Earlier this year, Apple introduced a branded credit card, managed by Goldman Sachs. And rumour has it, that the launch will be in August 2019. A lot of articles explain what the card is and what the benefits are for the customers. But what follows is an attempt to provide context and assess the potential to shake things up for incumbent and challenger financial players.
Before you continue reading, keep in mind that Apple is not a novice in financial services.
Apple Pay was introduced in 2014. It’s an implementation of Visa / Mastercard EMV card-on-file tokenization spec and relies on the standard tokenization services provided by Visa and Mastercard (the same are used for Google Pay and Samsung Pay). When enrolling a card in Apple Wallet (or a similar application), tokenization services would send a ‘token’ of the card to the phone – a device specific, credential specific clone of the physical card. As a result, the security is enhanced as the token can only be used from this device, and only in combination with biometric authentication of the enrolling user. While not entirely original, Apple’s particular twist on this service consisted in the use of the iPhone’s secure element to store the card-on-file data, and the biometric authentication (touch id, at the time) to access the card and to sign transactions (NB: back then, most Android phones still used pin codes).
At the time of the introduction in the US, Apple apparently used to get around 0.15% on the amount of the transaction for the facilitation of secure transaction from MasterCard and Visa. It’s extremely unlikely that it would get anywhere close to this percentage in Europe, because the interchange fees are capped and banks would be much more sensitive to an outsider coming in and eating a part of their pie.
Apple Pay Cash
Since 2017, Apple has been offering Apple Pay Cash. This is a prepaid virtual (card-on-file) debit card, provided in partnership with Green Dot Bank. Users would credit Apple Pay Cash from their other debit or credit card or would receive p2p transfers from other Apple Pay Cash users (using iMessage). Users would spend the balance at merchants where Apple Pay is accepted or by sending money to other Apple Pay Cash users, or by wiring funds to a bank account (although it would take 2-3 days to arrive). Although Apple Pay Cash is a full-blown bank account, which benefits from Federal Deposit Insurance up to 250k, it never gave the impression that it was anything more than an enabler for p2p payments over iMessage.
Apple Pay pre 2019 (see below for possible changes after introduction of Apple Card and daily cashbacks) seems like a tentative / preventive move to try out peer to peer payments, and to block potential competitors. For all the needs and purposes it seems like a feature of iMessage, more than a standalone payment / remittance play with profit generation motive. Nevertheless, when you do pay with Apple Pay Cash at a merchant, Apple would get the normal interchange fee (2-3% of the transaction amount in the US).
BarclayCard with Apple Rewards
In credit card space, for a couple of years already, there has been (and still is) another card partnership: Barclaycard Visa with Apple Rewards. It’s a relatively standard branded credit card, which offers 3% cashback for shopping at Apple, 2% for dining, 1% for everything else (NB: these discount rates are rather trivial for US market)
It’s not clear if there is / was much money at all in this schema. Interchange fees are around 3 percent in the US, with cashback to customer, and a percentage taken by Barclays, so there is not much Apple can receive. Most likely, they see it as sales promotion, to encourage people to shop at Apple (online and in stores).
You might also like: Apple Card, the reference for banks going forward?
Enter Apple Card
In March 2019, Apple announced a slew of digital content services and a branded credit card, running on MasterCard network, managed by Goldman Sachs. There are several unique features about it.
It’s digital first:
It means that when a traditional card is issued on plastic first, and then enrolled in a wallet application, Apple Card is digital first – i.e. you can receive a digital card-on-file on your phone within minutes after application and start using it. A physical card would arrive a couple of days later. This is a plus from the customer onboarding friction and user experience point of view.
It’s security, privacy, transparency and financial discipline oriented:
When you use it, you get to explicitly approve all transactions from your device, and the transaction history is neatly categorized and transaction location is pinned on a map. The wallet app also helps you estimate the cost of credit and optimise reimbursements.
Apple claims no costs and fees, which is nice. Transparency and simplicity here is welcome. The cost of credit is just average (13% to 24% annual). Also, the company is coy regarding ATM fees.
On the security side, the physical card – chip and PIN Mastercard in laser etched titanium, because why not – does not carry the card number, not the CVV or expiration date. This effectively makes it unusable if stolen.
Finally, it gives you rewards:
When you use it, you get same day cash backs (rewards), paid to Apple Pay Cash account on:
- Shopping at Apple, brings cash back of 3 %
- Shopping with Apple Pay (i.e. With phone) brings cash back of 2%
- Shopping with physical card brings 1% cashback.
The cash back is put on your Apple Pay Cash account. These are one of the main differentiators of the Apple card and are most directly relatable to what banks and fintech challengers are doing. So some context is required here.
US fees for credit card transactions
The following is a VERY approximate breakdown of fees and costs for a US credit card transaction:
- Purchase price (debited from customer’s account): 100%
- Interchange fee (goes to issuing bank): 2-2,5%
- Assessment fee (goes to card network, ex Mastercard): 0,1-0,3%
- Mark-up fee (goes to acquiring (i.e. merchant’s) bank): 0,1%
- Processing fee, fixed amount per transaction (goes to acquiring bank): 20-30 cents per
transaction, or 0,3% for an average 100 USD transaction.
- All the rest – 97% or so – goes to merchant.
In the US, we are talking 2 to 3% of the transaction amount which are split between issuer and acquirer, with interchange fee being the biggest part of the overall fee.
Interchange fee, in principle, is supposed to finance the costs of processing, fraud and bad debt. With the modern systems, cost of processing is a sunk cost. And the marginal
cost per transaction is close to zero. Cost of fraud can be minimized through security, biometrics etc – and this is where PIN- and chip cards and tokenized cards-on-file really bring a change vs key-in or swipe-and-sign.
Shop at Apple
When you use Apple Card to shop at Apple itself, Apple is at the same time acquirer, issuer and the merchant. 3% discount does not really cost them anything in this scenario. Apple-the-merchant receives exactly the same amount as if the customer was shopping with some other card, and Apple-the-issuer retains almost all of the 3 percent as there is virtually zero chance of fraud or breakage in this closed loop. And of course, these 3% are fed into the Apple Pay Cash account, where it may stay for a while (free cash flow for Apple) and will most likely be used for purchase of Apple products and services.
Shop at another merchant
When you use Apple Pay at another merchant, Apple is the issuer and receives a cutback from Mastercard on the assessment fee. The cost of fraud is arguably still low (Apple Pay having biometrics and all). So here again, it’s not difficult to give 2% discount. Again, 2% go to the Apple Pay Cash account.
Shop with the physical card
Finally, when you use the physical card (PIN enabled, without NFC, without expiration date, CCV and number of it), the cost of fraud is still lesser than with a traditional card, so again, 1% discount is just financed by the interchange fee that Apple, as issuer, would get.
Note that these levels of cashback are not rare in the US. There are competing cards from Citi, Chase or Capital One with similar or better discounts / cash back structures, but without obligation to shop at a particular place or to use Apple Pay (which still, 4 years after introduction, is not very widely used).
Should banks be worried?
So, should European banks (incumbent and challengers) be worried?
There is a number of reasons to think that this is not going to be earth shattering.
It’s probably not for Europe, at least, not all of it. Because the type of business models around interchange fee is problematic in Europe. The interchange fee for credit cards is capped to 0.3% of the transaction amount. Quick look at the cost structures of challengers such as Revolut, N26 and Monzo (hey, are they making any money yet?) shows a range of fees or complementary products (such as overdraft, insurance, premium accounts, etc) stacked on top of a range of free basic services. But none of them seem to rely on the interchange fees for their income. Apple would have trouble giving cash backs on its Apple Card payments. And without cash backs, Apple Pay Cash (still not available in Europe) becomes a less compelling product.
It’s 100% Apple, which is not good in this case. In the US, iOS has 43% of the market share, and is slightly growing. In Europe its 26%, and slightly shrinking. And in Asia, it’s 13% and shrinking. Given the fact that the key value add of Apple Card is buying Apple products with Apple card to get cash backs on Apple Cash Account usable exclusively on Apple devices, it’s not clear what kind of acceptance this closed ecosystem product can get.
It’s nothing special, really. In context, the usability and financial perks of the Apple Card are not that special. In the US, there are cards with more generous and less restrictive incentive structures. And in Europe, there are offers (ex: N26, Monzo) with similar or better usability and security features, and a bunch of value-add services not constrained to Apple Pay specifically, or the apple ecosystem in general. Even the digital first card issuing is not new. Wirecard has been doing it for a while in Europe, and there are similar offerings across the Atlantic.
A glimpse into the possible future
With all this said, even if Apple Card is not an imminent and direct danger in itself, it’s a glimpse into a possible future, and a sign of things to come.
Under the traditional banking model, banks made money on interest spread and fees. For the first to work, you need to have spread, which has been squeezed for a while. For the second, you need customer engagement, and this is where challenger fintechs, prepaid wallets and the likes of Apple Card are chipping away at the traditional bank’s normal retail business.
The nightmare scenario for European retail banks is being stuck managing costly systems and shouldering heavy legal and compliance duties and seeing every month exactly 2 transactions per account: salary coming in and wallet prepayment transfer coming out. And this while customers merrily interact with, and pay fees to, sexy wallets, prepaid and credit cards.
And we are not even talking about real elephants in the room – what about Facebook and its Libra? Amazon probably won’t stay behind for long…
- Interesting development
- Good (you could say, no brainer) for Apple, especially in the US
- It’s no WeChat – yet. Banks should fear much more Amazon’s or Facebook’s entry