The Evolution of Consumer Payments--The Future Merchant and the Rise of ISO 14443

The consumer payments industry is facing an important long-term shift, as electronic payments displace paper and the mix of electronic consumer payment volumes globally shifts further towards debit and away from credit. But from a user-value perspective, the basic consumer experience and means of transacting remain quite similar to those in use when credit cards first came of age a generation ago.

This is about to change, due to a third and final piece of the payments industry's ongoing evolution. For at the same time that electronic payment volumes increase, a vast number of new, mobile and other non-contact technologies are vying to displace cash and swipe-cards, either in general usage or within certain market segments. These technologies, including cellphones, contactless smart cards, and RFID fobs, have been pushing (with varying degrees of success) to gain penetration for several years.

And FSIs and merchants are seeking to build out relationships with users that provide better, more interactive loyalty and proactive marketing services that broaden and deepen consumer relationships. As a result, the future of payments will be tightly intertwined with the future of the retail merchant. In this scenario, a user could purchase tickets for a new movie via a mobile device, receive a confirmation code necessary to receive those tickets at the theatre, as well as a mobile alert coupon for 20% off the soundtrack. By logging in via a local-area wireless connection at the record store, the user could sample this and other albums, receiving points both for entering the store and ultimately purchasing the disk. The retail industry, like payments, is currently exploring these and other options.

Alternate retail payment systems, such as contactless systems like Speedpass in the U.S. and the transit/ retail payments CSC Oyster in London, are evidence of the growing nexus between the future of payments and the future of retail. They allow non-standard payment providers to gain better customer information, sop up existing excess processing capacity, and compete against the existing payments brands. Thus far, this potential has barely been tapped--TowerGroup predicts that the total mobile subscriberships worldwide will surpass the total number of cards issued by any of the major associations by the end of 2004. Yet it will take time to emerge--especially as many markets (including the U.S.) still view phones as voice devices, indicating that user habits will take several years to catch up both with the vision. And with contactless cards just beginning to make the shift from access/ transit to retail payments, FSIs must look carefully at what card changes make sense in evolving the consumer value proposition, and over what period of time.

How should FSIs respond, given the multiple demands, emerging services, and overall lack of standards? Bet on the future, but bet conservatively. Build out new solutions that are open, interoperable, add convenience and user speed, and which can support the introduction of value-added loyalty and affinity services as and when users demand them. And importantly, build on consumer habits, incrementally, with real additional value.

One example involves the deployment of solutions based on the ISO 14443 radio frequency standard. ISO 14443 is, at present, arguably the best and safest standard for the deployment of contactless retail payments at the point of sale. While early RF-based payment solutions relied on a variety of proprietary solutions--Speedpass, for example, was based on ultra-low-frequency 125Khz fobs and readers operating in a closed-loop environment. As a closed loop system, Speedpass helps drive loyalty to ExxonMobil (the firm attributes an average growth of 15% in gas purchases to it). And while limited deployment is occurring in other verticals, to expand the utility and affinity nature of Speedpass for ExxonMobil, looming interoperability issues and brand-protection concerns for ExxonMobil will ultimately limit the extent of this expansion.

The rise of ISO 14443 will help change that, and return the advantage to today's card associations and other consumer payments leaders, particularly in card-heavy, credit-centric markets like the U.S. Even in other markets, ISO 14443 allows card issues to leverage penetration of contactless transit cards, and to work with operators on carrier-branded cards and phone-based payments that can be converted to run on ISO 14443 chips, as those chips make it into phones.

What's more, contactless RF payments at the POS gained major support in 2002, when Visa, MasterCard and American Express all threw support behind RF-based contactless payments based on ISO 14443 for contactless payments. And now, all are in the midst of pilots proofing out ISO 14443 as a next-generation payments standard.

Though less sophisticated than the vision of a "personal trusted device," RF-based contact payments are emerging as a standards-based, cost-effective alternative with some big-name backing in the cards-heavy U.S. market. Their influence, and ability to leverage existing user habits, will be significant. Sealed, foolproof and virtually indestructible, such simple non-contact solutions are an important interim step in the future evolution of the payments market.

Mobile or contactless, what new value must FSIs consider with emerging payments? Carriers, beginning with digital content micropayments, are interested in enhanced revenues from such data services. For FSIs, enhancing revenues, relationships and market share while reducing cost of service is also an important driver in supporting payments services. And the ability of non-contact solutions to assist in this process rests on three factors.

(1) Convenience. Convenience involves provision of a more rapid, less constrained way to pay than via existing options. This can be measured by users in terms of speed, ubiquity of acceptance, and reduced hassle versus fumbling for a card or cash-in-pocket. For merchants, faster transactions mean greater transaction throughput, bolstering the bottom line. But convenience must be seen from the eyes of the merchant and end-user--the more difficult a solution is to use versus credit or cash, the greater other types of value must be to encourage adoption.

(2) Cost/ Security. For merchants and users, cash and paper are insecure, bulky and expensive. Storing, securing and processing cash can eat up between 4-10% of the total value of any given transaction, making seepage and the lack of a transaction record a primary driver in the move away from cash. In environments like quick-service restaurants (QSRs), where more than three out of every four payments is still cash, such seepage and anonymity can be extremely expensive. Like card payments, mobile and contactless solutions promise to change this, particularly in environments where cash usage remains high and the need for convenience is significant. If non-contact payments settle to a card account, and cost anywhere from 50-200 basis points on a transaction, the savings vs. cash is significant. The convenience and speed of non-contact payments will add an edge over cards, particularly as user volumes bring down costs of merchant hardware.

(3) Loyalty/ Affinity. The rollout of bar code based loyalty programs has been successful in some markets, like grocery. One recent survey concluded that 53% of polled consumers belonged to a grocery loyalty program, and 48% spent more as a result. Rather than just exchanging value for goods, this shift involves a multi-step process enhanced affinity and target marketing, and the penetration of mobile payments into new mobile-centric product streams and shopping environments. New and sophisticated proactive loyalty and marketing tools will help do this, and will help merchants and carriers better target the perceived needs of their customers.

ISO 14443 based contactless solutions will assist FSIs in leveraging existing user habits in card-centric markets, allowing incremental addition of value while accustoming users to non-standard payment tools. Where mobile data usage is highest, such as South Korea, the shift to full smart-device-based mobile payments is already occurring more quickly. There, all three major carriers are working on IR/ RF-based mobile payments, leveraging the early rise of contactless RF cards in transit and dual-interface contactless transit and swipe credit cards in recent years. In any event, partnerships with key network providers and technology vendors will be an essential part of the success of mobile payments, as will an understanding of the needs of end-users and merchant verticals.

Edward Kountz is a senior analyst, Emerging Technology Solutions, at TowerGroup.

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