China is progressing towards a cashless society with mobile payment

People who have traveled to China in the past few years probably noticed one phenomenon: the prevalence of mobile payment. It is so common and easy that it is being called one of China’s Four Great Inventions of the 21st century alongside bike-sharing, high-speed rails and e-commerce.

To put it into perspective, data published by People’s Bank of China (China’s central bank) shows that in 2016, mobile payment transactions totaled 25.7 billion, and volume totaled 157.6 trillion CNY (north of $20 trillion). What is even more interesting is that the market is essentially a duopoly with Alibaba holding a ~54% market share and Tencent holding a ~40% share as of Q1 2017. The Chinese card network UnionPay had less than 1% market share1.

Mobile payment with QR code at a grocery store (Image credit: 699pic)

Why mobile payment and Apple Pay’s struggle

There are many factors contributing to the prosperity of mobile payment in China. One of them is the mobile penetration rate. After all, you have to have a mobile phone in order to make payments with it. As expected, the number is high in China. A Forbes article goes as far as calling China the “only true mobile nation”.

A report released by China Internet Network Information Center notes that China had 751 million internet users and 724 million mobile internet users as of June 2017. This suggests that for every 100 internet users, more than 96 access from their mobile devices. The report also notes that mobile payment users reached 502 million.

Besides mobile usage, an easy payment experience helps drive the adoption of mobile payment. Merchants display their unique QR codes for customers to scan (mostly through Alipay [支付宝] or WeChat [微信]) and pay. Customers can also become recipients of money as each person has a unique QR code through the apps for others to scan (just like merchants do). They no longer need to fetch cash and get changes or swipe their cards; after all credit cards have never been big in China.

Credit card penetration is low in China. The average Chinese person had ~0.3 credit cards2. Part of it is cultural. Chinese like to save and are less inclined to owe money than their Western counterparts. Though in recent years, the younger generation in China has started to borrow more. At the same time, one issue that gets talked about often is the lack of savings the average American (particularly retirees) has, which is not as big a problem in China, if at all.

Many other reasons contribute to the low credit card penetration rate. Some of them include the relatively short history of credit cards in China (particularly after wealth per person increased meaningfully) and the lack of a credit score system. But more importantly, the surge of mobile usage, the convenient mobile payment experience and heavy subsidies from the likes of Alipay and WeChat Pay quickly cultivated a habit. Subsidies are often-used and were used to market products particularly in the early stages and put pressure on competitors in many sectors in China, such as the ridesharing sector. One of the most recent example is Apple Pay.

Apple Pay has not caught on in China and Apple struggles to get more users to use the service. In July Apple Pay rolled out a campaign to offer discounts as high as 50% off when users shopped at partnering merchant with Apple Pay. Transaction volume for Apple Pay spiked, but quickly subdued after the subsidies went away.

Many say Apple Pay missed the right timing in China. I agree with it but to me this is also inevitable given Apple Pay was introduced in October 2014 and didn’t enter China until end of 2015. Meanwhile, Alipay has been around since 2004 and WeChat Pay was launched September 2014.

In addition to timing, there is a higher bar to use Apple Pay. First and foremost, you need to have an iPhone, which is a more expensive phone compared to many other alternatives. Merchants also need to have NFC point-of-sale terminals. Instead, a QR code is all it takes for merchants to collect payments through Alipay or WeChat Pay. As mentioned, customers have also developed the habit of scanning QR codes that makes mobile payment a seamless experience for customers and merchants.

I personally am a fan of Apple Pay especially coupled with fingerprint recognition. To me, it is an easy experience given I don’t even need to unlock the phone, let alone to open an app and scan. However, the power of habits is tremendous and Apple Pay has a long way to go in China.


Alibaba and Alipay

Alibaba is best known as an e-commerce giant. When Alipay was founded in 2004, one of the initial objectives was escrow for Taobao [淘宝] transactions. Overtime, it becomes the largest third-party payment provider in China.

Having 450 million verified users as of 2016, Alipay is the most valuable asset of Ant Financial, Alibaba’s financial affiliate. Ant Financial was valued at approximately $60B last April according to TechCrunch, placing it within the top 5 most valued Unicorns globally.

While everyone would agree WeChat Pay is Alipay’s largest rival in the 3rd party mobile payment space, Alipay has taken on cash hard. After all, in a country where credit card penetration is low and you rarely see checks, cash is the No. 1 competitor to mobile payment especially for small purchases. Alipay leads the “cashless” efforts and have launched many initiatives such as cashless city and cashless society.

In February, Ant Financial announced that it plans to help China develop into a cashless society in 5 years. Two months later, the company forged a cashless alliance with UN Environment and 15 other members including Carrefour China, ofo and Beijing Capital International Airport. It also has partnered with 6 cities, including its headquarter HangZhou to build cashless cities.

Data released by Ant Financial showed some early success in Wuhan, the 2nd cashless city partner not too far from the company’s headquarter. On the transportation side, 5,000 buses and 200 parking lots can take Alipay and Alipay volume for bus-taking went up ten-fold. On the consumption front, 500 thousand merchants applied for QR codes for their stores, which are used to accept payments when customers scan those codes. In healthcare, 18 local hospitals partnered with Ant Financial and Alipay volume for getting appointment tickets (a ticket is needed to see a doctor) increased 40%.

In a related note, Alibaba recently opened its first unstaffed store, the Tao Cafe [淘咖啡]. To enter the store, customers scan the store’s QR code from their Taobao or Alipay app upon entrance. After selecting what they want, customers go to the checkout glass tunnel made up of 2 automatic doors. Customers receive payment confirmation notifications on their phones as they walk out the 2nd door. There is no cashier to take cash and give changes.

Ant Financial’s cashless initiatives also caught regulators’ attention. The company was reportedly asked by the central bank to remove “cashless” from its marketing campaigns. Essentially, regulators want to make sure that people who want to use cash would not be disadvantaged by merchants who refuse to take cash.


Tencent and WeChat Pay

For many years in the PC era, Tencent was best known for its widely popular instant messaging product QQ. Today, similar to Alibaba, Tencent’s business spans a range of areas such as games, entertainment and payment. Even though Alibaba’s e-commerce business is inherently closer to money and payment, Tencent quickly captured significant market shares capitalizing on another widely popular product WeChat – the dominant mobile chatting application.

While WeChat’s huge user base gives the application wide imagination for new features, red packets really catalyzed the adoption of WeChat’s payment feature. Red packets is a Chinese tradition where one person stuffs cash in a red packet and gives it to another person. Red packets are often used in celebrated occasions like holidays, weddings as a way to send good wishes. Having to prepare the physical red envelopes and put cash in them can be a taxing effort though, especially if a person needs to prepare a large number of them.

WeChat’s social features make it an ideal mechanism to turn the process virtual. Tencent rolled out WeChat red packets and usage exploded during the 2015 Spring Festival, China’s biggest holiday. WeChat also made red packets fun. Users can elect more than 1 recipient for a red packet and WeChat can also randomize the amount each person gets. Because the number of recipients are limited, people in chat groups scramble to open red packets to see their luck.

WeChat red packet

In the development of WeChat Pay, one thing that ruffled some features was the announcement in 2016 to charge a fee for withdrawals. Each user gets a 1,000 CNY lifetime withdrawal allowance free of charge, and then a 0.1% fee based on the withdrawal amount (from WeChat mobile wallet to the bank card on file). According to WeChat, the fee is to cover the fees charged by banks for facilitating the money transfer. To be fair, Alipay charges withdrawal fee too.

Unlike withdrawal, payment is free to users. WeChat Pay charges merchants approximately 60 bps to take payments for them. WeChat Pay does more than just accepting payments though thanks to the data it collects. It can provide sales analytics, customer profiling and location-based marketing just to name a few.

The proliferation of WeChat Pay and Alipay has had a significant impact on UnionPay, China’s card network equivalent to Visa and MasterCard. WeChat Pay and Alipay are both connected to banks directly so there is no need to go through UnionPay’s card network. UnionPay’s mobile payment solution QuickPass also has low usage.

Starting in June 2018 however, 3rd party payment providers are required to connect to a newly formed clearing agency WangLian [网联]. The central bank owns more than 30% of the new agency. The impact on the payment economics have not been made public, but it appears that direct bank connections from 3rd party payment providers might become a thing of the past.

(1) Based on data from YiGuanGuoJi. (2) As of Q1 2016 based on data from Wind ZiXun

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