Apple Pay(ment processor)

How Apple is turning the payment industry upside down and where the journey could end up…

In the relevant information sources of the payment industry, Apple appears with ever new rumours and efforts to launch new payment services (“Apple will soon no longer need a merchant payment terminal”) or even to enter the market as an independent financial institution (“Apple’s “Breakout” project – on the way to becoming an Apple Bank? “).

 

The birth and outstanding development of Apple Pay

But what is Apple actually up to? And why does one of today’s biggest technology companies have nothing better to do than to try to establish itself in one of the most regulated markets in the world? We try to sort the past, present and (presumably) future developments and approach the question of where the payment journey at Apple could be heading to.

Launched in Germany in November 2018, Apple Pay marked the beginning of a new era for many local payment enthusiasts. Driven by a lot of hope for a domino effect that would finally set in motion the somewhat sluggish development of electronic payments in our cash-loving country, one could read in the Finanz-Szene newsletter  on 6 Nov 2018: “Thank God, Apple Pay is coming, now, actually.”

It was not only the prospect of winning 3 to 6 bottles of sparkling wine, but also the hope that the German vacuum in cashless payments would soon come to an end that probably led the author to write these lines. Since then, Apple Pay has performed excellently in Germany. According to a GfK study from the summer of 2021, one fifth of Germans now use mobile payment, of which Apple Pay is just behind Google Pay (34%) with a 32% share.

 

The popularity of Apple Pay is particularly high among the younger generation

Among the younger generation in particular, however, the share of Apple Pay is much higher and reflects the popularity of this payment method among younger people. These figures are likely to rise even further over the next few years. We see this as excellent for a cash-affine country like Germany. But will Apple be satisfied with this? Especially since Apple Pay is merely an additional layer and is based on adding a virtual (digitized) debit or credit card into the e-wallet. Unlike Android, which can also be used by third-party providers, Apple has not opened up the interface and therefore only Apple Pay is available for iOS fans. The reason for this, according to Apple, is to protect customer data. How long this will continue (at least in the EU) is questionable. The European Commission has been investigating this since June 2020. These have now resulted in an antitrust complaint, to which Apple must respond. The last word has certainly not yet been spoken and we will be highly interested to see when Paypal, for example, will be able to offer its tap-to-pay function, which is currently only available on Android, on iOS as well.

 

The classic 4-party model of Visa and MasterCard

However, the search for further services along Apple’s value chain should by no means end here. To ensure that we do not forget any aspect or party of a payment transaction, we take the classic four-party model of Visa and MasterCard as a basis to examine where Apple’s payment journey can still go. The model introduces the four parties involved in an international debit and credit card transaction and their respective roles in card acceptance.

 

 

These four roles are to be used to derive the existing features but also possible future developments with regard to Apple and payment.

The (end) customer...is king – especially at Apple

We are talking about ourselves, or rather each of us who uses an Apple smartphone, for example, but also an iPad or the Apple Watch. In Germany, in the case of the iPhone, this represents almost 30% (April 2022) of smartphone owners. Among 18 to 29-year-olds, again, Apple is ahead. And as far as Apple Pay is concerned, more than 2.5 million Sparkasse customers, for example, are already able to get by and enjoy without a purse thanks to almost universal acceptance at the POS (if it weren’t for the corner pub I trust). In e-commerce, however, the numbers are significantly lower. And since the majority of retail banks now offer at least credit cards via Apple Pay (the Sparkasse also offers the girocard), most customers can now also be served. The issue of data protection has always played a major role in Germany. And this is where Apple supposedly plays in a big way. During the payment process via Apple Pay, the customer’s actual credit card number is never sent. Rather, for each card number, a Device Account Number is stored locally on the Secure Element chip of the device used (iPhone, iPad, Apple Watch). This chip is completely isolated and therefore not part of the backup. For each transaction, only this number is transmitted to the merchant and only the associated banking network can assign the device account number to the actual card number. According to Apple, this is to provide the best possible protection for sensitive credit card data. It creates security and trust and can be an important factor, especially in Germany, but it is not always a guarantee of success. Rather, Apple has scored with Apple Pay in the user experience, i.e. the very simple and intuitive use at the POS and e-/m-commerce. How can the payment process be implemented as simply and intuitively as possible from the customer’s point of view?

2 clicks. That was the requirement that Apple set for the card-issuing institutions as a condition for digitization, i.e., to add the card to the wallet. At least that is what Mr Schmalzl, as a member of the board of the Deutscher Sparkassen- und Giroverband (DSGV) as the leading umbrella association for the German Savings Banks Group, revealed at the EHI Payment Congress in April 2022 regarding the implementation og Apple Pay with the girocard for e- and m-commerce. Everyone can certainly imagine that the savings banks’ approach envisaged a multiple of these clicks. After much back and forth, the savings bank ended up with exactly 2 clicks. Only 2 clicks and Apple Pay is ready for use – thank you Apple at this point for your perseverance! But that is only one aspect of the user experience. On an iPhone with Face ID, you only have to press the side button twice and after the very quick authentication by Face ID, you can pay immediately. So, it’s a very fast and efficient as well as customer-friendly payment that is gaining more and more followers among Apple disciples. And Apple is trying to improve this UX more and more, which is of course welcome…

 

The Issuer – Go Where the Money is…

 Apple makes no secret of its basic strategy of consistently expanding its business where it can create significant added value for the customer in terms of convenience and user experience. This applies to both hardware and services that are offered. It is quite clear that Apple is not interested in a payment-specific hardware solution. This would not fit in with the credo of simplification for the customer. Rather, it is the transaction-based payments, e.g., a share in authorisation or service fees, that is the economically interesting aspect for Apple. Something similar can be seen in the App Store and the apps and digital services offered there, where Apple also earns good money with transaction-based payments. The logical and sensible step was the launch of Apple Pay. With Apple Pay, Apple is now the third largest mobile payment provider after Alipay and WeChat Pay. Just like the two competitors from the Far East, Apple Pay is only an additional layer or e-wallet in which payment cards from various issuers and schemes can be integrated and added. It goes without saying that Apple does not offer this service free of charge. What was interesting here was the approach of collecting these fees (allegedly corresponding to a significant share of the interchange fees) from the issuers, who are responsible for the digitisation and provisioning of the issued debit and credit cards and thus have to afford the layer and the branding Apple Pay accordingly. Good for those who enjoy the increased convenience through Apple Pay, i.e., merchants and customers. Speaking of convenience. Unfortunately, Apple is still dependent on issuers and their card deposits in Apple Pay for this. However, there are limits to the user experience and the additional functionalities and services offered. Therefore, Apple took the next logical step.

 

When will the Apple credit card come to Germany?

This is what will happen in the USA in August 2019 (no, this is not a remake of “Beyond Belief: Fact or Fiction”) with the launch of the Apple Card. Probably to lower the barrier to entry, Apple is cooperating with Goldman Sachs as issuer. This is also a novelty for Goldman Sachs, which has not been active in the private customer business so far. Now, more than two and a half years have passed, and outside the United States one still must be patient. If we take the rollout of Apple Pay, which was also available in Germany four years after its launch in the US, we will not have to expect a launch before summer 2023. As with Apple Pay, Apple will probably be slowed down by the European regulatory freedoms. To possibly get a grip on this, rumours of a $150 million acquisition of the up-and-coming open banking company Credit Kudos from the UK by Apple made the rounds in March of this year.

Do we see here the next strategic step towards the launch of the Apple Card in Europe? Or does Apple even want to go one step further and become active as an issuer or acquirer itself? Before we get to that, let’s take a look at another stakeholder in every card transaction.

 

The retailer – multiplier for Apple…

In February of this year, a solution was presented in Cupertino that is supposed to outstrip the previous solutions. With “Tap to pay”, merchants will soon be able to process card payments without having to use additional hardware. All that is needed is an iPhone XS or newer. This will be done with the help of NFC technology, which is already used for POS payments via Apple Pay. It is interesting to note here that buyers do not necessarily have to pay via Apple Pay. In addition to Apple Pay, credit and debit cards as well as mobile wallets are also accepted for contactless payment. What exactly “mobile wallets” include has not yet been further specified and only time will tell.

However, Apple does not (yet) want to take care of the processing itself. There is no way around a contract with a supporting payment service provider (PSP). Initially, the choice is between Stripe via the Shopify point-of-sale app or the payment darling from Amsterdam Adyen. Presumably, other providers are expected over the year.

Who is Apple cutting out of business with this? First and foremost, providers of integrated POS solutions for small and micro-merchants such as Square and SumUp, who will have to struggle with their hardware solutions. Which brings us to the supposed target group of the new SoftPOS solution. For small businesses with a small number of terminals and manageable transaction and turnover figures, as well as seasonal and thus strongly fluctuating usage figures of card payment processing hardware, it should be very interesting to use the iPhone that one (ideally) already owns for this purpose. An expected and comparatively high transaction fee is likely to be accepted in many cases. The high fluctuation in the corresponding sectors (above all the catering industry) should play into Apple’s hands with the initial limitation to selected payment service providers and the typical unwillingness of users to change.

Well, there are various rumors and reasons why Apple does not want to leave it alone with Apple Pay, Apple Cash (Apple’s P2P payment service in the US), the Apple Card and “Tap to pay”. If we look again at the 4-party model, we see that 3 out of 4 participants (at least currently in the US) are already served by Apple solutions. The customer through Apple Pay, his issuer or scheme through the Apple Card, the merchant, and his front end through Tap to Pay. As we know, the only thing missing is the acquirer, i.e., the merchant bank, where Apple currently does not (yet) have a foot in the door. Or maybe it does?

 

The acquirer – thus closing the circle…

Bloomberg reports that Apple is working with its partner Goldman Sachs on an in-house “Buy Now Pay Later” feature with the working title “Apple Pay Later” and is challenging competitors such as Paypal, Klarna and Affirm to a duel. This would also fit in with other reports that Apple also wants to offer a subscription model for its own hardware range. Cashback models are very popular in the US. It is therefore obvious that this is being promoted as one of the core features of the Apple Card.

 

Apple Pay vs. VISA & Co?

We hear about many services that Apple offers around the purchase of software and hardware and wants to create new purchase incentives for customers, but is it realistic that Apple will shake up the payment industry to such an extent and go toe-to-toe with big names in the industry like Visa, Mastercard, Stripe, Square, etc.? It is unlikely that Apple will rely on partners like Goldman Sachs in the long term and thus make itself dependent and vulnerable. It would only be consistent for Apple to take care of this itself sooner or (according to reports, they probably have trouble fighting their way through the regulatory jungle, so it is more likely) later and thus expand and acquire further vertically along the value chain. For Apple, it is always about making their hardware and software work hand in hand. This way, the complete check-out at the point-of-sale can be covered. Why not offer its own integrated checkout system in the style of Orderbird or Lightspeed? If an own Apple Bank for private and business customers is also founded, the circle can be closed, and a holistic payment processing can be offered.

However, a huge problem, of which Apple is certainly already aware, is acceptance by merchants. And the complexity of convincing a critical mass of merchants to use it is probably the main reason for the market power of Visa and MasterCard and the fabulous margins that the duopolists can charge for their services. This is where Apple could go the extra mile and approach merchants directly. More likely, however, is the Apple-typical approach of relying on strong regional and international partners, at least initially.

 

More theory than reality?

One big advantage Apple has are there loyal followers. Once you enter the Apple universe, you rarely leave. And it is precisely because of this loyalty of Apple customers that good marketing, such as bundles or simply a smart-looking card (be it virtual or physical), is sure to bring them to the people.

Another advantage is the dual use of the iPhone or iPad by the customer and the retailer. For the retailer, this means that (s)he can save him-/herself another device with monthly fees and additional contracts. However, this is only interesting until Apple takes on such a dominant position in the market and tightens the price screw on the retailer side as well.

However, we see probably the biggest advantage in the convenience, the uncompromising user experience, the all-encompassing ecosystem for both sides of a transaction business and the enormous network effect in the market. It is simply convenient to use one device for everything, both as a merchant and a customer. And the smartphone is now always with you.#

 

Where does Apple’s journey end up?

Despite all the advantages, we must not forget one thing. The payments industry is a very regional business. An enormous amount of work must be done per market or region, be it for the own set-up or through acquisitions, to meet the regulatory and licensing requirements. Compared to Apple Pay, this is many times greater for a fully comprehensive banking operation. The legitimate question arises as to how much staying power Apple will demonstrate here over the next few years and how far they want to move away from their actual core business.

Apple makes it difficult for us to figure out where the payment journey will go. We dare to allege that Apple itself may not yet be able to assess 100% where the most attractive product enhancements for customers will ultimately lie. What is certain is that payment has never been so important at Apple and that Apple is in a position to change the payment landscape significantly. We will see what this means for the industry and for us as customers. We will stay tuned!