Eric Greco, Portfolio Associate
September 30, 2020
Over the last decade, we have seen rapid global adoption of a superior form of digital payments. Known as “contactless payments,” “tap to pay,” or “NFC payments,” this rising digital payments technology represents a powerful tool for digitizing low-value, high-frequency cash purchases (like that daily takeaway latte) as well as driving credit and debit card volume growth. Particularly with the recently-increased adoption—underpinned by technological advancements, data security enhancements, and consumer preference for convenience—we view this shift as a mechanism for further acceleration in cash displacement within the payment ecosystem.
A Rising Trend
While contactless payments are already popular in a number of countries around the world, widespread adoption domestically has suffered from a lack of appropriate infrastructure. Nevertheless, over the past year, usage in the U.S. appears to have reached an inflection point on the continued expansion of merchant acceptance as well as increasing contactless card issuance from leading financial institutions. Further, hygienic concerns linked to COVID-19 present a unique opportunity for contactless payments to penetrate small ticket items (under $25), where approximately 80% have heretofore been conducted in cash.(1) We believe the upward trajectory of adoption creates a number of considerations in the investment space.
Remind Me: What are Contactless Payments?
Currently, consumers conduct contactless payments in two primary forms: either enabled credit and debit cards, or mobile wallets like Apple Pay and Google Pay. This functionality provides consumers with a way to pay for goods and services without physically inserting or swiping a card into a point-of-sale terminal. Instead, contactless payments exchange encrypted data from your credit/debit card or smartphone to a payment terminal or tag within close proximity, typically at a distance of less than four inches. And it’s Near Field Communication (NFC) technology that makes it all happen. NFC has key advantages over other wireless technologies—like Bluetooth and WiFi—tailoring its usage to payments technology. While NFC doesn’t have the same range as Bluetooth, its superiority in pairing connectivity and lower-power consumption far outweigh its drawbacks.
2020 Driving Changes in Consumer Behavior
COVID-19 has precipitated material changes in consumer behavior including a preference for contactless payments. As the global population works to limit virus transmission between individuals, we’ve seen businesses limit in-store foot traffic and shift to curbside pickup, public transportation systems expand the acceptance of contactless payments solutions, and consumers eschew cash as a payment method for goods and services. A combination of better technology (described below) and consumer acceptance together point to a strong future for contactless payments.
Infrastructure: A Chicken and the Egg Problem
The rise of new payment forms is entirely dependent on a rather complicated web of retailers, payment processors, merchant acquirers (merchant banks), issuing banks, and card networks. Together, these entities must develop the physical and digital infrastructure, security, acceptance, and frictionless experience in order to permit ease of use for consumers. Two of the most important components of the infrastructure build-out are widespread merchant acceptance (by installing the point-of-sale terminals) and early-stage issuance of contactless cards by the issuers. Early-stage development of the aforementioned components paved the way for successful rollouts in markets including Australia, Canada, the UK, and portions of Continental Europe.
Stateside, the rollout has progressed more slowly. The reality of the situation is, up until recently, the U.S. had a serious chicken and the egg problem: that is, an imbalance of contactless acceptance by retailers and proper payment cards issued to consumers. Culpability falls at the feet of the issuing banks that were mandated to issue compliant chip cards by late 2016. Most of them chose the path of least resistance and, in order to save roughly $0.35 per card, they issued consumers single-interface chip cards without the antenna needed for contactless technology. (2) Fortunately, the landscape has changed over the last year. The largest banks in the U.S. are now actively rolling out new contactless cards, with nearly 200 million in circulation as of June, 2020. Just six years ago, less than 5% of in- person card transactions were conducted at contactless-enabled terminals; that figure has now skyrocketed to nearly 65%. (3) The infrastructure dilemma has been meaningfully solved.
What Makes This Important?
In addition to making it more convenient to pay for that single-origin pour-over coffee, this growing trend has investment implications, too. Holistically, the entire payments chain stands to benefit from the secular cash-to-card shift, gaining 2% per year, and pull forward growth through the adoption of contactless payments. Annual global consumer-to-business spend is estimated to be a $33 trillion market. And 47% of that massive market transacts with credit, debit, and prepaid cards, which then generates several hundreds of billions of dollars in annual fees in the U.S. alone.(3) Not only do we expect a continuation of the cash-to-card trend, but we see contactless payments accelerating credit/debit card use, materially boosting card spend and the resulting fees for the entire payment ecosystem.
Contactless appears to be quite effective at converting small value payments from cash-to-card as well as increasing the frequency of use. Recent data points offer clear proof of engagement growth, with average card spend increasing 20% for customers who start using tap to pay. (4) From an investment standpoint, we expect the flow-through of growth materializing through two metrics: digital transaction volume and card spend.
1 “Mastercard Study Shows Consumers Globally Make the Move to Contactless Payments for Everyday Purchases, Seeking Touch-Free Payment Experiences”, Mastercard Data Exchange, 4/29/2020. https://mastercardcontentexchange.com/newsroom/press-releases/2020/april/ mastercard-study-shows-consumers-globally-make-the-move-to-contactless-payments-for-everyday-purchases-seeking-touch-free-payment-experiences/
2 “The Prepaid Market: Trends for 2018”, 1/4/2018, https://hi-tech.org.ua/prepaid-market-trends/
3 “Payments Primer: Navigating the value chain, powerful secular growth & intensifying disruption. Our responses to top FAQs.” Harshita Rawat and Matthew McLean, Bernstein, 11/5/2019.
4 “Piper Sandler Global Exchange & Brokerage conference”, FactSet CallStreet, LLC, 6/4/2020. https://s1.q4cdn.com/050606653/files/doc_downloads/2020/06/ CORRECTED-TRANSCRIPT-Visa-Inc.(V-US)-Piper-Sandler-Global-Exchange-Brokerage-conference-4-June-2020-12-30-PM-ET.pdf