Apple (AAPL -0.35%) recently introduced "Tap to Pay on iPhone," a new feature that allows merchants to accept NFC payments on their iPhones without using additional hardware or payment terminals.
Merchants can accept Apple Pay, contactless credit and debit cards, and other digital wallet payments with the service, which will roll out on the iPhone XS and newer devices across the U.S. later this year. Could this move spell trouble for Block (SQ 2.32%) and PayPal Holdings (PYPL 2.90%)?
Image source: Apple.
What's Apple's game plan?
Apple Pay has been adopted by more than 90% of U.S. retailers since its launch in 2014. Unlike Block's Square, PayPal, and other digital payment services, Apple Pay doesn't charge its merchants any fees. Instead, it merely allows a stored credit or debit card to be used on iPhones, iPads, Macs, and Macs with Touch ID, Face ID, and NFC security features.
Apple also launched Pay Cash, a peer-to-peer payments service, in 2017. This service, which competes against Block's Cash App and PayPal's Venmo, is also free to use.
For Apple, digital payments represent a way to lock in users instead of generating significant revenue. It's just another brick in its prisoner-taking ecosystem, which also includes its App Store, Apple Music, Apple TV+, Apple Arcade, Apple Fitness+, and other subscription-based services.
The stickiness of that ecosystem widens Apple's moat against Alphabet's (GOOG 9.96%) (GOOGL 10.22%) Google Android. Google's comparable solution, Google Pay, is also a free service for merchants.
Therefore, Tap to Pay on iPhone represents a natural extension of that strategy. Google Pay also provides peer-to-peer and in-store payments, but its merchants still need to install third-party NFC payment terminals.
What Tap to Pay means for Block and PayPal
To understand how Apple's latest move could affect Block and PayPal, we need to first realize that their business models are very different.
For merchants, Apple Pay and Google Pay are merely streamlined credit and debit card transactions. The merchants don't pay Apple and Google any fees, but they still need to pay a "card-present" swipe fee at physical stores, which can cost 1.3% to 3.5% depending on the card network.
Block's Square and PayPal shoulder those swipe fees and charge the merchants flat transaction-based fees instead. Those fees, which are reduced by the scale of Square's and PayPal's own payment networks, can be a cheaper option than card-present swipe fees for certain businesses. Square and PayPal also cross-sell additional products -- such as payroll tools, analytics services, and loans -- to offset those costs and boost their revenue per merchant.
Apple's latest move doesn't directly disrupt those business models. In fact, Block's Square Seller services and Cash App already work with Apple Pay, while PayPal integrates Apple Pay into its Braintree back-end payments platform. Apple already plans to integrate Tap to Pay with other third-party iOS payment apps -- starting with Stripe -- so Block and PayPal could also add the new option to their own payment ecosystems in the near future.
Apple's Tap to Pay on iPhone might eliminate the need for Square's payment dongles and terminals, but that loss-leading hardware generated less than 1% of its revenue in the first nine months of 2021. PayPal sells point-of-sale (POS) terminals through its Zettle subsidiary, but it also doesn't generate significant revenue from those products.
Apple isn't a threat to Block and PayPal (yet)
Apple's new Tap to Pay feature might initially seem like a threat to Block and PayPal, but it will actually only impact their tiny hardware segments.
Block and PayPal's core businesses should remain largely unaffected, since Apple Pay targets a completely different market. It also probably won't turn Apple Pay Cash into a major threat to Block's Cash App or PayPal's Venmo, which together serve at least 150 million active customers.
In addition, Apple won't expand Apple Pay's ecosystem with data-gathering value-added services like Block and PayPal, since its privacy-oriented platform can't actually identify the purchaser or the product being purchased.
Therefore, investors should simply view Apple Pay and Google Pay as secure, smartphone-based extensions of physical cards. Meanwhile, Block and PayPal are middlemen that leverage their scale to offer more favorable payment processing rates while selling additional value-added services.
These two markets overlap in certain areas like payment terminals, but Apple and Google's ecosystem-building fintech moves probably won't render digital payment platforms like Block and PayPal obsolete anytime soon.
