You are waiting to check out at a coffee shop, grocery store, or home improvement store. The person on line in front of you waves her phone at the register and walks out with her purchase. No cash, no card—she simply waves her phone. What you have just witnessed is the next big change in payment systems—mobile wallets. 

Mobile wallets add one more function to smartphones: They make them a virtual debit card, and allow a person’s money to travel with his phone. Market researchers paint a very rosy picture for adoption. Allied Market Research projects that the worldwide market will double from more than $16 billion in 2013 to $32 billion in 2014 and reach $5,200 billion in 2020, reflecting a growth rate of approximately 100 percent over seven years. Such lofty projections have garnered attention from such well-­established, industry-leading suppliers as Apple, AT&T, Google, MasterCard, PayPal, and Verizon, all of which are jockeying to become mobile wallet market leaders.

But there is a very dark lining around this silver cloud. At the moment, the mobile payment infrastructure is more blueprints and wish lists than available products. A variety of technical and business models have emerged that do not mesh with one another. A great deal of work and further experimenting are needed before these systems are commonly used. In the short term, the technology promises to increase the workload for harried contact center agents, but in several years, mobile wallets are expected to streamline the payment process and offer consumers a simple way to make purchases.

Appealing to a Variety of Audiences

The idea of adding mobile commerce functions to smartphones appeals to a number of constituencies for different reasons. 

Consumers benefit by gaining simplicity. Rather than carry a handful of credit and debit cards as well as cash, they only need one payment method.

With mobile wallets, financial assets are stored on a device that many consumers have grown attached to. A PayPal survey found that smartphones are second only to keys on the list of items people will not leave home without. In fact, many consumers already go out without cash or credit cards. In a second PayPal survey, more than two-thirds of Americans (68 percent) said they have been unable to pay for something because they did not have funds with them, and nearly one in three Americans (30 percent) frequently find themselves without access to needed cash. 

Smartphone manufacturers also have something to gain. They find themselves in a highly competitive marketplace and are constantly looking for new ways to differentiate their systems and expand their customer base. “The phone vendors are aggressively developing mobile wallet features,” says Christian Lunoe, senior client service analyst at comScore. Apple and Google are busy putting the pieces in place for not only the phones, but for the payment infrastructure as well.

More Personalized Shopping Experiences 

Retailers have also jumped on the mobile wallet bandwagon. With mobile wallets, they gain another way to reach consumers and increase sales. While online or at the store, customers are able to make spur-of-the-moment purchases because they have quick and easy access to money. Also, merchants can provide customers with more personalized promotional programs. They can target groups of individuals in different areas for different products or use coupons to spur binge buying. 

The smartphone love affair extends to younger consumers, the groups that marketing executives aggressively target. Consumers in this demographic are much less likely to carry cash or use credit cards than their parents and grandparents are, do not follow set payment processes, and think mobile devices are cool. If retailers want to harvest this segment, they need to offer mobile payment options.

But these solutions face many hurdles, starting with an infrastructure build-out, which is complex and requires the interconnection of a number of elements. Indeed, the work is so cumbersome that Square Inc., a high-profile mobile payments start-up that at one time had a $5 billion market valuation, is now struggling to stay afloat (see “Back to Square One”). 

Start at the Beginning

The process begins with mobile software apps. These applications need to be able to begin, authorize, and reconcile payments. Currently, a number of techniques are emerging to complete these steps.

The first element is identifying consumers via their phones. Smartphone vendors are outfitting their devices with Quick Response (QR) codes, which consist of black modules (square dots) arranged in a square grid on a white background. An imaging device, such as a camera, reads the code, and an application connects the code to the consumer’s phone. Apple, Google, Microsoft, and Samsung AG have all delivered cell phones with this capacity.

The handset vendors need to provide an interface to users so they can set up and monitor their transactions. Right now, the feature sets vary greatly. With Google Wallet, consumers redeem items from loyalty programs and take money from an ATM. Apple has been enhancing its Passbook service so customers can redeem coupons at stores. Square’s system produces a photo of the user at checkout. 

A New Way to Connect

Next, the mobile device needs to be able to exchange information with a receiving system. Near field communication (NFC) relies on radio frequencies to allow smartphones to communicate with other systems. Most smartphones support this communication option.

On the other side of the connection, the receiving station, much work has to be done. “There is a significant need for infrastructure at the retail store,” says Ashish Gedamkar, associate engineer of digital marketing at Allied Market Research. Retail outlets now rely on other network systems, such as Wi-Fi or Bluetooth, so their end points must be upgraded with NFC functionality or they’ll have to place another device at the checkout counter. 

Then the payment data needs to pass from the retailer’s system to a third-party authorization system. With credit cards, American Express, MasterCard, and Visa emerged as the primary authorizers. In the mobile wallet space, a handful of options are taking shape. 

PayPal Extends Its System

PayPal now plays a key role in many digital transactions. The company enhanced its electronic payment system, so it works with mobile devices from Apple, Google, and Microsoft. 

MasterCard developed the PayPass Wallet Service, which has three components: PayPass Acceptance Network, PayPass Wallet, and PayPass API. MasterCard’s partners include American Airlines, which has been integrating the PayPass Wallet into its mobile application, and Barnes & Noble, which developed a PayPass online checkout button on its Web site.

In October 2010, AT&T, T-Mobile, and Verizon Wireless developed the Isis system. It works with NFC technology and allows users to pay by tapping their mobile device to a payment terminal. Isis has partnered with the Discover network, American Express, Barclaycard US, Chase, and Wells Fargo. The group claims that more than 200,000 local and national merchant locations use its solution. (At the time this article was written, Isis was in the process of changing its name to avoid association with Islamic State of Iraq and Syria, a militant Islamic group.)

Retailers Take Charge

In August 2012, a group of leading U.S. merchants formed the Merchant Customer Exchange (MCX), a company dedicated to developing a mobile payment infrastructure. Some supporters include 7-Eleven, Best Buy, CVS/pharmacy, Lowe’s, Sears Holdings, Shell Oil Products, Target, and Wal-Mart Stores. 

Given the infrastructure problems, it is clear where the market is now. “We are now in a very early stage of adoption,” comScore’s Lunoe says. So early, in fact, that not everyone agrees that mobile wallets are the end goal. Instead, some pundits view digital wallets, which can be used with any device (phones, laptops, PCs, smartcards, or tablets) as the ultimate payment destination and mobile wallets as one application of that technology (see “A Digital Wallet Versus a Mobile Wallet” on this page). Whether mobile wallets will emerge as a stand-alone market or a digital commerce subset is unclear at this point.

Also up for debate are basic design issues. As noted, currently there are competing vendors, each with its own approach. Since no one system has emerged as a standard, it is now impossible to use a mobile wallet at a local coffee shop in the morning and a department store later in the afternoon.

Open or Closed Loop?

A couple of design options are gaining traction, however. The closed loop approach limits all transactions to a single retailer. Here, the retailer develops the payment option, which resembles a debit card, and it only works in its stores. The customer puts a set amount into the mobile wallet and draws on it later. The commerce system is often tied into the retailer’s loyalty program. Starbucks and Dunkin’ Donuts have put those systems in place. “Coffee shops have had success with their mobile wallet programs,” Lunoe states.

An open loop design is the mobile wallet Holy Grail. This solution offers consumers a variety of payment options: debit cards, credit cards, or cash. The consumers even place all of their plastic in one account, making a debit card or a credit card transaction when it best suits them. The wallet is tied into a variety of retailers’ loyalty programs and coupons. But none of the groups building such systems have even glimpsed the Holy Grail, let alone reached it. Significant pieces (select payment options, a lack of presence, limited functionality) are missing in their initiatives, but many have begun early rollouts, in which consumers pay for goods with their smartphones. 

As the market takes shape, suppliers need to address consumer concerns. The technology can be unreliable. Smartphone users have multiple applications on their phones, which consume power, and the chances of battery outages are high. Also, a phone may fall in a puddle and stop working. 

Security: The Big Kahuna

Security is a bugaboo. Tying a wallet to a phone has risks. Seventy percent of smartphone owners do not use a password to lock their phone, according to security vendor Sophos. So if someone loses her phone, whoever finds it has access not only to the personal data on the system but also to that individual’s financial information, which makes her a prime candidate for identity theft.

 Privacy is a concern. Customers are worried that their information will be compromised as it moves from place to place. Hackers have been focused on financial applications, with wireless transactions being especially attractive. Once these systems evolve, hackers are expected to take notice.

Given the market factors, confusion and competition now reign. As the different approaches gain traction, backers will need to turn their attention from putting the needed pieces in place to educating consumers about mobile wallet benefits and assuaging their security and privacy concerns. The mobile wallet has the potential to overhaul the payment process, but right now, it is not ready for prime time.  

Paul Korzeniowski is a freelance writer who specializes in CRM issues. He has been covering technology for more than two decades and is based in Sudbury, MA. He can be reached at paulkorzen@aol.com.