It was almost impossible to miss Apple’s product announcements yesterday. The usual new iPhones but also an Apple Watch that itself offers fascinating innovations in the user interface; but that is something that I’ll look at another day.
From an economics perspective, however, the biggest news was Apple Pay and near as I can tell the commentary has missed the importance of this. If particular, the commentary has missed what problem Apple Pay solves. And the answer is: the identification challenge.
The identification challenge (and economists will be familiar with this) is working out if X ‘caused’ Y. Of central importance in the economy is working out if a particular person (X) caused a purchase (Y). This ensures, in particular, that the person who acquires a good or service actually pays the merchant selling it. Cash does that job but cash has some insecurity built into it as it can be easily lost or stolen. Credit cards do this in a different manner: by providing a means of identifying the particular person and assuming that identification is correct; in other words, causal in the manner everyone is relying upon. It does this (a) by having a physical card andusing a signature, pin or physical swipe of that card or (b) having the card number, a security code and other identifying information. But in each of these there is a possibility that another person may substitute themselves in as the intended particular person (i.e., identity theft or fraud) in which case the inference is wrong. This has been handled traditionally by the card issuer being responsible for those mistakes or security issues. Consequently, it was up to them to build some of the cost of that into the charges (i.e., the interchange fee) it charges merchants who accept cards. There are other costs in payment systems to be sure but a failure to perfectly solve the identification challenge is a big one and it impacts on everyone who takes part in the system.
Apple Pay as we saw it demonstrated makes transacting with a credit card dead easy. Take out your phone, put you thumb on the Touch ID, touch the phone to the card pad and you are done. Apple Pay also has an API for third party apps which means you can use Touch ID to pay instantly from an app. It is arguable that ‘ease of use’ was one of the reasons why Google’s attempted mobile payment solution using NFC did not take off; put simply, by the time you take out the phone, open the app and put in the pin, you may have well just taken out a credit card. So Apple’s solution looks like it will be an easier sell and may drive some adoption. But don’t hold you breath. It will take some time before iPhones capable of this are in the hands of a critical mass of consumers.
This is why I think the resolution for the identification challenge is more significant. Last year, with the iPhone 5s, Apple finally got fingerprint recognition right. Last week I actually had to use a iPhone 5c for a few days without Touch ID and I couldn’t believe how much I had learned to rely on it. It really does work and you really do use it and it really is less hassle than a pin or even swiping to unlock the phone. But the security issues were not paramount but a fortunate side product.
Now they are paramount and what is more Touch ID solves the identification problem. It is really hard for criminals to spoof it or steal your identity using it. They would literally have to hold a gun to your head or take a hostage and, frankly, at that point, they are better off just robbing merchants directly.
With that in mind think about what Apple can offer payment networks (banks, AmEx, Visa and MasterCard). Those fees they have to build in to account for fraud — and apparently much of that occurs when merchants or store clerks get to see your card and other information — can be eliminated when Apple Pay is used. Indeed, if Apple has indeed solved the identification problem, Apple can offer to assume the fraud risk on Apple Pay accounts. That means that Apple can pocket on each transaction some portion of the previous cost assigned to fraud. We are unlikely to get a sense of that until it shows up on Apple’s balance sheet in a few years time, but if I had to guess, this is why Apple was able to get the major payments systems on board. It costs them nothing, allows them to reduce costs, and also assists them in driving merchant adoption of technologies that will reduce fraud both for physical and online payments. This is the big news here and Google and others are far behind on this one.
I expect we will see Touch ID on iPads and all Macs soon and that will have a major impact on payments online. Indeed, I have to wonder whether Amazon may jump right into it.
Which brings me back to the Watch. (By the way, for we bloggers writing about this, Apple Watch is a terrible name compared to iWatch or, for that matter, iPay. I wonder, in fact, if the Apple assigned names will stick). The Watch will allow the consumer to pay for things by tapping the card terminal with a double tap of some button on the Watch. That seems easy but there is a missing element in the picture: identification. Even if your phone is proximate, to get proper identification, you would need to reach into your pocket or bag and touch the Touch ID button. You may as well just use the phone. So that doesn’t sound like how it will work.
So how will Apple solve the identification issue with a Watch given that they didn’t put Touch ID on the Watch itself? My guess is that it will use heartbeat identification. The iWatch has built into it a heart monitor. That has currently been sold as a health feature (or a strange alternative to ‘Yo’) but, in fact, you can identify a person by their heart rate. A prominent graduate of the University of Toronto’s Creative Destruction Lab is Bionym. They have patented technology that allows such identification and have built it into a soon to be released band called Nymi. Here is a video demonstrating it:
Bionym has a solution to the identification problem. The technology itself can surely be put into the iWatch. I have no special knowledge on this — I imagine that the venture would be subject to lock-hard secrecy — but one can imagine the patent that does this is a licensing opportunity for Apple here. What is more, if the Nymi is released as intended, then it is the solution Google and others can use too. In fact, it has more potential in this regard than Touch ID.
I guess we will find out next year. But the point here is that yesterday Apple launched the most significant innovation in payments since the credit card itself. Few people have noticed and that includes the market that took Apple stock on its traditional, post-announcement, plunge.