The basics of Apple Pay (and the features built into iPhone 6 and 6 Plus) and how it works have been written about, spoken about, and analyzed by most analysts in the payments market (and quite a few nonpayments writers as well). Indeed, Apple is newsworthy— and has high consumer appeal and interest. My colleague, Tim Sloane, VP of Payments Innovation at Mercator Advisory Group, recently wrote a Viewpoint exploring what we know so far about the product and how it works (see A Sleeping Giant Awakes: How Apple Pay Works and What It Means for Payments).
Apple has managed to pull together an impressive consortium of companies interested in Apple Pay, including MasterCard, Visa, and American Express (Discover has indicated its participation is imminent), 11 major banks, First Data Corp., TSYS, Fiserv, and a group of merchants. Their purpose is to launch Apple Pay by leveraging what currently exists in the market—specifically credit and signature debit cards, Near Field Communication (NFC), and tokenization. None of the technology is particularly new or innovative (tokenization is being implemented at various processors around the world; biometrics have been utilized previously, such as in the Solidus Networks product known as Pay By Touch). It is Apple that has made the difference by establishing a scenario in which banks will be willing to pay to participate, and Apple has kept the payments infrastructure virtually the same (well . . . the requirement for NFC is asking a lot). With the help of the iPhone user community and the iTunes database of active users, Apple will over time bring a critical mass of adopters and users of their new payments capability.
The biggest barrier to success, at this stage, is merchant acceptance. At the launch of Apple Pay, only 220,000 merchant locations have NFC terminals at the point of sale or have signed on with Apple to provide them. That represents approximately 2% of the 9 million or so merchant locations that accept debit or credit cards in the United States. This a pretty big barrier to adoption. A secondary barrier (but one that will be more easily overcome in a short time) is the limited number of consumers that will have this capability in their mobile phones. Only 60% or so of consumers report having smart phones, and only 42% of those smart phones are iPhones, representing only 25% of the U.S. adult population. These iPhones are replaced every two years on average, driven by the typical two-year contract. This will translate into a replacement for existing iPhones over the next three years or by 2018.
Clearly competitive are Android phones, some of which have had NFC in place for several years now, which will continue to grow along with merchant acceptance expanding. Android phones will surely adopt some of the elements of iPhone. The biggest problem will come down to which bankcard issuers will negotiate with carriers for a place in the secure element of the smartphone. In the case of Android smartphones, there are problems with mobile carriers controlling access to the secure element. In these cases, Host Card Emulation (HCE) will be utilized, bypassing the secure element and the mobile carriers. However, there are still issues with implementing HCE, and the timeline is still in question.
So, where does Debit fit in?
Signature Debit. For the most part, signature debit cards are utilized by the Apple Pay ecosystem in the same way that credit cards operate. Banks/debit issuers will sign with Apple to provision the secure element with the token provided by the payment networks. Those tokens will be used in place of the PAN—so every iPhone-based transaction will be secure.
PIN Debit. What hasn’t been explained yet by Apple or any of the partners interviewed thus far is how PIN debit cards will function in Apple Pay. Will there be a PIN debit function embedded in the Apple Pay wallet, or will the transactions occur as PINless debit? Or, will Touch ID stand in as the authentication device for PINs? Alternatively, PIN debit cards might not function initially within Apple Pay. We are still looking for explanations of PIN debit.
EFT Network Routing. EFT network routing through Apple Pay is not clear at this time and appears to be slow to evolve. The only networks that have confirmed their participation in Apple Pay in any way from a routing perspective are STAR and Accel. Our understanding is that STAR (owned by First Data) will be ready for participation by late 2014, and Accel (owned by Fiserv) has announced it has expanded its capabilities via Visa’s Token Service and MasterCard’s Digital Enablement Service (required for participation in Apple Pay). In both cases, details are still forthcoming.
We will continue to research how debit cards will or will not operate in Apple Pay and update our findings in Mercator Advisory Service blogs.