Payments and IoT: Transactions in a World of Connected Devices

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1 White Paper Payments and IoT: Transactions in a World of Connected Devices Sponsored by: Electronic Transactions Association and Intel James Wester November 2016 SITUATION OVERVIEW At the moment, there are a handful of technology topics that elicit excitement and interest due to the sense that each will cause widespread disruption to entire markets. This excitement has spurred waves of investment as companies attempt to capitalize on the potential of these new technologies. Examples of technologies that have captured our imaginations include block chain, virtual reality, artificial intelligence, and the Internet of Things (IoT). Among these burgeoning new technologies, the Internet of Things is already moving beyond the realm of science fiction and beginning to provide real applications in certain sectors and regions. In an IDC survey of IT professionals across industries, 31% of organizations surveyed have already launched IoT solutions, while an additional 43% are looking to deploy in the next 12 months. What's more, 55% of companies surveyed said IoT is strategic to their business competing more effectively. All of these solutions to harness the Internet of Things come at a cost, and IDC predicts that the worldwide spend on the Internet of Things is set to explode. The market for IoT spend on hardware, software, and other areas that will make up the Internet of Things is forecast to reach nearly $1.5 trillion in The compound annual growth rate (CAGR) for will be an incredible 16.1% (see Figure 1). DEFINITIONS Before one begins any conversation on IoT, however, it is helpful to start with a definition of just what is meant by the "Internet of Things" since it is a term that has evolved over time. IDC defines the Internet of Things as "an aggregation of endpoints or 'things' that are uniquely identifiable and communicate over an IP network using some form of automated connectivity, whether locally or globally." This definition of the Internet of Things is adequate, but it admittedly fails to capture why an "aggregation of endpoints" is such a powerful idea. To understand that, one needs to understand first the expected scale of these aggregated endpoints. IDC anticipates that by 2020, more than 30 billion connected devices, sensors, smart appliances, and the like will be connected to the Internet of Things. What's more, the scope of the IoT, as well as the purpose of these more than 30 billion devices, is expected to cover use cases across dozens of industries, from healthcare to energy to transportation to financial services. These devices provide data, content, information, and more to power applications providing power distribution, traffic management, clinical care, and contextualized commerce in a seamless, ubiquitous fashion. November 2016, IDC #US

2 FIGURE 1 Worldwide IoT Forecast, ,600 1,400 1,200 1,000 IoT will grow to nearly $1.5T in 2020, a 16.1% CAGR ($B) Asia/Pacific EMEA Americas Source: IDC, 2016 BENEFITS While it is apparent that IoT is on the verge of explosive growth, crucial areas regarding the impact of IoT remain oddly unexplored; key among them is how the Internet of Things will impact the world of financial services and payments. According to IDC's discussions with IT executives at financial technology vendors, payment processors, financial institutions, and other stakeholders in the payment system, the topic of IoT is rarely discussed beyond the theoretical. Given the timeline for the development and deployment of applications of the Internet of Things, as well as the scale of the disruption these applications represent, the lack of thought given to the practical implications of the IoT and payments, both the requirements and the opportunities, is alarming. What's more, it is a topic that is not well understood by IoT vendors on one side or providers of payments and financial services on the other IDC #US

3 Fortunately, within the IDC definition of the Internet of Things are some important concepts that have a direct bearing on the understanding of Internet of Things from a payment perspective: Uniquely identifiable: Each endpoint which can mean any type of connected device, appliance, sensor, or meter exists as a distinct entity within a network, and each endpoint is treated as a discrete source of, or channel for, data or instructions. Whether a sensor or a smart television, each endpoint is capable of being differentiated on the network. Automated connectivity: Once established, connections and communications between endpoints on a network are managed with minimal input or direction. Local or global reach: The networks of devices scale according to the needs and numbers of the endpoints, growing as required to accommodate new devices or services. Where these concepts inform the discussion on payments and the Internet of Things is in emphasizing how varied, complex, and vast the aggregation of endpoints will be. In addition, the endpoints themselves will have their own identity as well as the ability to initiate actions independently, such as placing orders, sending invoices, and making payments. These types of actions, which make up a substantial number of potential IoT use cases already in development, require access by connected devices to financial systems and payments. How these billions of autonomous, connected devices will access the payments systems, as well as how those relationships will be managed, is an issue that has not been adequately discussed. Regardless, it is clear the Internet of Things represents a new market for payment networks, processors, financial institutions. To seize that opportunity, those same stakeholders must understand three key ideas to guide their investments and strategies: Payments are a key component of many important IoT use cases. Devices instead of consumers initiating payments represent a new paradigm. Requirements for the payment systems will scale very quickly. Payments Are a Key Component of Many Important IoT Use Cases The growing list of use cases IDC has identified for the Internet of Things is varied and applies to a wide range of industries. However, a significant number of those use cases involve the movement of money, automatically, in response to the input of connected devices. Examples include connected cars initiating the payment of tolls, machinery resupplying components for manufacturing, appliances like a connected refrigerator ordering groceries, or a smart meter automatically paying a utility bill. Across these use cases, IDC expects the more than 30 billion connected devices to initiate more than $1 trillion in transactions in From the perspective of participants in the payment market, it is important to note that these transactions are, for the most part, not incremental, meaning they do not represent new transactions. The tolls would have been paid, parts ordered, and groceries purchased without connected devices. In some cases, where activities would have involved cash, had they not been initiated by an IoT device, it is arguable that transactions are net-new purchases for the market. Whether new transactions or simply a new channel, IoT transactions represent an opportunity for payment providers, acquirers, processors, and others to bundle what were previously discrete purchases. Network providers, IoT device manufacturers, and others will need their devices to have connections to payment networks, providing an opening for vendors of payment services to make those connections and bundle the transaction from those IoT endpoints, whether they are appliances or cars or meters IDC #US

4 Devices Instead of Consumers Initiating Payments Represent a New Paradigm As defined, IoT devices are capable of connecting to networks and are uniquely identifiable. Thus the connection between IoT devices and payment systems will not offer a particular challenge. In addition, that ease of connection will be the domain of companies building devices and chips. However, making the transaction easy and convenient for those vendors will open the opportunity of bundling the transactions initiated by connected devices. That will require new, specialized approaches on both ends of a transaction. On the merchant side, relationships between vendors of IoT devices and networks and specialized payment providers (e.g., value-added resellers and payment service providers) will need to develop. Creating that web of partners will make it possible to connect large numbers of devices as well as manage access and security. Those same IoT vendors will want payment methods that are easily accessible for connected devices as well. Ease of integration with networks, and simple provisioning of payment credentials into devices, will make that process seamless and convenient for consumers and enterprise users. Unlike in-person or online transactions, IoT-generated payments will likely be a case of "set it and forget it." Issuers of payment accounts like credit and debit cards will want to encourage the simplest path possible in order to capture the payments made by connected devices. Connectivity is only part of this new payment paradigm. Equally important is the obvious point that connected devices are not people. Payments are fundamentally about security and risk: Is the person using the payment mechanism the person authorized to use it (security), and how large is the likelihood that the transaction is fraudulent or that a problem will prevent settlement (risk)? Validating identity and modeling that risk are the primary functions of the payment system and determine how the costs of payment services are priced. However, those processes and models are still based on a decades-old consideration: a plastic card. In the world of connected devices, cards and cardholders are anachronisms. So the question is, How can those processes and models be updated to ensure security is maintained, risk is properly assessed, and the costs of those services are priced reasonably? Requirements for the Payment Systems Will Scale Very Quickly With investment ramping up and use cases already in production across multiple industries (e.g., energy and automotive), understanding payments within the Internet of Things is becoming a matter of some urgency if companies want to have a part of seizing some of the transactions generated by connected devices. The Internet of Things will present a very different payment model for companies to participate in, and it will require fewer providers of payment services, far fewer than if those same transactions were initiated by consumers. This is because those connected devices will be responsible for purchases once handled individually. On both sides of the transaction, the network providers those responsible for connecting the devices will determine how to route payments and what payment methods to accept. An important consideration for network operators will be the safety and security of those endpoints, so choosing vendors they can rely on will affect their partnerships. In addition, as with all networks, businesses will be built on small margins across huge volumes. There will not be much room left for payment vendors IDC #US

5 CHALLENGES/OPPORTUNITIES In the near term, the primary challenge facing the payment market as it explores the Internet of Things is the lack of understanding required to make billions of connected devices payment ready. The IoT is coming, but the payment market is unprepared. Financial institutions lack business cases to exploit this exciting new channel. Their technology vendors lack products. As the market continues to grow, and grow quickly, stakeholders that fill that vacuum and anticipate the needs of all of those connected devices or more precisely, the millions of consumers those devices represent will find themselves rewarded. The situation facing payments and the Internet of Things is not unfamiliar. A similar state of affairs occurred at the advent of ecommerce. Hundreds of websites appeared seemingly overnight representing a new type of merchant, one acquirers and networks were unfamiliar with. Meanwhile, consumers who were offered a new way to shop were ready to pay but lacked safe and secure payment methods. A small number of companies in the payment space processors, acquirers, start-ups stepped forward with new security methods, business cases, and risk models. That will happen with the Internet of Things. Other issues will affect the development of payment services in the world of the Internet of Things. Scaling networks and platforms to accommodate billions of devices securely will take time. Threats, outages, hacks, and unforeseen difficulties will undoubtedly occur. Those concerns are easier to solve than consumers' doubts or discomfort with a pervasive web of connected devices. The doubts and discomfort will inexorably lead to regulatory issues. But all of these challenges are solvable as long as the Internet of Things that aggregation of endpoints is providing real value, which includes facilitating all of those smart use cases that need access to financial services and payments. For that to happen, however, the payment market must figure out how it extracts real value as well. CONCLUSION With more than 30 billion devices/things and $1.5 trillion in investment across dozens of industries on the way, the time for doubting the viability or even the reality of the Internet of Things has long since passed. It is no longer the stuff of science fiction. From smart TVs to connected cars to emeters, the IoT-enabled devices that will offer us movies on demand, pay our tolls, and deliver our utilities will very quickly be a part of our lives. The companies that will provide the connectivity and infrastructure, or make those devices possible, are evolving their solutions rapidly. It is now time for the payment market to evolve its products, solutions, and business models equally rapidly. IDC encourages payments industry leaders to form strategies and growth plans around what IoT will mean to their company and ecosystem partners IDC #US

6 About IDC International Data Corporation (IDC) is the premier global provider of market intelligence, advisory services, and events for the information technology, telecommunications and consumer technology markets. IDC helps IT professionals, business executives, and the investment community make factbased decisions on technology purchases and business strategy. More than 1,100 IDC analysts provide global, regional, and local expertise on technology and industry opportunities and trends in over 110 countries worldwide. For 50 years, IDC has provided strategic insights to help our clients achieve their key business objectives. IDC is a subsidiary of IDG, the world's leading technology media, research, and events company. Global Headquarters 5 Speen Street Framingham, MA USA idc-community.com Copyright Notice External Publication of IDC Information and Data Any IDC information that is to be used in advertising, press releases, or promotional materials requires prior written approval from the appropriate IDC Vice President or Country Manager. A draft of the proposed document should accompany any such request. IDC reserves the right to deny approval of external usage for any reason. Copyright 2016 IDC. Reproduction without written permission is completely forbidden.