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This week, both the Financial Times and Bloomberg reported that Apple (AAPL) will likely introduce “wave and pay”, or Near-Field Communication (“NFC”) technology, in the iPhone 5. In essence, NFC technology would allow iPhone (and potentially other iOS devices) users to purchase products at retail simply by touching their phone against a terminal without carrying cash or a credit card. This is similar to how certain credit cards can simply be touched against a terminal to pay.

This is hardly new technology, but with Apple potentially entering the game, the dynamics instantly change. The company’s dedication to pleasant user experiences will attract both early adopters and mainstream consumers. Despite Google’s (GOOG) Nexus S having NFC technology, Apple has a significant advantage with its iTunes collection of credit card information.

Requiring customers to enter credit card information is still a substantial hurdle and Apple already has over 100 million iTunes accounts. I can already envision how seamlessly Steve Jobs and Apple will make the process. While Andorid is a formidable platform, it is hard to deny that iOS is easier to use for most consumers.

To summarize the potential benefits of branding NFC as the “killer app” for the next iPhone are:

· Increased Sales: Most obviously, this will drive sales of the iPhone 5 and whatever other devices that Apple decides to include in the technology with the pure appeal of NFC and other innovation features stemming from it. For example, better phone-to-phone sharing and new location-aware apps.

· Reduce Transaction Costs: Negotiate reduced transaction costs with credit card companies via its economies of scale, thereby lowering costs and enhancing margins.

· Eliminate Transactions Costs: Allow customers to connect their iTunes accounts with their bank accounts, thus eliminating the processing fees of approximately 2%.

· Strengthen Barriers to Entry: Further build the Apple barrier to entry by increasing switching costs for customers by further linking everyday purchases with Apple and iTunes.

· Enhance iAd Effectiveness: Ability to track consumer spending habits, which could be utilized internally to produce even better products and/or shared with marketers for a profit in connection with the iAd platform

Alas, there are some notable disadvantages involved in Apple hitching their star to NFC:

· Increased Costs: Increased cost of the iPhone 5 for the physical chip, hiring NFC experts, and the associated research and development costs

· NFC Infancy: Potential for the NFC architecture to not be ready for the iPhone 5 launch, thereby being seen as a useless feature that simply takes away from other features

· Privacy Fears: Some consumers are fearful about sharing their financial information over NFC technology and this relatively minor factor could have an outsized negative impact on iPhone sales.

The most obvious obstacle to this strategy is the lack of NFC terminals at retailers. As a technology that is still relatively new to consumers, it would be difficult to convince retailers en masse to invest in NFC.

Richard Crone, who leads financial industry adviser Crone Consulting LLC, said:

The company [Apple] is considering heavily subsidizing the terminal, or even giving it away to retailers, to encourage fast, nationwide adoption of NFC technology and rev up sales of NFC-enabled iPhones and iPads.

I am confident that Jobs will not allow NFC to be branded as the killer feature of the iPhone unless it is ready for primetime.

Apple’s CFO, Peter Oppenheimer, may have tipped Apple’s hand in this are on Apple’s most recent conference call.

During the September and December quarters, we executed long-term supply agreements with three vendors through which we expect to spend a total of approximately $3.9 billion in inventory component prepayments and capital expenditures over a two-year period. We made approximately $650 million in payments under these agreements in the December quarter, and anticipate making $1.05 billion in payments in the March quarter.”

There has been speculation that this is related to battery, microprocessor, or storage technology; however, I believe that NFC is just as likely of a target. Tim Cook, COO, added in the Q&A that “these payments consist of prepayments and capital for process equipment and tooling” for something that Apple feels is “very strategic”. Out of all the numerous reasons to own Apple, I believe this is the single most overlooked factor by analysts.

Lastly, it is worth mentioning that this could potentially have a huge impact on numerous other companies outside of Apple, Google, and Microsoft (MSFT). The major credit/debit card companies; American Express (AXP), Bank of America (BAC), Discover (DFS), Mastercard (MA), Visa (V), all stand to be impacted depending on the strategy that Apple chooses.

In addition to these financial companies, I think the biggest winners could be the companies that manufacture the NFC terminals (I am not an expert in those companies so I suggest further research). It is always exciting and risky investing in companies associated with innovative technologies, but Apple has proved time after time after time after time that it has the capabilities to succeed. In closing, I believe that NFC technology will be a game changer and strong marketing point just like how Facetime was. Apple doesn’t always bring the future first, but they bring it the best.

Other Sources:

http://www.engadget.com/2011/01/28/apple-job-posts-point-to-built-in-nfc-capabilities-for-ipad-ip/

http://jobs.apple.com/index.ajs?BID=1&method=mExternal.showJob&RID=71094&CurrentPage=3

http://jobs.apple.com/index.ajs?BID=1&method=mExternal.showJob&RID=71111&CurrentPage=3

Disclosure: Author holds a long position in GOOG. Author plans to purchase AAPL and write covered calls.

Source: Why 'Wave and Pay' May Catapult the iPhone Over Android