Visa And MasterCard Will Win In Mobile Due To HCE

Aug.13.14 | About: MasterCard Incorporated (MA)


Mobile payment volumes have been insignificant thus far due to standardization issues and operator control.

Host Card Emulation opens up payment issuance to a wide range of participants.

Mobile payments should generate incremental card volume which will benefit Visa and MasterCard.

A payments revolution is slowly taking place with the shift away from physical card payments to mobile payments. Mobile commerce is still fairly small today, but the shift is expected to accelerate steadily, and mobile commerce should contribute close to $110B in U.S. retail sales by 2017.

While this number may still seem fairly small in the context of total commerce volumes, the growth trends point firmly in the favor of the mobile device as a transaction mechanism and as the basis for card issuance by banks. Why is this?

Increase in Basket Size

The wholly grail of mobile payments is the ability to deliver real time insight and analytics at the point of sale. Practically, what this means for the retailer is the ability to increase the basket size by pushing consumers relevant related items to go along with their purchase at the time of checkout. For example, a $1 off coupon on a drink with a purchase of fries could stimulate a larger basket order than may otherwise be the case. This is done in a fairly clunky way today with paper based coupons, but the whole experience should be far more elegant in a mobile world.

As such, mobile commerce payment volumes won't just be a straight replacement for volume that may otherwise have occurred on physical cards. The secret sauce here is that mobile should actually unlock purchase volume that likely wouldn't otherwise have occurred. It's impulse buying on a far bigger scale. For Visa (NYSE:V) and MasterCard (NYSE:MA), that means additional payment volumes running over their payment rails that they likely wouldn't have otherwise seen.

Minimal Issuance cost for banks

Getting plastic cards to subscribers comes at a cost for the banks. For a magnetic stripe card today, the physical cost and distribution of the card is roughly $1.00-$1.50. However the U.S. is about to join the rest of the world and embark on a journey down the path of EMV (EuroPay MasterCard Visa). Now EMV cards are far more sophisticated and have more elaborate encryption than traditional magnetic strip cards, but they also come at a far higher cost. Issuance costs for EMV cards are some $4-$5, making them quite expensive for banks to issue. Mobile issuance of EMV cards can be done at a fraction of the price, which is of significant value to the banks.

In emerging markets, card issuance and distribution can cause significant challenges, where logistics may not be very good. Mobile delivery of credit cards to consumers will be a far more efficient mechanism for banks to deliver card credentials.

Banks will be incentivized to push volume down the mobile channel to help reduce their cost structure.

So where does host card emulation fit in, and what does it mean for Visa and MasterCard?

While the benefits of mobile commerce and mobile payments volume are clear, growth of the mobile channel for card issuance has been fairly slow today.

The reason for this has been largely because of issues around what the relevant payment interface standard should be at the point of sale to accept mobile payments.

What has become clear now is that Visa and MasterCard have come down unambiguously in favor of NFC (Near Field Communications) by requiring merchant compliance with EMV. Visa and MasterCard have set requirements that merchants who do not support EMV based transactions by the end of 2015 will bear the cost of any fraudulent activity that happens as a result. This should drive merchants to deploy Point of Sale terminals that support EMV by the end of 2015.

This is very significant from a mobile payments perspective, because NFC technology embedded within mobile phones operates on the same technical specifications as EMV. What this means is that NFC handsets can support mobile payments that occur using EMV infrastructure.

While standards alignment now exists, one of the big roadblocks for banks in embracing mobile payments via an NFC infrastructure has been that mobile carriers such as AT&T (NYSE:T) have been exercising control of the secure element and charging banks hosting fees that banks have been reluctant to pay. Given that the mobile operators had a virtual monopoly on the secure elements within the mobile device and were reluctant to negotiate, this worked to limit the number of issuers willing to issue mobile payment credentials.

The recent innovation for mobile payment volume has been the introduction of Host Card Emulation (HCE) into the mobile device. What this effectively does is create a secure element which is stored in the cloud as opposed to on the mobile device. The cloud based secure element isn't controlled by the mobile operators and is effectively open to use for anyone.

This is significant for a couple of reasons. It means anyone can issue mobile payments credentials directly to the mobile device without needing to go through the mobile operator. For banks, this is important because it promotes low cost issuance of mobile credentials. Even more important, is that it allows the banks to control their own customer experience and not have to go through somebody else's wallet.

What this will effectively mean is that there will be a lot more banks who will be driving mobile payment volume that goes over the payment rails of Visa and MasterCard.

Implications for Visa and MasterCard stock

The implications of the introduction of HCE should lead to a steady uptick over time in mobile payment volumes processed on Visa and MasterCard rails. This is largely due to the "larger basket size effect" that I outline above. Mobile won't just replace physical card volumes. Rather it should lead to incremental growth of the pie.

While this phenomenon will be slow to emerge, it will pick up speed as EMV terminal deployment accelerates within the U.S., and more NFC handsets become available in the hands of customers.

While we are still some ways away from a tipping point in mobile payments volume, the eventual arrival of mobile payments at scale should prove a windfall for Visa and MasterCard.

Disclosure: The author is long MA, V. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.