Apple pays on time

Over at GigaOM, Kevin Tofel makes the excellent point that Apple’s timing seems a bit off for the launch of its Apple Watch. Apple has had its greatest successes where it has been able to redefine a market, as it did with portable audio and smartphones. But the market for smart watches — and wearable tech in general — is so nascent that there really isn’t anything there for Apple to redefine.

For all Apple’s creative flair, consumers are unlikely to appreciate what the Apple Watch does better than other smart watches because there simply aren’t enough uses of a smart watch at this point for it to matter. At at $350, it’s likely to be a tough sell.

Apple Pay, on the other hand, feels right on time. Our current system for mobile payments, which relies on magnetic stripes and clearly vulnerable point-of-sale terminals, is quite obviously broken, as anyone who has shopped at Target or Home Depot lately can tell you. The need for a more secure, convenient and technologically up-to-date system is manifest, making it ripe for redefinition.

Apple, of course, is hardly the first to notice, of course. Others, including Google and PayPal, have tried, so far without notable success, to redefine the mobile payment business. My GigaOM Research colleague Colin Gibbs, who follows mobile much more closely than I do, is no more than cautiously optimistic that Apple has gotten the mix of elements right. But I see three reasons to be slightly less guarded than Colin.

1. Timing: Apple is launching Pay on the heels of two major retail data breaches (Target and Home Depot) that resulted in tens of millions of credit cards being compromised and dumped on the international black market.

Though hardly the first time retailers have been targeted, the scale of the Target and Home Depot hacks (and the retailers’ seemingly lax security protocols) has sent ripples through the entire credit card industry. In addition to creating potentially huge financial liabilities for the affected retailers based on negligence, banks that issued the compromised cards could be left holding the bag for untold fraudulent charges.

As the risk to banks of issuing credit cards grows under mounting cyber-assaults aimed at retailers, pressure from the banks to adopt more secure payment systems will only grow as well. It’s not for nothing, I suspect, that the supporting quotes in Apple’s official press release on Apple Pay were provided by JPMorgan Chase CEO Jamie Dimon, Bank of America CEO Brian Moynihan and the CEO of American Express, Ken Chenault. That’s attention at a very high level.

Pressure is also mounting from regulators, particularly in Europe but also in the U.S., to give consumers greater control over the use of their personal data, including their buying habits.

While the true robustness of Apple Pay can only be known after it’s tested by determined hackers, Apple’s emphasis on the security and privacy features of its system is perfectly timed to address the growing concerns on both fronts. No credit card numbers are actually stored on a users’ iPhone. Instead, the system creates a unique Device Account Number for each credit card added to an Apple Pay account. Each transaction is then verified using a one-time unique number based on the DAN and a dynamically generated security code. It’s similar to the token-based dual-authentication system many banks already use for their online banking systems.

Since no credit card information is stored on the phone the merchant never sees the user’s name or card number, prevent misuse of that data by clerks. Apple insists it will not collect users’ purchase history, or gather data on individual purchases.

Apple Pay also relies on fingerprint identification, so even if an iPhone is lost or stolen it cannot be used for unauthorized purchases (see here for a good demonstration of Apple Pay in action).

2. System Architecture: As Colin notes, Apple Pay is built on top of the current credit card infrastructure. Instead of replacing the current system, it simply adds another layer. While Colin sees that as a potential bug (or at least an example of less-than disruptive design) I see it as a feature.

A key ingredient for Apple in redefining industries has been leveraging the existing investments of consumers and other ecosystem players in those markets. Millions of consumers had already converted their own music collections to MP3 files before Apple introduced the iPod. The iTunes store then gave record companies the means to participate directly in the new MP3 economy by selling downloads.

Likewise, consumers were well invested in mobile phone use and wireless plans before Apple introduced the iPhone. For their part, wireless carriers at the time faced multiple competitors and were willing to invest in differentiating technology in the form of higher subsidies for exclusive access to the iPhone.

One reason I’m skeptical of the Apple Watch is that consumer investment in wearable technology and services is negligible at this point, offering little for Apple to leverage. But the investment by consumers, retailers and credit institutions in debit and credit payments is measured in the trillions of dollars.

Contrary to its popular image, Apple’s successes have more often come from fixing what’s broken than from building anew. And that puts today’s credit card payment system right in Apple’s wheelhouse. As Tim Cook said on Tuesday,  “We love this kind of problem, it’s exactly what Apple does best.”

3. Apple Knows Retail: Apart from everything else Apple does, it is also a highly successful bricks-and-mortar (OK, glass-and-mortar) retailer. It’s 258 Apple Stores in the U.S. have the highest average revenue per square foot (the key metric in retail) of any U.S. retail chain. It’s also one of the largest e-retailers, with over 80 million e-commerce customers worldwide.

Brick-and-mortar retailing is a very tough buck and highly complex at scale. Big retailers do not change their POS systems lightly, especially when those systems are closely integrated with their inventory and supply-chain management systems. The fact that Apple has hands-on familiarity with their pain points is likely to be one of the key — if unheralded — advantages Apple has over Google and others without that core competency that try to tackle the mobile payment system.

Show me someone who has never had to handle customer service problems at the point of sale and I’ll show you someone who isn’t likely to get immediate buy-in from retailers on a new POS system. Apple, in contrast, has managed to get pretty impressive buy-in from major retail chains, including Bloomingdale’s, Macy’s, McDonald’s, Staples, Subway, Walgreens and Whole Foods Market, even before it ships its first NFC-enabled iPhone. I suspect that’s at least in part because Apple can speak their language better others who have tried their hands at mobile payments.