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Apple maintains a competitive advantage in consumer payments
What is the natural cost of a consumer payment? Close to zero. Electronic signals are almost costless. Once in place, verification systems are low upkeep. Fraud costs something, and someone other than the consumer has to cover that. Whether payment is from an account or as credit seems irrelevant.
Costs of course will not be zero and providers will naturally want to charge whatever they can for the service. But JPMorgan Chase coming out with its own system and undercutting Apple Pay by offering more to merchants shows how competition will work here, as it has worked in every other electronic system. Think about a phone call or a stock transaction or an email or text—the costs keep being driven down.
That does not make JPMorgan Chase wrong to start its service. The payments system is one of the most profitable parts of banking. The large banks have to try to defend their franchise, and consumers will benefit the most from the competition.
The WSJ recently wrote about this subject, fairly intelligently for the most part. But then it threw in this clunker:
J.P. Morgan has already lined up a huge group of merchants, including Wal-Mart and Best Buy to accept payments through its technology. How the bank won this business is instructive: The fees for Chase Pay transactions will be lower than for payments made with traditional methods such as debit and credit cards. That effectively means J.P. Morgan is willing to cannibalize profits from its traditional payments business to win market share.
While that can be painful, it is less so for banks. They can offset lower fee income with what they make lending money. The same largely isn’t true for tech rivals. As the struggle heats up, it is likely anyone who wants to be a big payments player will have to offer increasingly expensive incentives to merchants and consumers.
What I am focusing on here is the notion that banks can make up for lower fee income by making more on loans. If anyone has been around banking for more than a few years, they will remember that the search for fee income came about because banks were not sufficiently profitable based solely on the spreads they earned. And lending is a dangerous business because it is pro-cyclical. It makes money when times are good and loses money when times are bad. Fee income is less cyclical and therefore provides a suitable balance to spread income.
Have the WSJ writers forgotten this history? Or do they think that lending has changed? Whatever the reason, there is no difference between the profit per transaction for a bank or for a non-bank. Both have to use capital to create the system they use and both have to operate the system. Profit for either depends on cost per transaction, what they charge per transaction, and volume (crucially, volume). The conglomeratization of a bank through its several business lines or Apple through its far broader set of business lines or of PayPal through its narrower set of business lines is irrelevant. All the players will drive costs as close to zero as they can, and all will compete for business by charging consumers as little as they can while earning profits. The advantage that Apple has is that it sells the phones that originate the transactions; therefore it potentially benefits not only from Apple Pay transactions, but also from everyone else’s transactions that are originated using iPhones—and maybe the iWatch even newer devices as well.