A Deep Look Inside Apple Pay’s Matchmaker Economics
David S. Evans and Richard Schmalensee
Standing on stage on September 9, 2014 at Apple’s Worldwide Developer’s Conference (WWDC), Tim Cook announced, “We’ve created an entirely new payment process, and we called it Apple Pay.” Cook displayed a video of a woman who held her iPhone 6, the company’s upcoming upgrade, near a payment terminal. She paid in the blink of any eye. “That’s it,” Cook said, exclaiming twice over “just how fast and just how easy” the new payment method was. An Apple press release claimed the new service would “transform mobile payments.”
Executives, investors, entrepreneurs, analysts, and the media had to assess whether this would be another Apple juggernaut. Would Apple Pay do to financial services what iTunes had done to music? Was the game over for the many other players—big ones like Google, and small ones like LevelUp—that had mobile payment solutions? Should banks agree to pay Apple 15 basis points per transaction for allowing their customers to use their debit and credit cards with the new service? And should retailers agree to take the new payment method?
The tech press called Apple Pay a revolution. So did the Financial Times. PayPal went on deathwatch. In an article called “Will Apple Pay Kill PayPal?” CNN reported, “Apple wants us to ditch our wallet and credit cards. Wall Street is nervous that consumers may dump online payment service PayPal too.” eBay’s shares—it owned PayPal then–fell 6 percent.
We weren’t so sure.
The new economics of multisided platforms provides a theoretical framework and body of empirical knowledge for handicapping “matchmaker” businesses like Apple Pay. Of course, as the saying goes, it’s hard to make predictions, especially about the future. But the new multisided platform economics provides powerful tools for separating new platforms that will likely succeed from those that are going to fail spectacularly.
Most would-be matchmakers don’t get it right, though. In fact, platforms are based on one of the most challenging business models there is.
Economists, including us, have shown that matchmakers face a difficult coordination problem. They have to get a critical mass of customers that want to interact with each other to ignite and grow quickly.
Securing critical mass isn’t just a numbers game. There have to be enough members of both groups that could exchange value to make it worthwhile for either. They need density—what’s known as a “thick market” in trading financial assets—more than just scale. A smaller number of participants who actually want to do business with each other is much more important than a larger number of participants who don’t care so much.
No one had really figured out how common this business model was until a paper by Jean-Charles Rochet and Jean Tirole started circulating in 2000. It provided an organizing framework for collecting empirical evidence on how successful platforms operated and why some matchmaker pioneers succeeded and most didn’t.
Some of our empirical work is described in our new book, Matchmakers: The New Economics of Multisided Platforms, but many other economists have done significant research as well. In our work we’ve paid special attention to payment platforms, particularly on what has led some to ignite and others to implode. The modern payment card industry started with Diners Club, in 1950. It focused on developing a critical mass of cardholders and restaurants in a small geographic area—Manhattan. Once it had a thick market there it moved on to other cities, and eventually other verticals. Other payment networks, in one way or another, also deployed strategies to make sure they had enough cardholders and merchants on board their platforms quickly.
More recently we’ve followed a mobile payment startups in the US. Several of these were very well funded including Google Wallet; Softcard, which was backed by three of the four mobile carriers in the US; and CurrenC which was sponsored by a group of large retailers including Wal-Mart. They all fizzled. Softcard and CurrenC are officially dead. Google Wallet relaunched after a series of missteps. Many other less prominent startups died quieter deaths.
Our analysis of these endeavors during their startup phases found that they made two major mistakes.
They didn’t solve an important problem for consumers. In the US it is very easy and efficient to use payment cards at most merchants. There was no powerful reason for consumers or retailers to embrace alternatives—without more.
They didn’t have a sound strategy for creating the density necessary for critical mass. Each of these mobile payment schemes relied on technology that only worked at merchants that had NFC terminals. Most merchants didn’t have those terminals and didn’t want to spend money to get them. Since consumers couldn’t use the mobile payment schemes at most merchants, they didn’t have much incentive to use them anywhere. And since most consumers weren’t pining to use the mobile payment schemes, merchants had no compelling reason to upgrade their terminals.
It was immediately apparent, based on our previous work, from Tim Cook’s presentation that Apple Pay faced challenges. In fact, one of us predicted, on Sept 25, 2014 and October 31, 2014, that Apple Pay would have a very challenging road ahead to secure critical mass given its scattershot approach to ignition and the fact that it didn’t appear to be solving a significant friction for consumers or merchants.
To begin with, the Apple Pay story was based on a false premise. Cook claimed that it was inconvenient to use a card to pay retailers in the US. He showed a video to prove his point—of a woman fumbling through her purse to find her card, a clerk swiping it a couple of times to get it to work, asking to see her license, and then her signing for it. In fact, for most people it is very easy and quick to use payment cards at retailers in the US. It usually only takes a couple of seconds. While Apple Pay was slick in many ways, its main value proposition for consumers was that it was easy. But so were cards. Unlike Diners Club in Manhattan, it wasn’t clear that Apple Pay was addressing a significant friction.
Apple’s ignition strategy also raised red flags. Consumers could only use Apple Pay at merchants that had NFC terminals. But even in late 2014 most merchants didn’t have them. Also, consumers could only use Apple Pay if they had a new iPhone 6—which cut out most of the existing iPhone user base as well as the many consumers who used Android.
As Apple Pay was designed, it was difficult for Apple to secure the density necessary for critical mass. Few consumers would be able to use Apple Pay, which would reduce the value to merchants, and few merchants would be able to accept Apple Pay, which would reduce the value to consumers.
Working with PYMNTS.com, we started collecting data on Apple Pay acceptance to see, in comparison with other successful platforms, whether it was getting traction. The first results, which became available in November 2014, confirmed our skepticism. Few iPhone 6 users were installing Apply Pay but, more disturbingly, most of those who had it installed weren’t using it even when they were paying at the few NFC terminals that could accept it. We made an early call, on Dec. 5, 2014, that Apple would struggle unless it changed strategies in the United States.
Eighteen months later, the evidence bears us out. The latest research, as of March 2016, finds that only one in twenty iPhone users who could use Apple Pay—because they have the right phone, and are standing at an NFC terminal that can take Apple Pay—use it. That take-up rate hasn’t budged much over the last 18 months. Our calculations find that Apple Pay’s share of payment card transactions has remained well below 1 percent—ranging from around 0.7 percent in November 2014, to 0.8 percent in June 2015, to 0.6 percent in March 2016. There is no evidence of that Apple Pay is on the road to the exponential growth that matchmakers strive for and get once they build critical mass.
Tellingly, unlike they way it talks about its successes, Apple has been silent on the extent to which people actually use Apple Pay to conduct transactions. Monday, at WWDC, Apple execs were proud to say they had 15 million paid Apple Music subscribers and that Siri got a billion requests a week. They remained mum on how often consumers are using their payment service.
Of course, with its huge base of devoted iPhone users and more than $200 billion in cash reserves we can’t write off Apple like we might a typical startup. The company could change strategies to secure critical mass or play a much longer game than many mobile payment rivals could. In fact, Apple just announced that it is making Apple Pay available for online purchases on websites for mobile and desktop. That sounds promising but still challenging. And very different from the problem they set out to crack. For now Apple Pay is another revolution that wasn’t.
We didn’t get the prognosis for Apply Pay right because we have any special talent for making predictions. We simply used a toolkit—the theory of multisided platforms and relevant empirical evidence—that is available to everyone now to look under the hood of platform businesses.
Any executive scared about platform disruption, VCs getting ready to lay money down on the Uber of “X”, CEOs being pitched to start a matchmaker business, and entrepreneurs getting ready to work night and day to get their platform ignited would benefit from using it. None will get certainty, but they’ll improve the odds of separating likely failure from possible success. Most importantly, though, matchmaker-wannabees can use the new matchmaker economics to get their business model and strategy right in the first place.
Original source Harvard Business Review