Apple (AAPL, Financial) has had a long history of coming up with cutting edge products that have drawn a cult-like following. Due to its strong brand recognition, it seems that any product the tech giant develops usually attracts customers in droves more so in markets others have failed. Take for example the smartwatch that was recently launched -- over one million orders were booked, effectively making Apple the biggest smartwatch maker in the world.
After following Apple Pay’s progress for some time now, I am inclined to believe that it doesn’t fall into the category of products mentioned above and I’m going to explain why. While the announcement of the launch of Apple Pay did generate quite a lot of enthusiasm from different quarters, uptake of the technology has been somewhat sluggish. This can be attributed to a number of factors such as the system’s dependence on the iPhone ecosystem and the fact that mobile payments haven’t yet attained mainstream status.
The latest figures show that Apple Pay accounts for about 40% of contactless payment transactions, which although may sound like good news to investors, it should be no cause for celebration. It is going to take a long time before we see a meaningful impact on Apple’s top line as a result of Apple Pay. The counter argument to this assertion has been that the service is bound to exhibit exponential growth once it starts expanding to other regions outside the U.S. In what is likely to be seen as a step towards this goal, Apple has announced that it will be rolling out Apple Pay in Canada around November this year.
It seems that Canada was the logical choice as Apple Pay’s first international expansion destination based on the fact that it’s an early adopter of the service’s POS technology and also has a significantly high number of iPhone users. While the move into Canada signifies Apple Pay’s growing momentum, investors should avoid getting overly optimistic on its prospects as there are plenty of headwinds that first need to be overcome.
iOS factor and banks present major headwinds
As mentioned earlier, one of the inherent drawbacks of the Apple Pay system is that it is a closed system meaning that it only works on Apple devices. This may be the biggest problem if a recent report by IDC is anything to go by. Google’s (GOOG) Android powered 1.1 billion devices in FY2014 representing a 32% y-o-y increase when compared to 2013 while iOS powered 192.7 million devices, a 26% increase from the previous year. Consequently this resulted in Android capturing 81.5% of the OS market while iOS was left with 14.8%.
What makes these figures interesting is that it’s clear that more people are choosing Android over iOS which is mostly attributed to the pricing difference. This essentially means that for every one iOS user, there are five more Android users which effectively limits the size of the mobile payments market that Apple Pay can effectively hope to capture. With the introduction of high spec devices at substantially lower cost from makers such as Xiaomi, Lenovo and Huawei it’s no surprise that iOS is losing market share.
With Android dominating the OS market especially in markets outside the U.S, it would make little sense for vendors to adopt the Apple Pay POS system. No matter how many partnerships Apple strikes with payment processors, the number of transactions it’s going to capture will always be limited by the number of iOS users. A viable solution to this problem would be opening up Apple Pay to other platforms to bridge the gap in users (though this is unlikely in my opinion).
Banks who seem to be the major losers in the Apple Pay chain may prove to be a major challenge in the long term. For every transaction made with Apple Pay, banks lose a small percentage of the revenue that would otherwise be accrued to them. This is also what has been holding up plans for expansion into Europe and China as banks believe the fees charged by Apple Pay border on the exorbitant side. Yes, the Apple Pay system seems like a great idea but in reality, the service doesn’t move the needle in terms of mobile payments volume. This may be why banks are skeptical of partnering with Apple Pay as well as the belief that it may lead to other complications. Banks may also be reluctant to have Apple Pay “come between their brand and their customers,” said Greg Weed, director of Card Research at Phoenix Marketing International.
Also, a good deal of banks and businesses are also pushing their own apps which run on Android and other platforms as they hope to keep a solid connection to their customers. Ultimately, banks will want to retain as much interaction with their customers, something that increasingly looks difficult to do once they adopt Apple Pay for all their payments.
With regulatory concerns having stalled expansion plans into China, Apple Pay needs to quickly get back to the drawing board as a new threat has emerged. Earlier this month, China’s biggest smartphone maker Xiaomi announced a partnership with Alibaba’s AliPay that would see it make a wearable bracelet that could be used to make contactless payments. In my view, this will be Apple Pay’s biggest hurdle yet not only in China but also internationally as the two reportedly have plans to expand outside China. Should the partnership fast track the bracelet’s development, there is no doubt that Apple Pay will be in for an uphill task.
Conclusion
In the mobile payments debate, one thing is increasingly becoming apparent and that is the market is there and steadily growing. However, for Apple Pay to come on top, a number of significant changes to the system need to be implemented beginning with opening it up to other platforms. While Apple Pay may sound like an extremely great idea in the U.S, once it crosses the borders its popularity plummets exponentially.
Investors watching Apple need to be aware that there will be numerous challenges in its expansion plans for Apple Pay especially now that Xiaomi and AliPay have joined the battle. In my opinion if Apple Pay doesn’t undergo significant changes, it may end up going the way of the Google Wallet.
