Apple's New Strategy to Boost Adoption of Apple Pay

Apple is the leader in so many segments of the technology world.  With the surge in online shopping and mobile payments for merchandise and services, companies such as PayPal have been able to lead the way in profiting off the fees that accompany those billions of transactions.  Not to be left out of the action, Apple Pay was launched last year to compete with PayPal and others, but has been met with lackluster interest and users have been slow to come on board.  

So as one would expect, Apple is responding with a business strategy that the company hopes to greatly increase the overall adoption of Apple Pay, by tapping into the unprofitable business of person-to-person payment services that are increasingly being used by consumers to reimburse friends for dinner and movie tickets with the click of an app.  While these transactions are not generally profitable because they charge little or no transaction fees, there is still money to be made and the leaders in that market, PayPal and Venmo confirm that those users are some of their most engaged customers, spending more money with them overall.  So to get a piece of the action, Apple not only plans to offer person-to-person transactions, but to do it for FREE.  Although Apple will lose money on each transaction, by adding the ability for owners of newer iPhone models to send each other money could double the usage of Apple Pay by those users in as little as 18 to 24 months, and could “short-circuit the existing players,” according to Richard Crone, Chief Executive Officer at Crone Consulting. 
Apple’s business strategy is a great example of the use of penetration pricing to penetrate the surging market of online payments and the related transaction fees, and gain a critical mass of customers for Apple Pay.  Once Apple has gained those customers by offering the service for free, it is banking on those same customers using Apple Pay in stores, which is a real moneymaker as they charge bank fees each time customers tap their phones to pay.   It’s a smart strategy to lure customers away from the competitors, and after their first year of lackluster results with Apple Pay, it’s certainly a strategy that they estimate will be well worth the costs.
Kharif, Olga (2015) Why Apple Wants to Get Into the Unprofitable World of Payments Between Friends, Bloomberg Business, December 1, 2015.


Dr. Tufte said...

Reddish-Day: 100/100

I am dubious about this whole thing. I'm not sure if I'm dubious of Apple's managers, or the source article, or Reddish-Day.

I am not sure how you can refer to this market as "... are not generally profitable ... [while] ... there is still money to be made". It sounds from what you say in the next few lines that PayPal and Venmo make quite a bit of revenue off this market, but that it doesn't cover costs. Is that more correct?

I wonder why it is in Apple's interest to double usage of Apple Pay. I agree that this might "short-circuit existing players", and that might be a good thing for Apple's ability to charge a mark-up.

I do think it makes sense for Apple to manage this way if they think there will be network externalities associated with their service. I'm not sure if there will be or not. Obviously, there may be if Apple Pay is both closed to other transactions networks, and fairly good at what it does. But I wonder if the being closed to other networks conflicts with their strategy to increase users.

Then there's the whole bit about penetration pricing. I'm not sure that really applies here. I see more of a bundling issue. Penetration pricing is about offering a discount to get people to try your product before you charge them the regular amount on the same product. But this is more like loss leadership: offering one item at a low cost that is bundled with other items with higher mark-ups

Then there's the presumption of persistent mark-up ability. How is it that fees on P2P transactions have been driven to zero, while those between B2B customers have not been — even though the underlying marginal cost structure is similar for both? It seems to me that it might more naturally go the other way.

In the end, I'm not sure about any of this. But to me, the whole thing seems like a lot of wishful thinking.

Vickie said...

I am a huge Apple fan. I love the iPhone and iMac and everything in-between. But, I have not even once thought about using Apple Pay. I’m not sure why that is. I do currently use Venmo, Square Cash, and PayPal. I guess I just haven’t wanted to expend the effort to set Apple Pay up yet.

Additionally, both Venmo and Square Cash allow me to send money to family and friends with zero transaction fees. PayPal does as well. They only charge a fee for goods and services. I’ve often wondered how these companies can be making a profit. As Reddish-Day points out, it may be that these companies are taking losses on the consumer side to gain a large enough consumer base in order to tap into the business market. The business market, as odd as it may be, does still charge about a 3% transaction fee.

It will be interesting to see if Apple’s new strategy will double the amount of users within two years. Square Cash initially offered a $5 cash deposit straight into your bank account for every friend you referred to their service who used the service just once. I think I made about $20 the first week. Apple may have to adopt another, more aggressive, strategy to get users to switch over from their current providers.

As a side note, Apple Pay does incorporate Touch ID (the use of your fingerprint to authorize the transaction). As far as I know, no other providers are currently using this. This could be part of Apple’s product differentiation that encourages users to switch providers.

JP said...

It’s interesting to read about Apple’s strategy to compete in the payment-to-friends market. I did think it sounded like penetration pricing at first, so I appreciated Dr. Tufte pointing out that penetration pricing involves charging low prices at first to then charge higher prices later for the same product. The article points out that Apple hopes to lure customers away from competitors like PayPal and then make money from a higher volume of customers when they use Apple Pay in stores, since Apple charges banks fees for those transactions. I like the convenience of paying friends from my phone, and it will be interesting to see if Apple is successful with its strategy.

SpencerM said...

I think this new idea for Apple to join the person-to-person payment market will be very interesting. I agree with Vickie's comment that in order for Apple to actually succeed and reach their goal of doubling usage, they will need to have a pretty good incentive. I am a big Apple user myself, and I think the ability to use Apple Pay to easily transfer money from person-to-person might just be enough for me to finally set it up.

I personally don't like having my information in numerous companies' databases, and from what I can tell other people don't either. I think Apple is going to need to provide all the same services as Venmo and PayPal with additional security. If they can really convince consumers that their information is secure then I can see Apple Pay having success.

It seems to me that these companies are trying to become their own credit card service in a sense. They make their money by charging businesses a fee for allowing their customers to use their quick service. I am surprised that companies like American Express haven't developed their own money sharing services to try and get ride of Apple Pay.

I also agree with Dr. Tufte's point that by being closed to other transaction networks, their goal of increasing users may be hurt. I guess one way to look at it is the Apple "love group" may switch to using Apple Pay, whereas the Apple "sway group" may take more convincing to switch.

Dr. Tufte said...

Vickie: 50/50
JP: 50/50
SpencerM: 47/50 (you meant "rid" not "ride")


I don't think it's "odd" that B2B transactions are charged 3%, and P2P are charged nothing at all. I think it's something for which there's got to be good underlying economics. But I'm not sure what that is yet.

I do wonder whether it is just money down the drain. Basically, are all the firms betting that they don't have to monetize these transactions: if they're right, the get the benefits of network externalities and it won't matter, and if they're wrong they'll go bankrupt and lose someone else's money? There is some evidence to back that up. When we had the big tech bubble that broke around 2000, what we found out afterwards was that individual firms had values that were unrealistic, but that broadly defined industries did not have average valuations that were unrealistic. So maybe all the free P2P transactions are really just loss leading? But that is just a guess.


I didn't bring up penetration pricing, Reddish-Day (and the source article) did.

There's more to it than just charging low then high. You're charging the low price initially to get consumers to try your product. So you're overcoming some sort of hump: buying inertia on the part of customers, or difficulty explaining the advantages of your product without a "test drive". The whole idea is that the present value of the lower revenue stream now and higher revenue stream later is high enough to cover all your costs.


I like your addition that they are charging businesses a fee because they offer their potential customers a service. That's good. It means that the business demand is a derived demand and the consumer demand is not. That's getting us somewhere. But I'm not sure where :( This still comes back to the mark-ups. Somehow business demand is inelastic enough to make those mark-ups possible, and apparently sustainable. But generally, the elasticity of a derived demand depends intimately on the demand of the underlying product. So if business demand is inelastic, then consumer demand for this service probably is too. So I'm back to wondering why they just don't charge the consumers the mark-up, or split it more evenly between consumers and businesses.

And yes, it is like a substitute for credit card services. But I've never heard a decent explanation about why mark-ups mostly fall on businesses in that market either.

So I'm still perplexed.

David said...

As a consumer, I hate having to carry both my iPhone in one pocket and my wallet in the other. I have a George Costanza-style wallet that is full of credit and debit cards, receipts, store membership cards, a driver’s license, insurance cards, just to name a few (notice I didn’t mention cash). I would much rather carry only my iPhone. It is a slim, discrete, device that has the capability to do everything my wallet can, and much more.

I recently upgraded my phone to the Apple iPhone 6s, and last week I made my first purchase via Apple Pay. Having no previous experience using this payment tool, I walked up to the payment reader with some trepidation. I simply double-clicked the home button and held my phone up to the reader and—boom—that was it. My first Apple Pay experience. Moments later I received an email receipt of the transaction.

Apply Pay is not as familiar to consumers as other payment methods—for now. Our society has continued to move away from using cash as our primary tool in financial transactions. For Apple Inc. to be successful in this endeavor there are still many hurdles to overcome and issues to address. Ultimately, consumers will have to determine if the ease of the service outweighs the potential future costs. It is hard to believe that Apple will not charge fees on consumer-to-consumer transactions forever. This seems like an introductory promotion set up to encourage users to start using their service.

Dave Tufte said...

David: 50/50

Not much ManEc in here.

I do like the bit about your wallet. But the economics of that are that there's a transaction cost that you're putting up with in taking it around with you. To the extent that Apple Pay can substitute for that, they may be able to get you to pay for avoiding the transactions cost.

But, I wonder, in your case and for similar people if the amount they carry around in their wallets has less net costs than we suppose. Perhaps we just like that? If so, then there's less market for Apple Pay to improve upon.

mholley said...

I feel as though there has been a strong push in recent years to get people to use either Apple pay or Samsung pay. I personally have set up Apple pay on my phone but I have yet to use it. When the time comes to check out I usually forget that I have it on my phone or I just resort to my normal methods of pulling out my wallet and handing the cashier some cash. Apple does have a way of doing business that forces consumers to spend money to use their products. For example, when the new iPhone came out the charging mechanism was different and I had to purchase a new cord. Apple may ultimately do the same thing. Although they don't have any fees attached to using Apple pay right now, that may change once they have enough people using the product and decide to charge a small fee. I wouldn't be surprised if they charged a fee to cancel the use of Apple pay either.

Dave Tufte said...

mholley: 50/50

There's a bunch of buzzwords I can drop on this comment, but since the situation is still evolving, it isn't clear which ones will apply the best a few years down the road.

Clearly there some sort of sequential game going on here. Is Apple a first player? Do the have an advantage or disadvantage.

mholley's example of the power cord is, of course, an example of bundling. Apple is already known for that strategy.

And, mholley is right: perhaps Apple awaits a network externality that will make Apply Pay more valuable to consumers before raising its price.