Acquiring: The Troubled World of NFC Wallets

Peter Lucas

Despite backing from some of the country’s biggest carriers and tech firms, NFC-based mobile wallets are struggling to win acceptance with merchants and consumers alike. Does the solution lie in the cloud?

It’s been tough sledding of late for digital wallets based on near-field communication (NFC), the contactless technology that lets consumers pay at the register by waving or tapping their phone.

Since August, a series of events have unfolded that have dimmed the wallet’s once-bright prospects—prospects backed by the likes of technology powerhouses Google Inc. and Isis, a consortium of wireless carriers Verizon Wireless, AT&T Mobility, and T-Mobile USA.

And now questions are surfacing about the NFC wallet’s real appeal to merchants and consumers. At the core of these questions is a new debate over propositions that only last year were fundamental to the understanding of NFC. These include so-called card emulation, or the idea that consumer payment credentials (card numbers, CVV codes, expiration dates, and so on) should reside digitally on a secure chip in the phone.

The first major crack in the NFC edifice appeared in August when Google, whose wallet had struggled since its September 2011 launch, announced it was abandoning one of the essentials of NFC-based mobile payments. Where before the Google Wallet’s card credentials were stored in a secure chip in the phone, from now on consumers would save their payment cards onto Google servers, the tech giant said.

At a stroke, the move broadened the product’s consumer appeal by allowing users to access virtually any card they might have in their leather wallet. It also relieved Google of the necessity of making separate agreements with individual issuers.

To be sure, NFC chips would still be used to facilitate transactions against a virtual prepaid card stored in a secure element in the mobile device, with transactions being triggered at the physical point of sale by consumers tapping their smart phone against an NFC-enabled POS terminal. As the virtual-card issuer, Google pays merchants and then collects from the issuer of the consumer’s card on each transaction. Pretty slick.

But by adopting this two-step, hybrid cloud/device-based approach, Google had weakened the case for pure NFC and set itself up to collect card-present interchange while paying higher card-not-present rates.

‘There Must Be an Issue’

Later that month, a consortium of merchants generating more than a $1 trillion in annual sales gave what amounted to a vote of no-support for NFC wallets by officially announcing the Merchant Customer Exchange (MCX) to deliver mobile-commerce solutions to consumers at the point of sale. 

While MCX has yet to declare what technology will form the backbone of its platform, an MCX spokesperson said one of the driving reasons for the consortium’s formation is that no dominant mobile-commerce solution exists. The spokesman added that MCX members are in the best position to deliver the kind of mobile solutions consumers want and will use.

MCX’s backhanded dig at NFC-based wallets was overshadowed in mid-September when Apple Inc. debuted the latest version of its wildly popular iPhone—the iPhone 5—sans an embedded NFC chip many supporters of NFC-based wallets hoped would be included.

With nearly one-third of the smart-phone market, Apple has found its way into the hands of millions of fiercely loyal customers around the world. A nod from Apple would have given NFC wallets a huge credibility boost, according to payments experts.

A few days later, momentum behind NFC-based digital wallets ran aground when Isis announced it was delaying its expected launch in Salt Lake City and Austin, Texas, without making clear exactly what was causing the hold-up (Isis was widely expected to commence the two-city pilot on Oct. 22).

Isis had expected to launch in those cities this past summer with up to 1,000 merchant locations in each market. As of May, Isis had signed about 50 merchants, accounting for 300 locations in each city. The company has not updated the number of merchant locations since.

Individually none of these events would be enough to significantly slow adoption of NFC-based wallets. Collectively, however, they have taken the wind out of the technology’s sails for the time being.

A root cause of the problems affecting adoption of NFC wallets is that the technology itself—which is a hardware-based solution—simply replicates the underpinnings of the existing system, according to payment experts. For merchants, this means no change in current acceptance costs. For consumers, a mobile phone merely replaces a plastic card.

“Simply loading the physical wallet onto an NFC chip embedded on a smart phone does not create a better payment platform than the one that already exists,” says Anuj Nayar, senior director of communications for San Jose-based PayPal, which offers a cloud-based digital wallet. PayPal has 117.4 million digital-wallet accounts, up from 113.2 million in June.

“Digital wallets are about changing the relationship consumers have with payments, not putting the wallet in a different form factor, which is what the NFC wallet does,” he continues. “The fact that NFC wallets are experiencing slow adoption means there must be an issue.”

‘Another Layer of Cost’

The problems confronting NFC wallets are not as black-and-white as some payments experts believe. “There are several components to [the wallets’ slow adoption],” says Mary Monahan, executive vice president and research director, mobile, for Pleasanton, Calif.-based Javelin Strategy & Research.

Indeed, several stumbling blocks stand in the way, not the least of which is merchants’ current reluctance to install contactless NFC terminals. While Visa Inc. and MasterCard Inc. have mandated the installation of EMV-enabled terminals, which can read NFC chips, by 2015 for retailers and 2017 for gas stations, enabling EMV terminals to support an NFC wallet requires the addition of a contactless chip reader, which raises the cost of the device.

Not surprisingly, many merchants are chafing at the incremental cost for EMV contactless terminals.

“Merchants see plopping payments on the phone as adding another layer of cost to acceptance,” says the MCX spokesperson. “What merchants want are solutions that take additional costs out of the current payments system.”

MCX was formed by 21 merchants, including 7-Eleven Inc., Alon Brands Best Buy Co. Inc., CVS Pharmacy, Darden Restaurants, HMSHost, Hy-Vee Inc., Lowe’s, Publix Super Markets Inc., Sears Holdings; Shell Oil Products US, and Sunoco Inc.

Merchant resistance to contactless terminals has led to a dearth of them in the marketplace, which in turn is hindering consumer demand for the wallet. “There are not a lot of places consumers can use NFC wallets and until that changes, [their] appeal to consumers is limited,” says Monahan.

Isis, which has bet on NFC technology to serve as the foundation for its wallet platform, argues the limited acceptance of NFC wallets is only temporary. In an e-mail Q&A with Digital Transactions, Isis officials cited projections by Oyster Bay, N.Y.-based ABI Research that 85% of point-of-sale terminals shipped worldwide will accept contactless payments by 2016.

Since Isis is owned and controlled by wireless carriers, payments credentials in the Isis version of NFC will be stored in the phone’s SIM card, which will act as the “secure element,” in NFC lingo. Few experts question the Fort Knox-like security of the SIM.

“Isis believes that NFC is the best, most secure technology to modernize the payments process,” the company said by e-email. “We believe a combination of hardware and software—as opposed to software-only solutions—provides the best security protections for consumers and merchants.”

‘A Lot of Experimentation’

The ongoing struggle to get merchants to embrace NFC terminals is a key factor behind the growing interest in so-called cloud-based wallets, where payment card and personal information is stored in a secure server and accessed through an app on a mobile device or computer.

Unlike NFC-based wallets, cloud wallets are software driven and require substantially less investment by merchants to accept them at the physical point of sale. In addition, cloud wallets can be used to make e-commerce transactions, a feature currently missing from the Isis wallet.

“It is a lot easier and less costly for merchants to change or add [point-of-sale] software to enable use of the digital wallet than it is to buy new hardware for every checkout lane,” says Bill Clark, president of Spindle Inc., a Scottsdale, Ariz.-based mobile-payments solutions provider, which expected its cloud-based wallet solution to launch in October. “The opportunity in digital wallets extends well beyond NFC and that’s why momentum is building for cloud-based wallets.”

Making digital wallets appealing to consumers, however, depends on more than just having places to use it. Payments executives argue that the wallet’s real appeal lies in the value-added features that can be delivered to consumers through it, such as electronic couponing, automatic tracking, redemption of loyalty points, and notification of personalized and special offers.

Delivering this kind of value, payment experts argue, will not only drive incremental sales for merchants, but strengthen customer loyalty to the merchant’s brand.

Exactly what these value-added features will look like is still being debated. “Right now it is unknown what value proposition will move the needle in terms of adoption, because there’s a lot experimentation going on,” says Paul Coppinger, president of Scottsdale-based Apriva Inc., which began testing a cloud-based digital wallet earlier this year. “One thing merchants appear to be interested in is wallets that can help them manage sales and customer relationships.”

As part of the makeover of its wallet, Google included its Save to Wallet API (application programming interface), which enables consumers to download payment cards (including card art) and offers directly from bank and merchant Web sites to their Google Wallet. So far, the API has been adopted by Barclaycard US for its L.L. Bean and US Airways cards and Discover.

Although Google executives were unavailable, a company spokesperson said via e-mail that after launching the cloud-based version of Google Wallet, usage of the wallet itself nearly doubled. Google is not releasing the number of users or volume through the wallet.

Google Wallet is accepted at 200,000 U.S. merchant locations via the MasterCard Pay Pass contactless network. Merchants with a national presence include Gap Inc., American Eagle Outfitters, New Jersey Transit, Peet’s Coffee & Tea, and Walgreen Co.

‘More Compelling’

At the other end of the value-added spectrum are MCX members, which believe that the features of the wallet will be driven by personalized offers sent to customers based on their specific behavior across sales channels. This approach runs counter to sharing data gathered through the wallet to enable other member merchants to send generic offers.

“Creating personalized offers specific to a consumer’s shopping patterns at an individual retailer with which they have a relationship is more compelling than getting offers from merchants where no relationship exists,” says the MCX spokesperson. “Consumers may be able to opt in to share their data with other member merchants in order to receive offers, but we haven’t gotten to that yet.”

PayPal sees the value-added experience as removing consumer frustrations with redeeming coupons and loyalty points. “If a coupon is in a digital wallet, the consumer should be able to redeem it online or at a kiosk just as easily as they do in a store by tapping their phone against a terminal, not in just one sales channel,” says PayPal’s Nayar. “The digital wallet must be an integrated solution that allows consumers to access and update the information in it across all sales channels.”

Over the past year, PayPal has signed deals with 16 national merchants to accept PayPal. For consumers to make a purchase using PayPal, merchants only need to change their POS software to include PayPal acceptance. Consumers paying with PayPal select that option on the POS terminal, then enter their PayPal PIN and home phone number to debit their account.

PayPal further expanded the reach of its wallet in August by signing a deal with Discover to allow its more than 7 million merchants to accept a PayPal card. PayPal plans to begin issuing cards next year.

“The lines between stores, e-commerce, and mobile commerce are blurring,” says Nayar. “A cloud-based architecture makes it possible for merchants not to have to reboot their payments infrastructure by adding new hardware. In our view, software is the driver of the digital wallet, not hardware.”

Given the growing popularity of cloud-based wallets, payments experts expect more wallet providers to offer cloud solutions either as a standalone product or a complement to an existing NFC-based wallet. An increase in cloud-based wallets, however, does not necessarily mean the ultimate demise of the NFC-based wallet.

Quite the contrary, according to Javelin’s Monahan: “There is a need for digital wallets that can be used in-store and online and what form that wallet will take is unknown at this point,” she says. “The key to the success of the digital wallet is making the consumer payment experience that currently exists better.”