analyzing the business case for contactless payments[1]

8/13/2019 Analyzing the Business Case for Contactless Payments[1]

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www.informatm.com 2011 Informa Telecoms & Media 1

Analyzing the business case forcontactless payments05 September 2011

Guillermo Escofet

Key points

For banks and retailers, there are cost-saving opportunities in replacing cash paymentswith contactless payments. Potential savings can also be made by banks and operatorsfrom decreased customer churn.

Another factor driving bank and operator enthusiasm for mobile contactless paymentsis their common fear of becoming dumb pipes as online players use NFC to extend theirreach to the physical world. All would-be market players also share a common interestin promoting their respective payment products via mobile NFC, such as store cards inthe case of retailers and carrier billing and own-brand cards in the case of operators.

The main revenue-making opportunities lie in the additional fees that would beearned by banks and card-network providers through a greater number of cashless

transactions and newly-enabled P2P payments. For retailers, there is the potential forgreater turnover through the faster throughput of customers at the point of sale.

It is unlikely, however, that mobile users will pay more for the privilege of makingcontactless payments on their phones other than in emerging markets. There willbe little or no additional revenue to share with new value-chain members, suchas operators and other mobile providers, especially as regulators are increasinglysqueezing margins by placing strict caps on card-payment fees.

There is a big cash-replacement opportunity for NFC payments, even in developedmarkets. But it will be in those markets where card payments are most rooted, andwhere plastic-NFC infrastructure is most deployed, that mobile contactless paymentshave the most immediate opportunity.

Evidence from trials, polls and NFC-card deployments shows that contactlesspayments do have the potential to eat into cash payments. But adoption of both plasticand mobile NFC payments can be slow, as evidenced in the US, UK and Japan.

Business case

The main business case for NFC payments is replacing cash transactions. Substituting cashwith electronic payments represents a cost saving for banks and increased revenue for creditcard companies and their issuers (again, the banks), as they earn commission on the greatervolume of transactions processed through them. There is also a cost saving for retailers, which,according to research, can lose more than 2% of their cash turnover from theft, cash handlingand accounting errors. However, what retailers can save on cash-handling costs is probablymore than offset by the commission they have to pay on credit/debit card payments.

A bigger selling point for retailers is the potential of contactless payments to speed upcustomer throughput at the checkout and increase turnover. Mobile wallets and NFC alsoprovide retailers with the chance to make their closed-loop store payment cards more

prominent, against the increasing dominance of the open-loop card networks belonging toVisa and MasterCard.

Extending the reach, or defending the current position, of their respective payment services isthe most common driver for the players that are likely to battle it out in the mobile contactlesspayments space (see fig. 1).


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Fig. 1: Main drivers for market players' involvement in mobile NFC payments

The tap-and-go nature of NFC payments, where a card doesnt need to be inserted into apayment terminal or a personal identification number (PIN) keyed in, means that these

payments have a good chance of extending into the realm of cash-dominated, sub-20 (orUS$25) transactions, argue advocates. Contactless payments are meant to be twice as fast asother cashless payments. However, the jury is still out on how effective they are at replacingcash.

And, just as contactless payments have the capability of substituting cash, they are alsocapable of cannibalizing existing chip-and-PIN card payments. In fact, one of the biggeradvantages that mobile offers over mere plastic is that it makes it easier to extend NFCtransactions beyond the micropayment threshold to which they are normally subject,by enabling users to key in a PIN on their phone screen to authenticate higher-valuetransactions although this is also possible with NFC cards used on NFC point-of-saleterminals incorporating a chip-and-PIN interface.

There wont be any additional revenue for existing payment providers in instances where NFC

payments simply substitute existing card payments. In fact, the providers share of revenuemight be diminished if they need to pay part of it to the mobile specialists providing thetechnology and systems needed to enable contactless payments on phones.

Not that the revenue opportunity for mobile players looks that good either. Users in developedcountries wont want to pay a higher commission for such payments. Nor will retailers.There is plenty of cashless-payment options already available to users in developed countries,making mobile NFC payments are nice-to-have rather than a must-have. So there wont be anymore revenue to share with additional value-chain members than that already made fromexisting cashless payments.

The revenue opportunity for mobile providers will be mostly limited to fixed monthly orannual service charges per user around the provisioning of mobile-payment apps including

rental of space on the secure element, lifecycle management and personalization rather thana per-transaction share of revenue.

Whats more, margins are tight in cashless payments. And they are likely to get even tighter asboth retailers and regulators place increasing pressure on card-payment networks and card-issuing banks to reduce payment-processing fees.

Mobile NFC does, however, provide the opportunity for an additional revenue stream for card-payment providers: peer-to-peer payments. The idea is that someone could pay back moneyto a friend or contribute to a whip-round, say, by tapping phones with the recipient as longas both he and the recipient are equipped with NFC phones.

Such face-to-face transactions are usually made with cash, so NFC would again be playinga cash-replacement role. But NFC phone penetration needs to be pretty high for people to

commonly find themselves in a situation where they can pay friends and acquaintances inthis way.

Also, mobile NFC provides an opportunity for online payment providers, such as PayPal,Amazon and iTunes, to extend their reach to physical-world purchases, alongside card-


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payment networks, store cards and others. In a recent press conference, Stephanie Tilenius,vice president of commerce at Google, said that e-commerce accounts for only 8% of totalretail. This means 92% happens in the physical world, she said. With smartphones, geo-location and NFC technology, we're about to embark on a new era of commerce, where webring online and offline together.

Another possibility that has been mooted by payment providers is that of enabling one-click

payments on websites through cards loaded on phones for contactless-payment purposes.How this might be enabled has not yet been properly worked out, but, if it were to happen,it could increase the online mobile payments opportunity for card-payment providers. And itcould encroach on territory where carrier-billing services, such as Boku and Zong, have madebig strides in recent years.

Cash is still king

Despite the widespread availability of plastic money, cash still makes up the bulk oftransactions in many developed countries. And in emerging countries cash is unquestionablyking, it being most peoples only payment option, beyond bartering.

In the US, for example, cash and checks still underpin 60% of economic activity. And inGermany, Europes largest economy, cash accounted for just over 82% of transactions and

58% of turnover in 2009, according to a survey commissioned by the countrys nationalbank, Deutsche Bundesbank (see fig. 2). By contrast, debit/credit cards accounted for 13.4% oftransactions and 29% of turnover.

Fig. 2: Germany, share of payment instruments by turnover and number of transactions, 2009

Italy, one of Europes four biggest economies, is also predominantly cash driven. Its payment-card usage is, together with Germanys, less than half the European Union average. Thehighest usage in the EU is in the Netherlands and the UK, according to statistics collected byItalys national bank, Banca dItalia (see fig. 3). Yet, in 2009, cash payments still made up 66%of transactions in the UK. And 38% of cash payments were for purchases of more than 5.


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Fig. 3: EU, annual per-capita transactions by payment instrument, 2008

Generally speaking, southern European economies tend to be more cash-driven than northernones, with the notable exception of Germany.

Cash-handling costs are estimated to amount to 10 billion a year in Italy for both banksand retailers largely in terms of increased security and labor. In the US, the cost is more thanUS$70 billion a year. And globally, its calculated at US$300 billion.

Much cash handling is labor-intensive involving counting and double-counting of coinsand bills, and their transportation, under heavy security, from one location to another. Cashsmanual nature also exposes it to loss or theft through human error or design. According torecent surveys, 1.5 billion a year is lost by UK retailers through internal and external theftand handling errors at till points and during cashing up.

Cash replacement

It would be tempting to see the more cash-driven economies as a greater opportunity forcontactless payments. But in most cases there are strong cultural reasons for these economiesadherence to cash. In Western Europe, these economies have no shortage of people with bankaccounts or of card-issuing banks yet credit cards are relatively rare and cash remains thepreferred method of payment for many.

A big reason for the adherence to cash is tax evasion. A lot of companies pay their employeesin cash and a lot of merchants and service providers demand to be paid in cash so as to not tohave to declare such transactions to the taxman. The Italian government, for example, losesabout 100 billion a year from untaxed transactions; as in other southern European countries,it has a big underground economy, accounting for 22% of GDP.

Merchants also resent paying the commission on card payments. Although cash-handlingcosts are more or less equal to the money charged to retailers in card-payment fees now thatthe EU has capped such fees they are more hidden and are something that merchants havebeen living with for centuries.

So, all and all, there are less options to pay by card in these countries and, where cardpayments are accepted, customers usually get saddled with a surcharge as merchants passon interchange-fee costs.

There also tend to be more conservative attitudes to personal finance in many southernEuropean countries, as well as Germany. Credit-card usage is very low in Germany and Italybecause people there are less comfortable about taking on debt and are big savers. Italy hasthe EUs least indebted consumers, for example.

So the biggest opportunity for mobile NFC payments is likely to be in markets where cashlesspayments are most dominant. In fact, mobile NFC payments will follow on the heels of plasticNFC payments at least initially. It will therefore be in those markets where contactless-payment cards and the accompanying reader infrastructure are most widespread that

mobile contactless payments will find the most fertile ground.


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Most fertile ground

In Europe, that means first and foremost the UK, which contains the vast majority of thecontactless-payment cards issued in the region. Out of the roughly 18 million Visa NFC cardsthat had been issued in Europe by 1Q11, around 13-14 million were in the UK. Meanwhile,Visa is seeing the fastest growth in issued NFC cards in Poland and Turkey. A fair amount ofcards are also appearing in France and Spain, as well as in some Eastern European markets,

led by the Czech Republic, reports Visa.

Moves are afoot to introduce NFC cards in Germany too. In late June, 428 German savingsbanks belonging to the German Savings Banks and Giro Association (DSGV) announced theirintention to convert their customers debit cards into contactless payment cards. The DSGVsmember banks have 45 million debit cards in circulation, accounting for about half of debitcards issued in Germany.

The cards wont be introduced immediately, however. The DSGV will begin with a pilotproject involving 900,000 cards in early 2012 in Braunschweig, Wolfsburg and Hanover. Itdoesnt foresee converting all cards to NFC until 2015. The associations head of payments,Wolfgang Adamiok, was quoted in the German press as saying that NFC-based payments willbe introduced no later than 2014.

Digital-security vendor Gemalto, meanwhile, reports fast growth in contactless-cardshipments.

Not surprisingly, the UK is also the European country with the greatest number of NFC-enabled payment terminals. Visa expects that 60,000 of these terminals will have beendeployed by UK retailers by the end of 2011 (there were around 40,000 at the beginning ofthe year) and double that number will have been deployed by the end of the following year.It also expects most of the payments that will be made on these terminals over the next yearand a half to be plastic based.

Poland, meanwhile, has approximately 35,000 NFC POS terminals, notably in fast foodrestaurants, cinemas and supermarkets. The terminals will be used for a mobile contactlesspayments trial announced in June by PTK Centertel, Orange Groups affiliate carrier, involvingseveral thousand users.

But Europe is dwarfed by the US in terms of both cards and terminals for contactless payments.There are around 80 million US consumers walking around with NFC payment cards, andNFC payment terminals have been available for years, mostly in fast-food, drug-store and gas-station chains; hamburger giant McDonalds is one.

With the launch of Google Wallet in May, the range of retailers that will be supportingNFC payments in stores has been significantly broadened to include: toy store Toys R Us;clothing merchants American Eagle Outfitters, Foot Locker and Guess; department storesMacys and Bloomingdales; and electronics store RadioShack. Googles executive chairmanEric Schmidt was recently quoted as saying that a third of check-out terminals in retail storesand restaurants will be upgraded to NFC within the next year. That sounds a tad optimistic,considering that only around 3% of POS terminals in the US are currently NFC enabled.

Low take-up

Uptake of contactless payments has been disappointing so far. Reportedly, more than 90% ofthe US consumers with NFC cards are not engaging in contactless payments most are noteven aware that they have the capability to do so.

In the UK, meanwhile, just below 70% of people with NFC-enabled credit or debit cards havenever made a contactless payment, according to a survey by pollster YouGov published inJune (see figs. 4 and 5). As in the US, a lack of awareness seems to be an issue. Around 90% ofrespondents to the YouGov poll said they had never heard of NFC and 70% had never heardof a mobile wallet.


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Fig. 4: Results of poll into UK consumers attitudes to mobile NFC payments, YouGov, Jun-11

Fig. 5: Results of poll into UK consumers attitudes to mobile NFC payments, YouGov, Jun-11

Informa has learnt from talking to UK bank staff that, when there isawareness, it is oftenaccompanied by confusion. Many customers who have been upgraded to NFC-enabled cardspanic and contact their bank branch asking to replace their new card with an old-style one,say bank staff. Thats because they think the card is only enabled for payments of up to 15(the ceiling in the UK for contactless payments) without realizing that it can also be used asa normal chip-and-PIN card.

The low take-up and confusion can be largely put down to poor marketing by banks andretailers. Also, retail staff have been slow to warm to the technology. In current deployments,NFC at the point of sale tends to be a stand-alone reader separate from the main paymentterminal, which POS staff often ignore unless customers make a special point of wanting touse it.

Informa has learned from staff at NFC-enabled outlets in London that there is demand fromcustomers to use the readers but that the readers can be temperamental, often requiringseveral taps from customers before they register a payment, and that they sometimes dontwork at all. There have been instances of people being double charged, thinking that thecontactless payment hasnt registered and then paying with the chip-and-PIN machine


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instead, only to find later that they have been billed twice although these cases are morethe exception than the rule.

Whatever the reasons, the low take-up shows that, just because the technology is madeavailable to consumers, adoption is not a given. Marketing and end-user/POS staff educationare also necessary.

Japan numbers

In Japan, which has the worlds highest penetration of contactless-enabled cards and phones,the number of mobile-contactless-payment accounts was 13.5 million as of August last year based on data presented by FeliCa Networks (see fig. 6), a subsidiary of carrier NTT DoCoMoand media and technology giant Sony that runs FeliCa, the mobile version of Sonys contactlesstechnology, which is based on a different RFID standard to that arrived at in the West for NFC.However, this total of 13.5 million equals just a tenth of the number of contactless paymentcards issued in Japan, which totaled 135 million in May 2010.

Fig. 6: Japan, take up of FeliCa payment services, 2010

The proportion is in reality probably bigger, however, since in the information presented byFeliCa Networks there were no user numbers for four of the seven contactless payment cardsavailable as Mobile FeliCa apps although that might be because the numbers were notimpressive enough for publication.

Also, it is impossible to work out the percentage of FeliCa phone owners who are using their

phone to make contactless payments, since the total of 13.5 million does not necessarily referto unique users. It adds up users of three different contactless-payment services and it ispossible that some users might have more than one of these services in their FeliCa mobilewallet, leading to double counting. However, if we ignore that, the number would account foraround 20% of FeliCa handset owners based on a count of 66 million in March 2010. Thatswithin six years of Mobile FeliCa launching in 2004.

The lions share of payment users (10 million) on Mobile FeliCa are signed up to prepaidcard Edy, issued by electronic payments firm bitWallet and accepted at more than 220,000participating stores, as well as vending machines and websites. Then follow the 2.2 millionsigned up to Suica, a prepaid card issued by rail company JR East that is mainly used forticketing but can also be used as electronic money at around 100,000 stores and kiosks,primarily within train stations. Another 1.3 million use Nanaco, another prepaid card, issuedby convenience-store chain 7-Eleven and accepted only in 7-Eleven stores, of which there are

more than 60,000 in Japan.

Cash replacement

But how far does NFC eat into cash payments?

From what has been observed so far in both mobile NFC trials and plastic NFC deployments,NFC does seem to bring down the threshold for cashless payments to a lower transactionvalue. Plastic NFC brings it down a peg and mobile NFC brings it down a little further.

Also, in the YouGov poll conducted recently in the UK, 23% of respondents said that they wereinterested in paying for items using their mobile phone, instead of cash. According to researchby MasterCard, meanwhile, PayPass contactless-card holders increased their spending by 19%and usage by 29% compared with traditional card holders.

Although countless mobile NFC trials have been conducted, hard numbers on mobile-payment usage are difficult to come by. For example, Europes most high-profile trial, the Cityziproject in Nice, France which drew the participation of the countrys main operators andbanks hasnt published any stats on mobile payments. Informa requested to see some, but


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the query came to nought. Some sources close to the trial have told Informa that take-up ofmobile payments during the trial was low and that not all merchants were happy with theway the technology worked. The trial has, however, been officially described as a success. Itmust be added that its focus was not just on payments but a whole plethora of mobile NFCservices.

The most compelling evidence so far perhaps comes from a mobile NFC payments trial

conducted last year in Sitges, Spain by operator Telefonica, bank La Caixa and card-paymentnetwork Visa; 1,500 users and 500 merchants participated in the trial. Participants on averagecarried out 30% more transactions using the Visa card stored in their NFC phones than theyhad previously with traditional plastic cards. That translated to an average of 23% morespending per user on cashless transactions.

During the six-month trial, 60% of the transactions made were less than or equal to 20 theceiling placed on PIN-less NFC transactions in the Euro zone 35% were for less than or equalto 6 (see fig. 7). In the 20 bracket, the average per transaction was 9, which, according toJordi Guaus, head of mobile payments at La Caixa, is lower than for ordinary card payments although he didnt specify how much lower.

Fig. 7: Sitges mobile contactless payment trial results, May-Oct 2010

During the trial, 40% of the payments made required entering a PIN and were thereforelittle different from chip-and-PIN transactions (other than they were conducted via phones) especially since in Sitges users had to key in the number on the POS terminal, not the phone.Thats because in Spain banks are all linked to an online payments system, requiring the PINto be keyed in on devices connected to that system and not locally on the phone.

Most of the participants (90%) made at least one purchase with their mobile phone during thetrial, and 80% of merchants received mobile NFC payments. Satisfaction levels with the mobilecontactless service, which used a virtual Visa card loaded on Telefonicas m-wallet CarteraMovistar, were high, averaging a rating of 7.7 out of 10.

However, trials rarely mirror real-life conditions accurately. The participants were volunteerswho, by the very nature of being volunteers, were already predisposed to trying out theservice. And each one attended a one-hour training session and received a user guideexplaining how to use the technology.

Declining margins

Regulatory moves in different parts of the world are forcing banks and payment networks toreduce the amount they charge retailers for handling card payments what are technicallyreferred to as interchange fees.

These fees can vary a lot from country to country, and on the kind of card or transaction, oron the size of the retailer and its bargaining power. For example, interchange fees tend to behigher for credit cards than debit cards; also for remote payments rather than local payments,where the card is physically present during the transaction.

The fees are split between the cardholders bank (referred to as the issuing bank), themerchants bank (referred to as the acquiring bank) and the card-payment network (forexample, Visa and MasterCard). The lions share is kept by the issuing bank; the second-largestshare by the payment network; and the remainder by the acquiring bank. In the US, forexample, where interchange fees average out to roughly 2% of credit-card transactions, the


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cut taken by each party from a US$100 transaction would be: US$1.75 by the issuing bank; US$0.18 by the payment network; and US$0.07 by the acquiring bank (see fig. 8).

Fig. 8: Breakdown of interconnect fees taken from US$100 transaction in the US

There has been a steady rise in interchange fees throughout much of the past decade. But thetide is turning, largely due to regulatory pressure, often in the form of antitrust investigations.In the US, a law capping debit-card interchange fees to US$0.12 per transaction goes into effecton July 21. These fees currently average US$0.44 per transaction in the US so the cap willrepresent a big drop in earnings for payment providers, which currently make around US$16billion a year in the US from interchange fees.

Meanwhile, in the EU, Visa Europe is reducing debit-card fees to 0.2% per transaction, aspart of a deal struck in December to end an antitrust probe by the European Commission.MasterCard came to a similar settlement with the Commission last year, also reducing debit-card transaction fees to 0.2% and credit-card fees to 0.3%.

Proving the case for retailers

Merchant resistance to deploying NFC point-of-sale terminals is arguably the biggest barrierto contactless payments. With NFC credit and debit cards still the exception rather than therule in most countries and rarely any offers from other parties to help pay the cost of upgradingPOS infrastructure, most retailers are in no hurry to enable contactless payments at theirstores.

The retailers for whom contactless payments make most sense are those that handle a largevolume of low-value transactions every day and for whom speed at the checkout is essentialto ensure time-poor customers dont walk out without making a purchase. Food and drinkchains such as fast-food joints, sandwich bars and coffee shops fit this profile. These outletsare exposed to frenetic peaks of activity at meal times, and most of their sales are for less

than 20 or US$25, within the limit for contactless payments not requiring a PIN. It is nocoincidence then that they tend to be among the first to embrace NFC.

Supermarkets and convenience stores are also likely candidates. In the Sitges contactlesspayments trial, supermarkets accounted for the majority of transactions (see fig. 9).


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Fig. 9: Sitges mobile contactless payments trial, distribution of purchases by merchant type

Also, retailers in busy urban centers are more likely to want NFC than those in sleepiersuburbs or provincial towns. The initial crop of NFC POS terminals in the UK, for example,

has been seen primarily in London. But retail chains dont like deploying multiple kinds ofterminals across their footprint. They like to deploy the same terminals and accompanyinginfrastructure in every store, to cut down on complexity and maintenance costs.

Therefore, it is unlikely that big chains will choose to focus NFC-enabled POS terminaldeployments on their busiest stores only. It is most likely to be an all or nothing decision unless what is being deployed is stand-alone NFC readers that sit alongside the main POSterminals (see fig. 10). Stand-alone readers have been typically deployed by early-to-marketretailers, in some cases subsidized by card-payment networks and banks; for example, Visatold Informa that it has contributed to the cost of early deployments as a way of kick-startingthe market.

Fig. 10: Stand-alone vs. integrated NFC point-of-sale terminal

Some retailers Informa has spoken to question the use case of mobile NFC payments. Theysay that existing payment options, such as cash and cards, are already fast enough for mostcustomers. And that, unlike a prepaid card for transport ticketing, where a mobile screen addsa useful dimension for checking how much credit a ticket-barrier has just debited from a card,and how much is left, there is no such need in retail payments, because by law shoppershave to be offered a paper receipt for each purchase anyway. There are already plenty of waysfor users to check on their bank balance on their phone, whether that may be via SMS or adownloaded app.

Security is also a concern for retailers, who fear that contactless payments might expose themto fraud from hackers.


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Upgrading retail infrastructure

Assuming that a retail chain decides to deploy NFC across its entire POS infrastructure, thenext question is when is it next due to replace its terminals POS-terminal replacementcycles vary from retailer to retailer, but they can be as long as seven years. In the case ofsupermarkets, where POS-terminal use can be intense, the replacement cycle can be as shortas two years, but in the case of department stores, where checkout traffic tends to be less

heavy, it is more typically around five years. The replacement cycle for POS systems is evenlonger. Retailers invest in these only once a decade on average.

Upgrading POS infrastructure is the highest cost component of a retailers IT investment,including as it does not only the expense of buying and installing new hardware, but alsoof buying and installing new software and training store staff to use the new terminals andsystems. So anything that might add to that expense is likely to be closely scrutinized byretailer IT heads.

However, POS terminals that incorporate contactless-payment capabilities are not necessarilymuch more expensive than standard ones. According to VeriFone, one of the worlds biggestPOS-terminal makers, the price difference is negligible. It says that its new VX 820 terminal,which comes with NFC as optional, is only a bit more expensive than its non-NFC-enabledpredecessor the VX 810 without specifying how much exactly. And the difference will

become more and more negligible as NFC chips are produced in higher volumes and their costdecreases, it adds.

The price of terminals is not an issue, a VeriFone spokeswoman told Informa. The biggerconcerns for retailers are, first, development and integration time for NFC applications,second, having to make changes to their existing POS systems to accommodate NFC and, third,consumer awareness of what NFC is and how to use it.

In March, VeriFone announced that it would include NFC in all its future POS terminals. Thatshould make it easier for retailers to decide whether or not to specify the technology whenordering their next batch of terminals from VeriFone, even though they will be able to opt outof that option if they so wish. It will be interesting to see how long it will be before other POS-terminal makers follow suit and make NFC a standard feature on all their products.

There are two main models for deploying POS terminals in retail outlets: one is followedprimarily by large retailers and the other primarily by small-to-medium-sized retailers. Largeretailers with big chains tend to buy and install their own terminals and integrate them intotheir own IT systems. Smaller retailers tend to rent terminals from banks.

In the latter model, there is a greater chance of influencing the kind of POS technologydeployed by retailers. Banks that are issuing NFC-enabled payment cards are also likely pushNFC-enabled POS terminals to their business clients.

POS replacement

Rather than adding to the POS infrastructure bill, NFC could potentially reduce it by obviatingthe need for checkout counters. Retailers are keen to reduce POS staffing costs and, to that end,are introducing self-service checkout counters. This is especially true of supermarkets. WithNFC, they could go a step further by getting customers to download a checkout application totheir NFC phones with which to scan items as they place them in their basket or cart. On theway out of the store, all they would need to do is wave their phone in front of an NFC readerto pay for the scanned items. This would dispense with the need of a counter altogether. Onlya wall-mounted reader would be needed.

Of course, introducing such an app would not provide an instant replacement for checkoutcounters. There would have to be a certain critical mass of customers walking around withNFC phones first, and then sufficient education and encouragement for these customers todownload the app, before a retailer could start reducing the number of checkouts. And just asthere remains a need for manned checkouts at stores where self-service checkouts are now thenorm, so would there still be a need for a minimum number of checkouts of both descriptionsin stores even where a majority of customers were checking out items through their phones.

Another way in which mobile phones might dispense with the need for dedicated paymentmachines is by getting NFC-enabled phones to act as POS terminals something that isalready possible. Just as its possible to enable P2P payments by tapping one NFC phone withanother, so it is possible for a small retailer or service provider to use his NFC phone to accept


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payments from customers who also have NFC phones. This method was successfully testedlast year with taxi drivers in the city of Valencia in Spain, for example.

Store-card fight back

Beyond quicker transactions, reducing cash-handling costs is normally cited as the strongestdriver for retailers to enable NFC payments. But that argument is questionable, since what

retailers can save in cash-handling costs they can more than end up paying in card-paymentfees. A greater incentive for retailers is the potential of using NFC for their own mobile-walletservices, such as store-payment cards, loyalty cards and coupons and vouchers.

Retailers have long sought to reduce the fees they pay on card payments by issuing their ownstore cards and offering customers discounts and other incentives to pay with these insteadof their bank cards. Store cards come in various forms, including: private-label credit, prepaidor gift cards; co-branded retailer cards; PIN debit cards; lower fee-based branded cards; andcards that process transactions over automated-clearinghouse networks.

But these closed-loop cards so called because they are only accepted at the issuing-retailersstores have been fighting a losing battle over the past two decades against open-loop bankcards that can be used in all stores. With most wallets already stuffed with plastic, it is morelikely that people will leave their store cards at home than their Visa or MasterCard bank cards

when going out shopping.

The limited space in physical wallets could, however, be overcome by digitizing cards andplacing them in mobile wallets. Once a retailer-preferred payment card is issued to acustomer's NFC-enabled mobile phone, the customer always carries that payment card withthe phone, says a report published on the subject by the US National Retail Federation.Retailers may, therefore, be able to drive higher acceptance rates of their preferred-paymentoptions than is possible with plastic cards.

Retailers could also use NFC and mobile wallets to integrate store cards with loyalty pointsand offers, such as coupons.

Democratization of payment options

Just as mobile NFC can give a greater chance for store cards to compete against moreestablished cards, so it can leave the door wide open to other payment options. Paymentservices that are currently largely confined to the digital and online worlds, such as e-commerce payment platforms (e.g. PayPal, Amazon), digital-content platforms (e.g. iTunes),carrier billing, and even social media and gaming virtual currencies (e.g. Facebook Credits,World of Warcraft Gold, Angry Birds Bad Piggy Bank), could use mobile NFC to extend theirreach to physical-world purchases, undermining the hegemony of the big card-paymentbrands.

For the card-payment networks and card-issuing banks, entering the mobile NFC space is notjust about pursuing cash-replacement and new-revenue-stream opportunities it is also adefensive move to ensure that their brands are prominently in that space before others startmuscling in. Their biggest nightmare is a dumb-pipe scenario where users on platforms suchas PayPal and iTunes link their bank accounts directly to those platforms, bypassing credit anddebit cards and the rich pickings that the banks and card networks make from these cards.

In the YouGov poll conducted recently in the UK, for example, 64% of respondents said thatthey would like their mobile-wallet payments to be linked directly to their bank account.

This nightmare echoes that which has been haunting mobile operators in the last few years,as they have seen themselves gradually disintermediated by online players in many mobileservices.

The dumb-pipe fear shared by both banks and operators was starkly expressed by Peter VanLeeuwen, strategy and business development manager at Dutch carrier KPN, at last monthsGSMAs Mobile Money Summit in Singapore. Van Leeuwen made common cause with thebanks, saying that, just as operators risk becoming the bit pipes of the communications

industry, so banks risk becoming the bit pipes of the financial industry. By working together,banks and operators can strengthen their position in their own markets, he told delegates.We need to own the market space and prevent market differentiation before any other partyenters the market with enough money.


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KPN is part of a joint venture formed by the Netherlands top banks and operators that aimsto launch commercial NFC services by the second or third quarter of 2012.

The card networks also want to make sure they enter mobile NFC early to retain marketrelevance, as payment methods and habits evolve. Visa, for example, made up its mind earlyon that NFC would be part of the future payments landscape and wanted to be seen at thecutting edge of the market, playing a leading role in trials and other activities. Not all credit-

card companies have jumped into the fray in the same way, however. American Express, forexample, has yet to make any moves in NFC. It is taking a wait-and-see approach instead.

Banks business case

Beyond defending themselves from disintermediation, the banks business case for mobileNFC boils down to savings and additional revenue (see fig. 11). Banks can not only save on cashand check handling costs, including the costly business of keeping ATMs topped up with cash,but also on plastic-handling costs. The expense of printing, posting and replacing cards (if theyhave expired or have been lost or stolen) can be greatly reduced by the over-the-air delivery ofvirtual cards to mobile phones as long as mobile-provisioning prices are not too steep.

Fig. 11: Mobile-contactless-payments business model for banks

Another potential saving comes in the shape of churn reduction. If a bank is early to marketand can differentiate itself from the competition with things like mobile wallets and NFCmicroSD cards to turn ordinary phones into contactless payment devices it has a greaterchance of retaining customers, as well as acquiring new ones. Having said that, though, churnis not as big an issue for banks as it is in the telecoms industry. Bank-current-account churnin Europe is running at around 5%, for example.

Additional revenue can come from the commission earned on the greater number of cashlesstransactions that NFC will supposedly bring, as well as on new services such as P2P payments.Card payments are a significant revenue stream for banks. This revenue is comprised of

transaction fees and interest payments (the latter, in the case of credit cards). In Barclayscase, for example, 67.5% of its card revenues come from interest payments and 32.5% fromtransaction fees.

Operators business case

Like the banks, the operators business case for NFC payments boils down to savings andadditional revenue (see fig. 12). But the savings component would come entirely fromcustomer retention and acquisition. Again, there would be first-mover benefits for operatorsthat are early to market with NFC and mobile wallets in theory creating greater stickinessand a greater chance of churn from other operators. In markets where churn is running at 30%or even higher, a reduction of just 1% could be worth as much as US$100 million per year toa large operator.


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Fig. 12: Mobile-contactless-payments business model for operators

The extra-revenue component would come from: transactions, service provisioning, customersupport, data traffic and carrier billing.

Operators getting a per-transaction-cut of contactless payments are possibilities only inemerging markets, where mobile-wallet services are the only cashless-payment option formost people, or, in the developed world, where operators buy their way into the paymentsvalue chain by acquiring a credit-card company or bank, as seen in Japan and South Korea. Forexample, in South Korea, SK Telekom receives 1.3% of transaction revenues from its Monetamobile NFC service; however, the upfront cost of the latter is high, requiring huge volumes oftransactions to generate an adequate return.

The Western operators main hope of securing a place in the contactless payments value chainis by authenticating payments via the SIM card. If the SIM card becomes employed in this way,operators can then rent space on it to banks and other payment providers.

In addition to that rental income, operators could also earn revenue from selling customer-

support products for mobile NFC services, such as remote-device management and insurance.Mobile users usually turn to operators rather than handset makers or service providers whensomething goes wrong with their phone. So operators feel that customer support is one of thestrong cards they can bring to the table.

Operators could also earn revenue by playing the trusted-service-manager role, chargingbanks and payment service providers to manage their NFC-payment applications. However,the skills and knowhow required to be a TSM are not core to operators and most operatorsare not looking to take on this role, delegating it instead to companies such as Gemalto.

Mobile data traffic revenues are not one of the big selling points of NFC for operators. NFCoperates over an unlicensed short-range frequency separate from the cellular network. Inthe case of contactless payments, most of the transfer of data happens via NFC transmission

between the phone and the POS terminal and via fixed-line transmission between theterminal and the issuing and acquiring banks.

The mobile network only comes into the picture in a support capacity, taking on a service-provisioning and customer-relations role. For example, mobile-wallet apps can be installed,uninstalled, blocked or updated over the cellular network, and users can look up accountbalances and purchase records, top up (in the case of prepaid payment services) andpersonalize applications, again over the cellular network. All of this wont add up to a lotof data, but will provide another reason for mobile users to subscribe to a data plan or justgenerate pay-as-you-go data revenue.

Carrier billing

Carrier billing is a more compelling proposition for operators, revenue wise. Operators havefor years provided mobile users with the ability to charge content purchases to their mobilebill not only for content sold by themselves but by third parties as well. In fact, carrier billingis one of the first capabilities that operators chose to expose to developers in their open-APIprograms. Although it is mostly used to purchase digital content consumed on phones andother devices, it is also sometimes used to purchase physical-world goods such as parking andtransport tickets. These purchases are currently made remotely via either SMS or a WAP site,


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but NFC could allow users to buy directly from NFC-enabled parking and ticket machines, aswell as buy all sorts of other goods at the point of sale.

Austria, for example, has the most advanced mobile payments system in Europe, covering allmobile networks and handsets. Here, carrier billing is the most popular payment method outof the options offered by the Paybox m-wallet service. The other options include paying bycredit card and directly from a bank account again, parking and ticketing purchases seem to

be what Austrias carrier billing is most used for.

There are, nevertheless, a few cases of retailers experimenting with carrier billing for smallphysical goods. UK department store Marks & Spencer, for example, offers customers theoption of ordering and paying, via premium SMS, for a 5 (US$8) packet of 50 school-uniformname tags.

But carrier billing has several limitations. It is expensive, for one. The share of revenue keptby operators typically averages 30%, but can be as high as 50% far, far greater than theproportion kept by card-payment providers. So it doesnt make it ideal for physical-goodspurchases. In some countries, operators have introduced two-tier pricing for carrier billing,depending on the size of the transaction. In the UK, for example, which has some of the lowestoff-portal carrier billing rates in the West, transactions of 5 or less in value are charged at

around 20-25%, and those above 5 at as little as 10%. But that is not a typical scenario.

Another limitation is that there is a strict limit on how much users can spend per transaction(roughly around what is allowed for PIN-less NFC transactions) and, in some cases, as atotal per month. This is because operators dont want to risk fronting too much money tosubscribers. Again, this places a limitation on the e-commerce application of carrier billing.

The biggest advantage that carrier billing has over other payment methods from a userperspective is that it doesnt require pre-registration. An operator can roll out an NFC m-walletthrough which users can start making payments charged to their phone bill, straight out of thebox, without even registering their credit or debit card details. So it makes take-up easier. Forexample, Austrias Paybox service got low take-up when it first launched 12 years ago due to apre-registration procedure that it required from users. It wasnt until it lifted that requirementthat usage took off.

At the same time, however, if m-wallets loaded with credit and debit cards become the norm,carrier billing risks being pushed aside especially since it is unlikely that many stores willaccept it as a form of payment, unless operators drastically drop their per-transaction charges.And, worse still, mobile card payments could also start encroaching on the ground conqueredby operators online in website micropayments but only if one-click payments can be enabledon websites from phone-loaded cards. How that could be done is not clear yet.

analyzing the business case for contactless payments[1]

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