FIVE KEYS TO ADVANCING MOBILE PAYMENTS

FIVE KEYS TO ADVANCING MOBILE PAYMENTS BY MATO HOSHINO In the past decade, consumer adoption of smartphones and tablets has reached a saturation point. More than 80 percent of all smartphone owners say it is now central to their daily activities. 1 However, while using mobile devices for payments is high on the awareness scale, it has not yet gained large-scale traction with consumers in many countries. Actual usage reports have been limited to anecdotes and low-level participation data. Like any other mobile usage pattern, mobile payments will eventually gain that consumer traction. Financial institutions must be prepared for an eventual migration to mobile payments. A number of new players have entered the mobile payment market, most recently and significantly Apple. Mobile payments in general can pose a direct challenge to financial institutions. They have traditionally used their payment accounts to strengthen relationships with consumers and as a platform to cross-sell additional financial products. If alternative transaction processing providers succeed in routing payments outside the traditional infrastructure, financial institutions risk the potential for losing a key factor in the strength of their relationship with consumers. Financial institutions can embrace and advance their mobile payment offerings. We have identified five practical lessons learned from Japan and other countries to develop mobile payments without losing relationship strength....in JAPAN, THE MAJORITY OF MOBILE PAYMENTS ARE CONSUMER-TO-BUSINESS MICRO PAYMENTS IN THE RANGE OF $5-$20, MUCH SMALLER THAN THE AVERAGE TRANSACTION SIZE OF MOBILE BANKING AND CONVENTIONAL CARD PAYMENTS. 2 LESSON 1: ACKNOWLEDGE CONSUMER NEEDS AND EXPECTATIONS Consumers will approach mobile payments with different attitudes and expectations than other payments, such as cash, card, or ecommerce. Mobile devices are in effect powerful, networked computers that can support many technologies and work through many different channels. They present a clear distinction versus traditional face-to-face and electronic payments, which serve a more specific purpose. For example, chip-based contactless technology has a defined role at the point of sale, but is not necessarily required to facilitate remote transactions. Mobile payments can address multiple use cases for payments between consumers, businesses, and government. It is important to identify and prioritize the use cases based on real needs. For example, mobile payments can support micro payments, where the emphasis is on convenience, best served by a tap and go function without needing a PIN or signature. In Japan, the majority of mobile payments are consumer-to-business micro payments in the range of $5-$20, much smaller than the average transaction size of mobile banking and conventional card payments. 2 Japanese consumers typically use automatic charges in which the mobile prepaid balance will be automatically charged from a registered credit card when the balance falls below a minimum threshold amount. Of course the latest development here is Apple Pay. Typical mobile contactless payments require users to register name, address, card number etc. on small mobile devices. However consumers can use their itunes card info for Apple Pay, or just take a photo of a plastic card, rather than inputting 16 digit numbers. 3 Apple Pay also has several solutions for secure payments. Consumers can tap a finger when they purchase at a POS, without a PIN or signature. 4 They can block and erase token data, if the iphone is lost or stolen. Also they do not need to disclose their token or personal information to merchants, and others cannot use the token in another device, because the token will be only valid for payments by dedicated device. 1 GLOBAL INSIGHTS ADVANCING COMMERCE

A good example of the importance of acknowledging consumer needs can be seen in bitwallet s promotion of Edy, a contactless prepaid solution using FeliCa technology, as a means of payment for conventional ecommerce purchases (remote payments) by contactless reader on home computers, customer adoption was slow. 5 But after purchasing the Edy business, Rakuten, the number one ecommerce player in Japan, succeeded in using Edy to meet mobile gamers unique needs. 6 Through the use of a combination of technologies available on the mobile device, Rakuten was able to deploy Edy as a mobile payment solution that enabled this niche customer segment to pay for and play mobile games. LESSON 2: UNDERSTAND MERCHANTS KEY CONCERNS To succeed in mobile payments, it is essential to consider the concerns of all stakeholders within the ecosystem. However, merchants are particularly important as they will ultimately determine the payment type supported from a merchant s perspective and the payment type that is selected by the consumer when presented with a choice. Three questions are central in their decision-making processes: Is it convenient? Is it beneficial? Is it secure? Convenience is a key criterion for both merchants and consumers. For example, merchants with limited physical space may prefer an acceptance terminal that fits into their counter space and can process multiple types of payments. Consumers may prefer mobile payments if they re easy to use and add value to their shopping experiences. Hana SK in Korea is a good example of addressing convenience from both angles. Its POS terminals are easy for merchants to use and can accept all types of payments including credit/debit/prepaid across brands and schemes. At the same time, its mobile payment solution allows customers to scan QR code or NFC tag in-store, compare prices online instantly with other stores, complete the purchase online, and save customers the effort of carrying the goods home. 7 Benefits: Merchants often compare mobile payment terminal costs and fees with other forms of electronic payments. However, mobile payments are often used as a substitute for cash, which is often a more expensive medium of exchange. 8 Meanwhile, consumers often require an additional incentive to form a new habit and adopt a new means of payment, such as mobile. JR-EAST, a railway operator in Japan, achieved a positive benefit using mobile payments. While it invested Yen 13 billion (USD 130 million) over five years to introduce its prepaid card and mobile payment solution, Suica, the company reduced the operational costs associated with producing paper tickets, deploying ticketing machines, and maintaining gate machines. 9 At the same time, customers were offered triple reward points, top-up and usage of prepaid card, and Suica mobile payment loyalty points. Each reward earns one reward point; purchasing at partner merchants earns another reward point. The triple-point scheme encouraged customers to adopt electronic and mobile payment methods, as well as improved customer loyalty. 10 Security is critical. Merchants and consumers need to feel confident that the opportunity for fraud or other operational losses is kept to a minimum. To ensure security, NTT DOCOMO has deployed a number of technologies, such as PIN for accessing mobile/ charging, fingerprint and facial recognition, and using the GPS location of the handset. 11 Customers may not be aware of all the technical security measures put in place trust is therefore a key differentiator that favors large, established brands. 2 GLOBAL INSIGHTS ADVANCING COMMERCE

LESSON 3: CHOOSE THE RIGHT MOBILE PAYMENTS PRODUCT A variety of different mobile payments products have emerged, reflecting different market situations and the strategic aims of the organization responsible for its introduction. We have identified five categories in the diagram below: Mobile Banking, Mobile Wallet, Contactless with Chip, System Substituting Banking, and Mobile POS. Issuing/Acquiring Acquiring Mobile Banking Mobile Wallet Contactless with Chip System Substituting Kaching PayPal, Bump, PayPass TM, Suica, Banking HanaSK (online) Edy M-Pesa Mobile POS Square, izettle TRANSACTION INTERFACE CHARGING/ CLEARING Mobile Banking Apps Alternative Payment Mobile Apps Alternative Payment Mobile Apps Credit/Debit Card Prepaid Post-Pay By Chip Credit/Debit Card POS Terminal Mobile Banking Apps Prepaid Post-Pay By Chip Credit/Debit Card POS Terminal SETTLEMENT/ CASH OUT Bank Account Bank Account, Transfer Bank Account, Transfer Bank Account Partner, e.g., Grocery Stores Bank Account, Transfer In Detail: Mobile Banking is an alternative payment channel. For example, the Commonwealth Bank of Australia launched Kaching, an integrated mobile banking solution that allows face-to-face and remote payment, Bump payment, and payment to a mobile number, an email address, or even a Facebook friend. The Kaching app was downloaded 300,000 times in the first six months, 12 helped by a large mobile banking population and strong customer appetite for an innovative payment product. Mobile Wallet can supplement traditional ecommerce. One case is PayPal under ebay, where the payment service is core to the ecommerce site. Now PayPal is trying to expand its business into the physical environment with Bump payment, where money can be transferred by bumping two smartphones together, and Beacon technology, which uses Bluetooth for communicating proximity-based offers. Starbucks is perhaps one of the most successful users of the mobile wallet, which links online gift cards and loyalty to its in-store mobile payment application. The success of this mobile wallet can be attributed to a strong merchant and consumer proposition shortening queue times, lowering the cost of payments, and building customer loyalty through rewards. 13 Contactless with Chip: This typically works well for large chain stores and transit, particularly in highly populated areas that require efficient acceptance. JR EAST acquired over 3 million customers on mobile Suica. 9 It has achieved high penetration in mature, densely populated economies such as Tokyo, Seoul, Hong Kong, and Singapore due to investment in terminals by non-transit merchants to support low-value payments. In Japan, mobile payments linked to loyalty propositions have been instrumental in delivering optimal inventory management for convenience stores where stock supply is critical due to limited shelf and storage space. Mobile System Substituting Banking: This has been successful in African and Asian under-banked regions with high mobile penetration. Customers are able to send money through SMS and withdraw cash from partners such as small independent general stores. A good example is Kenya s M-Pesa, used by two-thirds of the adult population in a country where less than 10% have a bank account. Over time the use cases have evolved, from supporting airtime transactions, to sending money from person to person, to paying utility bills, 14 and ultimately are expected to migrate from closed-loop to open-loop payment systems. 3 GLOBAL INSIGHTS ADVANCING COMMERCE

Mobile POS: This targets small-merchant acceptance, allowing smartphones and tablets to function as card processing terminals, with lower-cost card acceptance as the initial incentive. The US market has seen the greatest adoption to date for three reasons: high card usage, high smartphone penetration, and the predominant use of magnetic stripe cards, which lowered the technical barriers. Solutions that work with chip-based cards are now gaining traction in other markets, such as izettle, based in Northern Europe. 15 LESSON 4: SELECT THE RIGHT PARTNERS For any payment system to succeed, each partner needs to receive an equitable share of the rewards, given the contribution it makes. Two types of partners are believed to be critical to a successful mobile payment proposition: agents and merchants (especially for Mobile Wallet/Contactless/System Substituting Banking). The agent s role is to sell the mobile payments application to consumers and install the user interface in the mobile phone (if required). Agent strategy becomes more critical for those who do not have a significant branch network or presence in certain key customer segments. Large merchants are uniquely positioned with access to a significant number of end consumers and are a key path to building trust and driving adoption at an early stage, including the education of consumers at point of sale promoting the use of mobile payment. Apple Pay supports consumer credit and debit cards from the three major payment networks, American Express, MasterCard and Visa, issued by the largest issuers in the U.S. including Bank of America, Capital One Bank, Chase, Citi and Wells Fargo, representing 83 percent of credit card purchase volume in the U.S. It has been reported that fees on this service are not charged to consumer or merchant, and will focus instead on issuing banks. 16 On the other hand, large changes like network level tokenization have been accomplished on the supplier side led by Network Brands, which uses a token for communication between issuer and acquirer. 17 Of course banks are chasing this opportunity. LESSON 5: BALANCE TACTICAL DEPLOYMENT VS. COMPREHENSIVE SOLUTIONS Deploying tactical solutions can bring first-mover advantages. Taking the example of mobile contactless payments, two tactical solutions have been used to speed up the market entry process. NFC Sticker Built-in Chip FUNCTIONS Single application Typically without integration with phone (some with Bluetooth) Multi-application Full integration with phone (communication) COST & CHALLENGES Low cost (~$5) Convenience for consumer (just attach) Widely used for any handset Low cost Convenience for customer (initially set/some settings) Need full tie-up with mobile carrier and handset maker (not on iphone 5s) 18 4 GLOBAL INSIGHTS ADVANCING COMMERCE

An NFC Sticker does not require negotiation or collaboration with any handset manufacturers and works on any mobile device. At a quarter of the size of a normal credit card, it can be attached to a handset, can be used with or without an accompanying app, and is relatively cheap at a one-off cost of $5. Garanti Bank of Turkey was one of the first banks to roll these out successfully. 19 NFC in Apple Pay is a Built-in Chip type, which is pre-installed in the iphone6, iphone6 Plus, and Apple Watch TM. There had been talk that it would enter the payments business, but its current strategy is consistent with Apple s winning pattern Not trying completely new technologies, but try to penetrate to Early Adopter / Early Majority by epoch-making usability which was observed in ipod and iphone as well. According to Innovation Theory, new services will be adopted by Innovator (2.5%), Early Adopter (16%, accumulated), Early Majority (50%, accumulated). The mobile payments users were 17% in 2013, up from 15% in 2012 out of 87% mobile users within adults in U.S. 20 Thus Apple might have waited for the right time for Apple Pay s introduction. A Built-in Chip is pre-installed in the handsets from the start, hence providing immediate access to mobile payment and m-commerce once provisioned over the air. For example, NTT DOCOMO in Japan collaborates with handset manufacturers to provide the built-in chip as a semi-open-loop payment scheme. 11 Consumers can register multiple contactless schemes and use them at acceptance locations. CONCLUSION Mobile payments are still a relatively new phenomenon for consumers. A variety of approaches are available, and dominance by a single player or solution is uncertain at this stage. These five lessons for those considering mobile payments will not guarantee success. Organizations will need to be creative and flexible, as new technologies and use cases emerge, and foster a corporate culture that encourages learning by trying different approaches. Further, it is unlikely that those that try to act independently will be successful collaboration within the organization and outside will be needed to develop a strong mobile payments ecosystem. ABOUT THE AUTHOR Mato Hoshino Senior Managing Consultant, MasterCard Advisors AP Mato_Hoshino@mastercard.com Mato Hoshino has worked as a strategy consultant for more than 10 years and in the financial industry for about the same amount of time. Mato has expertise in new business development and marketing across industries. This document is proprietary to MasterCard and shall not be disclosed or passed on to any person or be reproduced, copied, distributed, referenced, disclosed, or published in whole or in part without the prior written consent of MasterCard. Any estimates, projections, and information contained herein have been obtained from public sources or are based upon estimates and projections and involve numerous and significant subjective determinations, and there is no assurance that such estimates and projections will be realized. No representation or warranty, express or implied, is made as to the accuracy and completeness of such information, and nothing contained herein is or shall be relied upon as a representation, whether as to the past, the present, or the future. 5 GLOBAL INSIGHTS ADVANCING COMMERCE

APPENDIX: SOURCES OF INFORMATION 1. ExactTarget 2014 Mobile Behavior Report, page #6 http://www.exacttarget.com/sites/exacttarget/files/deliverables/etmc-2014mobilebehaviorreport.pdf 2. Rakuten research Internet inquiry on e-money (in Japanese) 3. Apple Press Info Apple Announces Apple Pay, September 9th 2014 4. MasterCard News Release MasterCard Works with Apple to Integrate Apple Pay, September 9th 5. Nikkei Trendy 2008.5.14 Questionnaire on e-money. Only 8.4% of holders use e-money for Internet shopping, compared to 75.9% for transit, 56.5% for convenience stores (in Japanese). 6. Rakuten Edy press release 2010.11.24. Nikkei article (in Japanese) 7. NFC World, Hana SK card website http://www.nfcworld.com/2010/02/22/32875/sk-telekom-hana-financial-to-launch-mobile-contactless-service-in-march/ http://www.nfcworld.com/2011/03/28/36656/sk-telecom-q-store-retail-nfc-browse-in-store-buy-online/ 8. European Commission Survey on Merchants Costs of Processing Cash and Card Payments 9. Impress interview to JR EAST 2011.8.17, JR EAST Technical Review 2003, Yano research (in Japanese) 10. Creditcard-kingdom.net (in Japanese) 11. NTT Docomo report 2009.7.1 5 years history of mobile wallet (in Japanese) 12. CBA website. Panel discussion in SIBOS Osaka in Oct/ Nov 2012, GIZMODO Australia 2011.10.25, 2012.7.5 http://www.commbank.com.au/mobile/kaching.html 13. PayPal website https://www.paypal.com/webapps/mpp/home Techcrunch.com 2012.3.29- Bump pay lets you PayPal someone with a tap. http://techcrunch.com/2012/03/29/bump-pay/ 14. Safaricom website 15. Square website, izettle website https://squareup.com/ https://www.izettle.com/ 16. Wall Street Journal September 9th 2014; http://online.wsj.com/articles/apple-introduces-payment-service-called-apple-pay-1410286677 17. Clover developer s blog; http://clover-developers.blogspot.jp/2014/09/apple-pay.html 18. NFC World http://www.nfcworld.com/2013/09/10/325859/nfc-iphone-5s/ 19. Garanti Annual Report, MasterCard Advisors case study http://www.garanti.com.tr/en/our_company/investor_relations/financials_and_presentations/annual_reports.page 20. Federal Reserve Consumers and Mobile Financial Services 2014 ; http://www.federalreserve.gov/econresdata/consumers-and-mobile-financial-services-report-201403.pdf This document is proprietary to MasterCard and shall not be disclosed or passed on to any person or be reproduced, copied, distributed, referenced, disclosed, or published in whole or in part without the prior written consent of MasterCard. Any estimates, projections, and information contained herein have been obtained from public sources or are based upon estimates and projections and involve numerous and significant subjective determinations, and there is no assurance that such estimates and projections will be realized. No representation or warranty, express or implied, is made as to the accuracy and completeness of such information, and nothing contained herein is or shall be relied upon as a representation, whether as to the past, the present, or the future. 6 GLOBAL INSIGHTS ADVANCING COMMERCE