As shoppers increasingly migrate online, whether via their computers, smartphones or tablets, brick-and-mortar retailers must find ways to keep consumers visiting their stores – or they risk having to shut their doors. This pressure facing offline retailers has opened a new opportunity for digital wallet providers, which are increasingly offering tools designed to keep smartphone-toting consumers buying at brick-and-mortar stores.

The Grim Future of the “High Street”

The future of brick-and-mortar retailers has become hazier over recent years, as “High Street” stores are increasingly edged out by online and mobile commerce giants – which have brought enhanced convenience and consumer engagement to the retail space. E-commerce sales have also been bolstered by the trend of “showrooming,” where customers try out products in stores, and then purchase them cheaper online.

According to a recent Forrester Research report, US online retail sales topped US $200 billion in 2011, and are expected to reach US $327 billion by 2016.[1] Purchases via tablets and smartphones are expected to comprise a large portion of e-commerce purchases, with eMarketer predicting that m-commerce sales will reach US $87 billion by 2016.[2]

In some cases, encumbered by the cost of rent, in-store employee payroll and long leases, physical retailers have found it difficult to compete with digital retail giants such as Amazon.  In the UK, for instance, the rise of digital retailers was followed by a string of “High Street” collapses, from media and entertainment powerhouse HMV to photography specialist Jessops.[3] In the US, bookstore chain Borders filed for bankruptcy in 2011 and was forced to liquidate its 399 remaining stores, likely due to competition from digital competitors.[4] And Borders is not the only US retailer suffering this fate; as others such as Barnes & Noble, J.C. Penney and BestBuy have reported plans to close many of their stores in 2013.[5]

Facing this new reality, physical retailers will need to adapt, leveraging emergent digital avenues to enhance the consumer experience and draw customers back into their stores.

Digital Wallets Move Into Offline World

Integrating digital wallet acceptance into the point-of-sale may be a key way to keep stores filled with a steady stream of customers – bringing the convenience & interactivity of online commerce into the offline world. In contrast to other mobile POS options, which may require cards to be present (such as dongles that can be attached to a smartphone or tablet), using digital wallets can remove cards from the equation completely – streamlining the customer experience.

App-based digital wallets also enable the integration of value-added offerings geared towards consumers, such as virtual loyalty cards or coupons. Some digital wallet operators have also begun to offer permission-based, geo-location services, enabling retailers to better target consumers who are nearby their physical location through push notifications of specialized deals based on their mobile shopping list or browsing history, among other factors. These value-added offerings serve to combat “showrooming” – incentivizing consumers to purchase goods within the store, rather than searching online for the best price.

PayPal, and the Others

Tapping into this opportunity, digital wallet operators such as PayPal and Google have recently moved to strengthen their presence at the POS – unveiling a range of new offerings targeting brick-and-mortar retailers.  PayPal, for instance, has partnered with at least 23 large national retailers, where shoppers can purchase items from their PayPal digital wallet simply by entering their mobile phone number and PIN code.[6] On April 19, the PayPal partnership with Discover Financial Services will commence, enabling PayPal acceptance at the roughly 2 million retail stores that already accept Discover credit cards.[7]

While PayPal is already a household name in the e-commerce space, supporting 125 million digital wallets globally, these partnerships signal the company’s increasing shift into the physical retail space. The transition toward offline retailers was born out of a desire to “work with retailers, not against them, in a world where people’s shopping habits increasingly blend the online and offline worlds,” according to a recent Financial Times article. Further, establishing a solid footing in the physical payment space will enable the company to tap into the US $10 trillion retail payment market, which is about 10 times the amount of online transactions.[8]

Beyond PayPal, other digital wallet providers are similarly targeting brick-and-mortar retailers, though awareness, adoption and interoperability remain a challenge. Google Wallet, for example, has forged partnerships with prominent retailers such as CVS, Macy’s and OfficeMax – offering customers the ability to pay, redeem offers and earn loyalty credit by tapping their mobile phone to Google Wallet-enabled POS terminals.[9]

Digital Wallet Adoption Barriers At The POS

While integrating digital wallet acceptance offers a number of advantages for physical retailers in the age of smartphones, there are several barriers that have (as of yet) prevented this trend from taking off on a grand scale. One key challenge, as detailed in the previous article, is that introducing digital wallets at the POS puts them in direct competition to the industry heavyweights that currently dominate the offline retail space, such as the “duopoly” of Visa and MasterCard.

Further, unlike dongle-based or other “card present” mobile POS transactions, digital wallets fall into the “card-not-present” category, which adds a bit of complexity. Namely, these transactions carry with them an increased risk of fraud, as merchants must resort to other means to authenticate the purchaser’s identity. Given increased risk, card-not-present transactions also sometimes carry an additional fee for the retailer, which may de-incentivize their use in favor of other mPOS solutions.

For digital wallets to gain adoption by both consumers and merchants, they need to be interoperable across multiple mobile devices and operators, and merchants need the proper hardware or software to accept digital wallet payments. Of yet, digital wallet operators have struggled to find the technology which does not require investment from either merchants or consumers – limiting adoption. Near-field communications, for instance, the technology that powers both Google Wallet and Isis, requires both consumers and merchants to invest in compatible technology, as we covered in this Mondato newsletter.

A Changing Retail Landscape

With digital wallets struggling to gain widespread traction, some operators have attempted to spur more immediate interest in their offering by introducing plastic cards. Last year, for instance, reports surfaced that Google was planning to add a physical credit card connected to its Wallet platform – enabling users to make purchases at retailers that do not support NFC.[10] Though the card has yet to materialize, the reports suggest that the company was exploring ways to win over customers reluctant to dive straight into digital wallets. PayPal, similarly, has integrated plastic card capabilities through their PayPal Anywhere platform, and their 2012 partnership with Discover Card.[ [11]](http://www.netbanker.com/2013/02/paypals_plastic_wallet_may_be_a_popular_nfc_work-around_model_for_next_few_years.html)

Unimpressed by existing third-party digital wallet solutions, some retailers have taken the shift to digital into their own hands. Last year, a group of US merchants announced the development of their own mobile commerce solution – deemed the Merchant Customer Exchange. In contrast to many other digital wallet solutions, the MCX mobile application aims to be available via nearly any smartphone, and plans to integrate special offers, promotions and loyalty programs.[12]

But even as brick-and-mortar retailers integrate digital wallet acceptance into their POS, they are likely to still face competition from digital retailers, who are gradually edging their way further into the physical retail space. In a seemingly counterintuitive trend, a number of online merchants have established an offline presence, tapping into the benefits of the in-store shopping experience, while maintaining a nimble and interactive online experience – the best of both worlds. According to a recent Economist article, this trend suggests that both online and traditional retailers are “migrating to a middle ground,” with boundaries between the two worlds slowly blurring.[13]

**The Future of Digital Wallets? **

Of yet, digital wallets have yet to catch on, or even make a dent, at the point of sale. A recent report from Javelin Strategy & Research showed that mobile POS proximity payments made up just 0.01 percent of total retail volume in 2012. The recent network access fee introduced by MasterCard signals that emerging digital wallet players may face an uphill battle moving forward.

However, change towards increased digital wallet activity is inevitable, as brick-and-mortar retailers look to mobile payments as a way to stay competitive amid rising competition from digital retailers. The Javelin report predicts that mobile POS payments will total 13 percent of retail transactions by 2018. We agree with this forecast, but anticipate that the road to 2018 is likely to be bumpy.