2019 Outlook: Merchant Services

8 Mill and Main Place, Suite 150 | Maynard, MA 01754 November 2018 www.mercatoradvisorygroup.com |phone 1-781-419-1700 |email: [email protected]

2019 OUTLOOK:

MERCHANT SERVICES

Mobile apps and new sales channels throw a lifeline to beleaguered merchants.

Store closings, especially legacy chains, continue to dominate headlines for the U.S. merchant industry. Empty storefronts dot Main Street USA, while metro and suburban malls have gaping holes left by vanishing anchor stores. But Armageddon has not yet arrived, as most macro indicators offer positive signs including a resurgent economy and a mostly confident consumer. Brick-and-mortar stores are not dead, and some retail verticals are even expanding. Many successful merchants are enjoying a lift from the rising e-commerce trade. For 2019, a key merchant sales driver will be mobile commerce and its increasingly pivotal role in consumers’ researching, shopping, and buying goods and services. This 2019 Outlook on merchant services provides insight on how this will happen.

by Raymond Pucci, Director, Merchant Services

8 Mill and Main Place, Suite 150 Maynard, MA 01754 [email protected]

Looking Back at Mercator’s 2017 Predictions for 2018 Merchant Services

Looking back at the predictions we offered in last year’s Outlook on merchant services (Mercator Advisory Group’s 2018 Outlook: Merchant Services, released in December 2017), we are pleased to report that reality matched or exceeded the predictions in all cases. Our predictions are in quotation marks at left in the table below:

What We Predicted for 2018 What Actually Happened

U.S. employers added 250,000 jobs in October and the “Increasing consumer confidence and decreasing unemployment rate held at a 49-year low of 3.7%, unemployment will drive retail sales.” signs of a strengthening labor market that delivered U.S. workers the best pay raises in nearly a decade. —Wall Street Journal, 11/2/18

The amount of retail space going dark in 2018 is on “Store closings will continue to occur in large numbers pace to break a record, as companies with massive albeit at a declining rate.” floorplans are either trimming back their store counts or liquidating entirely. —CNBC, 4/18/18

The U.S. Department of Commerce reported that 88.3 “Brick-and mortar department stores, electronics, and percent of sales still happen at brick-and-mortar home improvement will see increased business on stores. Marketers need to bridge that gap—which is click and collect, which is their variation of mobile why click and collect has become a rapidly growing order and pay.” trend in retail. —Adweek, 4/27/18

“The universal pay apps do not give shoppers enough Universal wallets show flat growth per Mercator reasons to use them. Mobile apps need more Advisory Group CustomerMonitor Survey Series, June incentives in addition for making a payment for 2018 consumers to use them.”

8 Mill and Main Place, Suite 150 Maynard, MA 01754 [email protected]

Consumers Are Choosy on Using Mobile Payment Apps, but Convenience and Immediacy Will Win Them Over

Mobile commerce has now established itself as a key component of merchants’ sales growth engines. Mobile takes many different forms and platforms. It is fulfilling consumers’ urge for “concierge commerce,” which means being able to shop and pay any way, any time, and anywhere one chooses. This 2019 Outlook starts by looking at where the significant mobile payments opportunities will be for merchants in the coming year and why.

Universal Pay Wallets Stuck in Neutral Despite universal mobile wallets such as Apple Pay, Google Pay, and Samsung Pay having been available as early as 2014, for most consumers in the United States they are not their preferred “go-to” choice for proximity payment (that is, in-person payment at the point of sale, or POS). The wallet providers have yet to offer shoppers sufficient reasons to use the wallets on a regular basis. Other than early adopters of technology products and services, who are a small percentage of overall users and tend to sustain brand relationships, the majority of consumers in the U.S. are just not gravitating to the universal wallets. Mercator Advisory Group’s 2018 CustomerMonitor Survey Series results show that moderate users (4 times per month or less) are decreasing, whereas early adopter, frequent users (10 times or more per month) are increasing.

We do not anticipate robust growth for the universal wallets in 2019, although they will ring in the New Year with some recent advantages. More POS locations in the U.S. than ever will be enabled for Near Field Communications (NFC) and therefore able to accept Apple Pay or Google Pay. Apple states that 60% of U.S. retail locations will accept its universal wallet by the beginning of 2019. Further, recent big merchant converts to both Apple and Google universal wallets include Costco, CVS Health, and 7-Eleven. To increase the pace of growth of their universal wallets, the wallet providers will need to increase both marketing aimed at consumers and marketing aimed at merchants. Apple Pay ran a summer 2018 promotional program offering discounts to customers using Apple Pay at Dunkin’ Donuts, Fandango, Grubhub, Hotels.com, Nike, StubHub, Under Armour, and other major retailers. This is the type of incentive that could win over new users. Samsung Pay also has a rewards program, although redemptions are restricted to its eponymous products.

Merchant-Sponsored Pay Wallets Gain Market Parity Conversely, it will be the mobile payment apps sponsored by a single merchant such as Starbucks and Dunkin’ Donuts (after January: Dunkin’) that will show the greatest growth in usage in 2019. While this mobile pay category suffers from inconsistency in quality and user experience, this is where to look for best-of-breed applications. Fast food and fast casual restaurants lead the way in how to develop a successful mobile pay app. That’s because they provide an integrated set of features beyond just making a payment and they continually revise their apps with the goal of improving the user experience. Starbucks’ and Dunkin’ Donuts’ apps have won enthusiastic usage that mirrors the devotion to each brand’s coffee by their respective customer bases. Although some customers prefer

to pay cash or reflexively pull out and pay with a plastic card, mobile payments will win the day at quick stop/ frequent visit retailers. This is why C-store/gas stations will see growth in mobile payments in 2019. Many regional players such as Cumberland Farms, QuickChek, and Wawa are taking advantage of mobile pay apps, especially as they roll out larger physical stores intended to carry more freshly prepared food and drink items.

Some merchants of products other than food and beverages have also jumped on the mobile pay bandwagon. However, for the most part retail categories such as department stores, electronics, grocery, pharmacy, and home improvement have not taken to in-store mobile payment use at the point of sale. Exceptions include CVS Pay, Kohl’s Pay, Wallet in the Target app, and Walmart Pay. These merchants’ apps typically combine features like digital coupons, store locators, merchandise finders, and payment within the app. The main focus of merchant- sponsored wallets will continue to gravitate toward mobile order and pay or mobile self-checkout (covered later in this Outlook).

Mobile Order and Pay Continues Its Rapid Pace Mobile order and pay will increase penetration across multiple market verticals. Just as QSRs and fast casual restaurants have capitalized on this new sales channel, other mainstream segments such as department stores, electronics, and home improvement stores will do the same. Although customers will not be using mobile order and pay apps for line-busting so much as they would at a Starbucks or Panera Bread, they will be ordering higher- priced and larger items such as apparel, big screen TVs, and power tools. Rather than pay and then wait for delivery, shoppers will order the merchandise, then drive to the store for pickup within an hour or two. Mobile order and pay becomes known as “click and collect” for nonfood stores.

Mobile Self-Checkout Will Enter Its Growth Phase Mobile self-checkout has landed. 2019 will see many more deployments of this nascent technology in both the U.S. and Europe. Realization of a pure-play, totally automated self-checkout has been taken a while to become operational for the buying public. Amazon’s development and testing of the Amazon Go mobile self-checkout concept took years and millions of dollars, but now the stores are starting to ramp up fairly quickly beyond the original Seattle location. Amazon Go achieved notoriety with its first store in early 2018, with plans for at least another four in 2019 in major U.S. cities including New York and Chicago. Some rumors surfaced that Amazon Go was considering ramping up to 3,000 stores in the next few years. This would be a significant development in mobile self-checkout systems, but actual fulfillment of this goal seems highly ambitious. C-stores and other small- footprint merchants represent a sweet spot for this technology. Maybe even smaller sections of Amazon-owned Whole Foods could become Amazon Go zones. Shoppers want convenience and immediacy, and this is simply another indication that mobile self-checkout is here to stay. Right now, deployment of the Amazon Go model is limited to merchants with deep pockets that can handle the big IT investment necessary to enable it.

Sam’s Club is another major retailer to watch for mobile self-checkout. Sam’s is no stranger to mobile order and pay as its current Scan & Go mobile app is operational in all its club stores. Now, Sam’s Club is experimenting with a new mobile app designed for a smaller club store concept. The new mobile app is in the testing phase and has

some new features. Sam’s is taking an integrated approach by providing shoppers with prompts based on buying patterns. The technology push here is that Sam’s is loading up with store cameras and machine learning to understand customer shopping habits as well as to handle store inventory management. This is not the same as the Amazon Go store, where cameras and sensors are used to charge the customer’s payment card on file. In any case, this pilot bears close watching as there seems to be a lot of potential to enhance the customers’ in-store experience as well as to help merchants with store inventory control.

Small and medium-sized merchants are getting access to more cost-effective systems for accepting mobile payments. White-label applications using basic smartphone scanning functionality are expanding their reach with installations in both the U.S. and Europe, and consumers will see more of this in 2019. Examples are applications provided by companies such as FutureRetail Proof and Rambus.

The Next Big Thing: U.S. Grocery Store Online Order and Pickup/Delivery

Online grocery sales in the United States have very low penetration, estimated at 1–2% of the total market. In comparison, penetration of the U.K. market is about 8–9% according to Ocado, a U.K. e-commerce grocer. Given that U.S. consumers have a seemingly insatiable appetite for immediacy and convenience, 2019 will be the year of online ordering business for the grocery store market segment in the United States. National grocers such as Albertson’s, Kroger, and Whole Foods are practically tripping over themselves to offer mobile order and fast pickup of groceries. Two hours or less will be the fulfillment standard. The value proposition of mobile order and pay is this: “Order and pay for products seamlessly, and the order will be ready very fast.” These grocers are betting millions in IT, logistics, warehouse robots, and staffing to win a decisive market share in what will be a hotly contested field. Look for more marketing of grocery mobile apps as a way to win and keep customers.

Conversational Commerce Amps Up the Volume

Conversational commerce has become a major market segment that merchants cannot afford to ignore. There are now at least 450 million voice assistant devices in place in the United States—smartphones, speakers, PCs, tablets, smart TVs, connected cars, and wearables—a number that is expected to reach 870 million by 2022 according to TechCrunch. Total value of voice-originated purchase transactions in the U.S. could reach $40 billion in 2022, from the current $2 billion. Amazon leads by far in the race for smart speaker market share. Microsoft and Google have respectable share, but Apple’s Home Pod has been late to the party. Watch for Apple to give Siri a jolt in 2019 in the conversational commerce competition.

One development to watch for in conversational commerce in 2019 is retailers developing their own voice assistants. For example, Domino’s Pizza introduced DOM, its new personal assistant for placing voice orders, which is being piloted in 20 of its U.S. stores. The QSR vertical would be prime space for other versions given the fast

order and takeout nature of these businesses. We expect most merchants will go the partnership route as they are doing in large numbers with Amazon, Google, and Microsoft.

Key challenges lurk ahead in conversational commerce for merchants and their technology and payment providers in 2019. These will be related to improving not only functionality but also security management and consumer privacy. In any case, conversational commerce is a new way of doing business, and technology will determine the speed and extent of growth of this new sales channel.

Remaining Thoughts Looking Ahead to 2019

Mobile POS (mPOS) will continue as a battle between Square and First Data’s Clover. Both companies are expanding their service offerings with business tools and lending as well as selling upmarket to larger businesses. Clover just sold its millionth device, sales having risen from 500,000 in the last, so the sky is still the limit for the mPOS market.

M&A activity will continue unabated. Legacy acquirers will look for more scale and volume, with international markets being their prime hunting grounds. Additionally, they will go after tech companies with expertise in a specific platform or vertical markets. Fraud detection firms and e-commerce related players are primary targets.

Asia mobile pay apps will be found in more U.S. merchant locations. The East will continue to come west as Alipay and WeChat Pay partner with acquirers and processors for an entry with U.S. merchants.

Payment fraud battles will intensify. Firms providing fraud-detection solutions will see continued growth that mirrors e-commerce and mobile commerce in 2019. Legacy acquirers will continue to develop organic fraud- fighting resources as well. Chargebacks will become a larger issue for merchants due to more restrictive card network rules, which will increase the need for chargeback solutions.

Self-service kiosks will become a common device in QSRs and fast casual restaurants. Higher labor costs and consumers becoming accustomed to self-order to avoid long checkout lines will accelerate the installation of kiosks. Restaurants also benefit will increased staff productivity and lower order-error rates.

Merchants will bolster their customer loyalty programs. Heavy competition among credit card loyalty programs with higher incentives and cash back means that stores will fight back by offering premium rewards for their best customers who use the store credit card.

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For more information about this report, please contact: Raymond Pucci, Director, Merchant Services [email protected] 1-781-419-1716

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