Analyzing the business case for contactless payments

05 September 2011 Guillermo Escofet

Key points

For banks and retailers, there are cost-saving opportunities in replacing cash payments with contactless payments. Potential savings can also be made by banks and operators from decreased customer churn. Another factor driving bank and operator enthusiasm for mobile contactless payments is their common fear of becoming dumb pipes as online players use NFC to extend their reach to the physical world. All would-be market players also share a common interest in promoting their respective payment products via mobile NFC, such as store cards in the 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 be earned by banks and card-network providers through a greater number of cashless transactions and newly-enabled P2P payments. For retailers, there is the potential for greater 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 making contactless payments on their phones other than in emerging markets. There will be little or no additional revenue to share with new value-chain members, such as operators and other mobile providers, especially as regulators are increasingly squeezing margins by placing strict caps on card-payment fees. There is a big cash-replacement opportunity for NFC payments, even in developed markets. But it will be in those markets where card payments are most rooted, and where plastic-NFC infrastructure is most deployed, that mobile contactless payments have the most immediate opportunity. Evidence from trials, polls and NFC-card deployments shows that contactless payments do have the potential to eat into cash payments. But adoption of both plastic and 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 cash with electronic payments represents a cost saving for banks and increased revenue for credit card companies and their issuers (again, the banks), as they earn commission on the greater volume 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 handling and accounting errors. However, what retailers can save on cash-handling costs is probably more 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 up customer throughput at the checkout and increase turnover. Mobile wallets and NFC also provide 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 to Visa and MasterCard. Extending the reach, or defending the current position, of their respective payment services is the most common driver for the players that are likely to battle it out in the mobile contactless payments 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 a payment 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 (or US$25) transactions, argue advocates. Contactless payments are meant to be twice as fast as other cashless payments. However, the jury is still out on how effective they are at replacing cash. And, just as contactless payments have the capability of substituting cash, they are also capable of cannibalizing existing chip-and-PIN card payments. In fact, one of the bigger advantages that mobile offers over mere plastic is that it makes it easier to extend NFC transactions 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-value transactions although this is also possible with NFC cards used on NFC point-of-sale terminals 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 revenue might be diminished if they need to pay part of it to the mobile specialists providing the technology and systems needed to enable contactless payments on phones. Not that the revenue opportunity for mobile players looks that good either. Users in developed countries 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 any more revenue to share with additional value-chain members than that already made from existing cashless payments. The revenue opportunity for mobile providers will be mostly limited to fixed monthly or annual service charges per user around the provisioning of mobile-payment apps including rental of space on the secure element, lifecycle management and personalization rather than a per-transaction share of revenue. Whats more, margins are tight in cashless payments. And they are likely to get even tighter as both retailers and regulators place increasing pressure on card-payment networks and cardissuing banks to reduce payment-processing fees. Mobile NFC does, however, provide the opportunity for an additional revenue stream for cardpayment providers: peer-to-peer payments. The idea is that someone could pay back money to a friend or contribute to a whip-round, say, by tapping phones with the recipient as long as 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 playing a 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 in this 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 cardwww.informatm.com 2011 Informa Telecoms & Media 2

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 total retail. This means 92% happens in the physical world, she said. With smartphones, geolocation and NFC technology, we're about to embark on a new era of commerce, where we bring 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 it could encroach on territory where carrier-billing services, such as Boku and Zong, have made big strides in recent years. Cash is still king Despite the widespread availability of plastic money, cash still makes up the bulk of transactions in many developed countries. And in emerging countries cash is unquestionably king, it being most peoples only payment option, beyond bartering. In the US, for example, cash and checks still underpin 60% of economic activity. And in Germany, 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 national bank, Deutsche Bundesbank (see fig. 2). By contrast, debit/credit cards accounted for 13.4% of transactions 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 paymentcard usage is, together with Germanys, less than half the European Union average. The highest usage in the EU is in the Netherlands and the UK, according to statistics collected by Italys 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 northern ones, with the notable exception of Germany. Cash-handling costs are estimated to amount to 10 billion a year in Italy for both banks and retailers largely in terms of increased security and labor. In the US, the cost is more than US$70 billion a year. And globally, its calculated at US$300 billion. Much cash handling is labor-intensive involving counting and double-counting of coins and bills, and their transportation, under heavy security, from one location to another. Cashs manual nature also exposes it to loss or theft through human error or design. According to recent surveys, 1.5 billion a year is lost by UK retailers through internal and external theft and 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 for contactless payments. But in most cases there are strong cultural reasons for these economies adherence to cash. In Western Europe, these economies have no shortage of people with bank accounts or of card-issuing banks yet credit cards are relatively rare and cash remains the preferred method of payment for many. A big reason for the adherence to cash is tax evasion. A lot of companies pay their employees in cash and a lot of merchants and service providers demand to be paid in cash so as to not to have to declare such transactions to the taxman. The Italian government, for example, loses about 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-handling costs are more or less equal to the money charged to retailers in card-payment fees now that the EU has capped such fees they are more hidden and are something that merchants have been living with for centuries. So, all and all, there are less options to pay by card in these countries and, where card payments are accepted, customers usually get saddled with a surcharge as merchants pass on interchange-fee costs. There also tend to be more conservative attitudes to personal finance in many southern European countries, as well as Germany. Credit-card usage is very low in Germany and Italy because people there are less comfortable about taking on debt and are big savers. Italy has the EUs least indebted consumers, for example. So the biggest opportunity for mobile NFC payments is likely to be in markets where cashless payments are most dominant. In fact, mobile NFC payments will follow on the heels of plastic NFC payments at least initially. It will therefore be in those markets where contactlesspayment 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 the contactless-payment cards issued in the region. Out of the roughly 18 million Visa NFC cards that 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 of cards 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 savings banks belonging to the German Savings Banks and Giro Association (DSGV) announced their intention to convert their customers debit cards into contactless payment cards. The DSGVs member banks have 45 million debit cards in circulation, accounting for about half of debit cards issued in Germany. The cards wont be introduced immediately, however. The DSGV will begin with a pilot project involving 900,000 cards in early 2012 in Braunschweig, Wolfsburg and Hanover. It doesnt 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 will be introduced no later than 2014. Digital-security vendor Gemalto, meanwhile, reports fast growth in contactless-card shipments. Not surprisingly, the UK is also the European country with the greatest number of NFCenabled payment terminals. Visa expects that 60,000 of these terminals will have been deployed by UK retailers by the end of 2011 (there were around 40,000 at the beginning of the 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 year and a half to be plastic based. Poland, meanwhile, has approximately 35,000 NFC POS terminals, notably in fast food restaurants, cinemas and supermarkets. The terminals will be used for a mobile contactless payments trial announced in June by PTK Centertel, Orange Groups affiliate carrier, involving several 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, and NFC payment terminals have been available for years, mostly in fast-food, drug-store and gasstation chains; hamburger giant McDonalds is one. With the launch of Google Wallet in May, the range of retailers that will be supporting NFC payments in stores has been significantly broadened to include: toy store Toys R Us; clothing merchants American Eagle Outfitters, Foot Locker and Guess; department stores Macys and Bloomingdales; and electronics store RadioShack. Googles executive chairman Eric Schmidt was recently quoted as saying that a third of check-out terminals in retail stores and 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% of the US consumers with NFC cards are not engaging in contactless payments most are not even 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 have never made a contactless payment, according to a survey by pollster YouGov published in June (see figs. 4 and 5). As in the US, a lack of awareness seems to be an issue. Around 90% of respondents to the YouGov poll said they had never heard of NFC and 70% had never heard of 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 is awareness, it is often accompanied by confusion. Many customers who have been upgraded to NFC-enabled cards panic 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 as a normal chip-and-PIN card. The low take-up and confusion can be largely put down to poor marketing by banks and retailers. 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 payment terminal, which POS staff often ignore unless customers make a special point of wanting to use it. Informa has learned from staff at NFC-enabled outlets in London that there is demand from customers to use the readers but that the readers can be temperamental, often requiring several taps from customers before they register a payment, and that they sometimes dont work at all. There have been instances of people being double charged, thinking that the contactless 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 more the exception than the rule. Whatever the reasons, the low take-up shows that, just because the technology is made available to consumers, adoption is not a given. Marketing and end-user/POS staff education are 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 DoCoMo and media and technology giant Sony that runs FeliCa, the mobile version of Sonys contactless technology, 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 payment cards 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 by FeliCa Networks there were no user numbers for four of the seven contactless payment cards available as Mobile FeliCa apps although that might be because the numbers were not impressive 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 refer to unique users. It adds up users of three different contactless-payment services and it is possible that some users might have more than one of these services in their FeliCa mobile wallet, leading to double counting. However, if we ignore that, the number would account for around 20% of FeliCa handset owners based on a count of 66 million in March 2010. Thats within six years of Mobile FeliCa launching in 2004. The lions share of payment users (10 million) on Mobile FeliCa are signed up to prepaid card Edy, issued by electronic payments firm bitWallet and accepted at more than 220,000 participating stores, as well as vending machines and websites. Then follow the 2.2 million signed up to Suica, a prepaid card issued by rail company JR East that is mainly used for ticketing 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, issued by 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 transaction value. 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 were interested in paying for items using their mobile phone, instead of cash. According to research by 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 mobilepayment usage are difficult to come by. For example, Europes most high-profile trial, the Cityzi project in Nice, France which drew the participation of the countrys main operators and banks 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 of mobile payments during the trial was low and that not all merchants were happy with the way the technology worked. The trial has, however, been officially described as a success. It must be added that its focus was not just on payments but a whole plethora of mobile NFC services. 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-payment network Visa; 1,500 users and 500 merchants participated in the trial. Participants on average carried out 30% more transactions using the Visa card stored in their NFC phones than they had previously with traditional plastic cards. That translated to an average of 23% more spending per user on cashless transactions. During the six-month trial, 60% of the transactions made were less than or equal to 20 the ceiling placed on PIN-less NFC transactions in the Euro zone 35% were for less than or equal to 6 (see fig. 7). In the 20 bracket, the average per transaction was 9, which, according to Jordi 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 therefore little 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 PIN to 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 the trial, and 80% of merchants received mobile NFC payments. Satisfaction levels with the mobile contactless service, which used a virtual Visa card loaded on Telefonicas m-wallet Cartera Movistar, were high, averaging a rating of 7.7 out of 10. However, trials rarely mirror real-life conditions accurately. The participants were volunteers who, by the very nature of being volunteers, were already predisposed to trying out the service. And each one attended a one-hour training session and received a user guide explaining how to use the technology. Declining margins Regulatory moves in different parts of the world are forcing banks and payment networks to reduce the amount they charge retailers for handling card payments what are technically referred to as interchange fees. These fees can vary a lot from country to country, and on the kind of card or transaction, or on the size of the retailer and its bargaining power. For example, interchange fees tend to be higher 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), the merchants bank (referred to as the acquiring bank) and the card-payment network (for example, Visa and MasterCard). The lions share is kept by the issuing bank; the second-largest share by the payment network; and the remainder by the acquiring bank. In the US, for example, 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 the tide 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 effect on July 21. These fees currently average US$0.44 per transaction in the US so the cap will represent a big drop in earnings for payment providers, which currently make around US$16 billion a year in the US from interchange fees. Meanwhile, in the EU, Visa Europe is reducing debit-card fees to 0.2% per transaction, as part 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 debitcard 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 barrier to contactless payments. With NFC credit and debit cards still the exception rather than the rule in most countries and rarely any offers from other parties to help pay the cost of upgrading POS infrastructure, most retailers are in no hurry to enable contactless payments at their stores. The retailers for whom contactless payments make most sense are those that handle a large volume of low-value transactions every day and for whom speed at the checkout is essential to ensure time-poor customers dont walk out without making a purchase. Food and drink chains such as fast-food joints, sandwich bars and coffee shops fit this profile. These outlets are 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 no coincidence then that they tend to be among the first to embrace NFC. Supermarkets and convenience stores are also likely candidates. In the Sitges contactless payments 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 sleepier suburbs 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 of terminals across their footprint. They like to deploy the same terminals and accompanying infrastructure 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 terminal deployments 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 POS terminals (see fig. 10). Stand-alone readers have been typically deployed by early-to-market retailers, in some cases subsidized by card-payment networks and banks; for example, Visa told Informa that it has contributed to the cost of early deployments as a way of kick-starting the 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. They say that existing payment options, such as cash and cards, are already fast enough for most customers. And that, unlike a prepaid card for transport ticketing, where a mobile screen adds a 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 shoppers have to be offered a paper receipt for each purchase anyway. There are already plenty of ways for users to check on their bank balance on their phone, whether that may be via SMS or a downloaded app. Security is also a concern for retailers, who fear that contactless payments might expose them to fraud from hackers.

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Upgrading retail infrastructure Assuming that a retail chain decides to deploy NFC across its entire POS infrastructure, the next question is when is it next due to replace its terminals POS-terminal replacement cycles vary from retailer to retailer, but they can be as long as seven years. In the case of supermarkets, where POS-terminal use can be intense, the replacement cycle can be as short as 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 even longer. 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 also of buying and installing new software and training store staff to use the new terminals and systems. So anything that might add to that expense is likely to be closely scrutinized by retailer IT heads. However, POS terminals that incorporate contactless-payment capabilities are not necessarily much more expensive than standard ones. According to VeriFone, one of the worlds biggest POS-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-enabled predecessor 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 cost decreases, it adds. The price of terminals is not an issue, a VeriFone spokeswoman told Informa. The bigger concerns 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. That should make it easier for retailers to decide whether or not to specify the technology when ordering their next batch of terminals from VeriFone, even though they will be able to opt out of that option if they so wish. It will be interesting to see how long it will be before other POSterminal 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 followed primarily by large retailers and the other primarily by small-to-medium-sized retailers. Large retailers with big chains tend to buy and install their own terminals and integrate them into their 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 technology deployed by retailers. Banks that are issuing NFC-enabled payment cards are also likely push NFC-enabled POS terminals to their business clients. POS replacement Rather than adding to the POS infrastructure bill, NFC could potentially reduce it by obviating the 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. With NFC, they could go a step further by getting customers to download a checkout application to their NFC phones with which to scan items as they place them in their basket or cart. On the way out of the store, all they would need to do is wave their phone in front of an NFC reader to pay for the scanned items. This would dispense with the need of a counter altogether. Only a wall-mounted reader would be needed. Of course, introducing such an app would not provide an instant replacement for checkout counters. There would have to be a certain critical mass of customers walking around with NFC phones first, and then sufficient education and encouragement for these customers to download the app, before a retailer could start reducing the number of checkouts. And just as there remains a need for manned checkouts at stores where self-service checkouts are now the norm, so would there still be a need for a minimum number of checkouts of both descriptions in 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 payment machines is by getting NFC-enabled phones to act as POS terminals something that is already possible. Just as its possible to enable P2P payments by tapping one NFC phone with another, 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 tested last 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 strongest driver 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-payment fees. A greater incentive for retailers is the potential of using NFC for their own mobile-wallet services, 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 own store cards and offering customers discounts and other incentives to pay with these instead of their bank cards. Store cards come in various forms, including: private-label credit, prepaid or gift cards; co-branded retailer cards; PIN debit cards; lower fee-based branded cards; and cards that process transactions over automated-clearinghouse networks. But these closed-loop cards so called because they are only accepted at the issuing-retailers stores have been fighting a losing battle over the past two decades against open-loop bank cards that can be used in all stores. With most wallets already stuffed with plastic, it is more likely 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 and placing them in mobile wallets. Once a retailer-preferred payment card is issued to a customer's NFC-enabled mobile phone, the customer always carries that payment card with the 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-payment options than is possible with plastic cards. Retailers could also use NFC and mobile wallets to integrate store cards with loyalty points and offers, such as coupons. Democratization of payment options Just as mobile NFC can give a greater chance for store cards to compete against more established cards, so it can leave the door wide open to other payment options. Payment services that are currently largely confined to the digital and online worlds, such as ecommerce 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 their reach to physical-world purchases, undermining the hegemony of the big card-payment brands. For the card-payment networks and card-issuing banks, entering the mobile NFC space is not just about pursuing cash-replacement and new-revenue-stream opportunities it is also a defensive move to ensure that their brands are prominently in that space before others start muscling in. Their biggest nightmare is a dumb-pipe scenario where users on platforms such as PayPal and iTunes link their bank accounts directly to those platforms, bypassing credit and debit 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 that they 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 mobile services. The dumb-pipe fear shared by both banks and operators was starkly expressed by Peter Van Leeuwen, strategy and business development manager at Dutch carrier KPN, at last months GSMAs Mobile Money Summit in Singapore. Van Leeuwen made common cause with the banks, 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 party enters 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 aims to 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 market relevance, as payment methods and habits evolve. Visa, for example, made up its mind early on that NFC would be part of the future payments landscape and wanted to be seen at the cutting edge of the market, playing a leading role in trials and other activities. Not all creditcard companies have jumped into the fray in the same way, however. American Express, for example, 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 mobile NFC boils down to savings and additional revenue (see fig. 11). Banks can not only save on cash and 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 they have expired or have been lost or stolen) can be greatly reduced by the over-the-air delivery of virtual 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 market and can differentiate itself from the competition with things like mobile wallets and NFC microSD cards to turn ordinary phones into contactless payment devices it has a greater chance of retaining customers, as well as acquiring new ones. Having said that, though, churn is not as big an issue for banks as it is in the telecoms industry. Bank-current-account churn in Europe is running at around 5%, for example. Additional revenue can come from the commission earned on the greater number of cashless transactions 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 Barclays case, for example, 67.5% of its card revenues come from interest payments and 32.5% from transaction fees. Operators business case Like the banks, the operators business case for NFC payments boils down to savings and additional revenue (see fig. 12). But the savings component would come entirely from customer retention and acquisition. Again, there would be first-mover benefits for operators that are early to market with NFC and mobile wallets in theory creating greater stickiness and 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 to a 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, customer support, data traffic and carrier billing. Operators getting a per-transaction-cut of contactless payments are possibilities only in emerging markets, where mobile-wallet services are the only cashless-payment option for most people, or, in the developed world, where operators buy their way into the payments value chain by acquiring a credit-card company or bank, as seen in Japan and South Korea. For example, in South Korea, SK Telekom receives 1.3% of transaction revenues from its Moneta mobile NFC service; however, the upfront cost of the latter is high, requiring huge volumes of transactions to generate an adequate return. The Western operators main hope of securing a place in the contactless payments value chain is 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 customersupport 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 when something goes wrong with their phone. So operators feel that customer support is one of the strong cards they can bring to the table. Operators could also earn revenue by playing the trusted-service-manager role, charging banks 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 operators are 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. NFC operates over an unlicensed short-range frequency separate from the cellular network. In the 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 the terminal and the issuing and acquiring banks. The mobile network only comes into the picture in a support capacity, taking on a serviceprovisioning 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 account balances and purchase records, top up (in the case of prepaid payment services) and personalize applications, again over the cellular network. All of this wont add up to a lot of data, but will provide another reason for mobile users to subscribe to a data plan or just generate pay-as-you-go data revenue. Carrier billing Carrier billing is a more compelling proposition for operators, revenue wise. Operators have for years provided mobile users with the ability to charge content purchases to their mobile bill not only for content sold by themselves but by third parties as well. In fact, carrier billing is one of the first capabilities that operators chose to expose to developers in their open-API programs. Although it is mostly used to purchase digital content consumed on phones and other devices, it is also sometimes used to purchase physical-world goods such as parking and transport 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, as well 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 all mobile networks and handsets. Here, carrier billing is the most popular payment method out of the options offered by the Paybox m-wallet service. The other options include paying by credit 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 small physical goods. UK department store Marks & Spencer, for example, offers customers the option of ordering and paying, via premium SMS, for a 5 (US$8) packet of 50 school-uniform name tags. But carrier billing has several limitations. It is expensive, for one. The share of revenue kept by operators typically averages 30%, but can be as high as 50% far, far greater than the proportion kept by card-payment providers. So it doesnt make it ideal for physical-goods purchases. 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 lowest off-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 a total per month. This is because operators dont want to risk fronting too much money to subscribers. 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 user perspective is that it doesnt require pre-registration. An operator can roll out an NFC m-wallet through which users can start making payments charged to their phone bill, straight out of the box, without even registering their credit or debit card details. So it makes take-up easier. For example, Austrias Paybox service got low take-up when it first launched 12 years ago due to a pre-registration procedure that it required from users. It wasnt until it lifted that requirement that 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 will accept 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 conquered by operators online in website micropayments but only if one-click payments can be enabled on websites from phone-loaded cards. How that could be done is not clear yet.

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