Where is the Next-Generation Wallet?

Why Contactless and Mobile Payments Have Lagged Behind in Consumer Adoption

In the United States and around the world, financial institutions and non-banks are considering how and to what extent they should incorporate mobile financial services into their business models. With worldwide mobile subscriber penetration rates surpassing 50 percent in 2008, these decisions take on an even greater importance for competitive institutions. The evolutionary path plotted by mobile banking and mobile payments can be very different, depending on a variety of factors, including a market’s level of banking sophistication, available technologies and experience with antecedent products, services or technologies. This “experience” provides a way to think about the trajectory that mobile banking and mobile payments may follow with regard to consumer adoption in the United States and around the world. To examine how consumer experiences influence adoption of mobile financial services, we will examine the U.S. market for mobile banking and mobile payments.

Experience is Everything

As a framework for considering trends in consumer adoption of mobile banking and mobile payments, one must fully understand the concept of “experience goods.” The term was first introduced by renowned economist Phillip Nelson, who built on prior work by George Akerlof, arguing that consumers are unable to evaluate the quality of an intended purchase if they haven’t had experience using that good. Indeed, consumers’ experience with financial services and with aspects of mobile communications — both the instrument itself and the technology and functionality provided as part of the service — have helped to shape the adoption pattern for mobile banking and mobile payments in the United States.

The Almost Ubiquitous Mobile Phone

In the United States, consumer adoption of mobile phones continues to increase. As of June 2008, 84 percent of the U.S. population, or 262.7 million people, were wireless subscribers, a seven-fold increase in subscriber base during the past 12 years, according to CTIA, the International Association for the Wireless Telecommunications Industry. Also as of June 2008, CTIA reported that 15.8 percent of U.S. households were wireless-only households, more than double the percentage from June 2005.

As more and more U.S. consumers become mobile phone users, they also have the opportunity to build experience with a variety of technical functionality, such as SMS text messaging, wireless Internet access and near-field communication (NFC). For example, CTIA estimated that SMS text messages in the United States increased from 57.2 billion in 2005 to 600.5 billion in 2008. Moreover, the U.S. mobile customer base is also building experience accessing the Internet using their mobile cellular phones. A survey conducted in December 2006 reported that, in the United States, 71 percent of mobile cellular phone subscribers have Web-enabled phones and 41 percent had used this functionality.

As consumers become increasingly familiar with using these technologies for non-financial purposes, such as sending non-verbal text communications to personal or business contacts or accessing Web sites for e-mail, search results, maps, directions, sports scores and so forth, these experiences could also translate into a natural extension toward mobile banking and mobile payments.

Mobile Banking: A Case in Point

By definition, mobile banking requires that a person have access to a mobile device and be a bank account holder. If these two prerequisites are satisfied, consumer experience with using the Internet, generally, and with using it as a channel to perform bank-related transactions may help spur adoption of mobile banking. Also helpful to adoption are consumer experiences with the tools necessary to access mobile banking functionality, for example, SMS text messaging. In the United States, many banking customers are also online banking customers and are familiar with using the Internet as a way to conduct a number of banking activities, including managing their accounts, tracking transactions and account balances, and transferring funds. The convenience of the online experience has led to its increasing use by consumers in countries that have a high rate of Internet access and a large population with established banking relationships, such as is the case in the United States. Additionally, as Internet access has moved from slower dial-up connections to faster broadband technology, such activities have become easier and faster to complete. Also, as previously noted, U.S. consumers are increasingly familiar with their mobile cellular phones’ “cool” functionality, allowing users to send SMS text messages and to access information on the Internet, both of which are likely ways that consumers will execute mobile banking transactions.

While consumers’ use of online banking and mobile technology may lead some to use mobile banking, widespread adoption of mobile banking in the United States is only likely to occur if consumers also find that the ability to access their banking information from anywhere, at any time, is useful and the industry has sufficiently addressed consumers’ security concerns. Only then will the foundations of experience be best positioned to help encourage consumer adoption of mobile banking.

Mobile Payments — Still a Work in Progress

Consumer experience with the building blocks of mobile payments is less clear when proximity payments — mobile payments made at the point-of-sale — are considered. Today, these types of payments rely on near-field communication or “contactless” technology. An initial objective for this technology was to help convert small-dollar cash payments — say, at quick service restaurants — and even micropayments, to card payments. Not only are contactless payments substantially different from Internet-based mobile functionality, they are also dissimilar to either SMS text messaging or mobile Internet access in that the consumer experience did not graduate from a non-financial environment to one that can be considered a mobile financial service. Therefore, consumers have not had the opportunity to become comfortable with contactless payments as part of a broader mobile banking backdrop or for anything other than as part of a purely payment-transaction environment. For this reason, consumer experience with contactless payments has tracked the development of the contactless environment in the real, as opposed to the virtual or mobile, world.

In the real world, or physical environment, several hurdles limit broad adoption of contactless payments in the United States. Many of these stem from the economics of the contactless business model as it relates to merchants, who have terminal upgrade and other acceptance costs on the one hand and insufficient adoption incentives on the other. For example, merchants must upgrade their existing terminals but pay the same acceptance fees for contactless payments as they do for traditional swipe payments. As a result, there is little incentive to switch. In addition, the networks and the regulators have made it easier for merchants to quickly process credit and debit card transactions because small-dollar payments do not require receipts. This flexibility hinders the adoption argument — that contactless payments will help more quickly process payments at the point of sale — made by issuers to merchants.

Mobile proximity payments in the United States are also challenged by coordination issues in this market. Because many industries may participate in these programs, including financial services firms (both banks and non-banks), telecommunication companies, technology providers and handset makers, the market is often fairly complex. For example, one coordination issue relates to how telecommunications companies and card issuers address the business model economics for these programs. On the one hand, telecommunications companies control the mechanism through which such mobile payments are initiated: the mobile phone. On the other hand, bank card issuers or their card networks are responsible for all aspects — authorization, processing, settlement, fraud risk and customer service — of the banking or payment process once instructions have been transmitted from the mobile cellular phone to either the financial institution or the merchant terminal. Therefore, the question arises as to how to share revenue among these parties and how to determine who owns the customer.

Overall, in the United States, adoption of mobile proximity payments, while seen as desirable among consumers who have participated in trials, is still uncertain in the near term. Instead, initial consumer adoption of mobile payments may be driven in either — or both — the mobile banking arena or the remote mobile payments environment, where a consumer can initiate a payment using SMS text messaging functionality in combination with Internet access or a downloadable application.

A Question of When

A question frequently asked in payments circles is whether the mobile phone can really become the next generation wallet, securely carrying all the essential information and providing the necessary functionality to facilitate banking and payment services. The next question is when such a transition will happen. The theory of experience goods provides a framework with which to consider the building blocks of experience that may influence the path consumers take toward adoption of mobile financial services in the United States.

Ultimately, greater adoption will rest on the ability of diverse and often isolated market participants and their regulators to work together in order to combine a telecommunications device and a payment process into an innovative way that connects consumers, merchants and banking and payments providers.


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About the Author Julia Cheney is an industry specialist with the Payment Cards Center of the Federal Reserve Bank of Philadelphia.