What needs to happen before the iPhone gets NFC

We may not have jet packs yet, but pretty soon plastic will be a thing of the past. At least in our wallets, that is.

The technology that will bring us part of the way there is near-field communications (NFC), an exciting tool that lets devices exchange information with one another when in close proximity. So far, its main use has centered on payments, specifically point-of-sale terminals at retailers. In fact, you probably have a credit card from your bank with an NFC chip in it.

The next frontier for those little chips is in smartphones. Like wallets, these have become something people carry around with them everywhere they go. More importantly, mobile application stores have warmed users to the idea that the phone can have a direct line of credit with your bank account and some of the same cards you're carrying around.

For nearly a year now, a mix of patent filings and third-party reports have pointed at Apple adding NFC to its devices, specifically the iPhone. But none has managed to offer a clear, well-supported stance of what Apple is really up to. CNET talked to two NFC experts about the current mobile payments landscape, and they spelled out some of the hurdles Apple faces not only in putting NFC chips into devices but also in setting up the infrastructure and partnerships to make it a reality.

Before delving into the nitty-gritty though, it's worth understanding why would Apple would even venture into NFC in the first place. The simple answer is that it's an enormous business opportunity.

"Electronic payments in the U.S., according to the Federal Reserve was $40 trillion in 2010," David Eads, who leads product marketing for Kony Solutions told CNET. "So for every 1 percent of mobile payment adoption that happens of that number, that's $407 billion in transactions."

Eads, who has a background in the mobile payments industry, founded the mobile consultancy Mobile Strategy Partners and held positions at mFoundry and Tealeaf Technology. He explained that the big ticket item in that magic $407 billion number was the "interchange" revenue, which is where various parties get a cut from fees. That can run anywhere from $4 billion to 6 billion on each $407 billion chunk. It also makes things more competitive among the various parties that take fees, since retailers can choose the card or payment provider they want to support.

Following the money
But the opportunity lies far beyond simple fees. There is the business of partnering with retailers with things like coupons and loyalty programs, which can be stacked on top of the purchasing process. And unlike retrofitting them to work with existing systems, Apple has the potential to start fresh and build that in from the start.

"Groupon doesn't make 2 percent of the ticket. They make 50 percent of what's paid," Todd Ablowitz, who is the president of the Double Diamond Group, another company that does consulting for the electronic payments industry, told CNET. "Everyone is chasing that promotional revenue, and that's where the focus is going to be," he continued.

That everyone includes Google, which recently added support for NFC in its Android OS though has not yet offered up its payment tools for retailers or developers. Near the end of last year, Google came close to buying Groupon and has since refocused its efforts on social deals with its Google Offers platform. There's also Facebook, Amazon, and start-ups like FourSquare, Gowalla, and Loopt, which have carved out deals with retailers to attract mobile phone users with coupons and discounts.

Discounts and deals could be putting the carriage in front of the horse though. The core of the technology centers on getting NFC chips into phones and NFC-capable point-of-sale units to flush the market, not to mention getting the underlying systems in place to make sure those two sides of the equation work from place to place and from phone to phone.

So what's holding all this up then? Part of it has been a chicken and egg problem: putting NFC chips in phones is neat, but if there are no scanners to use them, who wants to put them in the phones? Likewise, if there are barely any NFC devices, what's in it for a retailer to upgrade their point-of-sale hardware with an NFC-capable system?

As my colleague Elinor Mills pointed out in her story about NFC and mobile wallets last month, the GSMA, a trade association representing the Global System for Mobile Communications industry, began pushing handset makers to start including NFC chips in their phones back in 2008, with the end goal of having it be standard practice by late 2009. As we've seen with phone hardware, we're just now getting to the point where NFC is becoming a checkbox feature on phones that aren't geared toward specialty markets or professions.

In the interim, all manner of companies have sprung up and jumped in to fill the void, some offering SIM and MicroSD cards with build-in NFC chips, while others offered up stickers containing chips that can be affixed to the back.

At this point, it's not a cost issue with the actual hardware, Eads explained. For something like a point-of-sale system, the extra NFC hardware costs around $5, which is a drop in the bucket when you're paying $200 or more for a swiping machine. "The cost is being passed into the merchant," Eads said. "They can keep the same price point and help the units move faster." Even so, it might be a hard sell for a business with an already-functioning set of point-of-sale machines to upgrade.

All told, there are more than 750,000 point-of-sale terminals that support NFC in the U.S., according to Eads, who says most of those can be found in fast food restaurants, and in places like Wal-Mart Stores and Walgreens. Eads says that amounts to less than 1 percent of the total number of point-of-sale terminals across the United States. Overseas, in places like Japan and Korea, NFC-capable terminals are more common.

Apple's clear way to pay
"My take on what's missing right now, and the connection to Apple, is the payment mechanism," Eads said. "The infrastructure to make the leap from the chip in the phone, to getting the merchant paid, that's what's not real clear on the Google platforms and on the other devices. That's why Apple's story is so interesting, because Apple has a clear way to pay, and we've been trained to use it."

That "clear way" is the Apple ID system, which now has more than 200 million users signed up to use, all with credit cards or other payment options linked to those accounts. During the iPad 2's unveiling earlier this month, Apple CEO Steve Jobs claimed that the 200 million number made it one of the largest online payment providers in the world. More importantly, it was something customers could use not just in iTunes, but in the iBooks application to buy e-books, and in the App Store to purchase applications.

"By Apple adding NFC to the phone, they're really just extending the phone's payment abilities to the checkout, to be able to make that last leap to the phone to the point-of-sale device," Eads said. "That's the only piece Apple is missing."

So what would it take to get there? Will Apple simply partner with some of these existing point-of-sale hardware makers or go its own way with boxes that go out to retailers? According to Ablowitz, it's unlikely to go the latter way.

"The world of retail does not happen at the same speed as the consumer," Ablowitz said. "You can get consumers to pitch their cell phones and get a new one, or pitch their Walkman and get an iPod. Getting retailers to change their business practices, you need a return on investment. They don't do it just for cool."

Further proof that Apple would opt to partner over starting from scratch can be seen by looking at the way the company has already approached payments with its own products, Ablowitz offered.

"They haven't been trying to their own consumer payment application, they've been partnering with whatever you have in your wallet today on iTunes. So it's a fallacy to think that they'd be unwilling to work with a player," Ablowitz said. "They just know the difference of when they should build, and when they should partner."

That brings us to one of the last hurdles, which are the carriers. They continue to be the gatekeepers for the data connection that feeds devices like the iPhone when they're outside of a Wi-Fi network. More importantly, there's a contractual agreement that dictates what phones that run on those networks can and cannot do, which companies like Apple are required to adhere to.

Apple is credited with helping to change the balance of power between device manufacturers and carriers by taking control not only of things like application distribution but also things like system software updates, marketing, and design. Even so, NFC represents another battleground where Apple is up for a fight.

"Carriers recognize through the NFC trials for the last number of years in the mid-2000s that this is wildly popular with consumers," Albowitz said. "Once consumers try an NFC payment, it's been one of the best responses you will ever see from a consumer product. The carriers recognize that. They know that there's an enormous amount of commerce there, and they don't want to miss what they missed with the App Store."

One thing that sets NFC apart is that your phone doesn't have to be on or even connected to a carrier's network to have it work with NFC readers. The technology can also be set to require a PIN or password code to authenticate its use. That security decision, Ablowitz explained, was still something that was up to the payment provider. But there's a greater level of control being given to the carriers with NFC chips as far as security goes.

"The NFC that's in some of the Android phones--like the Samsung phones at Mobile World Congress--the carriers will have full control over that NFC chip," Eads said. "They'll be responsible for the secure element." Eads compared the arrangement with the certificate authority for HTTPS, which can offer Web site owners a way to verify themselves to users, and offer a secure connection. "The carriers will have control over that, and they will take a cut of the transaction."

How much of a cut would that be? And would Apple simply opt to find a way around that? Those two details in particular have likely been a sticking point in bringing any payment platforms to market. In Apple's case, this also represents a particularly important issue given the company's propensity for control, as well as releasing the same product in all markets. With something like the iPhone, Apple would be unlikely to want to manufacture a version of the device that was had a hardware feature in some places but not others.

"What needs to happen with Apple, is much bigger than a simple chip," Ablowitz offered. "They have to make a business decision to bring a service to market. That's every bit as big as iTunes was, or iBooks. They have to deal with the approach for how you get people's payment types onto the phone."