Out of touch?

By Red Gillen

Are contactless payments really the Holy Grail that the banking industry believes?

For years, the use of mobile NFC (near field communication) contactless payments has been touted as one of the most promising mobile technologies for the banking industry. In fact, many banks have built their entire mobile banking strategies on the assumption that mobile NFC would finally lead to the 'monetization' of mobile banking. This assumption has been shaped by the view that mobile NFC technology contains the ability to allow 'virtual' payment cards within mobile handsets to be used for payments at 'brick-and-mortar' merchants.  As a result, banks would gain incremental interchange revenue through such mobile NFC-enabled virtual cards.

Unfortunately, a number of business model issues have prevented industry players (mobile carriers, banks, payment brands, merchants, handset  and chip manufacturers) from achieving mobile NFC critical mass. Many of these issues are tied to these players' hesitancies about the uncertainties of mobile NFC adoption rates. Mobile carriers and merchants do not want to make infrastructure investments until there is proven demand. Banks do not want to issue virtual cards until the infrastructure is in place. In other words, a classic payments chicken and egg scenario has stagnated mobile NFC rollout.

Much has been written about the tension among these mobile NFC ecosystem players, especially their inability to come up with a cost-sharing model to cover the incremental expenses (e.g., NFC chips, secure data storage, over-the-air downloads of virtual payment cards).  This in turn has led to anemic growth of mobile NFC payments. In fact, despite the number of mobile NFC payment initiatives around the world, no 'open-loop' (i.e., Amex-, Discover-, MasterCard-, Visa-branded) solution has made it from pilot stage to full rollout.

Not that the various mobile NFC ecosystem players aren't doing their best to promote this technology.  In doing so, they make the following arguments:

Mobile NFC payments are fast and convenient.  Compared to the status quo (plastic cards), this is absolutely true.  However, this begs the question; is the status quo all that bad?

Because of this speed and convenience, mobile NFC enables 'top of wallet' positioning for a participating bank's card.  A card's 'wallet position' is less fluid than one would think - debit, credit or prepaid cards reflect the fact that checking accounts are for monthly budget purposes, savings accounts are for a larger, infrequent purchases, a line of credit is for large-ticket, emergency transactions and business checking accounts are for business payments. A mobile NFC form factor would not disrupt this logic. 

Consumers carry their mobile phones more than their wallets, thus mobile NFC virtual cards are more useful than plastic cards.  The fact that consumers always have mobile phones nearby may be true, but consumers aren't going to give up their wallets anytime soon.  Wallets contain important contents other than payment cards; for example driver's licenses/IDs, healthcare cards, membership cards, loyalty cards.

Mobile informational services (balance look-up, mobile promotions, transaction history, alerts) will increase mobile NFC payment volume and reduce fraud.  Mobile informational services are indeed very useful.  However, there is no need to tie them to a mobile NFC-enabled 'soft card'. These same services work quite nicely with plastic cards too, and already do - Visa itself demonstrated this in trials with Chase in the greater Phoenix area.

If financial institutions don't offer mobile NFC, somebody else will . This argument is actually rather valid.  As has been seen in Japan (with the Suica payment system) and in Hong Kong (with the Octopus payment system), NFC technology has enabled public transit operators to expand their proprietary payment systems into the non-transit sectors.

Mobile NFC will reduce fraud. This is a valid argument, but technically not directly due to NFC. This is because fraud reduction is not gained from NFC per se, but from the security measures established for EMV-compliant chips (EMV chips store virtual payment card data, NFC chips share card data between the EMV chip and contactless readers).

The above arguments pale in comparison to the most significant point in favor of mobile NFC - it has the ability to displace cash.  Simply put, the use of a NFC payment-enabled mobile phone makes the most sense for high-frequency, low-value transactions - the kind of transactions where cash is used today.  Research points to the attractiveness of mobile NFC payments at very specific, cash-heavy merchant segments, consistently identified as public transit, quick service restaurants (QSRs), convenience stores, newsstands and kiosks, vending machines and parking garages.

For banks, the natural subject of interest is the amount of incremental payment volume that is "in play" should the banks offer mobile NFC.  In other words, what is these merchant segments' (cash) payment volume that has not yet been captured by plastic cards?  In fact, for most every player in the mobile NFC payment space, this remains one of the largest unanswered questions. 

Although these target segments are laden with cash payments, a number of considerations pare down the cash displacement potential of mobile NFC.  Public transit will take an exceptionally long time to materialize (due to role of government), and many transit systems have already implemented proprietary NFC solutions.  About 70 percent of convenience stores' sales in the US come from fuel purchases, which are already marked by heavy card usage.  At least half of the parking market comes from monthly permits, which aren't typically paid via cash.  Newstands/kiosks and vending machines are not really major markets.

So where does this leave us in terms of mobile NFC's ability to displace cash in these target segments?  Celent estimates that in the US, the potential is about $225 billion.

In other words, $225 billion is mobile NFC's cash 100 percent displacement 'universe'.  Surely, 100 percent is an unreasonable expectation, but what displacement rate would be considered realistic?  50 percent?  25 percent?  10 percent?  The figure below shows what cash displacement would look like from a US perspective, expressed in sales lift per debit card account. For example, a 50 percent cash displacement rate would translate to roughly $251 in lift per debit card account, per year.

No one knows what the true cash displacement rate will be, and likely it will take years to find out.  Based on anecdotal data and for the purposes of this article, Celent is assuming a 30 percent cash displacement rate would be reasonable within a few years of mobile NFC reaching critical mass.  Put another way, this would be a $151 in sales lift per debit card. 

$151 certainly isn't a lot of money to a bank.  Assuming Visa's small-ticket interchange rate (1.55 percent  plus $0.04) less the payment brand switch fee, a $5 average transaction size and 30 transactions per year, this lift equates to $3.29 in incremental revenue per debit card account. 

Naturally, there are NFC-related costs to consider.  Assuming that banks won't underwrite the cost of NFC chips - a safe assumption - these additional costs mainly include fees charged by technology vendors to download virtual payment cards onto customers' mobile phones, as well as customer service costs.  Together, these amount to about $1.43.  Subtract this from the incremental revenue number and voilà, the bank makes an additional income of $1.86.

Of course, this $1.86 figure will differ by bank. However, it is directionally meaningful, especially in guiding financial institutions' decisions vis-à-vis mobile NFC. It simply means that on average, banks stand to make little incremental income above and beyond that of plastic cards. This is due to the fact that payment brands and banks have done an excellent job of growing plastic card usage, and there is increasingly less cash to be realistically displaced.  There is no doubt that mobile NFC represents a fascinating technology that will enthrall consumers and make money for industry vendors.  As such, banks would be advised to adjust their expectations of mobile NFC - it may largely end up being a technological enhancement for customer retention, not a long-sought pot of gold at the end of the mobile rainbow.

Red Gillen is an analyst at Celent.