Could Apple’s Passbook become a true digital wallet?

A bowl of shredded credit cards

Much of the attention at Apple’s WWDC conference this year has centered on the new Macbook Pro with a Retina display, and Apple launching its own mobile mapping service with iOS 6. However, another new feature coming in iOS 6, Passbook, may be a sign of bigger things to come from the Cupertino giant: a true mobile payment system. In iOS 6, Passbook will initially take the form of a sort of digital card carrier for things like store loyalty cards, event tickets, and even boarding passes for airline flights — a convenience feature for many consumers, but hardly earth-shattering. However, Passbook might represent just the tip of the iceberg. After all, Apple is one of the only companies in the industry with the momentum — and almost all the pieces in place — to roll out a true mobile wallet.

What is Passbook, and how could Apple morph it into a true mobile payment system? Could a mobile wallet system from Apple succeed where major efforts like Google Wallet have (so far) failed to gain traction?

What Passbook will do

Apple iOS 6 Passbook

Out of the box, Passbook in iOS 6 will enable users to quickly access and manage electronic versions of merchant cards, tickets, and boarding passes — all without having to fuss with wallets, purses, or pesky slips of paper. Instead of scanning a card or punching a ticket when buying a coffee or standing in line for an event, Passbook users will just be able to scan their iPhone or iPod touch. Passbook stores individual items as “passes.” Each pass can have location and update information associated with it, and the Passbook app will keep track of things. Passbook will also be location- and clock-enabled. When users get near a location (like an airport or their favorite coffee shop) where their tickets or merchant cards could be used (and, according to the clock, it’s during business hours), the appropriate pass will become available on the device lock screen so users don’t need to unlock their devices and fiddle with apps to bring up their pass. Furthermore, passes can be “live,” displaying up-to-date information on the fly. For instance, Passbook could alert a user that the gate for a flight has been changed “to make sure you’re not relaxing at the wrong terminal,” according to Apple.

It’s easy to see a few friction points here (and even fiction, if we consider for a moment the notion of “relaxing” at an airport terminal). For one thing, retailers who want to offer passes to iOS 6 users will have to work with Apple. So far Apple hasn’t not announced which retailers will initially be participating in the program, although Scott Forstall’s WWDC demo displayed support for Starbucks cards, United Airlines, and a ticket for a San Francisco Giants game. Other cards from Target, Fandango, Amtrack, and the Apple Store were also visible in the demo (and in Apple’s online materials). So far, no details have been disclosed about merchant eligibility: Apple might throw the doors wide open to any retailer with barcode-scanning capability and a loyalty program, or it might (at least initially) limit participation to only a few high-profile, mass-market operators. In short, Passbook might be represent a tremendous opportunity for the likes of Starbucks or Walmart, but could be a non-starter for your local independent bookstore — for folks lucky enough to still have one. No one knows what the threshold for entry will be.

Passbook also represents another instance where Apple is choosing to trample over a portion of its third-party developer community. This happens with every release of iOS: third-party developers who hit on an idea so good that it makes sense to be in Apple’s operating system find themselves cut out of the loop when Apple does put those features into its offerings. At the moment, there are a myriad of loyalty program applications for Apple’s iOS — some are specific to merchants, while others try to aggregate different merchant programs. If Passbook gains traction, those apps will probably see their markets vanish.

What Passbook won’t do

Apple iOS 6 Passbook Time and Location

Passbook might seem like a boon for managing things like loyalty programs and tickets, but it is not a full-fledged mobile wallet for one primary reason: it doesn’t handle money. A merchant card or ticket in Passbook can be used to confirm a purchase, rack up points, or debit an amount from a pre-paid account, but users will not be able to go into a Passbook-savvy merchant, grab some merchandise, wave their iPhone at a scanner, and walk out the door.

Passbook does not tie in with credit cards or banks to enable general payments. Folks who use Passbook will have to resort to old-fashioned credit cards, debit cards, checks, or even cash to top off their accounts with merchants. They won’t be able to authorize top-offs or refills using Passbook. Similarly, Passbook will not be able to transfer money between individuals: If you owe someone from the office $20 for picking up lunches, you’re not going to be pay that person back with Passbook by waving your iPhones at each other.

On on hand, this could be viewed as a good thing. If there should prove to be a major security issue with Passbook — and there have been some high-profile payment service breaches lately — Passbook doesn’t have any bank or credit card information for attackers to steal. Generally, the level of vulnerability associated with merchant cards or tickets is lower than bank accounts or credit cards — although, to be sure, tickets aren’t cheap, and many people would consider information associated with merchant cards private.

On the other hand, Passbook’s inability to serve as a general payment solution might hinder adoption. Sure, some people live for their rewards cards and membership points — but other people couldn’t care less, particularly since signing up for programs like that usually means handing over personal information. If Passbook also served as a general payment solution for iPhone users, it could see much broader adoption.

What Passbook could do

iphone cash money subsidy

Apple hasn’t given any indications about where it plans to take Passbook. Heck, Apple still hasn’t revealed many details about how Passbook will work at launch, or how retailers and merchants can get involved. But there are some indications in the broader Apple ecosystem about where Apple might take things — and why Passbook could be a major player in mobile payments.

Consider the Apple Store App. The idea is that users can walk into an Apple Store, use their iPhone to snap a picture of the barcode on a product they’d like to purchase, then confirm the purchase through the credit card they already have associated with their Apple ID. Users don’t even have to check in with an Apple rep: Once the purchase has been confirmed through the app, they can literally just grab the item(s) they want and walk out the door.

During Apple’s WWDC keynote, Apple made a point of noting that some 400 million people around the world have active credit card information on file with Apple. They use these credit cards to buy music, videos, and apps through iTunes.

Now imagine Apple extends the Apple App Store model to merchants who participate in its Passbook program. Passbook users could walk into a participating merchant’s retail location, snap a picture of the barcode on the item(s) they want to buy, and pay with the credit card information they have on file with Apple. Of course, there are some gotchas. For one thing, few merchants have inventory control and point of sales systems that are as tightly integrated as Apple’s. Any merchant using a system like this would probably still require users to confirm the purchase before leaving the premises, unlike Apple Stores where customers can just walk out the door.

In banking terms, such a system has Apple functioning as a “third-party aggregator” — Apple would be processing payments for products and services it does not own and does not provide. To a degree, Apple already does this with digital goods like apps, music, and movies, but does not currently provide services like that for third-party retailers. Getting into this business would create a certain amount of overhead for Apple. For instance, if a customer disputes a credit-card charge, the complaint would have to be taken up with Apple rather than the merchant themselves. Similarly, merchants would be losing control of some of their own customer service. If, say, a customer wants to exchange an article for clothing for store credit, the merchant would have to work with Apple to get the initial transaction reversed, then apply any new charges. Processes for fraud detection and prevention would also need to be adapted for third-party retailers.

However, these challenges aren’t insurmountable. Apple is already doing the majority of this work already with its own digital sales, and Apple could start slowly by launching a program with retailers with whom it already has a good relationship. Once the wrinkles are smoothed out, Apple could expand the program to more merchants.

And Apple could sweeten the deal by taking little or no cut of merchant transactions. Apple famously takes a 30 percent cut of every app and book it sells via the App Store, and while its cut for music and other media don’t match that level, Apple still generates a bit of revenue for every transaction. However, in those instances, Apple actually has costs for managing the storefront: the infrastructure, staff, and content delivery service behind Apple’s digital retail offerings isn’t free. But in the case of third-party retailers, Apple isn’t incurring the cost of storing inventory, employees, store space, or the other myriad of costs of running a brick-and-mortar business. If Apple could make a hypothetical Passbook system as affordable to merchants as using a processing traditional credit card transactions — or even cheaper — it could get retailers pounding on its doors.

Passbook challenges

If rolling out mobile payments is as simple as offering to process credit card transactions on behalf of merchants, why hasn’t anyone done it?

Well, they have. A good example in the mobile arena is Square, which enables essentially anyone to accept and process credit card payments using an iPhone, iPad, or Android device. From a banking point of view, Square’s situation is also that of a third-party aggregator that’s handling payments for products and services it doesn’t own. And Square is doing great: the company now claims to be processing the equivalent of over $6 billion in transactions a year, and has just hired a new CFO to lead its efforts to expand into international markets. And Square has its own app (now called Pay with Square) so users of Android and iOS devices can pay with their mobile devices at any retailer that handles Square.

But a more significant challenge may be posed by the traditional credit-card companies like Visa and MasterCard, which have literally spent decades making sure their credit platforms are almost universally accepted worldwide. They’re not going to be willing to cede any ground to companies like Square or Apple, and are busily working on testing their own mobile payments solutions that would turn compatible smartphones into the equivalents of portable credit or debit cards. (Google Wallet is built on the technologies championed by credit-card companies, including separate Secure Element hardware subsystems in mobile devices like the Samsung Nexus S 4G to secure payment credentials.)

All this leaves merchants in a bit of a lurch. It’s already costly for retailers to get into the credit-card game. The traditional route is to get a merchant account, set up a deal with a payment processing company, pay for appropriate point of sale hardware, and then pay a per-transaction fee for the privilege of offering consumers the convenience of using credit and debit cards. It’s kind of a suckers’ game, but most merchants have little choice but to play it. When was the last time you saw a brick-and-mortar retailer that only conducted business by cash or check? Square’s success lies in doing an end-run around the traditional process: It eases the hurdles for small businesses by acting as payment processor and omitting the need for a merchant account or expensive gear; they get by with a dongle that connects to a mobile device.

The credit-card market has matured over the years: For many consumers, it can essentially be treated as a single entity now, with most merchants accepting all major cards. The mobile wallet arena looks to be much more fragmented. In addition to near-field communications (NFC) and Secure Element systems being championed by traditional credit-card companies, merchants can choose to process payments via companies like Square, PayPal, and a number of other would-be mobile commerce players.

If Apple were to enter the mobile wallet arena, it would be getting into an already-crowded field that looks like it’s going to become more crowded in the near to medium term. And merchants will be forced to place bets on which systems(s) they think will stand the test of time. We could end up with a confusing array of different mobile wallet technologies — all of which lead to consumer confusion and higher costs of administration and training employees.

Could Apple pull it off?

Of all the companies that could get into the mobile wallet space, perhaps Apple alone has the credibility, the long-term vision, and (importantly) the cash reserves to make a long-term bet. The biggest impediment to Apple is that, like iOS and iTunes, the company is not likely to create a mobile payment solution that it would license out to the whole industry. It would not just be an Apple-first solution, but an Apple-only solution. Remember: Apple’s business model is in making profits selling hardware. Apple’s interest in developing a mobile wallet solution would not be in making money on transaction fees — although we’re sure they’d prefer the program to pay for itself. Instead, a mobile wallet solution from Apple would have to serve as an incentive for customers to buy iOS devices. That would mean providing the easiest and best mobile payment solution in the industry. If Apple isn’t convinced it can do that, it won’t even try.

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