I went into my local Starbucks (Nasdaq:SBUX) the other day and right there beside the cash register was a little card advertising its mobile app that makes paying even faster. Clearly, mobile phones are changing the way we conduct business. Many feel we are at the beginning of a mobile payment revolution. I'm not so convinced and I'll explain why.
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What History Tells Us
For those of you old enough to remember, think back to the Sony (NYSE:SNE) Betamax. Sony thought it had the world by the tail when it introduced the analog videocassette magnetic tape recording format in May 1975. It thought it could dictate an industry standard, but JVC had other plans, introducing its own format (VHS) one year later. By 1984, 40 companies used VHS compared to 12 for Betamax. The last Sony Betamax VCR rolled off the line in 2002, only 27 years after its development. I mention this because it's a classic example of what happens when a company or group of companies places a bet on the wrong horse. I'm not suggesting for one minute that the Betamax was the downfall of Sony. However, that product certainly cost the company significant revenue and profits after fighting a 27-year losing battle.
The broad-based acceptance of mobile payments, as Adam Blair points out in an article for Retail Info Systems News, is a chicken-and-egg dilemma. The two ingredients necessary for mobile payments to become an everyday part of life: consumers must accept mobile payments as safe and secure and retailers must invest in the point-of-sale hardware and software required to handle the transactions.
At the moment, everyone is standing around and waiting for the other guy to make a move. According to AC Nielsen, there are 91.4 million smartphones in the U.S. and more than one billion worldwide. That sounds like a lot, but the smartphone penetration in the U.S. is just 35%, less than Singapore, Canada, Hong Kong, Sweden and Spain. This means that there are almost 170 million phones in the U.S. that currently wouldn't be able to utilize mobile payments, even if consumers and retailers were ready to do so. The broad-based acceptance of mobile payments will only occur when the percentage of smartphones in the U.S. is significantly higher. That could take a decade or more.
SEE: A Primer On Investing In The Tech Industry
The Major Players in Mobile Payments
Google (Nasdaq:GOOG), Isis (owned by AT&T, T-Mobile USA and Verizon), PayPal (owned by eBay) and Square are the major players in the mobile payments game. In addition, you can include the Merchant Customer Exchange, which is a group of retailers that includes Walmart (NYSE:WMT), Target (NYSE:TGT), Best Buy (NYSE:BBY) and 7-Eleven. This super-group is in the midst of hiring a CEO and developing its own payment system. Payments consultant Rick Oglesby of the Aite Group suggests that big retailers are doing this because of the inadequacy of the solutions currently offered in the marketplace.
Lastly, there are individual retailers. Starbucks announced a deal August 7 to collaborate with Square, which will process all of Starbucks' credit and debit transactions. It's a very crowded field getting more crowded by the day.
According to Juniper Research, mobile payments total $325 billion worldwide and should reach $1.3 trillion by 2017. Given $1.3 trillion represents approximately 4% of retail sales on a global basis, the members of the Merchant Customer Exchange see enormous potential for mobile payments and therein lies the rub. All we have at the moment is potential. Nobody's actually sat down and analyzed what all of this is going to cost. It reminds me of the green energy dilemma. Plenty of companies are looking to benefit from it but very few seem to be making any money. A revolution can't sustain itself without profits.
Square's worked out a deal with Starbucks that's going to cost the payment firm 4 cents per credit card transaction and 14 cents per debit card transaction. The problem is it can't make money on low value payments or LVPs for short. You can blame the current card payment system for that. In the past, banks kept transaction costs low for LVPs by utilizing a two-tier pricing system where items of a greater value, like a cruise, were charged higher fees to subsidize the LVPs.
Then the Durbin amendment was signed into law in 2010, limiting how much the banks could charge per transaction, which meant they could no longer subsidize LVPs. According to Nebo Djurdjevic, CEO of Cardis Enterprises International, creator of a payment aggregation plug-in to deal with the problem, says something like 70% of cash retail purchases are LVPs. Until the aggregation of LVPs is commonplace, it's going to be difficult, if not impossible, for the mobile payment revolution to really take off.
SEE: Mobile Payments Could Replace Cash By 2016
The Bottom Line
Veteran business journalist Bill Snyder's recent article in CIO.com sums it up best when he suggests, "... run, don't walk, away from any mobile payments system for the foreseeable future." This revolution is nothing more than an attempt by retailers to get more hard data from its customers so they can sell you some more stuff you don't need. It's a solution in search of a problem.
At the time of writing, Ryan C. Fuhrmann did not own shares in any of the companies mentioned in this article.
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