At this week’s highly anticipated new product launch, Tim Cook (Apple’s CEO) introduced Apple Pay, Apple’s new payment platform driven by the event’s leading stars, the iPhone 6 and iWatch. As usual, the excitement was infectious and palpable, even for those virtually participating from locations thousands of miles from Cupertino.

Apple is entering the payments market as a starting point for a new service category in its groundbreaking product portfolio. A move backed by Apple, the top-ranking global brand, most surely has significant implications for banks, payment networks, retailers, consumers and beyond.

The technology of the current payments system is based on a model developed more than 50 years ago. The vulnerability of existing payments security has been made clear with the ongoing stream of data breach announcements from such places as Target and Home Depot.

Cook, followed by Eddy Cue (Apple’s SVP of Internet Software and Services), indicated considerable energy has been spent on “creating an entirely new payments solution.”

Previous reports suggested Apple Pay would likely be compatible with all four card networks, but the Apple launch confirmed partnership with only American Express, MasterCard, and Visa (notably, Discover is not included but will likely be added, possibly even by the October launch). Additionally, Apple Pay has partnered with the majority of bank issuers, including PNC, Citi, BofA, Wells Fargo, Chase, and US Bank, among others.

A starting list of major retailers accepting Apple Pay includes Disney, Macy’s, Whole Foods, Nike, Starbucks, Walgreens, and Nordstrom, among others. Although high-volume big box retailers such as these already negotiate discounted transaction fees with the likes of Visa, the potential for lower interchange rates that Apple Pay is rumored to offer is an important draw for the broader retail community.

Product Availability

• September 19: iPhone 6 and iPhone 6 Plus available in nine countries, with others to follow
• October 2014: Apple Pay available in the United States, expanded global launch to follow
• Early 2015: iWatch available, includes a unique Digital Crown navigation toggle

Industry Implications

• Apple’s signature play is to enter mature markets (consider how the iPhone completely redefined the cell phone market starting in 2007) and upend user experience to levels not previously imagined. By repurposing demand, Apple Pay has the same potential for far-reaching influence on established financial institutions, as well as start-ups long attempting to modernize the U.S. and global payments system.
• What’s different is Apple’s focus on security over payment method. Apple Pay and the ability to authorize payment with touch ID is the first mass consumer payment method that uses biometric data as an identifier. The issuance of a one-time card number for payment ensures a more robust security process. Apple’s existing captive user base of 800 million+ iTunes accounts is a further strategic pathway to large-scale adoption.
• The “tokenization” process of transacting with Apple Pay does not necessitate storing credit card information on Apple or merchant servers. Purchases through Apple Pay generate a device-only identifier, with each payment assigned an “anonymized” one-time payment number and dynamic security code. Additionally, the “Find my iPhone” feature can be used to suspend payment cards. The focus on privacy makes Apple Pay timely in that user data is not collected via the traditional, and increasingly vulnerable, remote server method.
• This is just the beginning. We believe more is coming from Apple related to payments and data security – especially with the incorporation of advanced biometric data, possibly extending to headphone sensing, cardiac-rhythm recognition applications. This potentially makes Apple’s May 2014 Beats acquisition all the more intriguing.
• With the iPhone and the iPad widely considered industry game-changers, Apple Pay is poised to shake up the financial services industry in similar fashion, starting with payments, one of the most fundamentally utilitarian services to the global economy. A recent survey concluded Millennials (otherwise known as the Apple generation) identified banking as an industry “at the highest risk of disruption.”  (Source: The Millennial Disruption Index)
• Apple retains patents issued in recent months that point to a range of technologies likely consistent with an expanding Apple Pay platform. For example: dual-factor authentication associated with an online service provider, biometric credentialing, and secure enclave processor within a chip. 
• Introduced at its June 2014 developer’s conference, Apple has been testing and promoting a proprietary iBeacon technology. A “beacon” essentially functions as an indoor GPS, providing a rich “context aware” customer experience of particular value to retail marketing efforts. If successfully implemented, the implications of transforming a highly customized experience into the convenience of a mobile sale can easily be imagined. Privacy (soon becoming a commoditized luxury) and appropriate consumer protections certainly apply here. However, Apple’s latest technologies that utilize Bluetooth Low Energy (BLE) and Near Field Communication (NFC) are quickly turning theory into practice.
• A tiered transaction authorization system is believed to provide authentication security thresholds that can differentiate between low-value and high-value transaction spend. This process assigns a more nuanced approach to risk.
• Financial services providers face both a challenger and a collaborator in Apple. Many emerging as a de facto standard, the company’s technologies require continuous adaptation of securely engaging with the next generation of agile, tech-savvy consumers.

Client Alert 2014-239