At launch, Google Wallet (GW) was based on Trusted Service Manager (TSM) business model, similar to the one still favoured by the mobile network operators (MNOs), e.g.
ISIS. Under that scenario, GW offered access to its embedded Secure Element for storing card details and authentication credentials. Unlike MNOs, GW was not greedy and offered reasonable commercial terms. Nevertheless, for many reasons, there were few takers...
When Google realized that it could takes months, if not years, to negotiate and agree a deal with every card issuer (there are over 8,500 card-issuing financial institutions in the USA alone), they ditched the TSM model. Instead, they decided to focus on
what they do best - delivering customer experience and monetizing "big data". Welcome to Google Wallet 2.0.
GW 2.0 works as follows: consumers can add any card to it by entering card details, just as they currently do at Amazon, iTunes and PayPal. GW 2.0 is "fronted" by Google's own card (MasterCard provided by Citi bank, although Google is planning to
add Visa card too to widen GW acceptance). To pay, the consumer selects one of the cards "stored" in GW.
Here's where things get interesting. All transactions are first charged to Google's own MasterCard; Google then charges the card which the consumer selected for that transaction.
That means Google effectively issues an instant short-term credit - and assumes credit risk (!) - for each transaction (that could be infringing BillMeLater patents which are now owned by eBay/PayPal).
But that's not all. Google shares interchange fee with Citi. Google's own card is a
debit one. That means that the interchange fee is capped to 21 cents + 0.05% of the transaction amount. However, if the card added to GW and selected by the
consumer for payment is a credit one, Google is charged around 2% on that transaction. Moreover, Google takes on an additional risk as all transactions with consumers' cards, "stored" in GW, are done on "card not present" (CNP) basis.
What is the significance of all that? Let me give you a monetary example. When I make a purchase using GW - but selecting one of my own credit cards "stored" in GW - Google first charges that purchase to its own card (Transaction 1), and only then charges
my card (Transaction 2). With a $100 payment, Google earns around 50 cents on Transaction 1, and is charged around $2 for Transaction 2, thus
incurring a net loss of around $1.50.
Google is also exposed to $100 risk twice: when paying the merchant before charging my card (Transaction 1), and when accepting my card on the CNP basis (Transaction 2). If I don't have sufficient funds on my card, or if the card I registered with GW is
stolen, Google could be hit for the full transaction amount.
Why do they do that? Several reasons, including consumer convenience, faster adoption, and - most importantly - access to the shopping/payment data. Is it worth it? If GW signs up 10m customers who would spend $1,000 during the first year making 100 purchases,
that's a $150m loss. How much money can Google make using (valuable) data on those 1bn transactions, via targeted offers, relevant advertising, loyalty rewards, etc. My (informed) conservative guess is - at the very least, enough to break even. What if Google
starts offering credit-based products (remember, they already provide instant short-term credit)? Using such companies as CapitalOne or GE Money as a benchmark, the value of a 10m GW customer base would be around $2bn.
When it comes to payments, at present, there are very few companies in the world who (even potentially) can operate using the same business model, i.e. losing money on every transaction in order to gain customers and data. By doing that, Google is setting
standards and consumer expectations which, for most players, are very hard to match. That's a strong "unfair" competitive advantage which is not to be ignored or taken lightly.
How does one compete with GW? By offering even better, unparalleled, user experience and delivering value and features not available elsewhere. Can MNOs or banks do that? No comment.