In the 2011 article "The Excitement Over Apple Isn't Over," this author posited payment systems as an area in which Apple Inc. (NASDAQ:AAPL) could create value not currently reflected in share prices. This article will examine Apple's intermediate and longer-term prospects in payments in light of its newly-reported deals.
Apple's Customers Buy Things
Apple's high-margin mobile customers demonstrate willingness to pay more for perceived quality. Customers of Google Inc.'s (NASDAQ:GOOG) (NASDAQ:GOOGL) Android platform may include tech-savvy experts keen to compile their own kernels, but overall Android usage looks like traditional dumphones. In concrete numbers, iOS users are seven times more active online. Despite having smaller numbers compared to Android users, Apple's customers buy things more often and when they do they spend more per purchase. More Android users have the ability to play music, but Apple's music store dominates music sales. Google Play may be Google's fastest-growing revenue segment, but a look at Apple's relative mobile revenue suggests part of that growth is related to Android's historically small revenue base. It's not that Android customers don't download apps - they do - they just don't, on the whole, like to pay for them. Even Google Play revenue that's expected to surpass Apple's App Store's by 2018 is virtually all free software ad revenue (see this report's graph on page 15, from App Annie). Android isn't going gangbusters because of its quality, but because of its price.
Who Wants Customers Who Buy Things?
Now imagine you are a retailer. You sell things for a living. Do you want access to a customer network that has been selected for its unwillingness to spend money, or do you want access to a customer network consisting exclusively of buyers who have proven they are willing to pay more for what they want? The desirability of this second class of customer - Apple's customer - is what makes Apple's customer base an interesting asset. Freemium software downloaders might make a great business for Google - but what use is that to retailers? Or, for that matter to payment companies like Visa Inc. (NYSE:V), MasterCard Inc. (NYSMA) and American Express (NYSE:AXP)? Which customers are going to generate revenue for your firm?
Presently, Visa and MasterCard have to pay third-party payment network operators and intermediary banks to process payments. Apple could offer its Passbook system as an interface directly between retailers and the card-branding firm (Visa and MasterCard don't so much issue cards as allow banks to brand cards they issue with a logo that will get them accepted, and a payment network that will get everyone paid). American Express has a third-party issued cards business growing regularly, and though AmEx deals directly with merchants many of its transactions still depend on third party networks. Now, Apple has arrangements with MasterCard, Visa and AmEx to use iPhones as an electronic wallet. By offering Passbook as an interface for authentication and payment processing, Apple can offer retailers and card companies a route around incumbent transaction processors while also promising access to - and identification of - premium customers.
Given the non-trivial risks (and uncertainty) facing small businesses seeking honest card processors in the U.S., the attractiveness of a known brand becomes immediately apparent - and the desirability of access to the kind of low-risk customer that supports modest fees and easily-anticipated transaction life-cycles. Apple might begin by replacing transaction processors between existing parties, with the merchant's bank or the issuing bank making some of the same decisions that drive retailers mad in existing transaction-processing agreements. But Apple could - whether initially, or after some experience in the field - begin dealing with new vendors who have no existing transaction processor, offering standardized terms to vendor-segments Apple understands well enough to serve properly, and expand its position in the transaction-processing world.
If Apple's data-mining (and perhaps some small acquisitions) gave the company the expertise to perform the kind of underwriting banks undertake when figuring out what they'd charge vendors to take the risk of making payments that could get reversed in unexpected chargebacks, Apple could replace traditional processors altogether. If Apple ever got interested in invoicing consumers for purchases (instead of being paid by credit cart, as it does now), Apple could use Passbook to replace cards.
Why think Apple would just compete with transaction processors? Consider countries in which credit card transactions are not currently the norm. Card-problematic countries like China, where retailers don't have lots of nationwide electronic transaction processors competing to speedily exchange information with the various banks needed to get a transaction approved and executed, might be a rich place for Apple to offer services. The complexity caused by China's central bank's unwilingness to allow foreign-issued cards to be settled in renminbi could be solved with an Apple-provided local-bank solution in which foreign currency settlements are immediately converted to renminbi for merchants. It's not like Apple lacks cash. Card companies interested in access to untapped markets might be particularly interested in the risk reduction associated with Apple's premium customers as they leverage Apple's communication system to expand into markets that have been historically inaccessible.
The more problems Apple solves for card companies, the more internal expertise it develops for creating a fully-integrated payment solution. Given the high-profile hacks at financial firms, privacy-minded consumers might be interested to trade Apple for a vast and unknowable network of intermediate banks and transaction processors whose security can't be known. By involving itself in large-scale transaction processing, Apple will join large enterprises in a whole host of data-handling and enterprise infrastructure concerns that potentially enable it to sell its solutions to third parties.
In looking forward at Apple Inc. in 2009, a Jaded Consumer article observed that the company had undergone several one-time-only conversions. A once-cash-burning enterprise became the world's fattest corporate treasury; a niche computer company became a consumer music device company, then a mainstream cellular hardware vendor; and margins improved an order of magnitude. None of these can happen twice. Naturally onlookers want to know what's left for Apple to do.
The fact that Apple is entering the payments business suggests that the scale of its operations and resources are creating opportunity to the benefit of Apple and its shareholders both. Apple isn't competing with existing card brands but partnering with them, it's opening a new business, building additional competencies, and expanding its reach to new customers. Apple will certainly continue to improve its hardware and software, but its movement into services and its partnership with International Business Machines (NYSE:IBM) in the enterprise show Apple is moving at a careful pace into markets in which it hasn't enjoyed historic strength. Since these moves involve little capital, the risk seems all to the upside.
Disclosure: The author is long AAPL.
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.