Paying With Your Phone Is Awesome Because It's Not 1960 Anymore: In Reply To Farhad Manjoo's "Paying With Your Phone Is Awesome, Because ... Because."
Mr. Manjoo oversimplifies the state of affairs with regard to mobile payments.

April 7, 2011
Also published on Quora

Topics = { Media + Payments + Technology }

The columnist Farhad Manjoo recently wrote an article on Slate with the subtitle "We already have a perfectly fine way to make non-cash payments." This article makes a lot of excellent points, but mixed in with these insights are a lot of misleading or simply incorrect statements. Mr. Manjoo should be forgiven for these misapprehensions, for they are commonly held amongst the general public as the result of massive misinformation campaigns propogated by some very large companies (most of them banks), but the final result of the article is a conclusion that is the polar opposite of what it should be, and a conclusion that actually hurts us all.

We don't already have a perfectly fine way to make non-cash payments. At best, we have a really antiquated way, but at worst we have a way that is helping to rapidly tear society in two.

The first issue that the article tackles is that of Near Field Communications, or NFC. NFC is a wireless data transmission technology, which is another way of saying a method that lets two devices communicate with one another minus the cords. Since roughly 2002 the financial industry has pumped billions (with a "b") of dollars into NFC, thinking that it would instantly revolutionize payments due to greater convenience. As Mr. Manjoo points out, this is mostly rubbish. In reality, it's not any more convenient to tap a phone than it is to swipe a card. So when MasterCard rolled out PayPass and Chase unveiled Blink, blinking was just about all they got. Several other NFC payment systems have met a similar fate, as merchants have consistently balked at the high installation costs for a system that no one could find a reason to use.

Unfortunately, after swiftly dispatching NFC to its rightful place in the garbage bin of hype, Mr. Manjoo goes astray when he discusses how few reasons there are to use a smartphone for payments. Many in the banking and telecommunications industry also suffer from an acute lack of imagination; at several recent conferences I have personally witnessed the banking elite scratch their heads, searching for reasons for mobile payments to exist at all. Such confusion demonstrates how out of touch bankers are with their own products, and how good a job they've done convincing the world, and themselves, that they couldn't possibly be any better. (I might call this the First Omen of Rapidly Approaching Disintermediation.)

In a world where the only benefit to mobile payments is the supposedly more convenient tap, Mr. Manjoo's argument that the transition from plastic payment cards will add unnecessary implementation costs is technically true. With some context and a bit of thinking, however, that argument quickly falls apart and even starts to look a bit suspect.

The fact of the matter is that phones are small computers these days, and as such they are capable of doing things that plastic cards simply can't. For one thing, they can store a lot more information than you can fit on a magnetic strip, which holds maybe one kilobyte (1KB) of data at most. Modern phones can generate images on the fly. They can organize information. By virtue of being telephonic devices in the first place, they can communicate with other devices, including more powerful computers. To say that none of this matters is to say that computers themselves are no better than metal typewriters—and yet I would venture to guess that Slate columns are not produced with typewriters, and probably never have been.

Mobile payments are important because they represent the first real opportunity that we as a nation have had in the past half century to update the country's financial infrastructure. In the transportation industry, the word "infrastructure" usually refers to roads, rails and bridges, and in payments it's no different—bankers frequently use the word "rails" to refer to the Visa and MasterCard networks. In other words, with a mobile payment system, a company could build an entirely new payment network from the ground up that does not depend on the same old companies, and that by design overcomes the various limitations and bottlenecks of the current system, therefore bringing costs down.

Would there be up-front implementation costs for an entirely new payment network? Sure, but they would be a blip on the screen, so to speak, when compared with the rapidly accelerating costs of payment processing. The reason that Congress is contending with two (or three?) wars, health care, and debit card payment fees in 2011 is that the costs of processing cards are serious: they're enormous, and they affect virtually every business in the country.

The conflation between NFC and mobile payments, embraced wholeheartedly by the media at large and not just Mr. Manjoo, leads to all kinds of flawed assumptions, false dichotomies, and problematic reasoning. It's possible to make a new payment network that works with smartphones, but doesn't require them, such that literally everyone can still carry an inexpensive payment device. (Think paper barcodes.) It's not entirely fair to NFC as a technology to say that NFC is "a solution in search of a problem," because it's really the payment-card-on-a-phone paradigm in general that is the solution in search of a problem. (NFC is one of many technologies out there that payment systems can use to transmit information.) At the same time, it's hardly as though cards on their own are perfect. Cards do work for making card payments, but by definition, card payments come with a whole slew of problems.

Paper (really plastic, it turns out) receipts are annoying, and beyond that, toxic. The companies that issue cards charge usurious interest rates that are only legal because of banks' combined efforts to twist the arms of South Dakota politicians years before many of us were born. The cards themselves require oil to produce and ship, and are routinely discarded in the trash as they expire. Hundreds of millions of account numbers have been stolen, many of them used to make unauthorized purchases, because of fundamental flaws in the security measures used to handle cards. In the forms of auditing fees and IT overhauls, retailers must pay exorbitant amounts of money for so-called Payment Card Industry (PCI) compliance, which simply does not work because one fundamentally cannot make an insecure design suddenly "secure" with rules alone, any more than one can turn lead into gold. But far and above all of these problems, there is one core problem, which is that it's not 1960 anymore.

In 1960, there was one phone company in the United States (AT&T) and long distance telephone calls were expensive. It's hard to imagine today, but even calls to another city in the same state were charged by the minute. To process a plastic card, stores eventually installed payment terminals that were effectively modems in boxes programmed to call central processing mainframes (which also had several modems attached) toll-free—except that nothing in life is really free. Toll-free calls are just long distance calls paid for by whoever answers. In order to keep costs low, payment processors who were paying for these calls designed the network to send the payment card data as quickly and efficiently as possible. In other words, the terminals were designed not to send any data about the purchase itself because that data would make the call take longer.

The system grew, and grew, and grew, and soon enough the whole country depended upon it. Modems started popping up on store counters everywhere in the form of payment terminals, all programmed in roughly the same manner. Now, fifty years later, they're still there. Re-programming them all or replacing them outright would cost billions of dollars, so they continue to sit as they were, unaware of the internet or fifty years of technological advances.

What does this mean for you as a consumer? It means a lot of things. It means that the merchant names on your statements can only be a certain length, so they're often garbled. It means you can't search for all of your transactions from a single merchant over time. It means you can't tell what you ordered last week for lunch unless you still have the paper receipt. It means e-mail receipts are impossible at many stores. It means you can't automatically separate out personal expenses from work expenses using the same payment card. It means that you can't note how much of a given transaction went toward sales tax. It means that your purchase of a hamburger at an airport restaurant will probably show up on your year-end summary as "TRAVEL AND ENTERTAINMENT." It means your bank has no idea how to accurately categorize your expenses for tax purposes. And it means that you or your accountant will have to waste an enormous amount of time doing arithmetic that a computer could do instantly (if it had the proper data) because the IRS says you must. It means entire wasteful industries exist employing tens of thousands to manually enter data that was digital to start with.

As it so happens, there isn't a single company in the financial industry working on solving these problems from start to finish save for one, which happens to be the company I run. The example of Square cited in Mr. Manjoo's article doesn't even come close. Square, which is attempting to make the ubiquitous payment card network even more ubiquitous, doesn't lower credit card fees fees for merchants—it raises them, and holds onto funds beyond $1,000 per month for risk management purposes. As long as the card networks are in place, offering "rewards" to the well-off that are financed by the punishing fees levied disproportionately on the poor, our society will continue to suffer as it becomes increasingly polarized, without even realizing why.

As a side note, the current regulatory environment in the financial sector is grossly distorted by lobbyists seeking to keep the aging rails of Visa, MasterCard, American Express and Discover from succumbing to age and market forces (this, the Second Omen of Rapidly Approaching Disintermediation). The Durbin Amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act, which regulates debit card interchange fees, was originally supposed to affect credit card fees as well. It doesn't. The legislation's goal is nominally to increase competition, thereby lowering processing costs for merchants, but in reality it does nothing of the sort. The fact is that market competition doesn't exist because of laws passed on the state level by 90% of states, who require money transmitters such as PayPal (which are not banks) to raise enormous sums of money for licenses before they can even operate. In the past four months California has changed its law to clamp down even harder, and New York has decided to re-interpret its law in a similar fashion. The banks, which are simultaneously raising fees on all types of consumer and business accounts, are clearly winning the battle, and with Congress so dysfunctional that it can barely stay in session, this seems unlikely to change.

In 1960, the most advanced instrument the banks could think of was a plastic card because computers filled entire buildings, but as we all know, it's not 1960 anymore. Average consumers hold the equivalent of a million building-sized computers in their hands, and so it's only natural to think that the next payment instrument will be the smartphone. It has the potential to make our lives a lot easier. All it takes is a little imagination.


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