PFCU-Evolution of Payments-reduced

THE EVOLUTION OF PAYMENTS PARTNERS FEDERAL CREDIT UNION

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2Copyright © 2015 Partners Federal Credit Union

This document contains confidential information, you are hereby notified that any disclosure, copying, distribution or use of any of the information contained herein is for internal use only and not to be shared outside of The Walt Disney Company.


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By Mike Terzian, Royce Ngiam, and Jose Castro Creative by Henry de la Espriella June 2015

CONTENTS

Executive Summary 5History 7 • NonCash Payments 8EMV 12EMV in Tokenization 14Changing the Way We Pay 15The Intersection of Smartphones and Payments—Mobile Wallets 18 • Key Mobile Wallets Today 18 • Apple Pay 19 • Google Wallet 19 • Samsung Pay 19 • CurrentC 20 • CUWallet 20 • Paydiant 20 • PayPal 20 • All-In-One Cards 20 • Starbucks 21 • MCX 22Glossary 24Appendix 26


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EXECUTIVE SUMMARY

Innovation in mobile technology has changed the average lifestyle and re-shaped the way consumers live their lives from shopping to banking. As of December 2014, 74.9% of Americans aged 13 and older have a smartphone.1

Smartphones have enabled us to be connected to every aspect of our lives 24 hours a day, 7 days a week. They have become as important as carrying our wallets and some hope that someday they can replace wallets.

MOBILE BANKING GROWTH

Regardless of the explosive growth in retail and social applications, adoption in the mobile banking field has been slower than expected or hoped. Of those with smartphones, 52% have used them to access mobile banking, with 94% of those saying they have used it to look up account balances, and 51% have used it to deposit checks.2 The main factor being the ease in performing those tasks compared to the alternative. Prior to dedicated mobile banking apps, to retrieve your balance via phone necessitated calling your bank’s automated system, navigating through their oftentimes confusing menu, and entering your account number and passcode. With a smart phone and mobile banking app, balances are now increasingly becoming available without even logging in to the account. Something that would have taken five minutes has been condensed to seconds. With a heavy bias towards technical proficiency and creativity, Partners Members are more likely to adopt and use smart phones and explore emerging payment technologies as Disney has been a pioneer in the payments space collaborating on contactless payments and digital wallet applications.

CONVENIENCE AND SECURITY

Convenience and making tasks easier will drive banking and payments via a mobile wallet. Over half of mobile smart users felt there wasn’t a benefit to making a mobile payment versus the other alternatives.3 Credit/debit cards are still easier to use than most mobile alternatives and with the move to Europay, MasterCard, and Visa (EMV) and the incorporation of near field communication (NFC) technology, they are becoming more secure and more convenient. The first step in driving emerging payments adoption is to demonstrate there is a need that is served or value created by embracing that technology. The second step is balancing security concerns with real world usability.

THE AGE OF MOBILE WALLETS

The momentum in electronic payments is growing, which will help in facilitating mobile wallet payments. Paper checks are on the decline while the ability of consumers to initiate Automated Clearing House (ACH) is fueling the mobile growth. The most common payment activity used by smartphone users is in paying bills, with 68% of the users reporting usage.4 Most of these mobile payments are facilitated through ACH transactions. Person-to-person (P2P) payments are also on the increase but not as significantly as bill pay transactions. This is partly due to the large number of applications to choose from and the way they transfer funds to each person. Having the proper infrastructure and payments strategy is crucial to Partners in developing the correct payments strategy. It is easy to purchase and implement solutions, the key to long term success is understanding the drivers of value and consumer usage and matching the credit union’s offerings appropriately.

When it comes to mobile wallets, the payment space is very fragmented and is reminiscent of the early days of banking when some banks negotiated some checks but not others depending on the agreements that had reached with each other. With so many options in mobile wallets it is difficult for both consumers and merchants to decide which one to adopt. If Partners is not the first card in or top of mind and wallet, it will be very difficult to become the card of choice.

1 Azevedo, Helene. “Smartphone Adoption Approaches Tipping Point Across Markets.” ComScore 23 Feb. 2012, INSIGHT/ Data Mine sec.2,3,4 Brown, Alexandra, Sam Dodini, Arturo Gonzalez, Ellen Mary, and Logan Thomas. “Consumers and Mobile Financial Services 2015.” Board of Governors of the Federal Reserve System (2015). Print.


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PROJECTS TIMELINE

Card Conversion

Instant Issue Credit

Couponing

Apple Pay

Peer-to-Peer

EMV

Credit EMV Debit EMV

Samsung Pay

CurrentC

2014 2015 2016Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

TODAY

Research (RFI/RFP) Implementation Completion Next Phase


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HISTORY

Payments systems have been around since the beginning of time. One of the first payment methods was the barter system. In the barter system goods of a certain value are exchanged for others of equal value. This system evolved to, instead of bartering goods, people sold the goods for currency of an equal value, usually precious metals.

Payments in the form of coin first began to appear in China sometime after 100 BC. Most of the metals used were not precious metals so payments for high-valued goods was a little difficult to conduct. This led in ancient Lydia to the introduction of coins being made out of precious metals. Gold and silver were considered rare and precious metals so people felt safer in transacting using these coins as a payments system.

Banknotes first began to be used around 600 BC in China. Merchants grew tired of carrying around bags full of coins so began to trade banknotes, which had their roots in merchants’ receipts of deposits. This concept was then introduced in the 13th century to Europe by travelers who had been to China. Banknotes have evolved over time, originally deriving their value by the precious metals each could be exchanged for. With the exchange of these notes there was a need for a trusted intermediary to facilitate these transactions.

When banking first began in the US it was very fragmented, with many restrictions on where branches could expand to. Many were restricted to small regions and their home state. This led to multiple banks operating regionally but none nationally.

During this time banks would issue their own notes to be used by their customers. People would use these notes to pay one another or they would write checks drawn from their banks. The banks would then negotiate the notes and checks amongst themselves. Banks would charge different fees based on how difficult it was for them to negotiate the check with the other bank. Banks with higher distances to each other tended to charge each other higher fees to negotiate the checks. With the US expanding further west, it was clear that the US needed a more integrated payment system to process checks across the nation.5

In 1913 congress established the Federal Reserve System to create a national clearing system to facilitate the exchange of payments at a more equal level. This system enabled paper checks and smaller community banks to thrive in an

The Walt Disney Company has had many successes in making payments at its parks easy.

When Disneyland first opened, each ride attraction had its own price based on popularity. To make it easier for guests, they sold ride coupons with the least popular rides being “A” attractions and the most popular “E” attractions.

In 1987 Disney introduced its own paper currency known as the Disney Dollars. This was just a fun way to pay for things around the Park.

In 2013 Disney Introduced the MagicBand. This Band is Disney’s solution to the digital wallet when at The Magic Kingdom. It can hold your payment information, room key, park pass, photo pass, and fast pass. There really is no need to bring your wallet into the park.

5 Santomero, Anthony. "Paper vs. Electronic." The Evolution of Payments in the U.S. Fairmont Banff Springs, 2005. Speech.


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environment in which larger banks tended to exchange checks with each other at a favorable value. With checks being able to be used and accepted with more confidence, by the 1970s checks had become the most favored type of non-cash payment. During this time the Fed introduced a new way of making electronic payments by developing the ACH. ACH has not grown in popularity , because up until recently only financial institutions could initiate an ACH transaction. The credit card, which was first introduced in the 1950s, was very effective in moving payments from paper to electronic at the point of sale. Credit cards were the first form of electronic payments adopted by consumers. Credit Cards experienced a rise in usage over other forms of payments until Debit Cards were introduced.6

In the last decade, new ways of making electronic payments have emerged, with most of these being tied to a smartphone and relying on credit card, debit card, or ACH networks to process the payments. Paying with a smartphone has not become easier than paying with a card but with the emerging technology, this could change.

KEY OBSERVATION

The payment system worldwide has been and will remain in a state of constant evolution. Evolution of services and technology is cyclical, driven by the following key stakeholders:

1. Consumers 2. Merchants3. Financial Institutions4. Payment enablers including networks and processors

These key stakeholders drive a process of evolution based upon several key needs, which may be summarized as:• Security—Is the payment service or process secure for all parties?• Accessible—Is the payment or process widely accepted by merchants?• Cost—Is the payment or process cost-prohibitive for any of the four (4) stakeholders identified?• Convenience—Is the payment or process easy or intuitive to use as well as fast?

NONCASH PAYMENTSHave you ever paid your friends directly from your phone? Do you take advantage of bill pay through mobile or online banking? These along with many other services are the essence of “noncash” payments. They are what you would assume . . . payment for goods or services performed without cash. Noncash payments have been increasing over the last decade due to technological advancements and innovation in banking. Over the last decade electronic forms of payments have been on the increase while non-electronic forms of payments like checks have seen a big decrease. One of the biggest factors affecting this is the speed at which transactions are being processed.

Checks have seen a large decline in usage. Checks went from making up 46% of all transactions in 2003 to making up only 15% of all transactions in 2012.7 This decline is due to many factors, the largest being the rising popularity of the debit card in the 1990s. Consumers have shifted from writing checks for smaller transactions to using a debit card

RECOMMENDED ACTIONCreate and widely share an enterprise-wide payments road map, then educate all Cast Members on the key drivers and value of each emerging payment. Knowledge and comfort is power.

6 Santomero, Anthony. "Paper vs. Electronic." The Evolution of Payments in the U.S. Fairmont Banff Springs, 2005. Speech. 7 "Recent and Long-Term Payment Trends in the United States: 2003 – 2012." The 2013 Federal Reserve Payments Study (2013). Print.


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at the point of sale. Another factor contributing to the decline is the growth in ACH transactions. ACH transactions are becoming a more common form of paying bills via a merchant’s site. Consumers choose this method because it is quicker and ensures the recipient receives payment sooner than waiting for it to arrive in the mail, hence avoiding late fees. Forty-eight percent of online banking users noted using bill pay as one of the top activities done online.8 Merchants have also gone from depositing checks physically to using them to process an ACH transaction instead. Although checks have seen a large decrease in the number of transactions in which these are used, the average value amount has gone up. All other forms of payments have seen a decrease in the average value amount. This can be attributed to the shift in paying for lower value transactions with a debit card.

However, checks are not dead. In fact, on an annual basis, Partners Members write 1,367,292 checks for over $624,349,622 annually. And this trend has remained flat, meaning the decline in check-writing has leveled off.

In terms of transactions, the largest growth in volume has been in the use of cards for payments. The efficiency and connectivity of the card networks has made it so that cards can be used virtually anywhere for any transaction amount. Card-focused processes, in fact, are enabling most of the transactions that are being conducted through mobile wallets. Without the card-based ecosystem in place, much of the digital functionality would not be possible. Debit cards have seen the largest growth since their inception and make up the largest share of all noncash transactions. Debit cards have seen more growth over credit because they are issued with checking accounts and do not require credit checks. Similarly, non-traditional bank competitors have attempted to take advantage of this preference by offering decoupled debit cards, where debit cards are issued without needing an underlying checking account. Prepaid debit cards, which are offered by both financial institutions and some merchants, have also seen a large increase. With payments shifting to electronic forms, prepaid debit cards are becoming very useful for funding mobile wallets.

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Credit Card Prepaid CardDebit Card ACH Checks

FEDERAL RESERVE NONCASH PAYMENTS

in Billion of Transactions

Source: 2013 Federal Reserve Payment Study

RECOMMENDED ACTIONAs Member behavior changes, it is important to continue messaging all the available payment and access options. This is the true age of ‘yes, and’ where Members are choosing to interact with their account, by proxy, to the credit union.

8 Brown, Dodini, Gonzalez, Mary, and Thomas. “Consumers and Mobile Financial Services 2015.”


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Although our lives are becoming digital, cards will continue to grow. Cards continue to be used as the payment method of choice for the majority of all online transactions. Companies like PayPal that facilitate online transactions require a user to enter a credit card number or bank details to process payments. Most prefer using their credit card for online transactions because of card companies’ policies on zero liability on online transactions. ACH will see growth online, but it will be in facilitating person-to-person transactions because of lower fees and recent advances in making these payments instantaneously.

KEY OBSERVATION

Historically, advances in payments have a substitution effect up to a certain point—meaning the new service will displace and cannibalize an existing payment service. However, at that point, the new payment service becomes additive (“yes, and”). In recent Partners surveys, Members who don’t use mobile deposit were asked “why?” The simple answer was, “my banking needs are already being met.”9 Thus for that audience, mobile peer-to-peer payments are either irrelevant or one more way to transact—but do not entirely replace existing payment services.

PARTNERS NONCASH PAYMENTS

PROS CONS OUTLOOK

• Security—each iteration of payment becomes more secure

• Convenience—while acceptance of noncash payments varies, they are almost always more convenient and fast.

• New ways to pay are not solving a perceived need

• Inconsistent experiences between merchants

• Technology has not achieved parity with the promises; some payment systems are physically easier to complete

• Non-traditional competitors and brands are becoming more dominant in the payments space

The payments ecosystem continues to evolve, yet the underlying technology and processes are still dependent on ancient technology.

Most digital payments are derivatives from the card-based system and not a truly new payment method.

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2003 2006 20102004 2007 2011 2012 2013 20142005 20092008

Credit Card Debit Card ACH Checks

in Million of Transactions



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EMV

Fraud is a persistent and enduring fact of any payment ecosystem. From the days of the first English settlements when polished shells served as currency to elaborate printing presses that produce millions of counterfeit (paper) currency each year, fraud has been a fact of life. In recent years, credit and debit card theft—both through point-of-sale and online transactions (“card present” versus “card not present”)—has exploded in the US. It is estimated that counterfeit cards make up 37% of all card fraud in the US10 and a little over half of the world’s card fraud.

To reduce card present fraud, many countries have switched to the EMV. EMV stands for Europay, MasterCard, and Visa, which created the global standard to ensure the security and interoperability of chip-based cards. The first EMV card was introduced in France in 1992; soon after that the rest of Europe started adopting it. EMV cards contain a small microchip similar to those used in smartphones and computers. This chip secures the cardholder’s information by encoding it by using cryptographic algorithms.

The EMV technology was first introduced in Europe for merchants that did not have systems that were always online. Before EMV the merchant would have to take the card and slide it through a magnetic reader. When the system was online the card would be authorized and then a receipt would print and be signed. The transaction was then validated by matching the signature on the back of the card to the one on the receipt. When the transaction was done offline there was no way to validate whether the card was real or the credit available, so in these cases the merchant would need to phone the issuer to validate the card and transaction limit. With the EMV card the merchant could validate the card was not a counterfeit and that the issuer authorized the transaction for a set amount so long as it was used in an EMV-enabled terminal. Unlike Europe, the US had the supporting technology and infrastructure to authorize most transactions in an online environment.

EMV cards were proving to be successful so in 2005 Europe enacted a fraud liability shift. The fraud liability shift was put in place to encourage merchants to adopt EMV terminals and help do their part in reducing fraud. When liability shifted it made the party who had not adopted EMV responsible for the fraudulent charges. What this meant was if the issuers had EMV cards but the merchant had not implemented EMV readers, then the liability shifted to the merchant. The liability would stay with the issuer if the merchant had implemented EMV and the issuer hadn’t or if both had EMV. The shift to EMV helped reduce fraud at the point of sale from 42% in 2008 to 24% in 2012.11

This shift to EMV in Europe and many parts of the world has led to the US being the number one country for card fraud overseas. Counterfeiters use US counterfeit cards in other parts of the world and use EMV cards from around the world in the US. They are able to do this because EMV cards still have a magstripe (card data is stored and transmitted from the “magnetic strip” found on the back of credit and debit cards) and since the US has not converted, counterfeits of these cards are run as magstripe cards in the US. If the US had EMV readers, these cards would not function because when swiped, and the EMV-enabled terminal would notify the merchant that this is an EMV-enabled card, forcing a chip and sign transaction.

Framing fraud from the perspective of all stakeholders is one method of understanding why specific services exist as well as the rules governing them. For instance, the fraud liability shift seen in Europe that has finally made its way to the US—this shift is one that “motivates” all stakeholders in order to avoid future losses.

According to the Nilson Report, global card fraud is expected to reach $10 billion by 2015.

10 Peterson, Thad. “Payment Processing: A Merchant’s Perspective.” Aite Group 18 June 2014, Reports sec. 11 “Third Report On Card Fraud”, European Central Bank February 2014


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The US will now be converting to the EMV standard and has set a liability shift for October 2015. Many are predicting this transition will take several years to complete. Current estimates show that about 46% percent of US terminals will be converted by the end of the year.12 Although conversion will take time, those who are more susceptible to fraud such as an electronic stores or jewelers will switch right away while some such as fast food restaurants may not.

KEY OBSERVATION

Motivation to evolve the payment ecosystem can come from the multiple “needs” previously noted, in this particular case Security. With today’s payment ecosystem, Security would be a fundamental motivating need much like Safety in Maslow’s hierarchy of needs. All stakeholders, from merchants to financial institutions to consumers, share the desire to meet this fundamental need with any payment service, even one as entrenched as credit and debit cards.

PROS CONS OUTLOOK

• Reduce card present (counterfeit card) fraud

• Higher Security compared to magstripe

• Heavy merchant and financial institution cost for upgrading payment infrastructure

• EMV cards are expensive

• Does not protect against compromises in the short term

• Card not present fraud has seen increases in other implementations

• Transaction time is slow compared to magstripe

• User experience is different

The reality is that the financial institution has always functionally carried the liability risk in a transaction.

Merchants are updating terminals to comply with the liability shift, which continues to put the financial institution in the same position as bearing the liability.

RECOMMENDED ACTIONRegardless of the pros and cons of EMV and its sustainability, industry inertia necessitates migrating to this format or else risk losing relevancy.

12 U.S. and Chip Cards, EMV Connection, Press Room Resource


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EMV IN TOKENIZATION

Tokenization in credit/debit cards is the process of replacing the personal account number (PAN) with a new random number that can be used once or multiple times. This new random number string is considered the ‘token’ and is only decoded by the token issuers, in most cases Visa or MasterCard. Tokenization is secured as no one else who touches the processing of the transaction will see any personal information, not even the core system of most financial institutions. Obfuscating and running a proxy serves to keep personal information out of the payment workflow.

EMV currently does not feature tokenization, but is currently being tested. Some mobile wallets like Apple Pay™ feature tokenization as it’s security protocol, others have adopted other methods. In Apple Pay, when a person enters their card information into the Passbook® app, that information is not stored on the mobile device. Instead, it is encrypted and sent to the card network. There it is exchanged for a token which is stored in a secure element on the iPhone®. When someone completes a payment transaction, this token is used for payments instead of a PAN.

When the merchant receives payment from someone using a token, they don’t see a difference in the way the payment is processed, the token looks exactly like a PAN to the system. The token is then sent through the card network. The card network in turn receives the token and matches it to the PAN which is stored in their secured token vault. Once it is matched, it is forwarded to the card issuer for payment.

Tokenization is a very useful tool to combat against data breaches; it reduces the number of card re-issues a financial institution needs to make. If a hacker was to breach a merchant’s system and steal any data, the tokens that were stored would be useless to them. Instead of having to send out a new card or to replace the old one, all an issuer would need to do is provide a new token.

Tokenization will reduce most of the negative impact card issuers experience during a data breach. When notices of a data breach are sent out it tends to make customers uneasy, especially when it’s their debit card that has been compromised. This results in lower usage of the card by the member as a strategy to avoid their card being stored with multiple merchant systems.


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CHANGING THE WAY WE PAY

Technology has been the primary enabler of advances to payment services. The evolution of smartphones and payment services has progressed on similar paths to today where we find an emerging intersection. At this intersection of technologies, we find new capabilities where the benefits of particular payment abilities are increased through the power of new smartphone technology. Currently, there are several different types of technologies powering mobile wallets. Like all technologies, each has advantages and disadvantages.

Hold steady to scan Paycode

Show this Paycode to the cashier

According to the Federal Reserve, QR/Bar codes are currently the most common method consumers use to make mobile payments.13 To make a QR/Bar code payment, when a user gets to the register, they need to open the mobile payment wallet and choose the account they would like to use. After they do this they will either be presented with a code at the register they need to scan or a QR/Bar code will appear on their phone and will then be scanned by the cashier.

The high number reported by Federal Reserve is likely a result of Starbucks, whose app utilizes this payment method, which has 13 million active users and processes 7 million mobile transactions a week.14 Besides Starbucks and Subway, there are not many other big name merchants currently using this type of payment system. The Merchant Customer Exchange is hoping to change that with its network of merchants that have annual sales of over $1 trillion. The Merchant Customer Exchange believes this payment type will enable a larger percentage of smartphone users to make payments since it doesn’t require NFC or Bluetooth, which older phones are not equipped with.

NFC technology in phones was first introduced by Nokia in 2006.15 Shortly thereafter the first use in payments took place in several countries, demonstrating an appetite for the new service by all stakeholders. Examples of NFC in use today include: Google Wallet, Apple Pay, Android Pay, and SoftCard (formerly Isis). To make a payment using NFC, all a person would need to do is place their phone against an NFC reader and then confirm their identity by either using biometrics or entering a pin number into the phone.

Although this technology has been commercially available for ten (10) years, it has experienced slow adoption in

13 Brown, Dodini, Gonzalez, Mary, and Thomas. “Consumers and Mobile Financial Services 2015.”14 Howard Schultz, Starbucks Q4 2014 Analyst Earnings Call15 Fraser, Adam. “Nokia’s NFC Phone History.” Conversation: The Microsoft Devices Blog 10 Apr. 2012. Microsoft. Web. 12 Apr. 2015.


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the US. With Apple Pay now using this technology to power its mobile payments, consumers appear to be more comfortable using NFC to make payments. In fact, while Google Wallet has been available for almost two (2) years, it experienced an approximately 50%16 increase in adoption following the release and interest around Apple Pay. Thus this technology put to work by a popular new player (Apple Pay) was a perfect example of the theory, “a rising tide lifts all boats.”

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GLOBAL NFC-ENABLED HANDSETSMillions of Shipments

NFC is not only becoming popular for payments via a smartphone. This technology is being implemented into credit and debit cards. In the UK, 40% of all debit and credit cards are enabled for NFC payments. The UK saw a 244% increase in contactless card payments in 2014, with 10 contactless transaction every second.17

Magnetic Secure Transmission was first introduced in 2013 by LoopPay as a Kickstarter campaign that quickly achieved its funding goal. This technology works on existing magnetic card readers by sending out a magnetic signal to the magstripe reader that emulates a card swipe. When it was first introduced it had the same Security as any card but recently Samsung, which now owns LoopPay, has been working with the major credit card companies to enable tokenization.

Check-In payments are not talked about much but are a very simple solution used by PayPal and Square. Both companies rely on GPS, an internet connection, and their merchant services. To pay for an item, a person would pull out their phone and open the PayPal app. They would select the merchant from those nearby and check in. This would queue up the customer’s picture and name and let the clerk know that the person is shopping at the store. Once the person was ready to pay for their items, the clerk would simply identify the customer based on their

PARTNERS PHILOSOPHY Implement a “yes, and” payment strategy whenever possible. Samsung Pay falls on the Partners roadmap for future consideration.

16 Geuss, Meagan , “Google Wallet use grows after Apple Pay launch”, ArsTechinca 5 November 201417 “Consumers turn to contactless as usage surges” The UK Cards Association, 6 February, 2015, News Release

Source: IHS Technology 2014


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picture and the transaction would be complete. Square had a partnership with Starbucks to accept this payment method for over a year but discontinued it in December because the adoption rate was low compared to their dedicated Starbucks wallet.

Beacons are starting to find their way into retailers and are being tested extensively by PayPal for payments. Beacons work with Bluetooth low energy, which is found in most phones manufactured today. Beacon devices are placed within a retailer or at the entrance. As a person comes within a certain radius these beacons pick up the device and perform an automated check-in. Once the merchant knows you are in or near the store, they can send promotions to you or bring up your information for a quick and easy checkout. Beacons are predicted to become more popular as more home automation becomes available. Beacons capabilities are already available on most phones including iPhones with iOS7 or above.

KEY OBSERVATION

The technology that drives mobile wallets have fulfilled needs around security, convenience and relevancy. The traditional questions for any new service, but especially for payments remain:• What is the need?• Where is the solution?• When will it be available?• How will it be accomplished?

By creating real-time, relevant, actionable offers that are sent literally steps away from the Member.

Beacon technology could be deployed within Partners branches to alert Members of personalized offers and services based upon user preferences.

Preferred Partners auto dealers are another example of leveraging beacon technology with special offers that are relevant and timely.

HOW CAN BEACONS HELP?

PROS CONS OUTLOOK

• Convenience—less stuff to carry

• Evolving Security—tokenization and other forms of encryption are protecting data

• Security Concerns—every major new mobile system has been breached and exploited

• Inconsistent Install Base—ability to make mobile payments is dependent on the merchant

We are in the nascent stages of mobile payments. Early adopters are embracing the technology, but mainstream acceptance is questionable. Most consumers have not adopted all of the current digital options, and checks continue to represent the largest dollar volume of payments.

RECOMMENDED ACTIONContinue to closely monitor this space until either a clear leader or model develops, then quickly adopt that standard. In the interim, it remains imperative that every advertising opportunity to exploited to get Partners plastics loaded as the payment option of choice on all new and upcoming digital wallets.


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KEY MOBILE WALLETS TODAY

The two top platforms at the moment are Google Wallet and Apple Pay, which both use NFC. NFC will be the prevailing technology for the time being. It’s the easiest for users to adopt. In the UK some of the major banks have created NFC tags that could be attached to any phone and allow mobile payments. Some have also created wristbands similar to

Disney’s Magic Band to pay for items. NFC is the easiest of the technologies to implement because it’s been around for so long.

THE INTERSECTION OF SMARTPHONESAND PAYMENTS —MOBILE WALLETS

The intersection of smartphones and payments is exemplified best by the rapidly evolving mobile wallet space. What is a mobile wallet? Quite simply, the term “mobile wallet” refers to the different payment solutions being offered that can be utilized using your phone. They consist of an application that stores your debit/credit card information and then facilitates payments using NFC or the scanning of a code. Today, Partners offers both Google Wallet and Apple Pay, the two (2) largest mobile wallets currently available. There are several mobile wallets fighting for space on a Member’s mobile phone.

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2011 2012 2013 2014

PERCENTAGE OF US CONSUMERS WHO HAVE MADE A MOBILE PAYMENT

Percentage

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Source: IDC: Press Release 2012, 2014


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The mobile wallets space will likely end up looking similar to the current credit cards eco-system. The majority will go with Google Wallet, Apple Pay, or Samsung Pay, and there will be several retailers who have their own app the same way they have their own store credit cards.

APPLE PAY

Apple Pay is one of the most recent mobile wallets to enter the payment space. But because of Apple’s large user base and their loyalty it is predicted to become the most popular payment wallet introduced so far. Apple Pay did not introduce a new payment technology but uses NFC, which has been around for quite some time. What Apple did well that most of the other wallets didn’t was to add more layers of security to their payments by utilizing tokenization and biometrics. Apple Pay works in the same way Google Wallet works; all a person needs to do is put their phone near an NFC terminal when prompted by the merchant while putting their finger on the fingerprint reader. The payment should then be processed immediately.

Google recently acquired Softcard, an NFC-powered mobile wallet backed by AT&T, T-Mobile, and Verizon. This acquisition will allow Google to preload Google Wallet onto all future android phones sold by these carriers. Softcard was launched over a year ago and failed to attract many users because of its cumbersome sign-up process. For a user to sign up, a special SIM card that contained the encrypted payment information was required. Once that was installed, a credit card needed to be loaded. Softcard had very limited credit card support so most users had to use an American Express prepaid card. Most payment terminals that were NFC enabled were able to accept this payment form. Google will also use Softcard to create an API that anyone can plug their app into to enable anyone to create their own NFC-based wallet.

GOOGLE WALLET

Google Wallet has been around since September of 2011 and is an NFC-powered mobile wallet. When it was first announced, it only supported MasterCard and a Goggle Prepaid account, but a year later it began to support all major credit and debit cards. Google Wallet works by sending a virtual MasterCard to the payment terminal at purchase and then charging the card you chose after the transaction has been completed. Your payment details are not stored in the device or app but on a Google server. Google does not charge merchants or consumers for the use of the wallet but plans to make revenue by selling targeted ads. To provide the data for targeted

ads, Google stores information on the user’s transactions such as merchant, amount, date, time, method of payment chosen, and geolocation. Google Wallet, like CurrentC, integrates loyalty cards into the app, with some adding or redeeming points instantly.

SAMSUNG PAY

Samsung recently announced its creation of Samsung Pay using technology they acquired through its purchase of LoopPay. LoopPay is a payment system that uses mobile secure transmissions (MST) to send payment information to a magnetic card reader. MST will first be available on the Samsung 6 series phones. Samsung Pay will work

by using NFC as a primary way to transmit payment details and then fall back on MST where NFC is not available. This will make payments possible in over 90% of merchants.


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CURRENTC

Development of CurrentC was started in 2011 by a company called Merchant Customer Exchange (MCX), which is member owned by Walmart, Best Buy, Target, and several other large retailers who combined have over 110,000 retail locations and process over $1 trillion in payments annually. These

retailers developed CurrentC as a way to avoid paying the 2%–3% fee they are charged by credit card companies for processing transactions. The group plans on avoiding these transactions by running them as ACH transactions, which have much lower fees. CurrentC uses QR codes displayed on a user’s phone or scanned from a terminal to initiate and verify the payment. It uses Paydiant’s mobile wallet solution on the backend, which works through ACH. CurrentC is built around solving the retailers’ processing fees versus making payments easier for consumers. CurrentC also applies any discounts and adds loyalty points for partner/member retailers. They hope to gain an advantage over other payment wallets through their loyalty point integration.

CUWALLET

CUWallet was created by a group of individuals as a CUSO, majority credit unions controlled initiative. It leverages Paydiant’s white label solution, which uses QR codes to process payments. Paydiant is also the same software being used to power CurrentC. CUWallet can be imbedded into a credit union’s

existing mobile banking application or as a stand-alone app. The only known place that currently accepts CUWallet is Subway sandwich shop, which is a retailer known to be integrated into the Paydiant system. The QR/Bar Code technology being used will be in direct competition with CurrentC and PayPal as they both use Paydiant’s underlying technologies.

PAYDIANT

Paydiant is the provider of the white label mobile platform used by several companies, such as CUWallet, Barclaycard, CapitalOne, and MCX, just to name a

few. It is a QR/Barcode-based system and can be used for mobile payments, loyalty/rewards cards, and to withdraw money from ATMs. It was recently purchased by PayPal whose strategy with mobile is to provide small businesses a way to accept all forms of payments.

PAYPAL

When PayPal first made its move into the mobile payment space it was by creating PayPal Here, a merchant app, to compete against Square Register, which allows individuals to accept offline debit and credit cards on their iOS or Android smartphone or tablets. With many merchants using PayPal for the

online side of their businesses, this made sense to adopt. PayPal then took it a step further and developed an app that would allow a user to place orders online and then pay for them on the app. Alternatively, a person can pay at a merchant who accepts PayPal by checking in on the app when they arrive. If that is not available, a second method is to tell the cashier you want to pay with PayPal. The cashier will ask you for your phone number to bring up your account. You will then need to enter your pin into a pin pad.

ALL-IN-ONE CARDS

Mobile wallets are not only coming in phones, but some companies are creating what they


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call all-in-one cards. These devices are the same dimensions as a current plastic credit card but are packed full of payment options. They come equipped with NFC, EMV, magstripe, even security features to lock the card. These cards come with readers that you use to scan your cards and store them into the device. These can store credit cards, debit cards, private store cards, gift cards, and access cards. Some have questioned the claims that these devices can store EMV cards. EMV cards were designed to be secure and unable to be cloned. These cards don’t charge any fees for being used as they are only mimicking your current card, but they do come with a costly price tag of between $100–$150 dollars. Several financial institutions and retailers have developed their own applications with payment capabilities but customer adoption has been really low. In a recent study by the Federal Reserve, it was found that 75% of non-mobile payments users didn’t use mobile wallets because they believed it is easier to pay with debit/credit or cash.18 This will continue to be a challenge until consumers feel that using a phone is simpler or easier than using a card or there is some kind of incentive.

STARBUCKSStarbucks has developed a mobile wallet that’s been very successful because they have been able to tie their customer’s rewards cards, gift cards, and credit cards to their app. Starbucks has promotions that encourage and reward customers for using their mobile app for payments. One such promotion is the Monday Starbucks happy hour. Starbucks offers their customers 50% off Frappuccinos as long as the customer pays using their Starbucks app.

$600

$500

$400

$300

$200

$100

0Q2 2013 Q3 2013 Q4 2013 Q1 2014 Q2 2014 Q3 2014

STARBUCKS MOBILE PAYMENT VOLUME

In Millions

$263

10%

11%

13%

14%15%

15%

$302

$380$414

$454

$517

U.S. Mobile App Sales Mobile Sales as a Percentage of U.S. Totals

Source: Business Insider



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MCX

MCX, with a similar strategy, wants to get its customers to abandon using credit-based transactions and use CurrentC, which will run

transactions through ACH. One of the challenges MCX will have to following a similar strategy is many of their members sell products with low margins, reducing some of the items’ prices to entice customers to use the app, which will negate any savings they see from avoiding credit card transaction fees. If they stop providing an incentive to use the app at some point, it no longer offers a benefit over using a regular credit card and will be abandoned for a simpler payment method.

The payment space is very fragmented at the moment and may remain that way for a while. No one can agree on which technology will come out ahead but some are trying to give users the choice of using the one they prefer. Samsung Pay will have NFC and MST, which gives it the advantage of being compatible with any terminal that accepts a magstripe card. PayPal has been acquiring several mobile wallets and payment services to create a wallet that will work across several devices. PayPal is currently testing a beacon service that will enable anyone who opts in to just walk into a store and automatically be checked in. You can go about shopping and paying without ever having to reach for your wallet. This is something that has been working with smaller retailers but for it to be successful, these would need adoption by larger retailers.

For any mobile wallet to be successful what the provider needs to focus on is making the experience easier and more convenient for the user and the merchant.

$200

$180

$160

$140

$120

$100

$80

$60

$40

$20

0

2013 2014E 2015E 2016E 2017E 2018E

MOBILE IN-STORE PAYMENT VOLUME

In Billions of Dollars

$1.8

$189

Source: Business Insider


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KEY OBSERVATION

No emerging payment service illustrates the importance of all stakeholders within the ecosystem more so than mobile wallets. Within two (2) months of launching Apple Pay, more than 4,000 Members enrolled, however less than 20% to date have completed a transaction. The primary reason remains accessibility, with an estimated 500,000 merchants accepting the payment service. However, while that might sound high, there are millions of merchants in the US alone. Thus the “tipping point” remains some time away as merchant adoption, smartphone ownership, and financial institution acceptance converge to meet an emerging (and large) consumer demand.

CLOSING THOUGHTS

The payment ecosystem is experiencing a rapid, fundamental shift enabled primarily through technological advancements. However the drivers of this shift remain the four (4) key stakeholders: the Consumer, the Merchant, the Financial Institution and the Payment Enablers. In order to receive widespread adoption, a ‘tipping point’* must occur. EMV adoption is a classic example of this alignment and as a result, all four (4) stakeholders are and will experience a comprehensive change in how card payments are made.

While the ‘noise’ surrounding the payment ecosystem will likely continue for several years, it is those stakeholders whom can sift through and remain focused on the key tenants of any payment service:• Security• Accessibility• Cost• Convenience

PROS CONS OUTLOOK

• Convenience—the ability to store card information from most financial institutions negates the need to physically carry cards

• Safer Online Shopping—no transmission of credit card numbers

• Too Many Choices

• Too Confusing—every wallet works differently

• Too Limited—few places to use a mobile wallet

Form versus functionality is fully in play here. On the surface, the concept solves by creating a simple data repository that should simplify paying transactions and storing loyalty cards. The reality is confusing, and poor execution is creating questionable experiences. Additionally, does it answer a question no one asked? How bad is it really to carry a leather wallet?


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GLOSSARY OF TERMS

ACH (Automated Clearing House)—A U.S. electronic network used to process large volumes of credit and debit transactions in batches. ACH transactions include direct deposit, payroll, and vendor payments.

Wire—A transfer made between two banks with no intermediary. Unlike an ACH, wires occur in real-time.

CCV (Credit Card Validation)—A 3 to 4 digit code found on the back of a card for security validation.

Network—Refers to the system that processes payments. Major networks include Visa, Mastercard, Amex, and Discover.

Processor—A company that manages credit card transactions through networks, merchants, credit card issuers,and merchant account providers.

QR/Bar codes— Similar to bar codes found on food packaging, these are generated and displayed on mobiledevice screens to be scanned by a merchant to process a payment.

Apple Pay—Apple Pay is Apple’s Mobile Wallet solution. It works by utilizing NFC to communicate between the iPhone and the payment terminal. A user must enter their credit/debit card information into the phone. A chip on the phone then creates a token, which is passed onto the merchant during a transaction instead of the personal account number (PAN). To make a payment a user will bring their phone into close proximity of the payment terminal while simultaneously holding their finger against the biometric reader. Usually, no signature is needed when using Apple Pay. Apple Pay is only accepted at terminals that accept Visa and are NFC enabled. Apple Pay can be used with any of Partners’ Visa Credit/Debit Cards.

CurrentC—CurrentC is the Merchant Customer Exchange’s mobile wallet solution. This payment solution uses a QR code to make payments. A customer would need to download the app then scan the QR code presented during checkout to process the payment. It will use tokenization to transmit the information to protect the user’s account details. This payment method will encourage the use of ACH, gift cards, and private label charge cards so that retailers can avoid incurring traditional credit card transaction fees.

EMV—EMV is a joint effort started between Europay, MasterCard, and Visa to increase card present security and the global interoperability of chip-based cards. EMV has now become the global standard for credit card and debit card payments. EMV Cards, also sometimes referred to as chip-and-PIN, chip-and-signature, chip-and-choice, or generally as chip technology, are different from traditional credit/debit cards. These cards in addition to a magnetic strip also have an EMV chip that supports dynamic authentication versus a magnetic strip, which holds static information and can easily be copied.

Google Wallet—Google Wallet is Google’s mobile wallet solution. Like Apple Pay, Google Wallet utilizes NFC to transmit virtual card details between the device and the payment terminal. To register, you must enter your card details into Google Wallet. Google Wallet usually requires a signature for purchases over $25.

Merchant Customer Exchange (MCX)—MCX is a company created by a consortium of US retail companies. It is led by merchants such as 7-Eleven, Inc., Alon Brands, Best Buy Co., Inc., CVS/pharmacy, Darden Restaurants; HMSHost, Hy-Vee, Inc., Lowe’s, Michaels Stores, Inc., Publix Super Markets, Inc., Sears Holdings, Shell Oil Products US, Sunoco, Target Corporation, and Walmart.


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Mobile Wallet—Mobile Wallet refers to the different payment solution being offered that can be utilized using your phone. It consists of an application that stores your debit/credit card information and then facilitates payments using NFC or the scanning of a code.Near Field Communications—NFC allows two devices to exchange information when placed in close proximity of each other. This is the underlying technology behind Apple Pay and Google Wallet. NFC payments are sometimes referred to as Tap and Pay, Pay Wave (Visa), or PayPass (MasterCard). This payment method is a bit more secure as the card never leaves your presence. You can tell if a card is NFC enabled when you see this logo on it:

PAN—PAN is a personal account number. This is usually a credit card/debit card number.

PayWave—PayWave is Visa’s NFC payment solution. A Visa debit or credit card with the PayWave logo is used by placing the card in close proximity to an NFC reader. For most transactions under $25 there is no need to sign, making this payment method up to three times faster than the traditional swipe and sign.

PayPass—PayPass is MasterCard’s payment solution. It functions in the exact same way Visa PayWave does but using an NFC-enabled MasterCard.

SoftCard—SoftCard (formally known as Isis Mobile wallet) is a mobile wallet solution in development by AT&T, T-Mobile, and Verizon. It utilizes NFC to facilitate payments between the retailer and the customer.

Tokenization—Tokenization protects card data by creating a unique, randomly generated sequence of letters and numbers that is used in place of the card’s original PAN. This sequence or “token” acts as an alternative value to a PAN that a retailer can store on its systems. With tokenization, retailers and mobile wallet operators no longer need to store sensitive payment information like PANs on their networks. The token can later be reversed to its original PAN by using the right decryption keys.

Visa Checkout—Visa Checkout allows you to make payments securely over the Internet at participating merchant’s stores. At participating merchants, you can choose Visa Checkout as your method of payment (instead of a credit card, similar to picking PayPal), and the transaction will be completed through Visa’s payment system. The advantage of this model is that your card information is not passed on to the merchant only Visa will know your credit card information. This becomes increasingly important with the rise of attacks against retailers and payment systems.


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SOURCES

Proprietary data, third party articles and analysis were utilized to construct this paper. These include:

Azevedo, Helene. “Smartphone Adoption Approaches Tipping Point Across Markets.” ComScore 23 Feb. 2012, INSIGHT/ Data Mine sec.

Brown, Alexandra, Sam Dodini, Arturo Gonzalez, Ellen Mary, and Logan Thomas. “Consumers and Mobile Financial Ser-vices 2015.” Board of Governors of the Federal Reserve System (2015). Print.

“Consumers turn to contactless as usage surges” The UK Cards Association, 6 February, 2015, News Release

Fraser, Adam. “Nokia’s NFC Phone History.” Conversation: The Microsoft Devices Blog 10 Apr. 2012. Microsoft. Web. 12 Apr. 2015.

Geuss, Meagan , “Google Wallet use grows after Apple Pay launch”, ArsTechinca 5 November 2014

Heggestuen, John. “The Future of Payments: 2014.” Busness Insider Intellegence 17 Nov. 2014, Technology sec. Print.

Wester, James, “IDC Financial Insights Unveils Results from 2014 Consumer Payments Survey” , 21 April 2014 Financial Press Release

“NFC-Enabled Cellphone Shipments to Soar Fourfold in Next Five Years.” IHS 27 Feb. 2014.

King, Douglas. “Chip-and-Pin.” Retail Payments Risk Forum 2012. Print.

Peterson, Thad. “Payment Processing: A Merchant’s Perspective.” Aite Group 18 June 2014, Reports sec.

Petro, Greg. “With Apple Pay, Everyone Better Play.” Forbes 5 Nov. 2014. Print.

“Recent and Long-Term Payment Trends in the United States: 2003 – 2012.” The 2013 Federal Reserve Payments Study (2013). Print.

Santomero, Anthony. “Paper vs. Electronic.” The Evolution of Payments in the U.S. Fairmont Banff Springs, 2005. Speech.

“Third Report On Card Fraud”, European Central Bank February 2014

U.S. and Chip Cards, EMV Connection, Press Room Resource

Howard Schultz, Starbucks Q4 2014 Analyst Earnings Call

PFCU-Evolution of Payments-reduced

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