February 17, 2015
Editors Note: This article was written long before Apple Pay was launched. This article is primarily about the potential Apple had for Payments.
This was actually a rather long journey for Apple. To craft the magical experience that you and I now see at the iTuens store was not close to being trivial. To gain a perspective, as always one should, we will present the historic perspective. This will help establish how Apple got to be into Payments and perhaps where it is going.
Warning: Jump to the last paragraph if you are a TL;DR person, as I am sure what follows will be horrifying.
Steve vs. The Record Labels
Throughout most of 2002, Steve Jobs and his team were crafting what we now know as iTunes. Steve was in many cases personally negotiating with the major record labels on how the service will actually help the music industry. The price per song he established primarily from a psychological standpoint. At first most of the record labels did not accept a fixed price, let alone one that was not set by them. The price point of 99¢ for a hit single was frightening to the industry. Clearly they wanted more, much more.
Steve vs. The Payment Card Companies
This was not the only issue Steve faced. This issue always seems to be missed by most writers and researchers of Apple's iTunes success. The price point of 99¢ was not aligned with the Interchange Rates (http://en.wikipedia.org/wiki/Int...) established by Visa and MasterCard. Steve logically assumed that there had to be a price structure to support micro transactions and if there was not, he would will it in to existence. I was on a team of outside advisors that had to break the news to Steve about how Visa and MasterCard set rates and how, at that time they did not cut any side deals.
There were some negotiations with both Payment Card companies but they really did not go anyplace. Thus our group suggested the Payment Card Aggregation method for billing that is still in use today. This is based on a dynamic computer model of buying habits of a typical user and tries to take transactions over an unpublished maximum amount of time, reaching a prescribed dollar amount to group multiple purchases into a single Payment Card transaction. Thereby reducing the effective rate to a more agreeable amount. This is precisely why your light purchase days at iTunes may take up to a day or so to produce an email receipt.
wholesale Payment Costs vs. Low Ticket Transactions
Today, there are many rates that could apply to an iTunes transaction. In fact, at this point it is very likely that Apple has negotiated rate reductions. However to give some insight on how costs could work out I will present some basics. I will select 2 rates that closely match what costs Apple experiences. I will use the EIRF wholesale Interchange rates and will be assuming a US based Visa Debit Card (1) or Visa credit card (2) (http://usa.visa.com/merchants/op...) page 3 and 4:
1) Visa: Debit Electronic Interchange Reimbursement Fee (EIRF) (Exempt): 1.80% + 20¢
99¢ x 1.80% + 20¢ = 22¢ + (2¢ Visa dues and assessments) = 24¢ wholesale cost to Visa).
The final cost (Including processing fees of about 2¢) to process a 99¢ transaction it is about 26¢ (26%)
One Song at 99¢ - 26¢ (Processing cost) = 73¢ - ~69¢ (To Record Label) =~4¢ Apple revenue
2) Visa: Credit Electronic Interchange Reimbursement Fee (EIRF): 2.40% + 10¢
99¢ x 2.40% + 10¢ = 12¢ + (2¢ Visa dues and assessments) = 14¢ (Wholesale cost to Visa).
The final cost (Including processing fees of about 2¢) to process a 99¢ transaction it is about 16¢ (16%)
One Song at 99¢ - 16¢ (Processing cost) = 83¢ - ~69¢ (To Record Label) =~14¢ Apple revenue
Breakdown of a typical 99¢ transaction using a Visa Credit Card.
Thus Apple's true Interchange costs are perhaps between the very high cost of accepting Debit Cards and the lower costs from Credit Cards. To help Apple out, don't use your debit card!
By no means is this the only rate that could apply in theory to Apple, there are many (For example: Business Card Not Present 2.45% + $0.15). In a perfect world, to meet full Visa CPS Interchange, a card not present transaction requires a number of points, one of them is full CVV2 verification and with some Cards there are other points that must be reached. Apple can not store the Payment Card CVV2 code and to request this number at every whimsical purchase would render the iTunes store useless. I will have to assume that Visa requires Apple to meet the same security standards that all other merchants are required too meet. Under current PCI (Payment Card Industry) DSS (Data Security Standards), transaction originating from Payment Cards can not store the CVV2 codes (http://en.wikipedia.org/wiki/Car...), thus we can verify this in PCI Data Security Standard (PCI DSS), Page 30:
Abstract: 3.2.2 Do not store the card verification code or value (three-digit or four-digit number printed on the front or back of a payment card) used to verify card-not- present transactions.
As mentioned these are approximate costs but very close to the center of true costs Apple experiences. This means that Apple is paying between ~16% - ~26% of transactions to the Payment Card Companies for a 99¢ transaction. There are currently only two ways to mitigate this high rate:
The iTunes gift card has had explosive growth. Saving by Apple is achieved by creating perhaps a single transaction of perhaps $20 rather then 20 transactions of 99¢. Moreover, if the iTunes Gift Card is purchased at a non-Apple location, Apple does not pay any Payment Card fees. Payment Transaction Aggregation is in a similar vein, as mentioned above. By grouping perhaps a $20 charge and aggregating transactions together over a few hours or a few days and then presenting this sale as a single transaction to the Payment Card companies, Apple lowers its effective rate, from the double digits to the low single digits. This is Payment Transaction Aggregation in action and has saved Apple from potential losses in the iTunes store to the profits that are now famous. Even more over, it did finally satisfy Steve Jobs. This point is very important as we would not be speaking about an iTunes store if this problem was not solved. I think it was a rather simple and elegant solution when you factor in all of the issues we faced. In the future Apple could become closer to a PayPal model (using checking accounts), but this seems less likely.
It must be clearly stated and recognized that the Apple iTunes experience is also partly an Amazon experience. Patent number 5960411 (http://worldwide.espacenet.com/p...) is one very powerful patent. Back in the pre web 1.0 days, a young Jeff Bezos thought about the processes and procedures of an Internet transaction. Jeff (his name is on the patent with others at Amazon) finally committed his ideas to a patent application in the mid 1990s and was later granted the famous one-click (http://en.wikipedia.org/wiki/1-C...) buying patent. In the late 1990s Jeff was challenged with how to protect the intellectual property and took what was at the time a rather hard line on products that copied the concept. This prompted negotiations with Apple and a number of other companies. Apple was granted a license for one-click in early 2000. We see the implementation of this license at iTunes and the Apple website.
Thus we have established that Apple has innovated the way they handle transactions and also the way they process orders. These are the primary ingredients, but there is more. Apple spent a great deal of time with working with consumer anthropologists and merchant anthropologists both internally and externally to fully research every aspect of the transaction experience. Apple is in a never ending study of how to optimize the entire experience. After a Billion+ transactions all of us have come to relish this outstanding experience. So much so that many are looking to Apple to become a Payment Company.
Virtual vs. Non Virtual Goods And The Apple Experience
Apple currently only collects payments for non-virtual, hard goods when they themselves are selling these goods. Apple does not currently allow for third party companies to sell hard goods using iTunes accounts. This seems to be missed by a great many people, even payment industry experts. Why is this so? The primary reason is that Apple can control every aspect of the buying and selling experience with the delivery of virtual goods. This can never be the case for non-virtual goods. Thus there is a very large possibility that the experience can become very un Apple-Like.
Apple guards its user experience more than any company in the industry and this presents a rather large problem. Amazon and to some extent eBay/PayPal had to go to extraordinary lengths to achieve no questions asked return policies. Anything less would create a re-tweet firestorm today. However on the opposite side of no questions asked return policies are 1000s of small merchants that very well could be innocent and be driven out of business. It is a precious balance and Amazon is doing a rather good job.
For Apple to expand beyond Collecting Payment for virtual goods, they would have to create a customer service department and chargeback unit larger then the top 3 Payment Card issuing banks combined, perhaps needing to add over 10,000 people working in customer service at Apple for Payments alone. I can personally state that Steve Jobs had absolutely no desire to be in that side of business. I am fairly certain that under the new guidance at Apple this will not change. However with Steve gone, I can't be absolutely sure.
Apple + NFC
On the other hand, I am 100% certain that Apple will become a facilitator of transactions for Payment Card Companies. This means that Apple acts just as a conduit between the customer and the merchant on behalf of the Payment Card companies. This takes Apple out of the liability loop entirely. Apple Merchant accounts would not be used for this type of relationship. There are two primary ways this can happen (there are others but I can not speak of them at this point), either by linking Payment Card(s) to an iTunes account and using this ID as a token to pay Merchants or to implement NFC on iOS devices and to associate Payment Cards in a wallet type setting. In addition perhaps in conjunction to NFC I am rather certain we will also see this in the future, Brian Roemmele's answer to Will Siri become a transaction completion system?
The Father Of The Starbucks Wallet
It is clear to me that Apple will move to the NFC option first and perhaps never implement an iTunes connection. I draw these conclusions from a number of public sources (I am not using any private information or violating any non disclosures). There is absolutely no doubt that Apple is committed to NFC technology. Certainly not just for Payments but for other interesting new use cases.
I spoke to this in a number of posts on Quora over the last year, some assumed I was insane (perhaps). In this post I point out not only that the inventor of the NFC protocol, NXP one of Apple's significant chip provider for a currently unreleased device, Apple also has significant patents covering a spectrum of use cases with NFC: Brian Roemmele's answer to Why does the iPhone 4S lack NFC support?. In 2010 Apple also hired one of the most creative wallet designers in the world, Benjamin Vigier. This guy is a powerhouse with that designed the Paypal Mobile, Sprint MyMoneyManager, Mobile Wallet application for 2 top#5 US carriers, mFoundry Mobile Banking WAP platform, NFC Wallet for a top 3 US bank and led SanDisk mobile commerce and NFC activities. However his grand achievement is the spectacular Starbucks Wallet:What retailer is the most successful in mobile payments?. Starbucks is the most successful company in mobile payments at over $42 million in transactions thus far in 2012.
We will no doubt see how Apple implements these ideas in 2012-2013 and how well these new service compare to the wonderful iTunes experience.
How Does Apple Do So Well In Payments?
Apple does not operate in a vacuum, the success it has in Payments is directly tied to the success it has had with the iPod, the iTunes Store, iPhone and iPad. We would not be speaking about Apple and the payments experience they create if they did not do so well in these products. This point is also lost on many people in the Payments industry that hope to aspire to Apple’s unique and successful processes. Thus to sum up why Apple is successful in a simple calculation:
iTunes + Payment Card Aggregation + One-Click + Spectacularly Successful Products Sold + Incredible Customer Experience = Apple’s Payment success.