display an ad.  If you can establish that business.

In 2Q2012, AT&T had 69.6 million postpaid customers driving. Operating income margin of 30.3 percent; EBITDA service margin of 45 percent. Wireless data revenues rose by $1.0 billion, or 18.8 percent, from the previous year, to $6.4 billion

For same quarter Verizon had 94.2 million total retail wireless customers, with a 7.3 percent year-over-year increase in wireless revenues; Data revenues were $6.9 billion, up $1.1 billion – or 18.5 percent; 30.8 percent operating income margin and 49.0 percent segment EBITDA margin

Apple – A Faustian Bargain?

Eating 50% of the cost of a new iPhone will certainly help wireless data growth, but will MNOs develop any other business that can take advantage of this investment?  Raymond James analyst Tavis McCourt shows that Apple (AAPL) is expanding  its share of  profits generated by the mobile industry to 77% in the second quarter of 2012, while also accounting for 43% of its total revenues.

I may be naïve, but I don’t see Apple as the 800lb Gorilla eating everyone else’s lunch. I see Apple as a company executing against a strategy focused on delivering exceptional customer experiences with a solid brand and a fantastic product. Apple is successfully monetizing an environment they control: iTunes, Apps, iOS, iCloud, iPhone, Mac, … They didn’t start with a “control” strategy.. they started with by delivering customer value (and did not go out of their way ease switching costs).

A Strategic Guide to MNO Investment

MNOs, why do customers choose you? This question more than anything else should frame your strategy. Investments in LTE certainly align here, as faster bandwidth improves a key customer requirement and enhances your core revenue.

However, it should be no surprise that consumers don’t want to use your applications and  services… your indigenous applications, or your approval (ex control over apps allowed) is not part of their buying decision (except in a negative context). Customers believe that Apple, Google, RIM, … create the platform.. and hold them accountable for delivering value. Customers want freedom to choose how the device works. They make this decision usually before they enter your stores.

These “platforms” will dominate the world much beyond what we witnessed in WINTEL. There is a unique convergence between the mobile and physical world: consumers interaction time,  global penetration, portability, connectivity…. The most substantial business impact we have seen due to this convergence (last 5 years) is impact to retail profit margins ( price transparency while shopping – see showrooming). The ability for consumers to check price in the store has been a key driver of retail margin compression, which has decreased from 4.2% in 2006 to 2.4% in 2010 (ref: IMAP’s Retail Industry Global Report 2010).

Even if MNOs could develop applications and services of the quality seen in the core platforms, or by small start ups, MNOs cannot possible coordinate and interconnect at the speed and scale of the platform providers. Google and Apple are quickly moving beyond isolated applications and into the cloud, thereby further accelerating their roles as Orchestrators of Value (See Blog – Stage 4 Value Shift).

MNO opportunities

I’m running out of time here.. need another cup of coffee .. may come back and polish this up. But here are the top areas I see

#1 Empty Space – Mobile Advertising

Leverage your assets in physical distribution, network ownership and consumer PII to reach well beyond anything google could provide. Mobile operators, you have data Google could only dream about… from ISP information (everything done in the mobile browser), to location, to direct customer billing agreements. You could target advertising like no other entity in the world.. plus you now have great 4G assets to deliver unbelievable content.

Mobile advertising is fundamentally broken. There is no one executing well here.. its because this space should belong to you. Go at this strong, hire a strong exec CEO and be willing to pay through the nose for a team comprised of less than 10% industry insiders. This is an advertising company.. not a mobile operator division. If done correctly, the revenue here will dwarf your mainline business in 3-5 yrs. I’ll be glad to quit what I’m doing and run it for you…

#2 Mobile – Physical connection

See my blog KYC $5B Opportunity. Many current businesses (finance, advertising, payments, …) require a physical touch with customer. In emerging markets we see telecom sales “agents” taking on licenses of bank/MSB agents so they can certify documents and take role in opening new accounts. I can tell you first hand as the exec running Citi’s remote channels globally I would love for VZ/Vodafone to take on a role in opening accounts. Additionally, think of the mobile phone operating as a form of digital signature for any type of business.. Or working to complete the biometric locks of Apple/Google/.. with an process that includes non repudiation and physical identification (VZ employee taking and witnessing the biometric registration).

I could think of many more that include Opt In/Opt out for advertising, ticket pick up, virtual concierge, or a cool and hip genius bar (renamed of course) where people are welcome to experiment with all the cool new apps and phones in your store… changing your store “experience” from volume dumb pipe and appliance sales.

#3 Service provider role

The first 2 were “leading roles”, this is “supportive”. Take a look at how your phones are  used in the real world, particularly in business. Create customer experience teams. How could your MNO support the business processes of others? In healthcare? In retail? In Airline/travel?

Take healthcare for example, although we have HIPAA, we still have few digital records agents. What could be done here?

You need a complete rework of your partnership strategy. Most MNOs have a model in partnership: buy exclusive rights.. Example is VZ’s deal to sell search to MSFT for $550M in 2009. This model deal continues to be the starting point in most discussions. Change happens rather fast in this industry, exclusive deals also don’t take consumer preferences into account. You must reworks your partnership strategy, away from a control mentality. Focus first on what the consumer wants.. how can you best support it? That can’t be radical… ??

#4 Business wireless

When I go to top 20 retailers to talk about mobile.. their immediate response is: “how do we stop it”? How can MNOs help retailers enhance their business?

Battle of the Cloud – Part 2

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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…)

Interpreting Square-Starbucks Deal

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18 August

From Press Release, key deal points are:

  • Customers will be able to use Pay with Square, Square’s payer application, from participating company operated U.S. Starbucks stores later this fall, and find nearby Starbucks locations within Square Directory;
  • Square will process Starbucks U.S. credit and debit card transactions, which will significantly expand Square’s scale and accelerate the benefits to businesses on the Square platform, especially small businesses, while reducing Starbucks payment processing costs;
  • Using Square Directory, Starbucks customers will be able to discover local Square businesses — from specialty retailers to crafts businesses — from within a variety of Starbucks digital platforms, including the Starbucks Digital Network and eventually the Starbucks mobile payment application;
  • Starbucks will invest $25 million in Square as part of the company’s Series D financing round;
  • Starbucks chairman, president and CEO Howard Schultz will join Square’s Board of Directors

My interpretation: Starbucks is selling their customer base to Square for a revenue share and an equity upside.

  • Square is buying the Starbucks payment user base, with all stored “reload” cards. This customer directory will move from Starbucks to Square and support both legacy Starbucks payment and enable all Starbucks customers to be “PaybySquare” capable with acceptance of new terms. Square is “processor” in the sense that it is now responsible for pre-paid balance and reload.
  • Its about DATA.. payments will be free (for Starbucks), and SBUX hopes to enable Square incentives that are BOTH loyalty and line item based. Square’s driver is to find a way to monetize Starbuck’s payment and location data before it gets to Chase PaymentTech. This means increasing consumer network so that it can make better case to prospective merchants. My guess is that Square is processing payments at no cost Starbucks is paying a lower overall cost for payment acceptance through Square/ChasePaymentTech for all existing Starbucks customers, and will actually PAY Starbucks (revenue share) for any ad revenue they can generate from Starbucks customers. There are 3 consumer transaction tranches: Starbucks mobile payment, Starbucks card, and Pay with Square (Square Register). All will go through Square so they can use the data.
  • Starbucks will start to roll out a new service: SquareRegister (pay by voice, see my previous blog). This will eventually replace the bar code if all things go well. Again, my belief is that Square will bear all of the cost here.

Revenue implications?

Short term there is no revenue upside for Square in this deal, it is about growing network (primarily on consumer side). Starbucks will see costs decline slightly and open up a new revenue channel by monetizing its consumer network outside of its stores. I have some thoughts on precise numbers, but making my own bets right now so I can’t share them.

LevelUp Free Payments

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4 Aug

Levelup just completed a $21M round and announced last month that payments would be “free” for merchants.

Take a look at this youtube video to review high level customer experience.

[youtube=http://www.youtube.com/watch?v=AltHtxsaLJQ]

In order for Level up to successfully complete a transaction:

  • Merchant must set up account
  • Teach servers how to “read a barcode”
  • Consumers create an account
  • Consumers set up payment instrument
  • Data connectivity in the store for consumer to generate barcode
  • Data connectivity in the store for merchant to read barcode (less of an issue as servers may be on internal private wi-fi).
  • Restaurant reconciles payments from levelup with cash register, payments from card processor, groupon, living social, …
  • Restaurant determines “value” of loyalty program vs other marketing forms.

My first question on seeing this is “why”!? why would restaurants want to do this? Why would consumers want an account? Why would Google Ventures and TMobile put money in this? (see rough start for mobile payments, Digital wallet strategies). What is the value proposition?

First, let me admit 2 very big biases I have (associated with this model).. they were formed by some very hard lessons learned

1) Building both sides of a network is very hard to do

2) Commercial buildings are a black hole for connectivity. My estimate is that 3G service is avail in less than 40% of all commercial buildings.

The primary value proposition is a loyalty, allowing a Starbucks like checkout  experience and loyalty program. As I stated in this blog, loyalty is a $48B business.. so can theLevelUp act as an effective loyalty program manager? What is their market?

Total Sales in US restaurants was $632B in 2011, of that $216B is for full service restaurants with the majority of restaurants (472,000 out of 474,000) operating with under 500 employees (independents and small chains). In the restaurant vertical, small businesses dominate.. compared to mainline retail (where the top 20 retailers capture about 60% of sales …ex gas, auto, restaurants).

LevelUp is currently focused on small restaurants. Top 20 retailers have already established very successful loyalty programs (CVS is #1 with over 60M members). Big chains are far less willing to let another company deliver value outside of their brand.

Loyalty program costs vary greatly, however program fees are typically below 5% of sales for participating customers.  Given a 5% participation rate and a 20% usage rate the total addressable market for loyalty program management (for small restaurants in the US) is $100M… a pretty small number

Can small chains benefit from a centralized loyalty program? Who is best positioned to execute on this? Loyalty programs are an important part of any acquisition plan: how do you keep customers coming back? Is it the product? They price? Experience? Every company has a strategy, and every customer is different.

Selling to 400,000 small businesses takes time. This would also seem to be something that either open table, paypal, Square, Google could do easily.

Free Payments may help LU find traction with small restaurants, but from what I hear restaurants have already been struggling to reconcile Groupon offers, LivingSocial Offers with their books.. taking payment through an alternate network (ie different processor) is likely to further challenge the book keeping of these small establishments.

Strong recommendation to restaurants:

1) See what kind of cell data coverage you have in your store before you roll this out. (Update. From notes below it seems that LevelUp does not generate a unique code at each use. Static QR code improves usability inside the restaurant, at the expense of fraud. LevelUp will be acting as a TPPA, so retailers will not bear fraud costs… My guess is that LU has the ability to generate unique QR codes, but has chosen not to roll them out while they build scale. Its a race to build scale before fraud develops, and they are required to generate unique QR codes. In this “future” scenario there will be a connectivity requirement. )

2) Get customer information yourself and use it…

3) Try the #1 restaurant marketing solution in the market: FishBowl.. unbelievable results.

Thought appreciated.

PayPal vs Google (at POS)

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3 Aug 2012

Paypal COULD do everything that Google wallet does today.. so why won’t they? (Note I’m talking about the Physical POS… not online)

I’ve had a PayPal debit MasterCard for 6 yrs, when I use it at any merchant PayPal deducts from any stored balance I have, and then hits one of my stored payment instruments. I use this card exclusively on international trips because they have always offered the best cross border fees (.. and just 3 years ago paid an interest rate higher than any of my banks). I looked on the back of my new PayPal debit card and see that JP Morgan Chase is the issuing bank. Given that Chase has over $10B in assets, this card costs the merchant $0.21 + 5bps in the US. This is a great deal for retailers. A REALLY great deal.

Why is PayPal pushing out its own Plastic? Unbranded? Obviously they really don’t like the standard debit interchange (above) and want a bigger cut (than $0.21 flat fee) from the retailer. (see PayPal at POS)

Why won’t PayPal expand its online wallet to allow me to select any card for any given purchase? In this I mean creating an app that works like Google wallet, prompting the customer “what card do you want to use”? The answer is that they want to drive the underlying account selection decision to ensure the instrument with the lowest cost is selected.

Take a look at your payment instruments in PayPal today, they let you define a DDA account as “primary” but NOT a card. In other words PayPal incents you to link DDA in order to get money out.. then PayPal looks to leverage this account whenever possible (sometimes taking take settlement risk). The most costly customer for PayPal would be an Amex customer with no linked DDA and a PayPal debit card (for ATM withdrawals). See my related blog on PayPal’s funding mix (estimate 150bps)

PayPal is a payments business.. not an advertising business. Their goal is to maximize revenue. This is not a bad thing…  But their recent moves are a “replay” of what happened to the bank payment networks as they pushed to ramp up merchant fees and grow interchange revenue at the expense of retailers.  Why on earth would any merchant agree to take on Paypal’s new plastic? If it is above $0.21 it makes no sense at all… UNLESS Paypal is driving incremental sales.

PayPal today could create a Virtual “wallet” tied to either a Sticker or a Card that would work across Android, iOS, Blackberry, … and do everything that Google has done.. Why won’t they? Because the instrument must operate as a debit card, and the interchange “arbitrage” could kill them. In other words they will bear the cost of 350bps for a CNP Amex transaction and only charge the merchant $0.21 flat fee.  If they rolled this out, I’m sure they would have MASSIVE success.. but if customers unlink DDAs and delete debit cards they would risk a funding mix that is “unsustainable” because they have no other revenue channel.

Google

The true “payment innovation” from Google has little to do with payment and much to do about risk management and monetization of data. Google drives business to retailers today.. google helps consumers find the right product… they also “know you” from your history. They can use this information drive value to consumers AND to retailers.. they are also willing to take a very big risk that the benefits of Google will out weigh the COSTS of WALLET. Google Wallet will likely loose money on every single transaction. If you never accept an offer, incentive or coupon.. never search.. never use maps to find a business, never use Zagat to find a restaurant, never watch you tube commercials… they will likely loose money on you.   However Merchants will ALWAYS win.. no matter what, they will have the lowest cost payment when accepting a Google payment.

This is either INNOVATION OR INSANITY.  From my perspective, what Osama and team have done is fundamentally game changing.. ! Bearing costs, giving consumers and retailers complete control.. in the hope that they can deliver value in other services. Payment is now just a small part of an overall Commerce Process. For example, a “new” feature of Google Wallet that has not received enough attention is the “saveto” API release at Google I/O . Google allows merchants to store 3rd party offers and payment types in the wallet. These offers don’t have to be created by Google.. it is a true “wallet” function. 

As I stated yesterday,  Visa, Mastercard, Amex, all of the banks are REALLY worried about data. Google will be in a position to deliver value to consumers independent (or dependent) on the card you use. Few other companies can do this… Consumers will always have a choice.. no one will be forcing them to use their Google wallet.  But why not? Why didn’t the banks use their information to help me earlier?  Why did the banks and payment networks stop retailers from passing their real costs along, of delivering incentives that they could control?

This “aggregate” model is something ANY company could do in short order.. Square is doing it, Revolution Money, LevelUp, … but no one else can make it profitable.

PayPal’s new POS “hope” is to re-engineer the customer experience at the POS, allow merchants to throw away their custom POS terminals.. As most of you know I believe Square Register was by far the best POS experience I have ever seen. From PayPal’s June Video it looks like they agree and have replicated the Square Register “voice” experience. While the customer experience is FANTASTIC.. it did not bring the customer into the store.. nor is payment cost competitive with Google.

[youtube=http://www.youtube.com/watch?feature=player_profilepage&v=CMByV-k9Oc4]

Investment take

PayPal has enormous runway left for them globally. I don’t see Google wallet denting current growth for 2 years. However this is VERY disruptive. IF google is successful in getting all Android users to register with a payment instrument (like Apple does in the App Store), and Google pushes Wallet out beyond NFC phones, it could result in a Tsunami wave which Paypal could not overcome in mCommerce.. This is a scenario where there are 3 primary mCommerce payments options: Apple Passbook, Google Wallet and Amazon.  For physical commerce.. nothing will impact this world in next 5 yrs if it does not entail a physical plastic card. NFC phones and payment terminals just aren’t materializing fast enough.  IF google creates physical plastic.. watch out…  In this scenario Google should  be pursuing an unbranded card.. “let the consumer decide”.. .”let the retailer influence” these are themes not heard in the payment world and would seem to resonate.

Google Wallet 2.0 – Who does not benefit?

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August 2, 2012

Yesterday I covered the winners… today I cover the flip side.

Mobile Operators

Most obvious is mobile operators payment efforts, at least those bent on controlling the NFC SE in a walled garden strategy. I covered this topic last month (Carriers as dumb pipes). As a refresh.. 5 years ago carriers were going to charge applications each and everytime they accessed the GPS.. you can see how that worked out…

Its really a shame.. Operators have tremendous distribution, brand, cash….  What they don’t seem to have is anyone that knows how to run a platform business (related blog). Running a platform is about creating a “sandbox where everyone can play and make money”.. Apple has it.. of course they also have 75% of mobile profits (related blog). Most of my frequent readers already know what I’ll say next: Control is NOT a value proposition.

The big problem with payments?  There aren’t any problems (and margins stink). Why focus on it? The mobile handset has the opportunity to do so much more. Google has an ad business which will greatly benefit from added payment information. It will be in a position to help retailers and consumers and deliver value (note I didn’t say banks). The MNOs don’t have a business that can leverage payments, and they are not the greatest at partnering. They couldn’t even work with Google… a company that built Wallet and Android for free. Just what were they trying to win? (related blog)

My STRONG recommendations to carriers: go partner w/ Google now.. If you thought Apple was a one time event you are sorely mistaken, google has more commerce assets (virtual and physical) than anyone in the world. Another recommendation? Focus where you can win easily, AND DELIVER VALUE (see KYC a $5B opp)

Big Banks

(At least the credit card divisions). Most of card teams were trying to position mobile as a “premium” payment service. Its not a total wash for you, given that Google is charging merchants regulated pre-paid rates while having to pay most of you full interchange… perhaps even CNP interchange. But while you see a quick win here remember that incentives can be tied to a card. If you don’t play nicely my guess is that you will see customers shift spend, particularly for small items.  Of course one big weakness of the Google wallet is the refund/return process.  Additionally, Google Mastercard consumer purchases will be covered under Reg E, vs the greater protections afforded consumers with a credit card under Reg Z.

The biggest bank loss however is Data.. not much of a problem today given the number of Samsung Nexus phones are in the market (.. with google wallet). But what if Google does issue their own contactless sticker.. like I have on the back of my iPhone? Why NFC at all… just a Google card to swipe would allow you to have all of the functionality. In the new Google wallet world, they will see all transaction data.. just like Paypal does. Difference Google knows how to use it in advertising.

Card Linked Offers

It just a guess.. but now I can have offers linked to any card I use.. For merchants TXVIA could create virtual pre-paid cards for you at no cost and let the “value” of the offer reside there. Basket level, or item level with POS integration. The writing is on the wall..

NFC Ecosystem

There are pros/cons here. If the carriers supported Google wallet it would be mostly a win.. We may actually see NFC handsets be common place… but not if people have to root their phone to install Google Wallet.  Apple will eventually put some sort of new combined SIM/NFC/BT radio in its phone (related blog). In this future Apple Passbook world I can guarantee the carriers won’t be keeping any version of the iPhone in a Garden.

Short term impacts with Google Wallet? The First Data TSM operates with Google as the SE owner and service provider, no SWP UICC chips, no OTA provisioning, …

Comments appreciated.

Google Wallet 2.0 – The Winners

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Today Google Wallet 2.0 launched (Google Blog announcement)

[youtube=http://www.youtube.com/watch?v=VuFVsaFCzsw]

Google will now allow me to add any card I want.. my Bank of America Debit, Citi Credit, my business Amex… My cards sit in the cloud and I can access them on the device at the POS, online, or for a mobile purchase. The device has a single card that acts as an “ID” that points to your account in the cloud. The gateway/acquirer then resolves this ID to the card (stored in the cloud) which you want to use and then processes an authorization with the corresponding issuer. Not all that different than how PayPal and Amazon work today (which card do you want to use)?

Google’s approach has empowered consumers and destroyed the ISIS Walled Garden Strategy. Banks no longer have to queue up to do OTA provisioning.. consumers just add their accounts. Retailers no longer have to take credit cards in mobile payment…

My view is that this is a huge leap forward, but there are at least 2 more steps to go. Allowing consumers to control the wallet must be followed by an ability for retailers to deliver value (independent of the latest phones). After all there are no payment problems in the market today (none of us ever left a store because they would not take our form of payment). Retailers are more concerned about driving top line sales growth, than bottom line card costs.. but the tools to do either are limited.

The wallet has the opportunity to be the “hub” of many new commerce experiences. What other company has the tools to create advertising campaigns? Shopping experiences?

A key “unknown” benefit is how broadly Google will expand the functionality of wallet outside of NFC. Afterall if I have only one master account.. I really don’t need an NFC phone.. I could use plastic or one of those stickers.  TXVia can certainly add value here.

Who are the winners?

  • Consumers. They control what goes in…
  • Retailers. Every retailer today should be thinking of having a pre-paid/gift/loyalty card with Google. Why not? Issuance is 100% electronic and should cost nothing. The other immediate benefit is lower cost (blended) due to debit mix and a new “platform” to offer targeted incentives (google offers) that is integrated into the payment.  Updated.. it looks like all Google wallet transactions are at regulated pre-paid debit rates. With Google wallet.. every transaction is at the lowest transaction price. Bancorp Bank has assets of $3.011B and is thus not covered under Dubin. Hence my best guess at the interchange is 1.05% plus a $0.15 (see comments below).
  • Small banks. Now your cards can go in the wallet … TODAY. You don’t have to pay ISIS that $1M after all.

Hey.. I could write more.. sorry for the short note. My previous blog gives a few other hints http://wp.me/pv8i-uv

Note the good discussion below.. my read is that the Google Card is a debit covered by durbin.. So merchants win big on card costs here. Everything is a debit…

Apple and NFC

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Apple and NFC..

Nothing really new here for the NFC crowd. No new information..  Purpose is to paint a picture by which investors can make a call.

Most of the issues associated with NFC today are NOT technical.. but rather business: What value can it bring? Who controls it? Who makes the money? How is it shared? For payments… NFC has been a complete bust (with the exception of Asia). Retailers just aren’t excited about the prospect of paying credit card interchange (3.5%) for the privilege of accepting a mobile payment which funds a 12 party supply chain  (necessary to make NFC work).

The WSJ (July 6, 2012) and I both have consistent information that Apple will NOT be rolling out NFC in the iPhone 5. If true, I believe Apple’s exec team is taking a brilliant approach to be a late follower here. Let everyone else pay the freight to educate the customer, and establish a high level retailer POS value proposition (with associated retail infrastructure). Apple is much better positioned to extend the App Store experience into mCommerce.. and control the customer end-end experience. Apple will also likely expand “selectively” into physical commerce areas like ticketing.

To be clear, I’m not positioning that Apple has run away from NFC.. but there has been no success to date and there is no reason for Apple to run into this space. In order to monetize and sort of physical POS solution, Apple must have a business structure that can orchestrate a very complex “physical commerce” value proposition. Keep in mind Apple doesn’t have much of a sales force to cover advertisers AND retailers globally. Rather than “focus” on the POS, or implementing standard NFC chipsets, I see Apple doing something “unique”… What is it?

I was meeting with senior NFC execs this week, and the consensus view is that Apple will likely redefine phone hardware architecture.  Most of you have read about Apple’s recent patent application which would allow the SIM to be logically placed within the SE. Also there are rumors about expanding the capabilities of the Radio and Controller to also cover Bluetooth functionality. The “value” that an integrated hardware solution? Not that much different than what NFC alone is capable of.. but it would greatly reduce footprint, power, time, and perhaps even expand “throughput” (example Accelerating/bypassing BT pairing: NFC is  424kb/s while Bluetooth V2.1 is 2.1 Mbit/s).

Although far from being an expert in this area, my summary view is that Apple recognizes the need for a secure radio and data store in the device that it can control.  A metaphore for an ID.  How do they want to control this ID? Well they certainly need to secure the wallet access (AuthenTec $356M last week, plus rumored IRIS scanning).

This approach is opposed to that of the carriers all of which are working very hard to “standardize” on an NFC architecture (Single Wire Protocol – SWP) that they will control. Apple’s plans are firmly in the opposite direction, and a brilliant business move. Giving carriers the control over this utility would be akin to letting them run an app store that they control.

Apple may be running much faster than anyone in the industry knows toward this vision. Perhaps they have already indigenously created this new combined secure element/UICC/BT Radio. Although I see no need for them to run with this early… But if they did create this capability in the iPhone 5 they will certainly have the control to govern how it is used.

What does this means for investors? Perhaps you start by asking Vivotech’s .. as they just folded up shop after 12 years. A fantastic team with a rock solid product line.. their fault? Betting  NFC would take off sooner.  Given Apple’s unique ability to capture mobile ecosystem profits it is always tough to find areas to nibble.  On the software side, how can new companies help Apple orchestrate value propositions in the physical world? Retail? Ticketing? Healthcare?.. The times.. they are a changin…

Random Thoughts: Settlement, NFC and CLO

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16 July 2012

Retail settlement

As most of you have read a $7.25B settlement was reached with some US retailers (led by Kroger, Safeway, Payless, Rite-Aid). I’m not going into depth on the settlement but rather the likely response by retailers, and potential impact on Visa/MA earnings.  The big retailers have been assuming that this settlement would be reached and have been in the midst of a plan. What would you do if someone was taking 3% of your sales and your average profit margin was 2.4% (ref page Aii IMAP Study)?  Well the retailers have plans to leverage a portion of this $6B windfall and invest it in a payment network they can control. Perhaps they should turn around and buy Discover (DFS market cap $18B). This rumor has been in the market (perhaps a driver of 2012 performance).

The US has 2 other countries which serve as benchmarks for a shift away from credit card at POS: Canada (Interact – debit launched 1994) and Australia (EFTPOS). Unfortunately I have limited information on Visa/MA transactions in these geographies to generate a decent analysis of spend shift. From http://www.interac.ca/media/stats.php we see in Canada that roughly 80% of all retail card present transaction are done via Interact (2011 GDV was $182B). I’m not implying a 40% hit to Visa’s GDV is imminent (US is $507B out of global $956B GDV for quarter 31Mar12), particularly since there is no competing network like Ineract (YET). But there are certainly references for success.

I presented some of the Retail Drivers last week and also in my March post (Retailer Wallet). My bet on retailer plans? Well Retailers are not exactly a small group marching in unison, so response will likely differ by segment, ticket size, purchase type (ex non-discretionary gas) and influence.

Gas/Automotive

  • Credit card use fee in 2-4 months nationally

Grocery

  • Slower roll.. we will see marketing to inform customers of the costs of credit and plans to implement a fee for use of credit cards
  • We will also see tests of fees in isolated stores/geographies. Not only assessing customer issues, but also competitive responses.
  • Loyalty cards that will be integrated into a payment system
  • Loyalty cards that have integrated digital wallet (WalMart issued a Digital Coupon RFP over 18 months ago).
  • Incentives dependent on payment type
  • Push for PIN Debit.. as it allows the retailer to route away from Visa/MA directly to the bank.

Big Ticket Retail

  • No fee likely as they benefit from access to consumer credit
  • “Carrot Trials” of Rewards programs and targeted offers will be contingent on payment type
  • New loyalty cards

Apparel / Luxury

  • Least likely to implement a fee.. wait for other stores to establish customer behavior.

Travel/Entertainment

  • No fee likely…
  • Discounts for debit, particularly with airlines.
Visa/MA impact. Minimal through 2012, but could result in negative US transaction growth by 2014 unless networks are successful in delivering some sort of retailer friendly service.

NFC

I’m still just laughing at the mainstream press’ reaction to Apple iPhone 5 plans. Perhaps I should crying at the disinformation that mobile payments (at POS) are taking off. Everyone should ask: what kind of mobile payments?… Transit/ticketing is a slam dunk for NFC technology, yet NFC is having problems (witness London TFL’s decision to defer). Other mobile payments segments which are doing quite well: mCommerce with Amazon reporting around $2B, Digital goods with Zynga leading the category around $1.2B (investor relations).

But the mobile payments at the physical POS? This has not even started. (update.. Starbucks is clear leader here)

I don’t know how much more bluntly I can educate the NFC aficionados, but retailers have not gone gaga over mobile POS payments.. In fact I will state that Payment is not the killer app for NFC.. payment delivers NO VALUE to the Retailer.

For all of you looking at Apple’s patents and thinking they will eventually put NFC in… here is news for you: every one of the patent claims could be fulfilled by Bluetooth (replacing NFC). In order for NFC to take off, the carriers must let go of control (see my long blog here on MNOs walled garden strategy). There is nothing wrong with NFC technology, but unless the carriers are willing to front all investment for retailers, consumers, marketing , …  this will never take off. There is a value proposition problem (payments only) AND a control problem.  The US MNOs won’t even work with Google who has built everything for free.. free is not good enough for them….  They want control…

Card Linked Offers

I have new stories of just how bad the open rates are on these offers, but most revolve around a central problem. It goes something like this

1) Banks want to get consumers interested in offers. The consumer experience is TERRIBLE (no discount on the receipt) and banks are experimenting with 3 types of distribution. Integrated into online banking (Bank of America), e-mail, and secure messaging.

2) Retailers are not buying basket level discount advertising.. they never have. Retailers must pay for the offer (15% back), the revenue share (% of margin) AND the tax on the offer since it is technically treated as a retailer rebate. Total Retail cost for the offer is approaching 25%.

3) Given lack of retailer participation, Banks (and the offer companies) are thus forced to create offers themselves with no retailer participation (see my WalMart Story)

4) Banks do not want to let consumers go with “no offers” so all available inventory is distributed to “everyone”

5) The poor targeting (universal distribution) has a twofold effect: Consumers see garbage offers and start to tune out the channel, retailers see poor lift in performance as the offer redemption is done by existing customers that would have normally come to store

I could go on.. the exception to the rule of CLOs is Card Spring.. I like them quite a bit. Also Linkable just purchased the assets of Offermatic, which will enable them to link offers across card networks (using Yodlee)..