Currently, there are rumors of Apple (NASDAQ:AAPL) implementing NFC capability, which will be unveiled at the upcoming September 9th event, along with mobile payment capabilities. Recent developments between Apple and various payment processors help confirm the rumors.
According to Re/Code:
Apple has reached an agreement with American Express to work together on its new iPhone payments system, according to sources familiar with the talks. American Express is one of several partners Apple will need to sign up before it can launch its new payments plan, which sources say it plans to announce at its September 9 product event.
Will Apple earn revenue from circulating ads on a mobile payment app?
While I'm confident that Apple will launch its mobile payment services to the masses, and in no time will be able to saturate the market with smartphone fed transactions, I don't really agree with the argument that Apple's goal here is to create another advertising platform. Sure, we can go back and forth, and hash the idea of how Apple monetizes its mobile payment services, but I don't think ads are the most optimal way to do this.
Quoted from Bloomberg:
Until now, iTunes accounts have been used in Apple's marketplace, which is tiny compared to the vast retail market, Crone said. If Apple's mobile wallet takes off, it could open up new possibilities as a marketing platform by generating advertising revenue from consumer brands wanting to reach shoppers while in a store. Crone's firm estimates that a frequently used mobile wallet application could generate about $300 a year per user from advertising.
The $300 per year figure doesn't really sound that realistic, in comparison Facebook (NASDAQ:FB) generates something closer to $20.48 per user over the past four quarters, and while that revenue per user figure is likely to improve, there's a massive discrepancy between the $300 per year, that Crone estimated, and the actual reality of what a top performing ad platform generates in terms of revenue.
And remember, Facebook has valuable data that marketers can use, and it even offers video ads as well, so there's no reason to believe Facebook's ad-efforts are weak in comparison to whatever Apple could advertise via ads that are displayed via a digital wallet application. Sure, Apple can put together a contextualized way for marketers to understand how much of a conversion rate they're getting while engaging in shopping inside of a store, but it's unlikely that privacy skeptics will welcome that kind of data sharing without some kind of class action lawsuit.
Apple will run into the question of, should Apple have user information on location data, and share it with marketers? Facebook generates enough PR nightmares with the information that users voluntarily provide ... imagine if GPS data was used without permission, and even if information was used with consent, what's to stop Apple's payment service from losing the hard earned trust of its customers who were completely ignorant of this fact? Again, advertising isn't the model that Apple is likely to leverage as it comes with complications that a non-ad oriented company shouldn't have to deal with.
How about transaction fees?
I think a more realistic revenue figure is to compare Apple's potential revenue to what merchant networks currently generate. And since Apple is supplying infrastructure and its own network of customers to merchants it's likely that Apple will have to charge some sort of transaction fee on transactions, similar to PayPal's business model, or that of Visa (NYV) and MasterCard (NYSE:MA).
At the present moment merchants have to pay two fees, and there's a very great explanation over at the New York Times over how the various charges work in combination together. However, the company that typically earns the most from any transaction is the issuer, because they take on the most financial risk in any given transaction. The rates that the issuer earns on a per transaction basis is 2% or so, and the remaining .21 plus .05 percent fee is shared between Visa and the acquirer bank.
I share the business model because I don't think Visa will give up the modest fee it earns from financial transactions, but at the same time, I can't imagine banks wanting to move away from the established ecosystem that they've developed over the years.
If I think very carefully about the situation, Apple will earn some sort of fee, but striking a deal with the banks could have been the primary barrier for Apple even wanting to include NFC capabilities in the phones. After all the added component cost, nominal doesn't really benefit Apple as much as it benefits the merchants that are able to receive transactions via phones. Because Apple provides the means in which transactions can occur via phones, and it has all the relevant credit card information through iTunes, merchants will have a relatively large base of customers to serve immediately.
Therefore, the ecosystem has to change somewhat to allow for Visa and MasterCard to continue earning fees from transactions, but at the same time reimburse Apple for providing the software and hardware to make this all happen. Therefore, I think Apple will earn closer to what Visa and MasterCard earn per transaction.
Merchants aren't going to want to pay more for transactions, so if anything the issuer has to give up some of the margin that it earns. Since the issuer bank earns 1- 2% per transaction, Apple has to offer some sort of tangible benefit to the issuer.
To prevent card fraud/theft, an iPhone is unique in that it has a thumbprint sensor and location specific data. However, GPS data can be used to lower the likelihood of transactions occurring in places they're not supposed to, and the added thumbprint sensor can act as a verification mechanism, which reduces the rate at which chargebacks occur. In that case, the short-term loans that the issuing bank makes to the acquiring bank carry significantly less risk, which is where Apple is able to absorb some of the economic profit from each transaction that occurs.
In a prior article, for Amigobulls, I estimate that Visa earns $5.33 per card holder. That's the average revenue per user figure we're going to work with in the case of Apple. The figure is based on Visa's full fiscal year 2013 results, and while it can grow significantly, I want to be conservative here with my estimates. I think that the next generation of iPhone, i.e. the iPhone 6 and 7, will accumulate an installed base in excess of 450 million users. However, to be fair, and to exclude the impact of shipment growth, I'm going to go with a 400 million unit figure. When I multiply 400 million Apple users by $5.33 in average transaction revenue per user, I believe Apple will earn $2.132 billion in revenue from its payment service in fiscal year 2016. Because Apple will earn margins like a license model, but will offer software and some hardware as a service, I think margins will be comparable to Visa. Because Visa earns a 45% net profit margin, I think Apple's mobile payment service will contribute $959 million or more to profit.
I think the merchants will have to bring their own hardware and implement it into legacy point of sales systems running on older versions of Windows enterprise, and Linux. Those are costs that Apple will not have to absorb. Another alternative is for merchants to buy an iPad that runs an Apple based POS (point of sale) software. In this case Apple earns additional revenue from merchants by selling hardware, and for smaller merchants, they might just offer an iPhone app that can accept NFC transactions. Again, integration will occur in a variety of different ways on the merchant end, but on the consumer end it will happen once we go through a 2-year refresh cycle.
While the estimate I create for Apple makes some key assumptions, I think they're fair in light of various assumptions that have been made by other commentators/analysts. In reality, Apple may earn a higher fee per transaction than what Visa earns, but without actual details on the actual business model, I'm going to stick with the conservative estimate that I have made.
Furthermore, if Apple is able to earn a much higher fee, perhaps $.50 per transaction, the ARPU figure could be 3 to 4 times bigger than what I had estimated. Therefore, we're working with a very broad range of possibilities.
I think that for a business that takes on hardly any incremental cost, and it's just about implementation/integration, the additional $1 billion or so in profit is a welcomed addition to Apple.
Furthermore, making financial transactions via a smartphone with a fingerprint and GPS does come at a considerable advantage from purely a data security standpoint. With more sensors, and more data, it's easier to come up with heuristics that can prevent fraud.
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