Mobile Commerce: AAPL and GOOG Have Home Field Advantage

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April 15, 2015

Mobile Commerce: AAPL and GOOG Have Home Field Advantage

AAPL and GOOG have enormous advantages in the emerging phenomenon of mobile commerce. With platform control over mobile devices, they stand between consumers and the many companies looking to engage with them to influence and complete mobile transactions online and in stores. In this position, AAPL and GOOG can define their own solutions as defaults and make them superior in convenience and performance, while thwarting alternatives. Still, while the two may wield similar power, their approaches will be very different. AAPL will look to establish the iPhone to a role as the primary trusted credential for digital identity on-line and in the real world, further cementing the loyalty of its customers, allowing it to collect tolls on transactions, and promoting the extension of iOS to other devices in its users’ lives. In contrast, GOOG hopes to lever its extraordinary consumer reach and data analytic capability to facilitate connections between brands, merchants and consumers, accelerating the progress of m-commerce and sharing in the value that can be created. Both should be successful on their own terms, but the benefits will be more meaningful to GOOG. Forward thinking merchants that embrace mobile platforms as partners can prosper, but more insular retailers may struggle, as could independent payments solutions like PayPal.

  • Mobile is accelerating changes in consumer commerce. B-to-C commerce is a cycle of money, goods and information that plays through distribution, retail merchants, and payments on one side, and brands, media, and communications networks on the other. The ubiquity of mobile enhances the power of e-tail and digital advertising to pressure both sides of the cycle. Pragmatically, these players are assessing opportunities created by the rise of m-commerce, even as the long term implications for many profitable aspects of their historic business roles are obviously and unequivocally compromised.
  • Mobile platforms have the power. AAPL’s iOS and GOOG’s Android platforms exert enormous influence over the way that users interact with the emerging m-commerce cycle. At the least, the platforms encourage the use of favored services by setting them as defaults – improving the convenience of using them, enhancing their functionality and promoting efficiency and value creation around the cycle. More ominously, platforms can impede or outright block the commerce services that they do not like, thwart efforts to promote independent branding and demand fees from commerce cycle players looking to reach end users on their devices.
  • Digital ads still stop short of the sale. Digital offers advertisers targeting and tracking that is impossible with traditional media, but, thus far, have been unable to tie ad impressions all the way to confirmed sales, particularly when they are completed off line. Mobile commerce be a solution, if the platform owners are able to negotiate partnerships to benefit the necessary stakeholders in the chain. These include advertisers and merchants, but also payments players and mobile network operators (MNOs), all of whom can either facilitate or stymie m-commerce.
  • Merchants have purchase data but no reach. Retailers jealously guard their transaction data, but have very limited means to act upon it. This data is isolated – not linked to demographic, interest and behavior profiles – and outside the store, merchants have little communication with their customers. Merchant apps are a hard sell. Smartphone owners use just 26 apps per month, new apps are installed infrequently, and 80% of apps are used just once and abandoned. Starbucks, with its caffeine addicted users making daily visits, may have cracked the code, but no others have replicated the success, and most will need the cooperation of the platforms if they are to build meaningful m-commerce businesses.
  • M-payments are necessary but not sufficient to drive m-commerce. Mobile tech can substitute for traditional cards, but the solution offers little of real value to either consumer or merchant without broader changes to the overall commerce cycle. Merchants must see more customers making more purchases with lower transaction costs if they are to support m-payments. Consumers must see an easier, faster, more convenient and/or cheaper way to shop if they are to adopt and use m-payments. Achieving these conditions will require coordinated change around the commerce cycle.
  • AAPL acts as an agent for its users. AAPL has a closed system centered on the iPhone, delivering tightly integrated products that interwork to offer a superior user experience and closely managing the access to and from 3rd parties. It has few ambitions to disintermediate most of the functions of traditional commerce, but rather to force them to come through iOS to get to the customers, fronting 3rd party brands with its own and requiring beneficial terms. With Apple Pay, banks, networks and merchants are denied access to the coveted iPhone user base unless they agree to AAPL’s requirements – a 15bp fee from the banks, replacement of the network brand at acceptance, no 3rd party m-payments on the platform, and no change to merchant economics.
  • GOOG looks to orchestrate value. GOOG already plays a key role in the m-commerce cycle, not just as the owner of the largest platform, but also as the leader in digital advertising. From that position, it can lever its platform control, its consumer reach and influence, its profile data and analytic capabilities, and a growing competency in logistics to accelerate the speed and efficiency of the cycle as a whole, facilitating transactions in the process. It aspires to forge partnerships to improve data flows, match buyers to sellers, reduce friction, and thus, drive value. We expect that GOOG will soon announce its intentions in m-commerce, explicitly tying a comprehensive m-payments initiative to enhancements in its digital ad program, including tracking impressions to completed sales with merchant partners.
  • M-commerce problematic for non-platform players. GOOGs initiative to track ads to completion, if successful, would be unique, and a real advantage for it vs. digital ad competitors, like FB, which do not have platform leverage to offer retailers. AAPL and GOOG’s moves to integrate payments directly into their operating systems for on-line, in-app and in-store purchases, particularly if they gain lower “card present” fees, is an existential threat to independent m-payment solutions, such as PayPal, Square and others. AMZN, the alpha challenger to traditional retail, has established sufficient consumer reach and logistical advantage to prosper in m-commerce, although a comprehensive m-payments solution may be off of the table. Other e-tail and retail solutions will cope with the power of platforms – app store fees, difficulty generating app downloads and usage, default payments utilities, promotion of favored shopping partners, etc. Only those with large, loyal and high frequency user bases can prosper without explicit support from AAPL and/or GOOG. Of the two, GOOG is the more likely to offer it.

Come Into My Garden

Mobile commerce is coming. Consumers are buying from their smartphones – AMZN now sees 60% of its sales from mobile platforms. Product producers are rapidly shifting marketing dollars to mobile. Brick and mortar retailers, many already reeling from the loss of volume to online competitors, now cope with would-be customers comparison shopping and executing transactions with rivals, right from their own aisles, and are planning their responses. Payments players are preparing for a world where the smartphone replaces the credit card, not just online but in person. All of the stakeholders in the traditional business-to-consumer cycle have high hopes that they can grab a piece of the high ground.

Unfortunately for most of these would be mobile kings, this will be played out on smartphones – ubiquitous and essential to consumers, but entirely dependent on operating system platforms designed and controlled by AAPL and GOOG. Android and iOS will exert enormous influence over the way that their respective users interact with advertising, payments initiatives, retail loyalty programs, and other elements of the emerging m-commerce cycle. Even at their most benign, the platforms will integrate favored services as enormously advantaged defaults, automatically launching on cue with privileged ties to platform hardware and software functionality and to popular and powerful services on the web, all while charging 3rd parties fees for access to the app store. At their most aggressive, platforms can claim functionality as an exclusive right, hamstringing 3rd party apps, fronting their brands, or even banning rival services entirely.

In this context, AAPL and GOOG will set the terms for m-commerce, defining the experience and driving adoption. In this, the fundamental differences between the two companies will be glaringly apparent, yielding two very different ecosystem constructs that will coexist and compete for years to come. AAPL’s devotion to the primacy of the device and to a tightly curated user experience has it positioning itself as a gatekeeper to its closely guarded user base and its devices as indispensable keepers of secure, authentic identity, there whenever authorization is needed. Its users would gain the convenience of executing transactions and gaining admission by wearing a watch or waving a phone, and AAPL would profit by taking a toll from businesses wishing to reach its coveted users.

GOOG’s approach is very different. It wants to build a network of partnerships around the emerging m-commerce cycle, sharing the benefits of completing the chain of customer information from targeting to completed transaction, facilitating the construction of effective customer affiliation programs, and removing fees and friction from the process. From its end, it offers its control of the largest smartphone platform, its extraordinary consumer reach and engagement, its market leading profile data and analytic capabilities, and a growing competency in logistics.

Most would-be players in m-commerce have little chance of succeeding independently. Few merchants have cracked the code of successful loyalty programs, and on the smartphone will face the cold realities of all 3rd party apps – few are downloaded, most of those are abandoned, and only a couple of handfuls of non-default apps are regularly used. There is just one “Starbucks”, and most retailers lack the visit frequency, loyalty and IT capability to follow its lead. With AAPL and GOOG moving to integrate payments as an OS utility, and their significant influence over the behavior of their user bases, merchants, banks, card nets, media companies, mobile carriers, and anyone else with an imagined claim on m-commerce had best cooperate.

The Circle of Mobile Commerce

Business-to-consumer commerce is an age-old process built on the flow of information to consumers from product brands and retail merchants as to the virtues and availability of products, and the flow of money from consumers to merchants to brands as they visit stores and walk away with purchases. Modern economies evolved with businesses that served to stimulate and accelerate the cycle and to make it more efficient – e.g. wholesale distribution to streamline inventory, new media and ad agencies to reach more consumers with more effective messages, and credit cards to make the act of purchasing more convenient (Exhibit 1).

Exh 1: Business to Consumer Commerce Cycle

Roughly 20 years ago, the consumer internet began to emerge, bringing with it a new set of innovations to the B2C commerce cycle. Electronic media fronted and displaced much traditional media, changing the way that consumers discovered new products and researched potential purchases. E-tailers arose with nearly limitless choice, home sofa convenience and advantaged costs to attack category after category. Same day delivery options began to chip away at the timeliness advantaged that remained a brick-and-mortar advantage. Still, despite making painful inroads, e-commerce tops 25% of total purchasing in only a couple of categories, remaining below 10% for most categories (Exhibit 2).

Enter mobile devices. The rapid rise of smartphones extends the reach of online services from only at home to anywhere and anytime. This corresponds to a significant increase in the time spent online, as a combination of penetration, network performance, and improved device functionality pushed the smartphone into position as the primary conduit between consumers and the Internet. Smartphones are ubiquitous and essential to the daily lives of consumers, and, increasingly, a tool for commerce. Mobile commerce, or m-commerce, has the potential not just to make online spending more convenient, but to bridge the gap between classic desktop e-commerce and the brick-and-mortar stores that still make up 93% of purchases.

Exh 2: US E-Commerce Penetration by Category

Still, the initial wave of m-commerce functionality is a bit “meh”. Mobile payments are currently isolated to merely replacing the swipe of a card at a point of sale terminal – hardly game-changing, and if the majority of physical stores don’t support it, hardly convenient. Apple is eager to share the statistics on the number of credit cards that have been loaded to Apple Pay, but considerably less eager to share the meager number of users actively shopping with the service. Retail loyalty programs are legion, but very few shoppers have bothered to download the apps, much less to use them. Mobile advertising is hot, but brands are still buying on faith as no one is able to complete the circle from targeting, to impression, to confirmed sale.

We believe that the promise of m-commerce will only be realized as roles around the entire cycle evolve with explicit cooperation from step to step. Mobile payments need to enable innovation in retail stores and online. Loyalty programs need to reach outside the store to find new customers and influence them to visit and buy, both in person and online. Advertising needs to reach the right people, at the best possible moment, and to confirm that the messages are leading to actual sales. All of this needs to be done in ways that clearly improve the experience of shopping and buying for consumers.

It’s MY Platform

The smartphone is the unavoidable constant of mobile commerce. If consumers are to respond to YOUR advertising, to use YOUR credit card, or to shop in YOUR store, by definition, they will be using THEIR smartphone. By THEIR, we mean not just the individual consumer, but also, the company that controls the operating platform that determines the way that they use the smartphone. If outside companies aspire to reach customers via the smartphone, there is little choice but to play by the rules established by the platform.

Exh 3: iOS versus Android Apps and Features

These rules greatly favor the home team. The platform designates its own apps as defaults, shipped pre-installed in prominent position and invoked automatically as other apps require a particular function. The platform runs the store where users find new apps, charges fees to companies that distribute their apps there (30% of the app price, 30% of associated advertising revenue, and 30% of purchases made in app), and recommends favored apps amongst the millions of options in the store (Exhibit 3). Commerce players may be optimistic about the potential of their apps, but the odds are stacked against them. The average smartphone owner uses just 26 apps in any given month, many of those the default apps that were shipped with the device. In a month, just 35% of smartphone users will bother to download even a single new app. 80% of new apps are used just once, and then discarded. Even if a company gains a bit of traction with their app, they are still at the mercy of the platform owner, which may choose to ban a single app or an entire category of apps at their whim, bury third party brands behind their own services, and/or demand stiff terms from potential service partners. This is not a hospitable environment for companies to press their own hegemony.

Smartphones are a duopoly. 71% of Americans currently have smartphones. About 40% of those are Apple iPhones operating on the iOS platform, and another 55% are built on Google’s Android platform (Exhibit 4). Of the two, Apple is by far the more heavy handed, exercising complete control over every aspect of the integrated iPhone/iOS experience. Google, balancing the interests of its many OEMs, tolerates more 3rd party innovation, but, increasingly, steps in as its sees need to support its own broader ambitions. M-commerce is obviously such an area of need.

Exh 4: US Smartphone Installed Base and OS Share, Jun 2014 – Feb 2015

The Missing Link

Digital advertising offers significant advantages over traditional media – a topic about which we have written extensively (http://www.sector-sovereign.com/2015/03/march-12-2015-digital-advertising-the-7-habits-of-highly-effective-ad-platforms/). However, while digital ads can find ideal candidates, target those candidates with tailored messages, deliver the messages in timely and compelling formats, and track the online behavior of those consumers afterward, unless a sale is completed on the advertisers own web site, there is no way to know for sure that the ad worked. Since 93% of US retail purchases still occur in physical stores, this confirmation is an elusive and valuable quarry (Exhibit 5).

On the other side of the cycle, retailers certainly know what their customers are buying, and occasionally, they may even know who their customers actually are. However, loyalty program members make up less than 10% of total purchases at most retailers, and merchants often lack even basic demographic data on these customers, much less an authenticated identity that can be used to link to digital advertising and its effectiveness.

Exh 5: U.S. e-Commerce quarterly sales and share of all retail, Q1 2000- Q4 2014

Thus, neither advertiser nor retailer can complete the information loop. The only player in the cycle that can complete it is the platform. Every iPhone user is required to have an iTunes account, credit information on file, a demographic profile, and eventually, a biometrically verified identity. Google, which had been less fastidious in the past, has quickly moved to follow the Apple model. Here, if everyone cooperates, advertising deliveries to m-commerce users on one side can be matched to transactions that they complete on the other, creating value that can be shared all of the way around.

Not Everyone Can Be Starbucks

Each week, Starbucks 9 million mobile app users make more than 7 million transactions, accounting for more than 16% of all purchases (Exhibit 6-7). Target has not had Starbucks’ mobile success, but reports that more than 20% of its transaction volume is paid for with its loyalty club Red Cards, which offer members 5% savings on all purchases, and that joining the program stimulates members to increase their spending by 50%. These are the poster children for merchant loyalty programs, siren songs to the multitude of retailers that do not have successful programs of their own. For most of these merchants, the siren song is a pipe dream.

Exh 6: Starbucks Weekly Mobile App Transactions and Active Users, 4Q 12 – 4Q 14

Exh 7: US Internet Users who have downloaded select Coffee/Doughnut shop Apps

Exh 8: 2014 US Loyalty Program Memberships by Category

Exh 9: 2014 US Loyalty Program Memberships by Category

Getting sign ups is easy, getting usage is hard. Colloquy’s 2015 report on loyalty programs had good news and bad news for retailers – total US program memberships were up 25%, but active participation fell to 42% of those registered (Exhibit 8-9). The average household had memberships in 29 different programs – not just retail merchants but also services such as airlines, hotels, and credit cards – and were active in just 12 of them. This is for all memberships, most of which are of the traditional loyalty card variety. As noted earlier, smartphone users concentrate their app use, typically launching just 26 apps a month. They download relatively few new apps – in any given month nearly 2/3rds of smartphone users will not download even a single app. They readily abandon apps – 80% of all app downloads are used a single time and then abandoned (Exhibit 10).

Exh 10: Reasons Users Delete Mobile Apps

Most merchants don’t have the visit frequency of Starbucks or the transaction volume of Target. The average Starbucks customer visits a store 6 times per month and the top 20% of its customers visit nearly 4 times per week. Very few merchants can aspire to that level of customer engagement. Target generates $71B in annual sales, the 4th most amongst US retailers, and one of only 8 chains that generate as much as $50B. Merchants without as much volume might hesitate to offer the 5% discounts to loyalty program members that have been such a draw for Target customers (Exhibit 11).

Most loyalty payments are isolated, and can’t address customers outside of the store. Merchants rarely know much more about their best customers than their names, addresses, phone numbers and email addresses. Even then, the information is isolated – the phone number can’t be used to track location and the email address can’t be used to discern interests. Merchant’s know what a customer bought in their store on the occasions that they actually bought something, but they don’t register that a customer visited without buying anything, and they don’t have a clue of products that the customer may have eying for future purchase. The loyalty programs also don’t help merchants find new customers who may not have visited a store or were unwilling to take the time to fill out the forms and/or carry another wallet card. With these limits, retail merchants cannot close the loop on verifying the effectiveness of product advertising and the value of the POS data is modest.

Exh 11: Top 15 US Retailers, 2013

Most retailers don’t have top tier IT departments. Walmart, with FY15 sales of $485B and total CAPEX of $12.1, reputedly spent $1.5B on its e-commerce initiatives. Target, with sales of $73B and projected 2015 CAPEX of $2.1B, expects to devote half of that to its digital capabilities (Exhibit 12). However, this is the exception rather than the rule, and even the top spenders are far from the top of the heap in attracting IT talent or delivering real innovation, particularly compared to digital challengers like Google, Apple or Amazon. Smaller merchants, who still make up the very large majority of total retail sales, are far, far less capable than Walmart or Target. Even Target has struggled, revamping its Red Card program with a MasterCard imprint and chip-and-PIN authentication technology after suffering its widely publicized security breach. Fellow top 10 US retail chain Home Depot suffered a similar security failure.

Exh 12: Retailer investment in IT and e-commerce

Mobile Payments are a Utility, not an application

Today’s mobile payments options typically replace a credit card swipe with a smartphone wave. For consumers, this is of no real benefit. This reality is exacerbated by limited acceptance of mobile payments options – the much hyped Apple Pay is only available at 8% of card accepting US retail locations, and its users must ascertain acceptance before using it – a further inconvenience and a serious barrier to establishing habitual use. To that end, adoption and usage of Apple Pay has been modest. CEO Tim Cook reported that more than 1.1M credit cards were registered in the first 72 hours after introduction, but more than 5 months later, only 15% of iPhone 6 and 6 Plus buyers have actually tried to use it and only 6% report using it regularly (Exhibit 13). While the regular users report great satisfaction, those that tried and do not use the service see it as only slightly better than using a credit card. We also note anecdotal reports of technical failures at point of sale and of thieves loading stolen cards onto iPhones to execute fraud are birthing pains that must be resolved less they further lower enthusiasm for the service (Exhibit 14).

Exh 13: Apple Pay Adoption by Survey

Mobile payments will not be enough to drive consumer loyalty. Merchants will need to provide real benefits to their customers via sharp discounts, loyalty rewards, or by redefining the customer experience. Uber is an excellent example of the last point. It has integrated payment with booking, enabling its customers to summon cars from their smartphones and pay for them automatically, without settling with the driver at the end of the trip. Starbucks will add ordering to its popular app this year, speeding lines and even eventually obviating the need for point of sale interaction. Service redefinition is potentially powerful, but challenging, requiring bold creative management and top-tier IT capabilities, qualities that are rare.

Exh 14: Problems Encountered by Apple Pay Users at POS terminals

All of this may prove vexing to merchants, who are keen on using mobile payments as a mechanism to circumvent the 2-2.5% transaction fees leveed by the banks and card nets. To that end, a consortium of retailers called MCX, led by WalMart and including more than 70 other merchants, is introducing their own payment mechanism called Current-C (Exhibit 15). The idea is that MCX member companies will integrate the Current-C technology into their apps, and provide economic and service incentives for consumers to use it for their transactions. Unfortunately, Apple does not allow competitive wireless payment systems on the iPhone, so Current-C will use QR codes downloaded to user smartphones, brought up on a merchant-specific app and then scanned at the point of sale to complete mobile transactions. This will be cumbersome for consumers who will have to have the app on their phones, open it when prompted, and then present their phone to the register clerk. MCX may have more leeway on Android to support payment by NFC, but the solution would still require having and opening a merchant is app. Moreover, there is no guarantee that Apple won’t further restrict payment options on future iPhones.

Meanwhile, Apple and Google are moving to make their respective integrated payments utilities defaults for in-app and on-line transactions made from their platforms. On iOS, Apple will require that 3rd party apps include Apple Pay for purchases, and could ban alternative payment options entirely once a sufficient threshold of its user base is Apple Pay enabled. We also expect that the credit card networks will grant the biometrically authenticated and secure tokenized Apple Pay a “card present” (CP) equivalent rate tier, a substantial advantage vs. alternative online and mobile payment options which carry the much higher “card not present” (CNP) rates. Google is also likely to be able to tap into this advantaged rate tier as it follows Apple with a similarly secure revamp of its Google Wallet payments solution. Along with the Wallet app, it will also include an Android Pay API that will enable 3rd party apps to access the payments utility for authentication and token management in their own branded payments services, but at the least, we expect that Google will require registration for the Play store and include it as a default for transactions from its own apps – e.g. Search, Maps, etc.

Exh 15: Merchant Customer Exchange (MCX) Participating Merchants

All of this will be a difficult blow for PayPal, which remains the dominant brand in online payments and a meaningful participant in mobile. Using Apple Pay and Google Wallet as default payment utilities for electronic transactions on mobile devices may break down some consumer barriers for the adoption of POS m-commerce as well. It will also front the Visa, MasterCard and American Express acceptance brands, first for electronic transactions, and then for POS m-commerce. Apple is already distributing bold Apple Pay decals to merchants, asking them to affix them to POS terminals and display them in their windows. Google can be expected to do the same.

Google wants to direct the m-commerce orchestra

We expect Google to introduce a comprehensive vision for mobile commerce that combines a revamp of its advertising platform, an ad friendly MVNO, an integrated payments utility for Android, an extension of its merchant friendly ecommerce/delivery services, and a program for supporting retailer loyalty efforts that enables the confirmation of product sales for advertisers (Exhibit 16). With this, Google hopes to orchestrate a network of brands, retailers and others to accelerate the shift to mobile commerce and create value for all participants.

Exh 16: Selected Google Market Opportunities

The first step is likely to be an integration of Google’s various adverting platforms that further consolidates registration and logon to a single Google ID, that combines profile data across its sites to yield a more complete picture of user interests, and that offers campaign design tools that manage ad placement across all sites based on those profiles. This is necessary, as the previous policy separating Search data from YouTube data from Maps data, etc. was unnecessarily restrictive given consumer willingness to accept much more liberal data use on Facebook and other sites.

The second step may be Google’s planned virtual network, confirmed by Google Senior VP Sundar Pichai during his address to the Mobile World Congress exposition in March. While much of the talk around the MVNO has centered on how it may lower costs for consumers, recently leaked details suggests that it plans to use the details of its customers telephone call logs in its user profiles for advertisers. This information could be very valuable, particularly to merchant advertisers who could have phone numbers for their loyalty program members, giving Google further enticements for potential retail partners.

Pichai also revealed some details about the company’s m-payment plans, which are expected to be revealed in full at the company’s I/O developer conference in May. An important piece is a developer API, called Android Pay, that will allow 3rd parties to access user authentication and secure payment tokens from the platform. Essentially, a user would register funding mechanisms – e.g. credit cards, debit cards, ACH bank transfers, etc. – with Google, along with authentication credentials – e.g. fingerprints, passwords, etc. The 3rd party app would then be able to complete secure m-transactions under their own branding using these utilities. This is a good deal more liberal than Apple’s policy, and likely motivated by a wish to negotiate information sharing with these 3rd parties. Of course, Google will also offer its own branded Google Wallet, embedding it into its own applications, promoting it for online/in-app partners, and pushing it as a POS m-commerce acceptance standard.

Google has also been busy with e-commerce services for traditional retailers, helping them compete with Amazon with increasingly rich advertising options around product search ads, one-tap payment mechanisms, local delivery, and other services. We expect Google to consolidate its e-commerce capabilities into a more integrated, merchant-focused service, including an explicit program to help drive customer loyalty. Google can offer visibility into the interests and behavior of customers. It can offer a channel to communicate with customers inside or outside of the store, at opportune moments, and in response to particular behaviors. For example, a phone call to a store could trigger a map to the nearest location or a coupon for a recently researched item. The WSJ reports that it will soon allow advertisers to target consumers by their email addresses, a boon to merchants who may have this as one of the few identifiers in their loyalty programs. In the future, Google is likely to begin focusing on lower cost funding mechanisms, so that merchant payment fees can be reduced. In return, the merchant can help Google complete the circle for its advertisers by confirming product sales.

Exh 17: Business to Consumer Cycle: Google

This is the Google consumer vision (Exhibit 17). The hub in a network of information and sales transactions. Removing barriers and friction to make the cycle of m-commerce move faster and to attract more consumers, advertisers and merchants to it. Create value for everyone, but particularly for Google.

Apple knows best

Apple has built an extraordinary franchise on the basis of its innovative reimagining of the mobile device, its matchless integration of hardware and software functionality, its powerful design vocabulary, and its relentless attention to managing the ecosystem of companies that have looked to complement Apple’s products. Having established its symbiosis with its large, loyal and demographically desirable user base, Apple’s overarching strategy has been to expand its sphere of influence, extending the iPhone experience to other devices –e.g. Macs, iPads, Apple TV, and the Apple Watch – always keeping the iPhone as the hub of its users’ experience and establishing barriers for those 3rd parties looking to play in the walled garden (Exhibit 18).

Apple exerts control on these 3rd parties by restricting the terms of their customer access, by requiring 30% of all revenues generated within the walled garden, and by reserving the right to obviate 3rd party apps by integrating new functionality directly into the iOS platform. Thus are the circumstances around mobile commerce on the iOS platform. Apple has done a magnificent job of integrating secure user authentication and token management into its hardware and software, and used that to launch Apple Pay, a utility that the company expects to useful to its users. The other major participants in mobile commerce – advertisers, digital media, mobile networks, payments players, and retail merchants – are all viewed as 3rd parties looking for access to Apple’s customers on Apple’s platform. This will happen on Apple’s terms.

Exh 18: Apple Quarterly Sales by Segment, 1FQ 2011 – 1FQ 2015

Advertisers and digital media? If you are advertising on an iOS app, 30% of the spending needs to come Apple’s way and the app itself needs to closely vetted for compliance with app store standards before it can be released to users. Mobile networks? You need to pay Apple a $450 subsidy or you can’t sell the product, you are not allowed to put your own apps or logos on the phone, and you certainly aren’t due a piece of advertising or payments revenue. Payments networks and banks? Apple won’t make a peep about the fee structure to merchants, but we require 15bp on every transaction. By the way, once a card is loaded into our system, the user doesn’t need to see your brand again and we are going to try to front you at point of sale as well. Retailers? Apple doesn’t need your transaction data so rest assured you can keep you customer information private, but Apple doesn’t really have any helpful data to share with you either. Moreover, Apple is not going to help you lower your payment fees or give you much help reaching your loyalty program customers, but perhaps our customers will shop at your store if you prominently promote Apple Pay. The terms are tough, but the 3rd parties are taking them.

Exh 19: Business to Consumer Cycle: Apple

With the Touch ID fingerprint scanner seamlessly integrated into Apple Pay on the most recent iPhone models and the clever integration into the Apple Watch, the company has a 12-18 month lead on the Google ecosystem in its user experience. Ultimately, we believe Apple’s objectives in payments are part of a larger strategy around holding its users secure, authenticated identity and applying it toward a wider range of applications – not just payments, but credentials, licenses, tickets, authorizations, locks, or any interaction where a person’s identity must be affirmed (Exhibit 19). This ambition is interesting, but it does not suggest a broader interest in extending payments further into the commerce cycle. Certainly Apple’s move to exploit its early mover advantage on payments has been constrained by its unwillingness to orchestrate value for other parts of the commerce cycle, perhaps the major factor in the modest acceptance by US merchants, who don’t really see what’s in it for them.

Winners and Losers

M-commerce should be a big deal for Google, which can monetize it in many ways. It can attract more advertising and drive higher ad prices if it can begin to complete the circle and confirm transactions linked directly to ad engagement. It can gain additional business from retailers if it can add reach, engagement and rich interest data to their customer loyalty programs, and to help them identify new potential program members. It may be able to expand shopping ad business and establish its local deliver service in partnership with merchants. It may be able to lever its coming payments initiative into transaction fees or even consumer financial services, particularly as Apple Pay blazes the trail for consumer awareness, merchant adoption, and credit card fee sharing. All of this will strengthen the Android ecosystem, and in turn, the appeal of its integrated applications.

Apple will also be a winner, but perhaps less of one than Google, as its more closed vision of m-commerce does little to accelerate progress or add value to other participants in the cycle. Apple will certainly collect fees – that 15 bp from credit card issuing banks and the normal 30% toll for in-app purchases – but the effect of its strategy is to perpetuate the position of incumbent payments players and leave merchants to pursue their own strategies without real aid from Apple. Ultimately, the payoff for Apple will be if its leadership in device integrated payments can help to drive share gain in smartphones and in adoption of the Apple Watch. We see the opportunity but are skeptical that it will play out as quickly as the most bullish observers believe.

While we didn’t focus on Amazon in this research, the evolution of m-commerce will have a huge impact. On one hand, mobile somewhat circumvents Google’s Search dominance, as users are more prone to begin product research directly on Amazon’s App. Already, Amazon is seeing 60% of its orders from mobile devices, and arguably, its share of e-commerce on mobile is higher than it is on the desktop. The company’s focus on the logistics and delivery aspects of internet based commerce will be as valuable in mobile as they have proved in desktop. Still, Amazon must be concerned about Apple’s aggressive move to ban alternative mobile payment POS options and mandate the inclusion of Apple Pay for in-app purchases, and very concerned about the CP credit card fee advantage to be enjoyed by the integrated platform payment utilities. For the investable future, this is not a significant problem for Amazon, but certainly an area to watch.

The same issues noted above for Amazon will also be in play for other online merchants, such as the legacy EBay business. However, these developments are ominous for the soon to be independent PayPal. As online shopping moves increasingly to mobile platforms, the dramatic advantages of the integrated payment mechanisms looms large. The situation is dire on the iOS platform, but somewhat less so on Android, where the Android Pay APIs should allow PayPal to build a competitive alternative. Still, the first mover and scale advantages built over the years will be badly eroded and it is not clear that the company’s relative cost structure will allow it to be competitive with the platform based solutions.

SEE LAST PAGE OF THIS REPORT Paul Sagawa / Artur Pylak

FOR IMPORTANT DISCLOSURES 203.901.1633 /.1634

psagawa@ / apylak@ssrllc.com

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April 15, 2015

Mobile Commerce: AAPL and GOOG Have Home Field Advantage

AAPL and GOOG have enormous advantages in the emerging phenomenon of mobile commerce. With platform control over mobile devices, they stand between consumers and the many companies looking to engage with them to influence and complete mobile transactions online and in stores. In this position, AAPL and GOOG can define their own solutions as defaults and make them superior in convenience and performance, while thwarting alternatives. Still, while the two may wield similar power, their approaches will be very different. AAPL will look to establish the iPhone to a role as the primary trusted credential for digital identity on-line and in the real world, further cementing the loyalty of its customers, allowing it to collect tolls on transactions, and promoting the extension of iOS to other devices in its users’ lives. In contrast, GOOG hopes to lever its extraordinary consumer reach and data analytic capability to facilitate connections between brands, merchants and consumers, accelerating the progress of m-commerce and sharing in the value that can be created. Both should be successful on their own terms, but the benefits will be more meaningful to GOOG. Forward thinking merchants that embrace mobile platforms as partners can prosper, but more insular retailers may struggle, as could independent payments solutions like PayPal.

  • Mobile is accelerating changes in consumer commerce. B-to-C commerce is a cycle of money, goods and information that plays through distribution, retail merchants, and payments on one side, and brands, media, and communications networks on the other. The ubiquity of mobile enhances the power of e-tail and digital advertising to pressure both sides of the cycle. Pragmatically, these players are assessing opportunities created by the rise of m-commerce, even as the long term implications for many profitable aspects of their historic business roles are obviously and unequivocally compromised.
  • Mobile platforms have the power. AAPL’s iOS and GOOG’s Android platforms exert enormous influence over the way that users interact with the emerging m-commerce cycle. At the least, the platforms encourage the use of favored services by setting them as defaults – improving the convenience of using them, enhancing their functionality and promoting efficiency and value creation around the cycle. More ominously, platforms can impede or outright block the commerce services that they do not like, thwart efforts to promote independent branding and demand fees from commerce cycle players looking to reach end users on their devices.
  • Digital ads still stop short of the sale. Digital offers advertisers targeting and tracking that is impossible with traditional media, but, thus far, have been unable to tie ad impressions all the way to confirmed sales, particularly when they are completed off line. Mobile commerce be a solution, if the platform owners are able to negotiate partnerships to benefit the necessary stakeholders in the chain. These include advertisers and merchants, but also payments players and mobile network operators (MNOs), all of whom can either facilitate or stymie m-commerce.
  • Merchants have purchase data but no reach. Retailers jealously guard their transaction data, but have very limited means to act upon it. This data is isolated – not linked to demographic, interest and behavior profiles – and outside the store, merchants have little communication with their customers. Merchant apps are a hard sell. Smartphone owners use just 26 apps per month, new apps are installed infrequently, and 80% of apps are used just once and abandoned. Starbucks, with its caffeine addicted users making daily visits, may have cracked the code, but no others have replicated the success, and most will need the cooperation of the platforms if they are to build meaningful m-commerce businesses.
  • M-payments are necessary but not sufficient to drive m-commerce. Mobile tech can substitute for traditional cards, but the solution offers little of real value to either consumer or merchant without broader changes to the overall commerce cycle. Merchants must see more customers making more purchases with lower transaction costs if they are to support m-payments. Consumers must see an easier, faster, more convenient and/or cheaper way to shop if they are to adopt and use m-payments. Achieving these conditions will require coordinated change around the commerce cycle.
  • AAPL acts as an agent for its users. AAPL has a closed system centered on the iPhone, delivering tightly integrated products that interwork to offer a superior user experience and closely managing the access to and from 3rd parties. It has few ambitions to disintermediate most of the functions of traditional commerce, but rather to force them to come through iOS to get to the customers, fronting 3rd party brands with its own and requiring beneficial terms. With Apple Pay, banks, networks and merchants are denied access to the coveted iPhone user base unless they agree to AAPL’s requirements – a 15bp fee from the banks, replacement of the network brand at acceptance, no 3rd party m-payments on the platform, and no change to merchant economics.
  • GOOG looks to orchestrate value. GOOG already plays a key role in the m-commerce cycle, not just as the owner of the largest platform, but also as the leader in digital advertising. From that position, it can lever its platform control, its consumer reach and influence, its profile data and analytic capabilities, and a growing competency in logistics to accelerate the speed and efficiency of the cycle as a whole, facilitating transactions in the process. It aspires to forge partnerships to improve data flows, match buyers to sellers, reduce friction, and thus, drive value. We expect that GOOG will soon announce its intentions in m-commerce, explicitly tying a comprehensive m-payments initiative to enhancements in its digital ad program, including tracking impressions to completed sales with merchant partners.
  • M-commerce problematic for non-platform players. GOOGs initiative to track ads to completion, if successful, would be unique, and a real advantage for it vs. digital ad competitors, like FB, which do not have platform leverage to offer retailers. AAPL and GOOG’s moves to integrate payments directly into their operating systems for on-line, in-app and in-store purchases, particularly if they gain lower “card present” fees, is an existential threat to independent m-payment solutions, such as PayPal, Square and others. AMZN, the alpha challenger to traditional retail, has established sufficient consumer reach and logistical advantage to prosper in m-commerce, although a comprehensive m-payments solution may be off of the table. Other e-tail and retail solutions will cope with the power of platforms – app store fees, difficulty generating app downloads and usage, default payments utilities, promotion of favored shopping partners, etc. Only those with large, loyal and high frequency user bases can prosper without explicit support from AAPL and/or GOOG. Of the two, GOOG is the more likely to offer it.

Come Into My Garden

Mobile commerce is coming. Consumers are buying from their smartphones – AMZN now sees 60% of its sales from mobile platforms. Product producers are rapidly shifting marketing dollars to mobile. Brick and mortar retailers, many already reeling from the loss of volume to online competitors, now cope with would-be customers comparison shopping and executing transactions with rivals, right from their own aisles, and are planning their responses. Payments players are preparing for a world where the smartphone replaces the credit card, not just online but in person. All of the stakeholders in the traditional business-to-consumer cycle have high hopes that they can grab a piece of the high ground.

Unfortunately for most of these would be mobile kings, this will be played out on smartphones – ubiquitous and essential to consumers, but entirely dependent on operating system platforms designed and controlled by AAPL and GOOG. Android and iOS will exert enormous influence over the way that their respective users interact with advertising, payments initiatives, retail loyalty programs, and other elements of the emerging m-commerce cycle. Even at their most benign, the platforms will integrate favored services as enormously advantaged defaults, automatically launching on cue with privileged ties to platform hardware and software functionality and to popular and powerful services on the web, all while charging 3rd parties fees for access to the app store. At their most aggressive, platforms can claim functionality as an exclusive right, hamstringing 3rd party apps, fronting their brands, or even banning rival services entirely.

In this context, AAPL and GOOG will set the terms for m-commerce, defining the experience and driving adoption. In this, the fundamental differences between the two companies will be glaringly apparent, yielding two very different ecosystem constructs that will coexist and compete for years to come. AAPL’s devotion to the primacy of the device and to a tightly curated user experience has it positioning itself as a gatekeeper to its closely guarded user base and its devices as indispensable keepers of secure, authentic identity, there whenever authorization is needed. Its users would gain the convenience of executing transactions and gaining admission by wearing a watch or waving a phone, and AAPL would profit by taking a toll from businesses wishing to reach its coveted users.

GOOG’s approach is very different. It wants to build a network of partnerships around the emerging m-commerce cycle, sharing the benefits of completing the chain of customer information from targeting to completed transaction, facilitating the construction of effective customer affiliation programs, and removing fees and friction from the process. From its end, it offers its control of the largest smartphone platform, its extraordinary consumer reach and engagement, its market leading profile data and analytic capabilities, and a growing competency in logistics.

Most would-be players in m-commerce have little chance of succeeding independently. Few merchants have cracked the code of successful loyalty programs, and on the smartphone will face the cold realities of all 3rd party apps – few are downloaded, most of those are abandoned, and only a couple of handfuls of non-default apps are regularly used. There is just one “Starbucks”, and most retailers lack the visit frequency, loyalty and IT capability to follow its lead. With AAPL and GOOG moving to integrate payments as an OS utility, and their significant influence over the behavior of their user bases, merchants, banks, card nets, media companies, mobile carriers, and anyone else with an imagined claim on m-commerce had best cooperate.

The Circle of Mobile Commerce

Business-to-consumer commerce is an age-old process built on the flow of information to consumers from product brands and retail merchants as to the virtues and availability of products, and the flow of money from consumers to merchants to brands as they visit stores and walk away with purchases. Modern economies evolved with businesses that served to stimulate and accelerate the cycle and to make it more efficient – e.g. wholesale distribution to streamline inventory, new media and ad agencies to reach more consumers with more effective messages, and credit cards to make the act of purchasing more convenient (Exhibit 1).

Exh 1: Business to Consumer Commerce Cycle

Roughly 20 years ago, the consumer internet began to emerge, bringing with it a new set of innovations to the B2C commerce cycle. Electronic media fronted and displaced much traditional media, changing the way that consumers discovered new products and researched potential purchases. E-tailers arose with nearly limitless choice, home sofa convenience and advantaged costs to attack category after category. Same day delivery options began to chip away at the timeliness advantaged that remained a brick-and-mortar advantage. Still, despite making painful inroads, e-commerce tops 25% of total purchasing in only a couple of categories, remaining below 10% for most categories (Exhibit 2).

Enter mobile devices. The rapid rise of smartphones extends the reach of online services from only at home to anywhere and anytime. This corresponds to a significant increase in the time spent online, as a combination of penetration, network performance, and improved device functionality pushed the smartphone into position as the primary conduit between consumers and the Internet. Smartphones are ubiquitous and essential to the daily lives of consumers, and, increasingly, a tool for commerce. Mobile commerce, or m-commerce, has the potential not just to make online spending more convenient, but to bridge the gap between classic desktop e-commerce and the brick-and-mortar stores that still make up 93% of purchases.

Exh 2: US E-Commerce Penetration by Category

Still, the initial wave of m-commerce functionality is a bit “meh”. Mobile payments are currently isolated to merely replacing the swipe of a card at a point of sale terminal – hardly game-changing, and if the majority of physical stores don’t support it, hardly convenient. Apple is eager to share the statistics on the number of credit cards that have been loaded to Apple Pay, but considerably less eager to share the meager number of users actively shopping with the service. Retail loyalty programs are legion, but very few shoppers have bothered to download the apps, much less to use them. Mobile advertising is hot, but brands are still buying on faith as no one is able to complete the circle from targeting, to impression, to confirmed sale.

We believe that the promise of m-commerce will only be realized as roles around the entire cycle evolve with explicit cooperation from step to step. Mobile payments need to enable innovation in retail stores and online. Loyalty programs need to reach outside the store to find new customers and influence them to visit and buy, both in person and online. Advertising needs to reach the right people, at the best possible moment, and to confirm that the messages are leading to actual sales. All of this needs to be done in ways that clearly improve the experience of shopping and buying for consumers.

It’s MY Platform

The smartphone is the unavoidable constant of mobile commerce. If consumers are to respond to YOUR advertising, to use YOUR credit card, or to shop in YOUR store, by definition, they will be using THEIR smartphone. By THEIR, we mean not just the individual consumer, but also, the company that controls the operating platform that determines the way that they use the smartphone. If outside companies aspire to reach customers via the smartphone, there is little choice but to play by the rules established by the platform.

Exh 3: iOS versus Android Apps and Features

These rules greatly favor the home team. The platform designates its own apps as defaults, shipped pre-installed in prominent position and invoked automatically as other apps require a particular function. The platform runs the store where users find new apps, charges fees to companies that distribute their apps there (30% of the app price, 30% of associated advertising revenue, and 30% of purchases made in app), and recommends favored apps amongst the millions of options in the store (Exhibit 3). Commerce players may be optimistic about the potential of their apps, but the odds are stacked against them. The average smartphone owner uses just 26 apps in any given month, many of those the default apps that were shipped with the device. In a month, just 35% of smartphone users will bother to download even a single new app. 80% of new apps are used just once, and then discarded. Even if a company gains a bit of traction with their app, they are still at the mercy of the platform owner, which may choose to ban a single app or an entire category of apps at their whim, bury third party brands behind their own services, and/or demand stiff terms from potential service partners. This is not a hospitable environment for companies to press their own hegemony.

Smartphones are a duopoly. 71% of Americans currently have smartphones. About 40% of those are Apple iPhones operating on the iOS platform, and another 55% are built on Google’s Android platform (Exhibit 4). Of the two, Apple is by far the more heavy handed, exercising complete control over every aspect of the integrated iPhone/iOS experience. Google, balancing the interests of its many OEMs, tolerates more 3rd party innovation, but, increasingly, steps in as its sees need to support its own broader ambitions. M-commerce is obviously such an area of need.

Exh 4: US Smartphone Installed Base and OS Share, Jun 2014 – Feb 2015

The Missing Link

Digital advertising offers significant advantages over traditional media – a topic about which we have written extensively (http://www.sector-sovereign.com/2015/03/march-12-2015-digital-advertising-the-7-habits-of-highly-effective-ad-platforms/). However, while digital ads can find ideal candidates, target those candidates with tailored messages, deliver the messages in timely and compelling formats, and track the online behavior of those consumers afterward, unless a sale is completed on the advertisers own web site, there is no way to know for sure that the ad worked. Since 93% of US retail purchases still occur in physical stores, this confirmation is an elusive and valuable quarry (Exhibit 5).

On the other side of the cycle, retailers certainly know what their customers are buying, and occasionally, they may even know who their customers actually are. However, loyalty program members make up less than 10% of total purchases at most retailers, and merchants often lack even basic demographic data on these customers, much less an authenticated identity that can be used to link to digital advertising and its effectiveness.

Exh 5: U.S. e-Commerce quarterly sales and share of all retail, Q1 2000- Q4 2014

Thus, neither advertiser nor retailer can complete the information loop. The only player in the cycle that can complete it is the platform. Every iPhone user is required to have an iTunes account, credit information on file, a demographic profile, and eventually, a biometrically verified identity. Google, which had been less fastidious in the past, has quickly moved to follow the Apple model. Here, if everyone cooperates, advertising deliveries to m-commerce users on one side can be matched to transactions that they complete on the other, creating value that can be shared all of the way around.

Not Everyone Can Be Starbucks

Each week, Starbucks 9 million mobile app users make more than 7 million transactions, accounting for more than 16% of all purchases (Exhibit 6-7). Target has not had Starbucks’ mobile success, but reports that more than 20% of its transaction volume is paid for with its loyalty club Red Cards, which offer members 5% savings on all purchases, and that joining the program stimulates members to increase their spending by 50%. These are the poster children for merchant loyalty programs, siren songs to the multitude of retailers that do not have successful programs of their own. For most of these merchants, the siren song is a pipe dream.

Exh 6: Starbucks Weekly Mobile App Transactions and Active Users, 4Q 12 – 4Q 14

Exh 7: US Internet Users who have downloaded select Coffee/Doughnut shop Apps

Exh 8: 2014 US Loyalty Program Memberships by Category

Exh 9: 2014 US Loyalty Program Memberships by Category

Getting sign ups is easy, getting usage is hard. Colloquy’s 2015 report on loyalty programs had good news and bad news for retailers – total US program memberships were up 25%, but active participation fell to 42% of those registered (Exhibit 8-9). The average household had memberships in 29 different programs – not just retail merchants but also services such as airlines, hotels, and credit cards – and were active in just 12 of them. This is for all memberships, most of which are of the traditional loyalty card variety. As noted earlier, smartphone users concentrate their app use, typically launching just 26 apps a month. They download relatively few new apps – in any given month nearly 2/3rds of smartphone users will not download even a single app. They readily abandon apps – 80% of all app downloads are used a single time and then abandoned (Exhibit 10).

Exh 10: Reasons Users Delete Mobile Apps

Most merchants don’t have the visit frequency of Starbucks or the transaction volume of Target. The average Starbucks customer visits a store 6 times per month and the top 20% of its customers visit nearly 4 times per week. Very few merchants can aspire to that level of customer engagement. Target generates $71B in annual sales, the 4th most amongst US retailers, and one of only 8 chains that generate as much as $50B. Merchants without as much volume might hesitate to offer the 5% discounts to loyalty program members that have been such a draw for Target customers (Exhibit 11).

Most loyalty payments are isolated, and can’t address customers outside of the store. Merchants rarely know much more about their best customers than their names, addresses, phone numbers and email addresses. Even then, the information is isolated – the phone number can’t be used to track location and the email address can’t be used to discern interests. Merchant’s know what a customer bought in their store on the occasions that they actually bought something, but they don’t register that a customer visited without buying anything, and they don’t have a clue of products that the customer may have eying for future purchase. The loyalty programs also don’t help merchants find new customers who may not have visited a store or were unwilling to take the time to fill out the forms and/or carry another wallet card. With these limits, retail merchants cannot close the loop on verifying the effectiveness of product advertising and the value of the POS data is modest.

Exh 11: Top 15 US Retailers, 2013

Most retailers don’t have top tier IT departments. Walmart, with FY15 sales of $485B and total CAPEX of $12.1, reputedly spent $1.5B on its e-commerce initiatives. Target, with sales of $73B and projected 2015 CAPEX of $2.1B, expects to devote half of that to its digital capabilities (Exhibit 12). However, this is the exception rather than the rule, and even the top spenders are far from the top of the heap in attracting IT talent or delivering real innovation, particularly compared to digital challengers like Google, Apple or Amazon. Smaller merchants, who still make up the very large majority of total retail sales, are far, far less capable than Walmart or Target. Even Target has struggled, revamping its Red Card program with a MasterCard imprint and chip-and-PIN authentication technology after suffering its widely publicized security breach. Fellow top 10 US retail chain Home Depot suffered a similar security failure.

Exh 12: Retailer investment in IT and e-commerce

Mobile Payments are a Utility, not an application

Today’s mobile payments options typically replace a credit card swipe with a smartphone wave. For consumers, this is of no real benefit. This reality is exacerbated by limited acceptance of mobile payments options – the much hyped Apple Pay is only available at 8% of card accepting US retail locations, and its users must ascertain acceptance before using it – a further inconvenience and a serious barrier to establishing habitual use. To that end, adoption and usage of Apple Pay has been modest. CEO Tim Cook reported that more than 1.1M credit cards were registered in the first 72 hours after introduction, but more than 5 months later, only 15% of iPhone 6 and 6 Plus buyers have actually tried to use it and only 6% report using it regularly (Exhibit 13). While the regular users report great satisfaction, those that tried and do not use the service see it as only slightly better than using a credit card. We also note anecdotal reports of technical failures at point of sale and of thieves loading stolen cards onto iPhones to execute fraud are birthing pains that must be resolved less they further lower enthusiasm for the service (Exhibit 14).

Exh 13: Apple Pay Adoption by Survey

Mobile payments will not be enough to drive consumer loyalty. Merchants will need to provide real benefits to their customers via sharp discounts, loyalty rewards, or by redefining the customer experience. Uber is an excellent example of the last point. It has integrated payment with booking, enabling its customers to summon cars from their smartphones and pay for them automatically, without settling with the driver at the end of the trip. Starbucks will add ordering to its popular app this year, speeding lines and even eventually obviating the need for point of sale interaction. Service redefinition is potentially powerful, but challenging, requiring bold creative management and top-tier IT capabilities, qualities that are rare.

Exh 14: Problems Encountered by Apple Pay Users at POS terminals

All of this may prove vexing to merchants, who are keen on using mobile payments as a mechanism to circumvent the 2-2.5% transaction fees leveed by the banks and card nets. To that end, a consortium of retailers called MCX, led by WalMart and including more than 70 other merchants, is introducing their own payment mechanism called Current-C (Exhibit 15). The idea is that MCX member companies will integrate the Current-C technology into their apps, and provide economic and service incentives for consumers to use it for their transactions. Unfortunately, Apple does not allow competitive wireless payment systems on the iPhone, so Current-C will use QR codes downloaded to user smartphones, brought up on a merchant-specific app and then scanned at the point of sale to complete mobile transactions. This will be cumbersome for consumers who will have to have the app on their phones, open it when prompted, and then present their phone to the register clerk. MCX may have more leeway on Android to support payment by NFC, but the solution would still require having and opening a merchant is app. Moreover, there is no guarantee that Apple won’t further restrict payment options on future iPhones.

Meanwhile, Apple and Google are moving to make their respective integrated payments utilities defaults for in-app and on-line transactions made from their platforms. On iOS, Apple will require that 3rd party apps include Apple Pay for purchases, and could ban alternative payment options entirely once a sufficient threshold of its user base is Apple Pay enabled. We also expect that the credit card networks will grant the biometrically authenticated and secure tokenized Apple Pay a “card present” (CP) equivalent rate tier, a substantial advantage vs. alternative online and mobile payment options which carry the much higher “card not present” (CNP) rates. Google is also likely to be able to tap into this advantaged rate tier as it follows Apple with a similarly secure revamp of its Google Wallet payments solution. Along with the Wallet app, it will also include an Android Pay API that will enable 3rd party apps to access the payments utility for authentication and token management in their own branded payments services, but at the least, we expect that Google will require registration for the Play store and include it as a default for transactions from its own apps – e.g. Search, Maps, etc.

Exh 15: Merchant Customer Exchange (MCX) Participating Merchants

All of this will be a difficult blow for PayPal, which remains the dominant brand in online payments and a meaningful participant in mobile. Using Apple Pay and Google Wallet as default payment utilities for electronic transactions on mobile devices may break down some consumer barriers for the adoption of POS m-commerce as well. It will also front the Visa, MasterCard and American Express acceptance brands, first for electronic transactions, and then for POS m-commerce. Apple is already distributing bold Apple Pay decals to merchants, asking them to affix them to POS terminals and display them in their windows. Google can be expected to do the same.

Google wants to direct the m-commerce orchestra

We expect Google to introduce a comprehensive vision for mobile commerce that combines a revamp of its advertising platform, an ad friendly MVNO, an integrated payments utility for Android, an extension of its merchant friendly ecommerce/delivery services, and a program for supporting retailer loyalty efforts that enables the confirmation of product sales for advertisers (Exhibit 16). With this, Google hopes to orchestrate a network of brands, retailers and others to accelerate the shift to mobile commerce and create value for all participants.

Exh 16: Selected Google Market Opportunities

The first step is likely to be an integration of Google’s various adverting platforms that further consolidates registration and logon to a single Google ID, that combines profile data across its sites to yield a more complete picture of user interests, and that offers campaign design tools that manage ad placement across all sites based on those profiles. This is necessary, as the previous policy separating Search data from YouTube data from Maps data, etc. was unnecessarily restrictive given consumer willingness to accept much more liberal data use on Facebook and other sites.

The second step may be Google’s planned virtual network, confirmed by Google Senior VP Sundar Pichai during his address to the Mobile World Congress exposition in March. While much of the talk around the MVNO has centered on how it may lower costs for consumers, recently leaked details suggests that it plans to use the details of its customers telephone call logs in its user profiles for advertisers. This information could be very valuable, particularly to merchant advertisers who could have phone numbers for their loyalty program members, giving Google further enticements for potential retail partners.

Pichai also revealed some details about the company’s m-payment plans, which are expected to be revealed in full at the company’s I/O developer conference in May. An important piece is a developer API, called Android Pay, that will allow 3rd parties to access user authentication and secure payment tokens from the platform. Essentially, a user would register funding mechanisms – e.g. credit cards, debit cards, ACH bank transfers, etc. – with Google, along with authentication credentials – e.g. fingerprints, passwords, etc. The 3rd party app would then be able to complete secure m-transactions under their own branding using these utilities. This is a good deal more liberal than Apple’s policy, and likely motivated by a wish to negotiate information sharing with these 3rd parties. Of course, Google will also offer its own branded Google Wallet, embedding it into its own applications, promoting it for online/in-app partners, and pushing it as a POS m-commerce acceptance standard.

Google has also been busy with e-commerce services for traditional retailers, helping them compete with Amazon with increasingly rich advertising options around product search ads, one-tap payment mechanisms, local delivery, and other services. We expect Google to consolidate its e-commerce capabilities into a more integrated, merchant-focused service, including an explicit program to help drive customer loyalty. Google can offer visibility into the interests and behavior of customers. It can offer a channel to communicate with customers inside or outside of the store, at opportune moments, and in response to particular behaviors. For example, a phone call to a store could trigger a map to the nearest location or a coupon for a recently researched item. The WSJ reports that it will soon allow advertisers to target consumers by their email addresses, a boon to merchants who may have this as one of the few identifiers in their loyalty programs. In the future, Google is likely to begin focusing on lower cost funding mechanisms, so that merchant payment fees can be reduced. In return, the merchant can help Google complete the circle for its advertisers by confirming product sales.

Exh 17: Business to Consumer Cycle: Google

This is the Google consumer vision (Exhibit 17). The hub in a network of information and sales transactions. Removing barriers and friction to make the cycle of m-commerce move faster and to attract more consumers, advertisers and merchants to it. Create value for everyone, but particularly for Google.

Apple knows best

Apple has built an extraordinary franchise on the basis of its innovative reimagining of the mobile device, its matchless integration of hardware and software functionality, its powerful design vocabulary, and its relentless attention to managing the ecosystem of companies that have looked to complement Apple’s products. Having established its symbiosis with its large, loyal and demographically desirable user base, Apple’s overarching strategy has been to expand its sphere of influence, extending the iPhone experience to other devices –e.g. Macs, iPads, Apple TV, and the Apple Watch – always keeping the iPhone as the hub of its users’ experience and establishing barriers for those 3rd parties looking to play in the walled garden (Exhibit 18).

Apple exerts control on these 3rd parties by restricting the terms of their customer access, by requiring 30% of all revenues generated within the walled garden, and by reserving the right to obviate 3rd party apps by integrating new functionality directly into the iOS platform. Thus are the circumstances around mobile commerce on the iOS platform. Apple has done a magnificent job of integrating secure user authentication and token management into its hardware and software, and used that to launch Apple Pay, a utility that the company expects to useful to its users. The other major participants in mobile commerce – advertisers, digital media, mobile networks, payments players, and retail merchants – are all viewed as 3rd parties looking for access to Apple’s customers on Apple’s platform. This will happen on Apple’s terms.

Exh 18: Apple Quarterly Sales by Segment, 1FQ 2011 – 1FQ 2015

Advertisers and digital media? If you are advertising on an iOS app, 30% of the spending needs to come Apple’s way and the app itself needs to closely vetted for compliance with app store standards before it can be released to users. Mobile networks? You need to pay Apple a $450 subsidy or you can’t sell the product, you are not allowed to put your own apps or logos on the phone, and you certainly aren’t due a piece of advertising or payments revenue. Payments networks and banks? Apple won’t make a peep about the fee structure to merchants, but we require 15bp on every transaction. By the way, once a card is loaded into our system, the user doesn’t need to see your brand again and we are going to try to front you at point of sale as well. Retailers? Apple doesn’t need your transaction data so rest assured you can keep you customer information private, but Apple doesn’t really have any helpful data to share with you either. Moreover, Apple is not going to help you lower your payment fees or give you much help reaching your loyalty program customers, but perhaps our customers will shop at your store if you prominently promote Apple Pay. The terms are tough, but the 3rd parties are taking them.

Exh 19: Business to Consumer Cycle: Apple

With the Touch ID fingerprint scanner seamlessly integrated into Apple Pay on the most recent iPhone models and the clever integration into the Apple Watch, the company has a 12-18 month lead on the Google ecosystem in its user experience. Ultimately, we believe Apple’s objectives in payments are part of a larger strategy around holding its users secure, authenticated identity and applying it toward a wider range of applications – not just payments, but credentials, licenses, tickets, authorizations, locks, or any interaction where a person’s identity must be affirmed (Exhibit 19). This ambition is interesting, but it does not suggest a broader interest in extending payments further into the commerce cycle. Certainly Apple’s move to exploit its early mover advantage on payments has been constrained by its unwillingness to orchestrate value for other parts of the commerce cycle, perhaps the major factor in the modest acceptance by US merchants, who don’t really see what’s in it for them.

Winners and Losers

M-commerce should be a big deal for Google, which can monetize it in many ways. It can attract more advertising and drive higher ad prices if it can begin to complete the circle and confirm transactions linked directly to ad engagement. It can gain additional business from retailers if it can add reach, engagement and rich interest data to their customer loyalty programs, and to help them identify new potential program members. It may be able to expand shopping ad business and establish its local deliver service in partnership with merchants. It may be able to lever its coming payments initiative into transaction fees or even consumer financial services, particularly as Apple Pay blazes the trail for consumer awareness, merchant adoption, and credit card fee sharing. All of this will strengthen the Android ecosystem, and in turn, the appeal of its integrated applications.

Apple will also be a winner, but perhaps less of one than Google, as its more closed vision of m-commerce does little to accelerate progress or add value to other participants in the cycle. Apple will certainly collect fees – that 15 bp from credit card issuing banks and the normal 30% toll for in-app purchases – but the effect of its strategy is to perpetuate the position of incumbent payments players and leave merchants to pursue their own strategies without real aid from Apple. Ultimately, the payoff for Apple will be if its leadership in device integrated payments can help to drive share gain in smartphones and in adoption of the Apple Watch. We see the opportunity but are skeptical that it will play out as quickly as the most bullish observers believe.

While we didn’t focus on Amazon in this research, the evolution of m-commerce will have a huge impact. On one hand, mobile somewhat circumvents Google’s Search dominance, as users are more prone to begin product research directly on Amazon’s App. Already, Amazon is seeing 60% of its orders from mobile devices, and arguably, its share of e-commerce on mobile is higher than it is on the desktop. The company’s focus on the logistics and delivery aspects of internet based commerce will be as valuable in mobile as they have proved in desktop. Still, Amazon must be concerned about Apple’s aggressive move to ban alternative mobile payment POS options and mandate the inclusion of Apple Pay for in-app purchases, and very concerned about the CP credit card fee advantage to be enjoyed by the integrated platform payment utilities. For the investable future, this is not a significant problem for Amazon, but certainly an area to watch.

The same issues noted above for Amazon will also be in play for other online merchants, such as the legacy EBay business. However, these developments are ominous for the soon to be independent PayPal. As online shopping moves increasingly to mobile platforms, the dramatic advantages of the integrated payment mechanisms looms large. The situation is dire on the iOS platform, but somewhat less so on Android, where the Android Pay APIs should allow PayPal to build a competitive alternative. Still, the first mover and scale advantages built over the years will be badly eroded and it is not clear that the company’s relative cost structure will allow it to be competitive with the platform based solutions.

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