The Evolution of Mobile Payments

The primary rationale for mobile payments is to make it possible for mobile phone companies to provide paid services above and beyond simple voice transmission. Without paid services, the wireless carriers would have no way to recoup their investments in high-speed data transmission, which makes it possible to play games, view pictures, and exchange other types of multimedia in a way that was not possible with the first generation of digital mobile phones.

However, it is not clear exactly how mobile payments will be used. At present, there are two basic models:

* Virtual. Mobile payments where the two parties are at different locations and the wireless device is used to communicate information about the goods or services being transacted, in addition to serving as the payment instrument.

* Point of Sale (POS). Mobile payments where the two parties are at the same location and the mobile device is used only as a payment instrument, not to communicate information about the goods or services being transacted.

For example, if someone uses a wireless phone to order and pay for a traffic report, the payment is considered virtual because the company providing the traffic report is distant from the person receiving it. On the other hand, if someone uses a wireless phone to buy a soda from a vending machine, that is considered a POS mobile payment because the vending machine and the consumer are at the same location.

How Mobile Payments Will Evolve

At present, the POS model of mobile payments has not had much success, because it is essentially a substitute for a credit or debit card; the user does not gain access to any new services as a result of using it. Mobil Speedpass is the most successful type of POS mobile payment today, with more than six million users, but acts more as a loyalty device for Mobil than as a source of new revenue.

The virtual model is where most of the growth will be in the short term, because it solves an important problem for wireless carriers: how to charge for goods and services in a cost-effective way. It also takes advantage of the mobile device in a way that POS mobile payments do not, making it less of a substitute for payment cards. Since most mobile purchases today are in the $1-$5 range, it is both cumbersome and expensive to require users to enter a card number and expiration date using their keypad. Companies such as iPIN, Qpass and Encorus are providing wireless carriers with mobile payment systems that manage user authentication, payment authorization, and allocation of the proceeds between the carrier and the merchant.

As mobile payments become more common, we believe that they will be used for a wider array of applications, culminating in POS payments, according to the progression shown in Figure A:

Figure A. Stages of Mobile Payment Evolution.

Source: Financial Insights, 2004

The earliest mobile payments were simple flat-rate bundles, such as $12 per month for up to 2 megabytes of data. More sophisticated systems being introduced now can individually price items such as ringtones and games, increasing the incentive for sellers to provide quality content in an effort to maximize revenues. According to Financial Insights survey data, in the first quarter of 2003 27.8% of American consumers used their mobile phone to make a payment. Mobile payments are still being used primarily by the young; 34.0% of households with children had made a payment with a mobile phone, versus only 23.8% of households without children.

Mobile payments will expand more quickly once location-based services such as traffic reports and driving directions are available that are clearly superior to substitutes in the wired world. Only when mobile payments are widely used will brick-and-mortar merchants see opportunity in supporting them for POS payments.

Understanding how mobile payments will change over time is crucial to selecting partnership opportunities that will pay off within a reasonable period. For now, the main applications are services that appeal to young people, such as ringtones, games, and short messaging service (SMS).

Aaron McPherson is a research manager at Financial Insights specializing in the strategic implications of new technology for the retail payments industry.