Apple Pay

When Apple Pay was announced in September, Osama Bedier was unimpressed. A longtime PayPal executive who now runs a payment startup called Poynt, Bedier had spent more than two years leading Google’s mobile wallet service, which lets people use their phones to pay for things at checkout counters. It used some of the same technologies as Apple Pay and failed to catch on widely. So despite Apple Pay’s appealing promise—safe payment with just the press of a thumb on your iPhone—there was good reason to be skeptical of its chances, too.

Momentum for mobile payment technologies was building even before Apple Pay debuted last fall. Some 17 percent of all smartphone users reported making a point-of-sale payment with their phone in 2013, up from 6 percent in 2012, according to a U.S. Federal Reserve survey. In-person mobile payments in the United States more than doubled in 2014, to $3.7 billion, according to Forrester Research. Meanwhile, as services such as Uber and stores like Starbucks allow people to pay via mobile app, transactions that once brought out the wallet are disappearing into the phone, where they are faster and should be more secure. You can use your existing credit card accounts, but you never have to pull out the physical cards. “We know after people tap their phone to pay two or three times, they don’t go back to their old behavior,” says Ed McLaughlin, MasterCard’s executive in charge of new payment technologies.

But even if Apple didn’t invent mobile payments, it has significantly enhanced them. Just as Apple made it far easier to use a computer, listen to music, and communicate on the go, Apple Pay is all about doing the same for buying goods and services, online and off. Each financial innovation from the invention of money to the credit card reduced friction in commercial exchange and accelerated the pace of commerce. Apple Pay does that too: it marks the end of scrawling a signature, producing a driver’s license, and other hassles that came with earlier forms of payment. It’s also smoother than mobile services that came before it. Apple Pay works automatically when your phone is held up to the checkout terminal, with no need to open an app as you must to use Google Wallet or PayPal. Pressing your thumb to the phone eliminates the need to use a PIN, speeding the transaction. This is true no matter whether you’re booking a room on Airbnb or buying sandwiches at Subway. It fuses the virtual and physical worlds of commerce in a way that no other payment system has done.

That doesn’t mean most of us will be ditching our wallets and waving phones in every store in 2015—far from it. The $3.7 billion worth of mobile payments made in U.S. stores last year was just a drop in the $4 trillion bucket of consumer retail spending. Beyond that, an additional $12 trillion was spent on services. Apple Pay itself faces a raft of challenges, too, and not just from rival wallets offered by Google, PayPal, retailers, and wireless carriers. Currently only people with the new iPhone 6 can use Apple Pay in stores. It’s officially available only in the United States for now, but 98 percent of U.S. stores lack the right checkout terminals to accept it. Finally, Apple Pay is far from replacing some of the things in a physical wallet—in particular, popular store rewards cards. Starbucks’s app, which is a combination store locator, rewards card, and payment engine all in one, still accounts for the majority of all mobile payments in retail stores.

Still, Apple has done a lot of things right, suggesting that Apple Pay will turn out to be a milestone. Even if it is only a moderate success for Apple, it seems certain to be a driver of mobile payments in general. None of the individual technologies in it is novel, but the extent of Apple’s control over both the software and the hardware in the iPhone—which exceeds what Google can do for Google Wallet even on Android phones—allowed it to combine those technologies into a service demonstrably easier to use than any other.

As a result, Apple is now cementing standards for the payment industry. Merchants have been debating whether bar codes or the radio technology near-field communication (NFC), for instance, should be the method that a phone uses to relay payment information when you wave it at a checkout terminal. Apple’s choice to build NFC into iPhones means many stores will feel compelled to get terminals with NFC support if they want to maximize their appeal to millions of iPhone owners.

Likewise, Apple Pay is setting the pace in payment security, outdoing credit cards with multiple layers of protection (see “Tighter Security,” at left). The phone doesn’t store real card numbers, and even the merchant doesn’t see them, let alone keep them in the databases that hackers routinely plunder. Each transaction generates a unique code that can be used only once. The capper: the payment is triggered with Touch ID, which responds only to the owner’s fingerprint. This level of fraud protection is one reason banks representing 90 percent of U.S. consumer payments support Apple Pay, says Avin Arumugam, head of next-generation payment products at JP Morgan Chase.

Most of all, Apple’s timing is impeccable. Card networks have set an October 2015 deadline for merchants to upgrade to terminals that can take credit cards with embedded chips for security—after that date, the merchants who don’t upgrade will have to eat fraudulent charges. Most of those terminals they’ll need to install will have NFC built in. Although that upgrade cycle will take years to reach most stores, Apple Pay could speed it up, says Keith Rabois, a former executive at PayPal and Square and an investor in several payment startups. “Apple Pay removes most of the barriers to adoption of mobile payment,” he says.

Already, Apple Pay has taken off more quickly than Google Wallet or any other mobile payment system to date. “The time was ripe for Apple,” says Jason Buechel, chief information officer at Whole Foods Market, where almost 2 percent of store sales were coming in through Apple Pay by mid-January. McDonald’s said Apple Pay was accounting for half its mobile-phone transactions, and Walgreens’s mobile payments doubled after Apple Pay debuted. Some 60 percent of customers used it on multiple days in November, using it three times as frequently as new PayPal customers used that system in the same time period, according to a study by the brokerage firm Investment Technology Group.

Apple stands to gain big if Apple Pay’s momentum continues. Not from the 0.15 percent of each transaction that it charges card-issuing banks: those fees would bring in only $2.5 billion by 2017 even if the new system got an unexpectedly large 30 percent share of U.S. credit and debit card expenditures, according to one estimate by investor Carl Icahn. That’s a tiny fraction of Apple’s fiscal 2014 revenue of $183 billion. The bigger impact will be ensuring the iPhone’s appeal. Once you’re using Apple Pay every day, in addition to other Apple services like iCloud and iTunes, you may think thrice before switching to an Android.

For all the focus on Apple Pay in retail stores, its biggest opportunity in the next few years will probably be greasing payments for countless apps and services. When you take a ride with Uber, the payment happens almost invisibly, without friction. Rabois suggests that Apple Pay could bring that level of ease to thousands of on-demand services in transportation, food delivery, and more. Once people get used to making app payments with a touch, they’ll start expecting to do the same everywhere else they can.