Opinion & Analysis: Could NFC Payments Be DOA?

George Peabody

From financial institutions to card networks to mobile carriers, a fixation on payments has dimmed the once-bright prospects for near-field communication technology.

Wences Casares, founder of Bling Nation and Lemon.com, once said of near-field communication, “NFC is a great technology. But it was abducted by payments, and hasn’t been heard from since.” He was right. If the current trajectory remains unchanged, this hostage technology may perish in captivity.

NFC faces a closing window of opportunity as a payment vehicle in the United States. Among the unfortunate consequences of that loss will be another round of payment-method incompatibilities between the U.S. and the rest of the world as Europe, Canada, and other markets appear increasingly likely to deploy NFC payments.

It would also be a lost opportunity for mobile operators attempting to generate revenue from their NFC investments.

The dimming prospects for NFC payments are due to several significant barriers. Here’s a rundown:

– An Ecosystem Build. Hardware components require an ecosystem to thrive. A wide variety of software that exploits the hardware’s capabilities is required because ubiquity matters. While NFC capability is becoming available, we are years away from an NFC-payments ecosystem.

– No Cool Factor This Time. Past and present contactless boosters—from card networks to mobile network operators—have hoped the “cool factor” of a contactless payment via card or phone would give accountholders reason to tap and go. Not so much. Ever since the iPhone was launched and app stores proliferated, “cool” has been forever redefined. The card networks’ no-signature requirement for lower-value transactions, now under $50, blew up any meaningful differentiation between the tap and the swipe.

– Proliferating Alternatives. More important, the number of viable, smart-phone-based alternatives to NFC continues to rise. Over the next three to five years, transaction-origination methods will continue to proliferate, and consumers will adopt them based on convenience and value.

– QR Codes Don’t Suck. Quick Response codes are gaining traction. The Merchant Customer Exchange (MCX) network being built by a consortium of major merchants is expected to make use of the technology for its mobile-payment method. It would not be surprising to see a QR-code scheme for transaction origination connected to an MCX closed-loop card or an eventual linkage to a customer’s bank account, in the manner of a provider like Paydiant. Yes, image scanners add cost, but image scanners can do more than take payments and that use can remain under merchant control. Depending upon the implementation, they may not even be necessary.

– Geo-fencing And the Customer Experience. Blessed by Starbucks, geo-fenced approaches like Square Wallet have appeal for reasons that go beyond payments. Merchants care about sales over payment cost. The complete experience, from the barista’s smile to the receipt on the phone and the updated rewards-point tally, affects sales volume far more than the narrowing distinction between a tap and a swipe.

– Digital Wallets Proliferate. Cloud-based digital wallets from PayPal Inc., Google Inc., Visa Inc., and scores of smaller firms confer valuable flexibility at a time when that attribute is especially desirable. While NFC sorts itself out, the cloud-based approach allows the wallet provider to gain traction in e-commerce and mobile transactions and to work with merchants and financial institutions. The proliferation of cloud-based wallets connected to merchant- and financial-institution-specific apps will continue to put pressure on the NFC proposition.

– Cards Really Matter. Cards will be with us for at least another decade if not two. Their longevity argues for their continued success. Even Millennials recognize that a backup for a smart phone’s dead battery or, worse, a lost phone, is necessary. While cards will no longer be the hugely dominant source of transaction origination, they’ll be needed for a very long time.

Finally, it is worthwhile recalling that NFC’s roots as a payments mechanism stem from the need for strong cardholder-present verification as well as an increased dynamic-data component in the authentication process. The lowly contactless card already achieves much of that function.

Today’s smart phones also generate a flood of device-specific signals that, when combined with big-data-sourced behavioral analytics, may produce fine-grained risk scores. This at a time when payments-fraud rates are low and risk models are strong. Competitive approaches abound.

Merchant risk is another story, but even that is undergoing change as services like Visa’s Consumer Authentication Service mitigate card-not-present risk. The card-present security imperative is losing urgency as cloud and other device-based approaches subsume portions of the NFC payments security role.

The Fourth Wave

Given these conditions, a probabilistic forecast for widespread NFC-based payments that examines a low-to-high range of outcomes for each of three scenarios is sobering. While NFC forecasts have been missed time and again (Apple Inc.’s decision to skip NFC last year blew up a number of them), an examination of just three variables—NFC-enabled handset availability, NFC wallet card-activation rates, and merchant NFC acceptance—suggests that, even in the best case, NFC-based transactions will be under 12% of volume by the end of 2017 (table).

Optimistically, that number could leap to 51% in the 2018-2020 timeframe, but a pessimistic forecast for the same period reaches only 13%.

These numbers alone suggest that the prospects for an NFC-payments pure play such as Google Wallet 1.0 or the wireless carriers’ Isis venture are unpromising. The carriers’ hard focus on NFC payments is based on the increasingly shaky assumptions that NFC’s contactless gesture will become the dominant way to pay, that there are available margins in the payments industry, and that merchants—the ones that pay the costs under the Isis model—are eager to add mobile operators to the payment-industry cost structure.

Over the last three decades, waves of capital-hungry technologies have swept through the mobile industry. To use telecommunications expert Chetan Sharma’s taxonomy, voice was the first wave, SMS text the second wave, and mobile broadband data is the third. Times have been very good for this industry, but margin pressure is increasing because, as an AT&T Mobility executive put it, “Voice and SMS are cheap. Bits are expensive.”

Sharma’s Fourth Wave is, as he sees it, the mobile network operators’ best answer for margin relief. It’s also, in his view, the way to avoid becoming what every telecommunications company fears most: a dumb-pipe provider with utility-like margins.

The Fourth Wave is a mix of programmatically accessed horizontal services and specific industry applications. Geo-location and machine-to-machine networking are horizontal services. NFC payments is an industry-specific application.

These Fourth-Wave initiatives boil down to either an application programming interface (API) or a complete customer experience. Both require a far higher software component than the prior waves. While software reduces the high capital requirements of mobile infrastructure, it demands a degree of nimbleness that most mobile operators lack.

The Wrong Bucket

Today’s uncertain NFC payments prospects are due, in no small measure, to the fact that mobile operators have put NFC into the wrong bucket. NFC is neither an application nor a complete customer experience. It is a horizontal service initiated by the tap gesture. The NFC radio is just a short-range communications mechanism.

The NFC chipset’s real value, of course, lies in the secure element, which is hardware specifically designed to store encrypted credentials for payments, building access, health-care record access, and secure Web-site and network access, to name leading use cases.

Because the secure element holds the valuables—the consumer’s payment card numbers, an employee’s access ID, health-care identity—it’s valuable property for which its network-operator owners demand rents. As long as heavily subsidized handsets are a feature of the U.S. mobile market, the operators will consider themselves to be the owners of those devices.

NFC is not cheap. The operators want to be paid. Besides the cost of the chipset itself, the secure-element model requires credential provisioning and management functions provided by an increasingly complex trusted-services-manager scheme.

This approach may break under the weight of the operators’ reliance on payments to pay the freight for NFC infrastructure. Participation costs for issuers alone is a model breaker. With rumored annual rental fees for storage of a single payment card credential ranging between $2 and $5, issuers double what they annually spend on their plastic card issuance simply for the new form factor with few prospects for lift in transaction volume. Rental discount arrangements no doubt can drop the cost, but these secure- element rental rates blow up the current issuance model.

Let’s be clear. NFC is worth saving. The tap gesture is an elegant means of granting permission, making an acknowledgement, or initiating a transaction. And issuers, mobile network operators, financial institutions, and government agencies have a common interest in encouraging consumers and citizens to add the “tap” to their repertoire.

Marooned

But a reinvigoration of NFC’s prospects will require its gatekeepers to reimagine the technology’s role—if it’s not too late.

NFC, like SMS and broadband data, is a platform-level service. From a security-technology perspective, the secure element is a strong authentication tool for use in a wide range of identity-assurance scenarios. But the longer NFC is marooned on the payments island, the less likely its success.

A secure-element-based, multifactor authentication service could have broad applications and revenue potential. Estimates for such a service range between $1 billion and $8 billion by 2017, depending upon cost, the breadth of applications, and, critically, the number of credentials in use. Opt-in marketing permissions, secure access to Web sites, health-care records, government services, enterprise networks, and more are all revenue opportunities that should be enough for mobile operators to target.

While the prospects for NFC are challenging, the incumbent payments-acquiring industry should take no comfort. An overly complex supply chain that has mostly failed to deliver innovative services beyond payments, it is ripe for disruption. Just ask Square Inc.’s Jack Dorsey.

It is ironic that the mobile operators have ignored the lesson of the network effect that Fourth Wave competitors like Google and PayPal understand so well. The network effect is, after all, what made the telephone network so valuable.

NFC cannot achieve ubiquity based on payments alone. Should mobile operators redefine NFC’s mission as a service rather than as a niche application, open up the APIs, and lower costs, real money can be made and a valuable technology can be applied to real problems.

George Peabody is an independent payments industry consultant. He writes at paymentsinnovationroadtrip.blogspot.com and he can be reached at www.georgepeabody.com.

A Bewilderingly Complex Business

To add to the uncertainty surrounding the future of NFC in the United States, here’s a set of other relevant variables, both positive and negative:

Consumer Variables

Consumers choose to “tap” whenever possible

NFC incompatibilities and inconsistent experience do not frustrate consumers enough to reduce adoption rates

Consumers pay a monthly wallet fee

Merchant

Merchants are willing to add Isis and other mobile operator-based costs

The retailer-controlled Merchant Customer Exchange launches and takes mobile transaction volume away from NFC-based payments

Other, non-MCX, merchants adopt non-NFC mobile payment methods

NFC-adopting merchants integrate NFC payments with couponing and other services to create rich interactions, i.e. Google Wallet SingleTap

Issuers

Issuers are willing to work with Isis, Google, mobile operators

NFC account activation is streamlined through issuer integration into online banking and better provisioning flow by the operators

Issuers choose alternative NFC and contactless scheme to go around operator control of the secure element and its rental fees

Issuers choose to employ alternative transaction-origination methods such as QR codes, geofencing, and digital wallets

Mobile Network Operators

Isis is bankrolled sufficiently to fund national deployment and marketing

Degree of operator control over programmatic access and management of secure element

Operators broaden NFC usage, lower secure-element rental fees