Innovation – Finance – Technology


Digital wallets are set to dominate payments, and banks are not in the driver’s seat

By now, we’ve all heard the talks of mobile wallets becoming the one app to rule them all that eventually disintermediates banks from the customer relationship. However, reality has failed to meet expectations so far. Although mobile wallet adoption is slow, activities are picking up the pace, and the main players are not the incumbent banks.

Payments have been the hottest area within fintech for more than a decade, and while many have failed to gain customer trust and establish sustainable revenue streams, the likes of Alipay, Apple, Klarna, and Paypal are all strengthening their positions in the payment space, one transaction at the time. Both Apple and Google made notable moves toward mobile wallet dominance with the launch of the Apple Card and the Google smart checking account.

According to Adyen, one of the leading European payment fintechs, there still a huge opportunity within the payment space in the years to come. As an example, mobile wallet usage at point of sale went up by a whopping 400% in addition to strong growth in both online and in-app payments performed through digital wallets.

The expanding availability of NFC-enabled terminals is expected to drive mobile wallet adoption. According to Berg Insight, NFC will be a part of almost all payment terminals in the US by 2022, and Mastercard already states that 60 percent of Mastercard’s card-present volume originates at merchants have NFC enabled, and expect those numbers to increase. In Norway, all merchants are mandated to offer NFC capabilities at the point of sale starting in 2020.

With a new generation of consumers that have come of age in the smartphone era, many predict that millennials will drive digital wallet adoption, as they are frequent users of peer-to-peer payment apps. Other sources tell a different story, as younger customers are just as active in signing up for credit cards, especially those offering rewards. For the sake of not letting millennials be the answer to why payments are disrupted for once, let’s disregard this factor as this may swing both ways.

Technology matters

Today, the dominant technologies for use of digital wallets at the physical point of sales are either Near Field Communications (NFC) or QR-codes. Although some wallets, like Mobilepay utilize Bluetooth Low Energy in addition to QR-codes, I personally consider BLE as a technological dead-end as this technology combines the worst of both worlds. Consumers need to perform additional steps on their phones, making NFC-based payments superior. For merchants, BLE requires investment and/or installation in hardware, which makes QR-codes superior.

For many, the QR vs. NFC debate has become equivalent of east vs. west distinction when it comes to mobile payments, where QR-codes dominate in particular the Chinese market, where NFC-based payments are the standard of western markets.

For NFC-based payments, Apple reigns supreme due to its lock on the built-in NFC-chip. Although Apple is secretive when it comes to adoption numbers globally, Apple Pay outpaced Starbucks as the most popular mobile payment option in the US last year after an increase in 38% from 2018 estimates. Even though Apple has a 19 percent market share globally, its strong grip on the NFC-chip offers a strong competitive advantage over Android-based mobile wallets such as Google Pay and Samsung Pay.

There have been numerous attempts to force Apple to open up access to their NFC-chip, and the first legal battle for NFC-access was fought and lost by Australian banks. Already back in 2016, leading Australian banks submitted an application to the ACCC (Australian Competition and Consumer Commission), urging for access to NFC for third-party payment solutions.

As a response to the claim for NFC access by Australian banks, Apple stated that the increased competition claim doesn’t apply, as if the banks were given NFC access, they could start specifically charging customers for using Apple Pay, discouraging the use of the mobile payments platform and thereby reduce competition with their own proprietary wallets. Offering NFC access to the banks also creates significant costs, including negative effects on consumer security and data privacy, the ability for users to select their payment card at the point of sale, and a depreciated customer experience.”

The request by the banks was eventually denied by the ACCC, as the benefits were outweighed by the downsides of granting access to NFC.

However, this development took an unexpected turn of events last year as a proposed German law requires that Apple should be forced to give access to their NFC-chip for third parties. Apple was quick to respond and stated that they fear that the draft law could be harmful to user-friendliness, data protection and the security of financial information.

Whether the law passes or not is up to the jury to decide. Germany should be an attractive market for Apple Pay as 67 percent of point of sales transactions are still made with cash according to McKinsey.

There is no doubt that Apple will remain unwilling to open up NFC-access is to maintain its competitiveness in the battle for mobile payments. While this market is still at an early stage, it is estimated to amount to 3,4 trillion USD by 2022, with a compound annual growth rate of 33.4 percent. This is a global battleground and Apple could easily be considered an underdog compared to Chinese competitors WeChat Pay and Alipay as well as Paypal. While Apple is working to close that gap, proximity-based mobile payments such as NFC have proven to be a slow train coming, and Apple needs their technological advantage to keep up.

QR-codes have proven to be a winning recipe for mobile payments in the Chinese market, as NFC only accounts for 10 percent of mobile payments. Even Apple struggle to penetrate the Chinese market (even though they account for 90 percent of all NFC-based payments). QR-codes have been the default practice for Chinese customers, and once payment habits are formed, they prove difficult to change. As a result, many western players attempt to roll out QR-codes in competition with Apple and Google/Android Pays mobile wallet dominance.  

One often-overlooked factor that has paved the way for the success of QR-codes, is the facto that NFC-enabled phones, although on the rise has been considered a luxury in the Chinese market, where brands like Huawei, Oppo, Vivo, and Xiaomi account for roughly 70 percent of the mobile phone market. Among the smartphones with the highest sales volumes on JD.com, China’s leading e-commerce website, few are shipped with NFC chips. To many Chinese users, cheaper smartphones from domestic brands priced below a thousand yuan are often more favorable options than high-end products.

At the same time, credit card adoption in China remains low, and as a result, POS-terminals are less common. In order to enable NFC-payments merchants needs to invest in expensive hardware, making QR-codes a cheap and easily accessible option for both consumers and merchants

The customer is always right

No matter what technological marvel lies behind any digital service, consumer adoption is the key metric of success. Despite ever-repeating predictions of mobile wallet breakthroughs, consumers are still hesitant to widespread adoption of mobile wallets.

The one reason that is pointed out is that mobile payments offer few benefits over the use of plastic cards when it comes to physical payments. Even though adoption is rising; only 6 percent of consumers that install a digital wallet will use it again within 30 days, according to App Annie.

This is vastly different in developing markets, where mobile wallets have seen strong growth. China is again an example of how AliPay and Wechat pay emerged out of adjacent services such as marketplaces and chat apps. The Chinese market is inherently mobile-first when it came to digital services and payment infrastructure was limited. As the usage of Alipay and Wechat expanded outside their initial starting points, the demand for digital payments where growing. Where QR-codes may seem clunky for developed markets, it was a perfect fit for the Chinese market.  The problem was apparent, and while not the most sophisticated technical solution, the solution got the job done.

M-Pesa is considered the ancestor of mobile payments and is now operating a digital wallet in several markets in addition to its starting point in Kenya. When M-Pesa launched in Afghanistan, the national police discovered that corruption was so widespread that 10 percent of the alleged police were fictional identities used to pocket their salaries. As salaries were paid in cash and-passed down through the ranks where higher-ranking officers pocketed a portion of the salary pool for each level of the hierarchy. When lower-ranking officers started receiving their salaries through M-Pesa, many believed that they were given a raise. Now we’re talking a strong argument for mobile wallet adoption.

Ecommerce was and still is the killer app

For incumbent banks, it is easy to get lost in analyzing physical retail. Physical retail is after all representative of the old world of brick and mortar business models where the majority of the banking industry belongs. From my perspective, the banking industry as a whole lost their grip on digital payments a long time ago by being obsessed with transaction fees rather than understanding the dynamics of online retail. In an online world, conversion rates are what matters, and by failing to recognize this, the banking industry let the likes of Paypal and Klarna pave the way for a checkout experience that did not require consumers to pull out their card and go through an astonishing amount of clicks to finalize their purchase. As a consumer, if I am not offered the option to pay with either Vipps, Apple Pay or Paypal, there is a high probability that I will be leaving my virtual shopping cart behind.

With Contextual commerce on the rise, meaning that retailers are looking beyond the storefront and see a big opportunity in allowing customers to shop while doing something else. Whether this is browsing social media or looking for recipes online. In a contextual setting, convenience is king, and one-click buy is the only way to buy. The continuing growth of online and mobile commerce will be the primary factor driving the adoption of digital wallets.

Many players, potentially few winners

According to PYMNTS.COM there are approximately 170 mobile wallets worldwide. Some of them are well-known such as Apple Pay, Alipay, Wechat, Paypal, Google Pay, Android Pay, while others are small, local and/or regional, and familiar to almost no-one but their own users. As mobile wallets rely on transactional revenues, size matters.

Looking at the dominant providers of digital wallets today, one of the primary success factors for both Alipay and WeChat Pay was the fact that they entered the payment space with an already enormous user base. In addition, players like Alipay, Apple and Google are willing to invest close to ridiculous amounts of money in mobile wallet developments. Google first announced Google Wallet back in 2011, and while they have failed several times along the way, they are still not giving up on payments. For a market that is becoming a commodity, that shows persistence that few banks can match. After all, Google is not after transactional revenues, they are seeking to expand their aggregation of data. Even highly anonymous data such as the number of transactions within an area code on a certain time of day can be valuable if collected at scale.

Let us not forget about merchants either. Several retailers are building their own digital wallets. Amazon is already a force to be reckoned with, but Walmart Pay is quickly becoming the number-one digital wallet in the US-market.

As mobile wallets follow a platform logic, the market shows all the signs of a winner takes it all environment, and consolidation of this market is inevitable. Research from Bain shows that third parties are leading the pack when it comes to payment apps.

The exceptions are in countries like the Nordics, Poland, Singapore and Switzerland. The Bain survey shows that in the markets where banking-led initiatives were the preferred solutions, the apps supported multiple banks rather than being tied to one single bank. Digital wallets by single banks seem to follow the same destiny as JP Morgans Chase Pay and ABN Amro.

By joining forces, Swedish Swish, Norwegian Vipps, and Swiss Twint has managed to establish themselves as household brands and widely used payment solutions in their respective markets. The question that remains is whether they have the staying power when facing their global opponents like Apple and Google that are following a turtling strategy.

The last decade has shown us that the battle for digital wallet dominance is for those who are in it for the long run. Developing and launching a digital wallet is far from cheap, and one must be prepared to continue to invest as widespread adoption is moving at a slow pace.

What should keep banks up at night?

For now, most wallets rely on traditional card schemes for payments, by doing so revenues are not disbursed differently. In addition, traditional plastic cards show no signs of going anywhere soon. In fact, credit cards are growing at a steady pace.

Even though smaller every-day purchases will be with a traditional plastic card, holiday shopping is seeing an uptick in mobile commerce, and this is where bigger-ticket year-end gifts can bring larger recurring interest revenue. According to Deloitte, the share of shoppers doing their Christmas shopping on their phone has doubled in the last five years, and half the respondents planned to use their phone to shop for gifts in last year’s holiday season.

In the short term, the primary concern for banks and credit card issuers is how to stay top of wallet. Looking at how other industries like the hospitality industry where players like Expedia take commissions between 10 to 15 percent has been disintermediated; there is likely a willingness to pay to be the default payment option if third-party wallets become dominant players for digital payments.

A shift in payment infrastructure from card schemes to other forms of payment processing or store of value may prove to shake things up even more than whoever provides the end-user experience, as this may either diminish or shift the profit pool.

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