Mercator Blog

Why Apple Pay Isn’t a Trojan Horse Intent on Eating the Credit Card Industry
Date: January 4, 2016
Research Team
An article in Innovations column of the Washington Post argues that Apple Pay represents a Trojan horse that will eat the card industry.The piece asks a fascinating question—what will the long-term impact of Apple Pay be on the banking industry?—and then draws a series of illogical and strangely generic conclusions in an attempt to answer that question. Let’s walk through a couple of them.

“Apple Pay is, however, a Trojan horse. Once Apple has established its platform, it won’t need the banks and credit cards any more. It will be able take advantage of another new technology, the blockchain, to offer an alternative payment option.”

Wow! What an incredibly naïve statement! There are a couple of problems here. First, Apple has shown no interest in developing an alternative payment option that bypasses the banks and the card networks. Apple is a device manufactuer. Apple makes an insane amount of profit on every device it sells (particularly the iPhone). The company’s interest in payments (or any other ancilliary market) extends only so far as it helps increase the value of Apple’s core products. It isn’t trying to make money from Apple Pay (for evidence of this, look no further than the rumored person-to-person, or P2P, payments capability coming to Apple Pay that Apple will give away for free). Apple isn’t interested in disrupting the banks or the networks. I state this because the design of Apple Pay (creating tokenized versions of existing payment accounts) specifically relies on the banks and the networks.

Second, you can’t just casually toss in the blockchain as a viable replacement to the existing payment infrastructure that Apple Pay relies on. That mistaken belief is often asserted by financial industry commenters opining, “Blockchain will replace everything!”or “Banks are no longer necessary!” Wrong. Blockchain, the distributed ledger system that currently underlies Bitcoin, is able to function as a decentralized and trusted network only because of the economic incentive provided by Bitcoin. Now that’s not to say that there aren’t other variations of the Blockchain concept being explored that don’t rely on mining virtual currency (Ripple, R3, etc.), but those variations come with trade-offs and constraints that are unlikely to be compatible with Apple’s plan for Apple Pay. Just saying “blockchain” when talking about disruption in payments is a bit like jumping into a conversation about last Sunday’s New England Patriots game by shouting “Go sports!” The Post article continues:

“Think about it: today you have a choice between American Express, MasterCard, and Visa, and they charge merchants roughly 2 percent of every transaction. If you were given another payment option, let’s call it AppleCoin, which provided you with a rebate of this fee, and the transaction was easier and more secure than with a credit card, which would you pick? I doubt many people would show loyalty to the credit card industry. After all, it extracts more than $100 billion in fees — a tax that we end up paying for — and gouges us the moment we miss a payment. Apple would dominate this industry.”

There are a couple of major assumptions in this quotation that need correcting. First and foremost, the “AppleCoin” described in the article is currently accepted at exactly zero locations. Gaining broad merchant acceptance takes decades; witness Bitcoin, MCX, EMV, NFC, and many others. The author states that merchants pay transaction fees when accepting credit cards (and debit cards). This is true. So why, in the next sentence, does the author suggest that consumers would be more likely to pick “AppleCoin” over credit cards when those transactional fees are completely hidden from the consumer? If merchants were getting a better price from Apple for “AppleCoin,” they would certainly be in favor of it (in the same way that they favored the Durbin Amendment capping debit card interchange rates), but why would consumers care? In fact, we have seen in other countries that have capped interchange rates (as Australia has) that the “tax” consumers end up paying (in the form of higher prices) doesn’t diminish when swipe fees are reduced; the merchants just pocket the difference.

Two other things merit mentioning. First, the Post author correctly notes later in the article that Apple Pay is much more secure than traditional payment cards (even the new EMV chip cards). Again, this is true. So why exactly would Apple Pay via “AppleCoin” be more secure than Apple Pay via a credit card? Both would presumably use biometrics. Both would presumably use tokenization (although Apple would have to directly manage the token service if it cut out the card networks). I agree that using Apple Pay is more secure than using a plastic card, but I’m unclear on how this hypothetical “AppleCoin” payment option would be even more secure. Second, the author takes the stance that consumers would not show loyalty to “the credit card industry” because of the aforementioned interchange “tax” and the fact that credit card issuers charge interest on balances. The problem with this, apart from the use of the very vague term “credit card industry” (quick, name an entire industry you do feel loyal to), is that it ignores the fact that many consumers are indeed loyal to their credit card issuers and a main driver of that loyalty is the reward programs provided by issuers and funded by interchange fees. Again, this isn’t to say that Apple couldn’t combat that with its own incentives or rewards (as the author suggests later in the article), but it is hard to fathom how Apple could afford to provide those incentives without charging transactional fees and/or charging interest on overdue balances. Additionally, the zero liability protection offered by credit card issuers provides consumers with a significant benefit that Apple would likely have to match (at its expense) in order for “AppleCoin” to be competitive.

The rest of the Post’s Innovations article lays out a number of additional reasons reasons why Apple Pay will achieve significant market penetration and enable Apple to become a “disruptive broker” in the financial industry. Among these reasons (with my response in brackets) are the following:

• Apple’s “cult-like” customers who are generally eager to upgrade to latest harware and software and thus gives Apple a quickly expanding base of potential Apple Pay users. [I actually agree with this point.]

• The financial levers that Apple can pull to incentivize customers to use Apple Pay such as “iTunes credits” and “exclusive discounts.” [This ignores the financial reality of needing to pay for these incentives with some source of revenue that apparently (according to the article) won’t include transaction fees or interest on revoloving balances.]

• The switch to EMV chip cards, which imposes a more burdensome (and less secure) payment experience on consumers than does Apple Pay. [I’m a little skeptical on how much the longer transaction time for chip cards will motivate consumers to try mobile payments. Even if the longer transaction time does prove to be a motivating factor, all that means is that Apple Pay could replace plastic cards, not the underlying credit card accounts.]

To be fair, the author of the Post’s Innovations article does acknowledge that Apple Pay, according to current surveys, hasn’t gained any meaningful level of consumer adoption. However, this doesn’t seem to slow the speculation much. More problematic is the author’s failure to clearly articulate which companies in the “credit card industry” will actually be disrupted or displaced by Apple Pay. This is troubling to me because a more nuanced examination of the topic might have revealed a few specific and credible examples of Apple Pay’s disruptive potential.

For example, while I believe that Visa and MasterCard have positioned themselves extremely well within the Apple Pay infrastructure (and the broader tokenized mobile payments infrastructure), I do think that credit card issuers may struggle to retain top-of-wallet status when a majority of consumers abandon leather wallets in favor of digital ones.

Alas, such nuance seems to be unneccessary (and even a little unbecoming) when prognosticating on the disruptive potential of literally anything Apple says or does.