Apple is taking biometrics mainstream. Watch out as software eats identity and payments.

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Identification using fingerprints dates to the 1890’s. But automated commercial biometric identification is much more recent. Some dates: automated fingerprint recognition (1969), hand geometry (1974), iris (1995), face (2000), vascular (2000). That last one is vein pattern recognition, typically done using IR sensors on the back of the hand. Continuing the trend, IBM put a fingerprint reader in a laptop in 2004, and India’s biometric identity program dates to 2009. With that said, I’d argue mainstream consumer adoption of biometric identity only happened in 2013 with the release of the fingerprint reader in the iPhone 5s. These things take time. And because they take time, they arrive gradually and unappreciated. Touch ID is more than just how to unlock your phone. Biometric identity is here. Attention must be paid.

Prior to the Apple Watch announcement last week, I was wondering if Apple would put some type of vascular ID sensor on the back side of the watch. Instead we got what at first looked like quirky and overhyped heartbeat sharing. Then I read an excellent post by Joshua Gans on payments and biometric id. Quote: “So how will Apple solve the identification issue with a Watch given that they didn’t put Touch ID on the Watch itself? My guess is that it will use heartbeat identification.” Gans then cites the company Bionym, which is working on a wrist band ID bracelet that identifies your unique ECG heart rhythm. This spurred me to do some searches on the topic. What’s fascinating is Apple applied for a patent on heartbeat identification in 2010. That patent was granted in 2013. From a 2013 Techcrunch write up:

As for the heart rate monitor, Apple’s patent describes a sensor found in the screen bezel or other conductive portion of the device that could read EKG data. You could imagine it going into the conductive metal ring around the Touch ID sensor in the current iPhone 5s design, for instance, which would be fitting also because of similar function between the two sensors.

You could imagine that. Sure. Or you could imagine it going into a brand new product category, say a watch, which has hearbeat biometric identity as a showcase feature of said watch. What’s interesting is Apple says you have to enter a PIN when you put the watch on, which enables payments, and then the watch automatically disables payments if it loses contact with the skin. Disabling payments after loss of skin contact is an ingenious design approach. But the PIN part seems like a 1.0 move. It’s not clear if Apple is hedging their bets on heartbeat recognition, saving a key aspect of the watch for a later announcement, worried the technology won’t be fully capable until Watch 2.0, or planning to have no heartbeat ID at all. Personally I’d be shocked if biometric identity wasn’t a core part of Apple’s plan for watches. Owning identity is such a strategic platform win. I guess we’ll have to wait and see. Apple plays a long game.

Software Eating Music

Before we get to software eating identity, let’s recap how software ate music. It will serve as a rough model for what biometric identity could do to payments.

  • Phase 1: Digitization. Software eats the product, in this case music. This first phase starts out as a sustaining innovation, making the existing business more cost efficient. Everyone is happy as costs go down. Phase 1 for music was the iTunes store. Note: music piracy and changes in distribution channel are a big part of the music story, but for our purposes I want to stress how digital downloads were a cost savings compared to physical CDs.
  • Phase 2: Commoditization. Digitization turns out to be a Trojan Horse. It commoditizes the existing product, and causes a radical drop in prices and margins. Zero marginal cost with internet distribution is economically brutal and transformative.
  • Phase 3: Disruption. Lean businesses built on the newly commoditized product take over the market using a new model. In this case Pandora and Spotify built ad supported subscription streaming models. These are now displacing the digital music downloads created by iTunes in Phase 1.

Digital music news says that “Eventually, streaming will cannibalize all recording things.” Their chart below gives their forecast for what I’m calling Phase 3. Low margin music streaming is replacing digital downloads, so 2012 was the digital download peak for iTunes. 2013 is the start of decline. Like many industries touched by digital economics, music is a producer nightmare and a consumer paradise.

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We saw this devaluing of music most directly at the Apple launch last week when people whined inconsolably about getting the new U2 album put on their iPhones for free. Free music is spam. Even if Apple hasn’t noticed yet. Editorial note: 1) the Who is U2 site is hilarious, and 2) if Apple felt compelled to give away free music from an overage, arena filling white rock star, why not ask Dave Grohl? Anyway. Charles Arthur from the Guardian captured the zeitgeist perfectly:

What’s important to note is even though Apple kicked off the digital commoditization of music with iTunes, they did not lead the next phase of streaming. That was left to companies which took commoditzation for granted. In fact, Apple has a minor strategy tax against streaming since the profits from their old digital download model are still coming in. So their iTunes Radio streaming product was late to market in 2013, despite Apple acquiring music streaming service LaLa in 2009. By now it’s no longer critical for Apple to be the most dominant player in music. Commodities are not differentiators. Apple has bigger fish to fry, like watches with biometric identity.

Software Eating Identity: a disruptive force

With that template, let’s move to software eating identity. Its arrival has been so gradual, we’ve had plenty of time to think about its advantages:

  1. Locks: phone/watch replaces house keys, car keys, bike locks
  2. Passwords: web site passwords, airline check in, hotel check in
  3. Government identity: India is leading this, but I’d be surprised if over the next decade other countries don’t start to follow.
  4. Payments: digital credit card, banking, online purchases, loyalty cards, coupons
  5. Health: medical ID tied to health records

As software eats identity, the first three items in the list above will work a lot better. But these changes won’t be disruptive. For example keyless door entry for cars is already a thing, and car companies could adopt Apple identity keyless entry without disrupting their business. Personally I am eager for this. I hate having keys in my pocket, and even using a password manager is a pain. So I’ll be glad when these are gone, or at least greatly reduced. As for government biometric id, well, it’s controversial but I’ve argued the transparent society is already upon us.  So it’s more a matter of getting good regulations passed rather than preventing government from adopting biometric identity.

Payments and health are far more interesting. There are plenty of people who believe Apple Pay will commoditize payments, though I have no doubt this view is more common in the tech world than at Visa. From just before Apple’s announcements last week:

I expect commoditization to roughly follow the music model used above.

  • Phase 1: Digitization of Identity. Biometric ID leads to efficiency gains for banks in terms of fraud prevention. This drives down costs and leads to widespread adoption and improved profitability. Apple gets 15 cents on every $100 of purchases, but this is for providing better security and a net win (or at least neutral) for credit card companies. In this phase, Google is likely to relaunch Google wallet or a new Android service more like Apple Pay, though I’m skeptical if Google will go as anonymous on the data as Apple. At this stage everyone is rich and happy. Smiles and cost savings all around.
  • Phase 2: Commoditization. Biometric ID is a Trojan Horse. It greatly reduces fraud risk, but by doing so commoditizes it. To be clear there’s still return/default risk and the short term credit loan to deal with. Even so, fraud risk becoming a commodity will lead to ruthless competition. In particular I expect retailers will eventually gain an advantage in being able to request their preferred payment method at point of sale using Apple Pay. For example I have a debit card and a credit card in my wallet. The debit card fee is less, so if retailers could tilt me toward using it every time they would do so. Apple won’t care that much. Consumers won’t care. Banks and Credit Card companies would flip out. This is still 3-5 years away, but Apple is taking a strategic approach. In particular note how Apple Pay is marketed under the Apple brand, not the bank’s brand. Commoditization of credit issuers is coming.
  • Phase 3: Disruption. Banking is highly regulated so it’s not clear how easily new companies can enter this market. Should be fascinating. Like music, Apple is unlikely to be a leader after commoditization since they straddle the past and future of payments. They will still be getting a small transaction fee using the existing model (just like iTunes digital downloads), which will slow them from pushing for radical change. Plus payments will become far less attractive once moving money around becomes commoditized. Value is likely to be built on top of that newly commoditized payment layer. Eventually bitcoin will slot right in. Some will adapt. Many will not. Consumers should benefit.

Healthcare is another area Apple is interested in, and also one ripe for a digital makeover based on biometric ID. Plus machine diagnosis. But that’s a topic for another post.


Appendix – Payment and Biometric ID references with some commentary.

This appendix is here in case I come back to this topic later. So skip unless you want to dig deeper. The technical payment details are pretty interesting, but the post was so long I mostly left that out.

  • Joshua Gans  – piece mentioned above on payments and heartbeat id. A good quote: “But the point here is that yesterday Apple launched the most significant innovation in payments since the credit card itself. Few people have noticed and that includes the market that took Apple stock on its traditional, post-announcement, plunge.” – Apple’s new Identification Revolution
  • Richard Brown – excellent explanation of tokenization and Apple Pay, including the EMVCo spec – A SIMPLE EXPLANATION OF HOW APPLE PAY WORKS (PROBABLY): IT’S ALL ABOUT TOKENIZATION
  • Tom Noyes – insightful writer on payments with very deep experience in the industry. Very fond of italics, caps and the jumpcut. Don’t always agree (he’s very skeptical of merchant adoption of changes to payments) but a pleasure to learn from someone with such a deep background. He’s also skeptical of how loyalty cards would work for merchants if Apple doesn’t provide them with the identity of who is buying their product at point of sale or online. This is a good point, though one it’s possible to workaround using beacons or loyalty apps. Glad he’s sharing what he knows. Good posts: iPhone 6 – Quick Thoughts and Brokering Identity.
  • White paper on EMV standards compliance. This is a change in liability, where US retailers will be at fault for the use of fraudulent cards if they don’t upgrade to the newer EMV compliant card systems by October 1, 2015. This is a huge deal because it means that a year from now all US retailers will have modern point of sale systems. This is a huge plus for Apple Pay rolling out, as these new systems are NFC compliant, so technically able to work with Apple Pay. This is also why US payments are are likely to skip over Chip and PIN systems used in Europe and move directly to NFC. EMV: Preparing for Changes to the Retail Payment Process
  • Chamath Palihapitiya – argues that Apple Pay will take over payments and their profits, does not see it being commoditized. Disagree as argued above, but interesting speculation on what Apple Pay utter dominance would look like. ApplePay Just Co-opted a Multi-Trillion Dollar Market — And Its Awesome!
  • Vascular ID – more details on how this works – Bank customers to sign in with ‘finger vein’ technology
  • Ben Bajarin –  interesting write up. he’s been big on identity for a while – Apple Payments and Smart Watches: Just the Beginning
  • Om Malik – general Apple event review, but interesting quote on the future of Square: “Square will have to focus on becoming the Amazon Web Services for real-world businesses — starting with the point of sale system, and building a massive backend system that captures everything from inventory, ordering to bookings and business management.” Some reflections on the new Apple Event

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