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Monday 14 November 2011

Disruption by Digital Wallet: The Sailing Ship Effect Rewritten

From Sailboats to Digital Wallets

When steamships were introduced they caused a significant improvement in the technology of the sailing ship, as shipwrights worked to increase the capability of their ancient craft to keep the newfangled interlopers at bay.  Of course, we now know this was to no avail, as technology and service improvements to steam-power eventually combined to override the best that sail had to offer.  Disruption happened, but slowly.

In the world of payments we now have more disruption: a payment card in your smartphone, integrating retail payments, mobile communication and digital advertising, with Google simply the biggest new entrant on the blocks.   When your smartphone is also your digital wallet and you can use it to buy stuff in shops faster and more securely than with your credit card then the walls of Jericho are really falling: the question is, who are the modern equivalents of the sailing ship manufacturers?

Up The Hudson Without a Sail

Mostly when we think of the battle between sailing ships and steamboats we simply assume that it was a one-sided affair, but this was far from the case.  Steamboats were primitive and initially occupied only niches that sail couldn’t compete in: the first successful steamboat service was up the Hudson River, against the tide and through lots of fuel (or "trees" as they were colloquially known), and other inland waterways in continental America followed, most notably around the Mississippi Basin.

It took a long time and a fair amount of government intervention, primarily for military purposes, before steam power was properly harnessed, and the improvements made to sailing ships kept them afloat for far longer than you’d expect.  The theory is that the competition from steam made sailboat designers ever more innovative, wringing the last ounce of performance out their vessels – the so-called sailing-ship effect.  However, in the end, there was a limit to the performance upgrades possible and steam, quite literally, overtook sail.

This, of course, sank the sailing ship industry because it didn’t matter how a good a sailboat they could build, the skills involved in knowing how to rig a mast weren’t much use when what you needed was spot welding.  Such is the nature of disruption: the old industries are stuck with old skills and infrastructure which they eventually can no longer upgrade.  By the time they realise that their business has changed forever it’s too late: this is Schumpeter's creative-destructionism at work.

Internet Disruption

The internet has caused this type of disruption  all over the place in the past few years. In Moats, Unbundled we saw how the advent of the web has radically changed the business models of the music and the newspaper industries and, in Book Value, how digital books are changing the publishing industry.  The internet not only has the power to disrupt industries we’d commonly think of as information based but also, as we discussed in 3D Printing is Not Exogenous, may upset the traditional balance of labour in physical production as well.  When you can download a template of a gun to print in your own office then distance is well and truly dead for the handgun industry; and probably quite a lot of people in the vicinity of the printer as well.  In this world, information really is power and printers are armaments.

Money, of course, has long been digitised.  We’re all used to internet banking and the idea that our money is simply digits on a computer somewhere, rather than a shoebox full of cash under the counter of our local bank branch.  This is simply the modern version of legers and accounts, allowing money to be shipped around the world at the touch of a button.  However, the one place that this change hasn’t completely impacted is at the merchant, when we make a payment.

Going Mobile

Of course, payments can be made through credit cards, which initiate electronic funds transfers, but we need to present that physical token representing our identity to make this happen.  Now, however, that’s about to change because a new generation of devices will allow our credit cards (and our travel cards, and driving licenses, and much else besides) to be securely loaded into our smartphones, and these devices will be able to both contactlessly communicate with the merchant’s sales devices and out to the mobile internet.

What may seem, at first blush, a small change is potentially a big one.  If your credit card is inside your phone who owns it: is it your bank, your mobile service provider, your handset manufacturer or the provider of the digital wallet that will sit on your phone?  If you can communicate wirelessly from your phone to your bank, or your card provider, then you don’t need to transmit your personal details to the merchant, as long as they get a secure receipt.  Possibly you don’t even need a traditional bank, as we currently recognise them.

Disruptive Payments

Unsurprisingly everyone is moving in on this space, and contactlessly communicating handsets are appearing everywhere.  In the middle of this morass of confusion sits Google, who have created their own digital wallet and will presumably allow any bank to download their cards into it eventually: although currently Google Wallet only supports one bank and one phone, the Samsung Nexus.

This is likely to be disruption writ large, with no-one wanting to take on the role of the sailing ship manufacturers.  The challenge is that the changes in the space are happening so quickly that it’s hard to keep pace with them, but the concept of having a payment token, your car rental keys or even your passport in your phone isn’t a fantasy, it’s about to happen, it’s going to be worldwide and it’s going to change a lot of games.

For consumers there’s danger here, but probably not the risk you’d expect.  Obviously having your phone stolen would be a problem, but this is probably manageable: devices are on-line, identification will be required, refunds will be offered, backup systems will get you mobile again.  No the bigger problem is that the demateralisation of money has a strange effect on humanity’s propensity to spend and to steal.

The Behavior of Digital Money 

Nina Mazar, On Amir and Dan Airely showed in The Dishonesty of Honest People that if you give people tokens in lieu of actual money then they’ll cheat more: the further away from real cash is the representation of money then the more likely they are to exhibit dishonesty:
“As society moves away from cash, and electronic exchanges become more prevalent, mediums are rapidly more available in the economy. Again, if we take our results at face value, we should pay particular attention to dishonesty in these new mediums (e.g., backdating stocks), because they provide more opportunities for under-the-radar dishonesty."
We also know that using credit cards makes it easier for people to spend; it puts off the actual need to experience pain by handing over cash.  As Jashim Khan and Margaret Craig-Lees point out in “Cashless” Transactions: Perceptions of Money In Mobile Payments it would be quite easy to see this behaviour transfer over to mobile payment forms:
“The underlying assumption is that the tangibility of notes and coins creates awareness (conscious/unconscious) that something of value is being exchanged. This is in part, intensified by the consumers’ ability to process transactional information using perceptual senses such as sight and touch and translates into an immediate experience of the amount spent. Under a mobile payment condition, consumers may not, at that specific point, be mentally (or emotionally) ‘tuned in’ to the actual amount of money being spent.”
Self-Controlled Steamships

Phone based payment mechanisms will change our relationship with money, so finding ways of managing this behaviour is essential.  Fortunately phones can give us instant feedback on our spending habits, so it’s not a one-way street, but trying to stem the tide of innovation is hopeless.  As  investors all we can do is try to avoid being set adrift on useless sailboats as the steamers cruise off into the distance.  As consumers, we need to learn a bit more self-control.

Actually, make that: a lot more self-control.

Related articles: From the Railroad to the Internet ... and Back Again, Moats, Unbundled3D Printing is Not Exogenous, Book Value, Eat Your Stocks


  1. "tokens in lieu of actual money"

    "actual money" is only tokens. It's just a matter of familiarity.

  2. "actual money" is only tokens. It's just a matter of familiarity.

    To an economist. And yet it appears to make a psychological difference. Curious, no?

  3. This is all negligible in comparison with the scope of manipulation performed by the 1%. Your focus is a bit off, to say the very least.

  4. What causes people to overspend with "credit cards" is not the card but the credit. Smartphones could show you your account balance after every transaction in real time so to remind you constantly what there is left.

  5. What causes people to overspend with "credit cards" is not the card but the credit. Smartphones could show you your account balance after every transaction in real time so to remind you constantly what there is left.

    The effects are similar but they're not the same. So, for instance, people will take a pencil from their employer's stationary cabinet for their child's use but won't take a dollar from the petty cash: the form of the money makes a difference. So electronic money is thought to be easier to spend than physical cash, regardless of the account behind it.

    The credit card issue is more about hyperbolic discounting - the tendency to discount the future cost of something, like a credit card bill, to approaching zero - and the aggregation of lots of small payments and moments of pain into one payment and one moment of pain. See Putting Down The Credit Cards.

    Clearly there's some relation here, but they're not the same. I agree, though, that technology can be used to reduce the "gap" between digital money and real money: but do we believe that the industry will encourage this? Or will we be deluged with special offers and multiple payment cards that make it increasingly difficult to track what we've actually spent?