Apple Pay

Icahn Gets Apple Pay Math Wrong

It’s way above my pay grade to weigh in on Carl Icahn’s proposal to Apple to accelerate its share buybacks. But the letter made for good reading, nonetheless. Someone did a whole lot of work to assemble a bunch of stats on Apple and its various products and market share. If you want the cheat sheet on the ten things that you need to know about what is in the letter, PYMNTS did a nice piece on it. Check it out here.

But the one thing that isn’t above my pay grade is weighing in on the rationale that Icahn used to support Apple Pay’s adoption and the billions of dollars he believes it will drive to Apple’s bottom line.

Let’s first start by looking at the excerpt from his letter that referenced Apple Pay:

“As the home represents one compelling category for Apple, payments represents another.

“Apple Pay will launch in October 2014, and while we expect limited financial impact in FY 2015 as retailers upgrade their infrastructure to incorporate the requisite near-field communications technology (NFC), we expect a more meaningful contribution in FY 2016 that accelerates into FY 2017 and the following years.

“We estimate that, based upon Apple Pay’s rumored fee of 15 bps of all spend on credit and debit cards (U.S. card spend was $4.2 trillion in 2012) and merchant deployment of NFC reaching 80 percent+ in 2017, Apple in the U.S. could generate revenues (also equivalent to gross margins, as the variable costs are de minimis) of $2.5 billion in FY 2017 if it reaches 30 percent market share of all spend on U.S. credit and debit cards.

“The potential in the U.S. and internationally over a longer term is much larger. Apple, dominant in the premium market, has customers who spend more on average than its peers, and it is therefore unusually well positioned to succeed with Apple Pay where others could not.” 

Let’s work backwards and take a look at what he said.

“Apple, dominant in the premium market, has customers who spend more on average than its peers.”

True enough that Apple’s customers do control more spend. Their users are more educated, make more money and by our calculations, control about two-thirds of the spend in the U.S.. We published a nifty chart last week that supports that assertion.  It’s also dominant in the premium smartphone market – in fact, it is the premium smartphone market.

“The potential in the U.S. and internationally over a longer term is much larger.”

Although that is indeed true, there is a huge “but.” Apple has a miserably low share of the smartphone market in countries outside of the US where it is Android land. I wrote a piece on this earlier in the week. In Europe, for example, Android has a 76 percent share and in China Apple is in teens. Apple certainly has its sights set on the global market, but for it to make money from payments, it will need to first sell iPhones. And, figure out a business model that isn’t based on a percentage of interchange. Or buy a payments network.

The story line sort of falls apart from here.

“… merchant deployment of NFC reaching 80 percent+ in 2017,”

Unfortunately, Icahn just used bad data. (And, I really hope Apple didn’t use the same data to build its financial models.)

One of my colleagues dug up the source that he believes was responsible for the 80+percent number. Apparently Berg Insight of Sweden issued a widely quoted report back in 2012 in which it said the following: “According to Berg Insight’s predictions, the global installed base of NFC-ready POS terminals will grow at a compound annual growth rate (CAGR) of nearly 50 percent from 3.9 million units in 2011 to 43.4 million units in 2017. The penetration rate for the NFC POS terminals — that is the percentage of merchants with installed equipment — will increase from 8 percent in 2011 to 53 percent in 2017, the firm said. North America is predicted to have the highest penetration rate by 2017, with 86 percent of merchants using NFC-ready terminals. Europe will follow with a 78 percent penetration rate by 2017. The rest of the world will see penetration rates of 38 percent.”

Even the NFC evangelists aren’t projecting anything even remotely close to that these days.

In the U.S., which is where Apple Pay is launching, at the moment, there are 220k locations that accept NFC payments. That’s out of 9 million merchants. It’s a teeny, weeny share of the card accepting locations and represents a teeny weeny share of spend. Now, to be fair, the EMV migration in the US is going to mean that new terminals will ship with NFC capabilities but they are being shipped dark.

Lighting them up will mean that merchants have to be convinced that there are a lot of consumers waiting to use it for payment.  And, even with the hype around Apple Pay, there are way too many variables for the majority of merchants to consider doing that right now, not to mention the fact that getting something like 6 or 7 million merchants turned on in 2 years is nearly impossible even if they all wanted to and started today.  Many may take a wait and see approach and by the time they decide to do it, if they decide to do it, won’t even start the process until 2017.  And, we know that the largest merchant in the world, Walmart, has said no way Jose to Apple Pay, even though they have NFC capabilities in their EMV-enabled terminals. Even the most optimistic projections I’ve seen show a 47 percent share of terminals being capable of accepting NFC transactions in 2018 (and even that seems like a stretch) not necessarily turned on and ready to accept NFC payments. (So, for example, Walmart is in those numbers and, at least, today, they won’t be using NFC for payments) .

“..it reaches 30 percent market share of all spend on U.S. credit and debit cards.”

Wowza. That’s a pretty ambitious statement.

Calculating share of spend is pretty tricky since Apple Pay isn’t really taking share away from anyone, it’s just the onramp for volume that flows to the issuers. But the maximum amount of “spend” that they could drive is their share of the smartphone market.  In the U.S. today, that’s roughly 42 percent.

So the absolute top end “share” is 42 percent if every single iPhone was capable of using Apple Pay and every single person used their iPhone and Apple Pay for every single transaction at every one of the merchants they visited.

That’s pretty unlikely.

Here’s the math problem that you have to solve for in order to see if 30 percent of spend is doable in two years.

Multiply the percent of people with iPhones times the percent of iPhones capable of using Apple Pay times the percent of those people who will use Apple Pay and you get a small number.

Then let’s take that tiny share and multiply that by the percent of transactions at stores that have NFC terminals. That’s an even smaller number.

Then multiply that number by the number of times that people make those transactions with their Apple Pay iPhones and that’s an even smaller number.

At the end of all this, only a small share of spend is likely to be made with Apple Pay anytime soon.

Like in the low single digits.

Okay, so Carl Icahn is obviously better than me at a lot of things since he is like a gazillion-billionaire, but on this one, I think I got him aced.        

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