Wireless uptake credited to prepaid
Telecom service providers can be credited for the development of the prepaid model, which depends on rating and billing engines that are designed to automate the billing for long distance calls. This innovation included making an actual charge to the customer’s account at the time service is rendered rather than saving the billing records and then sending a statement to the customer, which would require the customer to establish some form of credit with the carrier before he could use the service.

This invention has been essential to the worldwide growth of wireless phone service. In the developing world, people not only don’t have credit, they don’t have the means to pay for the service if bills were rendered in the traditional mode.

Providing customers with convenient and flexible payment programs has always been an important aspect of total customer service. However, in the United States, wireless carriers have taken a different stand with regard to flexible payment programs. They have downplayed prepaid because they believe it increases churn and reduces average revenue per user.

U.S. service providers prefer to lock customers into a 12- or 24-month contract by offering a great deal on the handset that comes with the contract. Arguments can be made both pro and con whether these contracts lead to long-term customer retention. In any case, the evolution of wireless services delivered by the carriers, such as voice and broadband, and the services of others that use a wireless service as a delivery mode, will eventually require prepaid or, at the very least, real-time payment systems.

In spite of their initial experience, carriers outside the United States anticipated that they would someday be able to convert prepaid users to postpaid. However, due to the expanded scope of services now offered, such as digital downloads and on-line gaming, carriers in Europe now believe that prepaid will continue to be the dominant method, if not the exclusive way, to pay for wireless and other services that can be paid for with a wireless phone. Furthermore, current experience in Europe indicates that prepaid will eventually be the dominant payment method in the United States as well.

Why postpaid works for U.S. carriers
While prepaid indicates that people pay for service before it can be used, it also means that the service will be cut off when the prepaid amount is consumed. Prepaid subscribers are never extended any credit like that provided to postpaid customers. Some carriers in the United States, such as Sprint, tried to offer a semi-prepaid wireless service to their credit-challenged customers. Under this system, subscribers had a preset spending limit. Since this system was run on a postpaid accounting system, the company had problems limiting its exposure to bad debt. Customers could get significantly beyond their allowed limit before service was cut off. Many of these balances were never collected, and Sprint had to discontinue the program.

Any postpaid payment system requires some form of credit. The supplier provides goods and services and awaits payment as an accommodation to its customer. However, since telecom suppliers are delivering their own product or service, their exposure to bad debt is limited to their cost of goods sold plus shipping, if a physical product is involved. Suppliers with a high gross margin are willing to incur the risk of bad debt because incremental sales garnered by selling on credit are greater than the losses from people who never pay their bill.

Historically, telecom carriers have been more willing than most other vendors to sell on credit because they have high fixed costs. If a customer doesn’t pay the bill, the carrier only loses a small out-of-pocket cost. In addition, monopoly wireline service providers have the ability to deny an essential service until the bill is paid.

Digital content drives new usage
Carriers have incurred significant expense installing high bandwidth services that can be used to deliver digital content such as music, videos and games. In almost all cases, digital content is produced by an entity other than the telecom carrier; therefore, the carrier is acting only as a middleman.

Since telecom companies have the most efficient micro-billing systems, especially when a product or service is delivered over a phone line, the carriers have provided a payment system to these content developers. They also have acted as bankers in the sense that telecom carriers are extending credit to their customers for product or service other than their own.

In the early days, carriers provided the billing service to developers to encourage them to develop digital content. Furthermore, since the average transaction is a few dollars, processing payments through the carrier is the lowest-cost way to do business. However, in percentage terms, the charge for billing could be 40 or 50 percent of the selling price, which provides some buffer for bad debts.

Today, more digital content is produced by large companies with other channels of distribution and with greater bargaining power regarding fees charged for processing payments. In the long run, they will drive the fees for processing payments down more in the range of fees charged for a bankcard transaction, which ranges from 1 to 5 percent. With fees in this range, very little money can be lost through bad debts before the service becomes unprofitable.

Additionally, the average transaction size is increasing. Content developers are creating more sophisticated content and games which, over the course of a month, could add up to significant dollars. In the case of a heavy user, the charges for other services and products could far exceed his charges for voice or messaging services.

Account funding
Using a wireless phone to make payments seems to be a natural extension of the functionality of the technology. It is not much of a leap to think about the wireless phone as a payment device in all environments. Once the wireless phone is used extensively to make payments, the only issue is deciding how the payments are funded. There are three options:

1. The charge goes on the phone bill and then all charges are paid to the phone company, which becomes a defacto payment processor. Phone companies did this before with 900 numbers.
2. Phone companies provide an access service to traditional payments methods such as checking accounts or credit cards.
3. Phone companies provide true payment services where subscribers transfer assets from funds held in their name to merchants and/or other people.

Payments evolution
The evolution of payments made with wireless phones will be influenced by several factors:

• transaction size and the gross margin available to the vendor;
• number of services that are best delivered via a wireless phone such as ring tones, music downloads, traffic reports and driving directions;
• the utility provided by making payments with the phone, such as loading a parking meter;
• cost and availability of alternative payment systems to specific consumer segments, such as young people or immigrants;
• ability of merchants or vendors to integrate other functionality into the payment system such as rewards or loyalty programs;
• total number of people using such systems to make payments; and
• awareness and a critical mass somewhat like the ubiquity of payment cards today

In general, the progression will be from low-value transactions such as ring tones to non-digital merchandise that is purchased today at the point of sale with debit or credit cards. Today more than 99 percent of money placed in prepaid accounts is used for voice services. At some point in the evolution, prepaid wireless users will go from putting money in a prepaid account with a wireless carrier to placing funds in a general spending account, which the wireless carrier can charge for communication services.

The players
It is still too early to tell who will be the primary players in the mobile payments space. Wireless carriers could directly or indirectly provide this service to their customers, or third-party payment processing services could emerge to serve the market. It probably will be some combination of these two options.

Wireless carriers already provide directory assistance via third-party suppliers. In the case of directory assistance, customers are not aware that the service is being provided by an outsourced provider. With ring tones, the customer may be aware that the ring tone is coming from a third party, and the charge goes directly on his phone bill.

Carriers could offer a payment service directly similar to the service offered by SMART Communications, a wireless operator in the Philippines. This service can be used by customers to top off their cell phone account, and the service can also be used to make payments to other non-communications-related vendors. More than 2 million of the company’s 17.5 million wireless customers use the service. The service offered by SMART Communications may be more attractive outside the United States, since fewer people have access to traditional financial services for payments of any kind.

Also, independent companies not connected in any way with a wireless service provider may emerge. A new company in the United States, SVC Financial Services, now offers a service, Scoot Mobile Money, which allows person-to-person money transfers via a cell phone. It also comes with a debit card that is accepted at more than 5.5 million merchants worldwide.

Forecast
As wireless payment systems evolve, the distribution channel between the end-user and carriers will shorten. Competition among third-party distributors of prepaid products will reduce margins and industry consolidation will be inevitable. However, entrepreneurs will still be able to deliver certain niche users of telecom services to carriers, as well as financial services to the unbanked and credit-challenged.

Over the long term, bankcards may face a greater challenge as wireless payment systems provide more efficient and convenient payment services to mainstream American users. For example, new services will allow people to check their balance, review recent transactions and even change their PIN using their cell phone. Telecom service providers have the potential to gain significant competitive advantage over other communication service providers by offering advanced payment systems. n

by Tom Miezejeski
Information in this article is excerpted from from “Wireless Payments: The New Payments Paradigm,” a report from The PELORUS Group. For more information, visit www.pelorus-group.com. The author can be reached by e-mail at tmiezejeski@pelorus-group.com or by phone at (908) 707-1121.