eOctopus in Hong Kong – A feasibility study

Table of Contents

EXECUTIVE SUMMARY

TABLE OF CONTENTS

1 INTRODUCTION

2 BACKGROUND INFORMATION
2.1 INTERNATIONAL E-CURRENCIES
2.1.1 E-MONEY DIVISIONS
2.1.1.1 Credit Cards
2.1.1.2 Electronic Cash
2.1.1.3 Smart Cards
2.1.1.4 Micropayment
2.1.2 INTERNATIONAL OPERATORS
2.1.2.1 PayPal
2.1.2.2 Moneybookers
2.1.2.2.1 Benefits of Moneybookers
2.1.2.3 Mondex
2.1.2.3.1 How Mondex Works
2.1.2.3.2 Multi-Currency
2.1.2.3.3 Security
2.1.2.3.4 Risk Management
2.2 OCTOPUS
2.2.1 OCTOPUS TECHNOLOGY
2.2.2 BACKGROUND AND HISTORY
2.2.3 BIRTH OF INNOVATIVE IDEAS
2.2.4 FEATURES AND BENEFITS
2.2.4.1 Operational Benefits
2.2.4.2 Financial Benefits
2.2.4.3 Business Benefits
3 METHODOLOGY
3.1 GENERAL APPROACH OF REPORT
3.2 SECONDARY RESEARCH
3.3 SURVEY DESIGN AND DISTRIBUTION
3.4 COMPANY CONTACTS AND INTERVIEWS

4 FINDINGS
4.1 SWOT ANALYSIS
4.1.1 STRENGTHS
4.1.1.1 Market Leader in Smartcard Transactions
4.1.1.2 Focus on a Coin Free Strategy
4.1.1.3 Technical Leadership
4.1.1.4 Strategic Partnerships
4.1.1.5 Customer Relationship Management
4.1.1.6 Other Services
4.1.2 WEAKNESSES
4.1.2.1 Limited Technology
4.1.2.2 Switching Cost is Low
4.1.2.3 Limited Venue to Add Cash
4.1.2.4 Limited Usage of Octopus
4.1.2.5 Not Protected by Password
4.1.3 OPPORTUNITIES
4.1.3.1 Cross-selling Opportunities
4.1.3.2 Government to Introduce Smartcard into new HKID Card
4.1.4 THREATS
4.1.4.1 The Security and Confidence of Users
4.1.4.2 Competition
4.2 THE NEW ‘EOCTOPUS’
4.2.1 EOCTOPUS: HOW WILL IT WORK?
4.3 PROFESSIONAL FEEDBACK ON THE NEW EOCTOPUS MODEL
4.3.1 IS IT TECHNICALLY FEASIBLE TO UPDATE THE ONLINE OCTOPUS ACCOUNT AUTOMATICALLY WHENEVER ONE ADDS OR DEDUCTS MONEY TO/ FROM OCTOPUS AT THE EXISTING TERMINALS? IS IT TECHNICALLY FEASIBLE TO TRANSFER MONEY FROM AN INTERNET BANKING ACCOUNT TO THE EOCTOPUS ACCOUNT?
4.3.2 WOULD IT BE TECHNICALLY FEASIBLE TO UPDATE OCTOPUS AUTOMATICALLY TO REFLECT ANY AMOUNT CHANGES IN THE ONLINE OCTOPUS ACCOUNT?
4.3.3 COULD EOCTOPUS BE PROFITABLE?
4.3.4 WHAT SHOULD BE THE BEST-SUITED OCTOPUS' REGISTERED ONLINE SHOPS OR INSTITUTIONS UNDER OUR ONLINE BUSINESS MODEL?
4.3.5 WILL EOCTOPUS FULFIL RELEVANT REGULATIONS?
4.4 SURVEY FINDINGS
4.4.1 DEMOGRAPHIC FINDINGS
4.4.1.1 Implications to Octopus
4.4.2 ONLINE SHOPPING BEHAVIOUR FINDINGS
4.4.2.1 Experience of Online Transactions
4.4.2.2 Reasons for No Transactions Online
4.4.2.3 Frequency of Online Transactions
4.4.2.4 Online Transactions Amount
4.4.2.5 Implications to Octopus
4.4.3 EXISTING ONLINE TRANSACTIONS MODE
4.4.3.1 Implications to Octopus
4.4.4 OCTOPUS CARDS
4.4.4.1 Implications to Octopus
4.4.5 EXTENDED ONLINE USE OF OCTOPUS
4.4.5.1 Implications to Octopus
4.5 OVERALL SUGGESTIONS TO OCTOPUS

5 FUTURE OUTLOOK
5.1 NEW HONG KONG ID CARD, ECERTIFICATES AND EOCTOPUS
5.2 THE NEW SMART CARD AND EOCTOPUS

6 CONCLUSION AND RECOMMENDATIONS

BIBLIOGRAPHY

Executive Summary

This paper firstly examines the concept of eCurrency and how it has been used globally, and then highlights how this could be applied in Hong Kong. The situation in Hong Kong was assessed, and it is believed that Octopus is able to take advantage of its strong brand name and wide use taking its business online to an extended business model, termed eOctopus.

The eOctopus model suggests that Octopus becomes an intermediary in online transactions where the users will have the option to set up an online Octopus account on the web. Money will be deducted for online and offline transactions, and money can be added at current Octopus terminals or via Internet banking. It will also allow users to shop and pay bills online.

To test feasibility of this proposed new online-model, a survey of mainly undergraduate and graduate students in the School of Business and Management at HKUST was conducted. The results were found to be favourable to the proposed eOctopus model. Most significantly, the majority of respondents stated that they would use eOctopus because of Octopus' brand name.

Further, an interview was conducted with Professor Tam of HKUST for his feedback on the proposed eOctopus model. Mr Tam commented that a key service that eOctopus can provide is micro-payment where credit card payments are not feasibly. According to Professor Tam, the eOctopus model is sensible and workable, though some technical issues would have to be addressed before a possible implementation.

Given the current development concerning the introduction of a smartcard (including an eCertificate function) to replace the existing Hong Kong ID card, synergies are expected to exist if Octopus were to work together with the government on this issue. Since every resident in a Hong Kong is required to possess an ID card, Octopus would thus gain in trust and overcome security issues, as expressed by respondents. The Hong Kong government could benefit from this arrangement, since Octopus' technology and know-how regarding smartcards is advanced.

If the eOctopus model is implemented in Hong Kong, it could then serve as a global role-model to the rest of the world, making eOctopus a successful eCurrency for online transactions possibly beyond the boundaries of HK.

1 Introduction

Money, in its various forms and practices, is as old as people can remember. In the old days, before notes and coins were common like today, live stock such as cattle, and later on precious metals such as gold and silver, were used for this purpose. They replaced more traditional means of payment such as pure barter^[1], and made transactions faster and more efficient.

In the last decade of the 20th century, a new form of payment has been on the rise: eCurrency. As the name suggests, eCurrency no longer involves the physical exchange of notes and coins; rather, money is handled electronically (thence the ‘e’ in eCurrency). Viewed from an international perspective, and focused on the end-user level, various international operators have entered what promises to be a huge, fast-growing and lucrative market. Mainly backed by strong partners, a few of these systems, most famously PayPal.com, have developed into international systems, available, to some extend, in numerous countries around the world.

However, evaluating the situation from a Hong Kong (HK) perspective, the picture looks rather gloomy. To date, no dominant eCurrency is operating in HK, and, what is worse for many consumers, no international system offers them convenience and speed as users in the USA and Europe currently enjoy.

This report, then, sets out to test the feasibility of establishing eCurrency in HK. To achieve this, various scenarios have been considered. Of these scenarios, the one idea that proved most promising is the one centred around Octopus. Whilst Octopus is currently a mostly offline system, it is argued that Octopus, due to its popularity and strong brand name, has the ability to leverage its existing name to a new system. This new system will be referred to as eOctopus (Electronic Octopus); the exact features of which will be discussed later on in this paper.

Following from the above, the overall objective of this report is to test the feasibility of such an extension of Octopus to online transactions. To test the concept, we conducted a survey on a small sample of the HK population, namely the undergraduate and the graduate students in the School of Business at HKUST. Additionally, we conducted expert interviews, which offered an in-depth and independent evaluation of the proposed new eOctopus.^[2]

Specifically, the following report will offer relevant background information on the topic of eCurrency - with reference to currently successful eCurrency companies such as PayPal - in section 2. Section 2 will further offer a brief introduction to Octopus, while also stating the concept of the envisioned new version of Octopus, eOctopus. Section 3 will list the adopted methodology for this report, starting with the basic approach of the report, followed by information regarding secondary and of course primary research. Section 4 will then highlight the main findings from primary research, both from interviews conducted and from the questionnaire distributed at HKUST. Section 5, then, will offer a brief outlook for the future of Hong Kong and Octopus, concerned primarily with the introduction of the new HK ID card and its linked eCertificate system. Lastly, section 6 will offer the final suggestions and overall conclusions of this paper.

2 Background Information

2.1 International E-Currencies

Money was originally a physical substance like gold and silver. It could even be alive, as cattle were one of the oldest forms of money. Today although much of the money used by individuals in their everyday transactions is still in the form of notes and coins its quantity is small in comparison with the intangible money that exists only as entries in bank records. If experiments with various forms of digital cash succeed then perhaps coins and banknotes will become as obsolete as cattle-money. If that happens, the change in the nature of money will surely have significant effects on society.

Today, with consumers flocking to the Net, shoppers and sellers alike are wondering, "How are we going to pay for our purchases?" In addition, how, exactly, does the money travel from wallet to e-tailer?

2.1.1 E-money Divisions

There are two main categories of e-money:

- software-based product (SBP)
- card-based product (CBP)

Originally, CBP was designed to enable the point-of-sale payments and SBP for network payments. In the case of SBP, value is stored on the computer hard disc and it is loaded via network. All protections are focused only on the software and thus SBP is considered as less credible than CBP solution since the latter is supported by special hardware i.e. chip card.

However, currently that distinction is an artificial because with card reader development (e.g. mobile phones), CBP can be used to make network payments and, on the other hand, the software can be downloaded into a mobile equipment.

Going further, one can distinguish between:

- Identified e-money; and
- Anonymous e-money.

Identified e-money contains information revealing the identity of the person who originally withdrew the money from the bank. In addition, in much the same manner as credit cards, identified e-money enables the bank to track the money as it moves through the economy. Anonymous e-money works just like real paper cash. Once anonymous e-money is withdrawn from an account, it can be spent or given away without leaving a transaction trail. You create anonymous e-money by using blind signatures rather than non-blind signatures.

Obviously, bills and coins are not an option online. Four options exist for the consumer, some mainly for online transactions, some for purely offline, most as a mixture between both worlds:

2.1.1.1 Credit Cards

They are commonly used for online purchases, and are the preferred method of payment among online consumers. Their benefits include:

- Easy to use -- no technology hurdles, almost everyone has one
- Consumers trust card companies to conduct secure transactions
- Most merchants accept them

2.1.1.2 Electronic Cash

Few people would use a credit card to buy a single newspaper. Which is why ecommerce experts are struggling to find a way to charge consumers for stuff costing less than $5 -- not worth the transaction costs involved with credit cards? These micropayment methods are having a tough time. First Virtual Holdings has given up on low-value transactions. CyberCash, parent of CyberCoin, is losing money. DigiCash, the company behind eCash, filed Chapter 11 bankruptcy protection in November.

Resulting from the above, there are currently various solutions that try to incorporate typically smaller consumer payments. These try to utilize proven security features that are equal if not superior to these of traditional money, while at the same time being more convenient and easy to use than bills and coins.

- Consumers must install and learn new software
- Few merchants are participating
- Pay-to-view content is often free elsewhere
- Frequent mini-invoices discourage shoppers
- Who wants another account to keep track of?

”Electronic money is broadly defined as an electronic store of monetary value on a technical device that may be widely used for making payments to undertakings other than the issuer without necessarily involving bank accounts in the transaction, but acting as a prepaid bearer instrument” (European Central Bank).

”Electronic money products are defined […] as stored value or prepaid products in which a record of the funds or value available to the consumer is stored on a device in the consumer’s possession. This definition includes both prepaid cards (sometimes called electronic purses) and prepaid software products that use computer networks such as the internet (sometimes called digital cash)” (Bank for International Settlement). Summing up one can thus state that e-money is not an access product like checks, bank transfers, payment cards, etc. It creates a new sub­ category of money. It constitutes, at the same time, payment instrument, monetary value, and accounting units - so it operates just like cash.

Based on these definitions and the real nature of money one can describe e-money as follows:

- They are dematerialized;
- Payment should not require intermediary;
- Payment should be final;
- They have to be a multi-purpose instrument (telephone units stored on telephone card are not e-money);
- They are stocked on a smart card or on the computer hard disk;
- Real virtual money offers full anonymity;
- They are likely to circulate outside the banking sector;
- They ensure the exact denomination;
- In most cases they are prepaid but it is not a rule; and
- They are designed to provide small value payment (in the UE majority of systems let customer to make payment lower than 100 Euro).

2.1.1.3 Smart Cards

Smart cards - onto which consumers digitally download "money" - are popular in France, but not in the U.S. Many banks and tech firms -- including Microsoft -- are intent on establishing smart card systems.

"Smart Cards are typically credit card-sized customer Scheck which contain a microchip or a magnetic data area. When this chip contains monetary information (which can be added via credit card or bank account), which can then be used for later transactions (such as paying at a kiosk), these smart cards belong to the group of e-cash as described above. However, at present, smartcards and e-cash are, less a few successful examples, still generally separated into online and offline applications. Some of the issues of smartcards are:

- Smart cards are efficient, secure, paperless, intuitive and speedy
- Real and virtual stores accept them
- Support for smart cards spans many industries, from banking to health care
- Consumers abroad dig them

2.1.1.4 Micropayment

These are typically used for payments that range in the value of cents, or even fraction of cents. Its use is often transparent for the end-user, as they happen in the background. They are characterized through low transaction values, but through a high number of transactions. One objective of micropayments is a very low transaction cost to make even the smallest payment profitable. This is often done at the expense of extra security (as found amongst e-cash operations). The possible use of micropayments is regarded as rather good, for example charging users only for articles they actually read in a newspaper, for downloading single images from the Internet, charging users for the actual time that they use an online software package and so forth.

2.1.2 International Operators

The UK has become the first member country of the European Union (EU) to implement the EU directive on electronic money issuing. In other words, provided they comply with the Financial Services Authority (FSA) rules, anyone who wants to can issue electronic money. These requirements are, for instance, that they meet the capital requirements of a million euros or 2% of the e-money outstanding. In addition, the maximum "purse" value is set at £1,000 (although that can be increased subject to certain conditions), and the e-money must be valid for at least one year. Other EU countries are expected to implement the directive soon.

In the UK, to follow the above example, a group of companies that include Association of Train Operating Companies, Transport for London, Vodafone and T-Mobile, have already banded together to form the Electronic Money Association (EMA), a new trade body to represent issuers and potential issuers of electronic money. Other members range from the Post Office and PayPal to BT and American Express (The Guardian 2003).

Internationally, various systems have sprung up that have jumped the bandwagon of eCurrency, smart cards, and micro-payment systems. Please refer to Appendix I & II for a more detailed account of eCurrency division and a list of currently operational service-providers. The following section will briefly highlight the background and operations of one US and one European consumer payment system, namely PayPal and Moneybookers respectively. Mondex, a failure in Hong Kong, but successful abroad, will examined later on in this section.

2.1.2.1 PayPal

With PayPal, one can send and receive payments through the Internet. Once signed up for the service, one can send money to anyone with an email address using the money from the PayPal balance or another funding option of the member’s choice. Recipients are notified by email that they have received a payment.

PayPal prides itself in making sending money as easy as sending email. Members can instantly and securely send money to anyone in the U.S. with an email address. It is far less time-consuming than making a trip to the ATM or writing and mailing paper checks. Moreover, unlike checks, which can take days to clear, PayPal transactions clear instantly. PayPal is now available to people in 38 countries. Its system builds on the existing financial infrastructure of bank accounts and credit cards to create a global, real-time payment solution.

Currently (as of April 2003), PayPal has over 16 million registered users, including more than 3 million business accounts, with an account base growing by an average of 28,000 accounts per day.

As PayPal states:

The size of our network and widening acceptance of our product has helped us become the leading payment network for online auction websites, including eBay. PayPal is also being increasingly used at other e-commerce sites, for the sale of goods such as electronics and household items, the sale of services such as web design and travel, and the sale of digital content. Offline businesses, including lawyers, contractors and physicians, have increasingly begun to receive payments online through PayPal. PayPal’s service, which lets users send payments for free, can be used from PCs or Web-enabled mobile phones.

2.1.2.2 Moneybookers

Similar to PayPal, Moneybookers is the European equivalent, also with global ambitions, and, interestingly, also backed by the second biggest online-auction sites on the web, Ricardo.com.

Moneybookers enables any business or consumer with an email address to securely and cost-effectively send and receive payments online in real-time. One can use Moneybookers to send money via email from a credit card or bank account, to make online purchases, and to collect money via email. Moneybookers states that it delivers a product ideally suited for “small businesses, online merchants, individuals and others currently underserved by traditional payment mechanisms”.

Appendix III offers an overview of the differences and benefits to the end-user that arise by using the Moneybookers system in contrast with traditional bank-transfers and cheques.

2.1.2.2.1 Benefits of Moneybookers

- Secure: with Moneybookers, you will no longer need to expose your credit card information every time you shop online. Moneybookers can process the payments for you securely.
- Convenient: With Moneybookers, all you need to send a payment is the recipient's email address. This eliminates the hassle of dealing with complicated bank wire forms and the inconvenience of sending and depositing cheques!
- Fast: With Moneybookers, you can send and receive payments in Internet time - real-time.
- Borderless: As a truly international payment product, Moneybookers is the best and cheapest way to send money cross-border.

Source: Moneybookers.com 2003

2.1.2.3 Mondex

Mondex Electronic Cash enables cardholders to carry, store and spend cash value using their payment card. It is faster than handling conventional currency, and in many cases safer and less expensive. It eliminates the need for cardholders to fumble with notes and coins, while also allowing cash payments to take place in new acceptance environments. It behaves exactly like cash, offering immediate transfer of value while requiring no signature, PIN or transaction authorization. Yet, Mondex takes the cash concept a step further - enabling value to be exchanged from one party to another instantaneously via telephones, PCs and TV set top boxes.

2.1.2.3.1 How Mondex Works

Mondex stores value as electronic information on a microchip, rather than as physical notes and coins. Value is exchanged securely from the chip on the card to the chip in the terminal. A Mondex wallet allows person-to-person payments. A Mondex telephone or Internet link lets you make this person-to-person payment anywhere in the world. As such, Mondex presents a powerful, new opportunity for your institution to claim its share of the global cash marketplace.

Mondex uniquely combines high security, person-to-person payment functionality, immediate value transfer, and multi-currency capability. With these proven features, Mondex can enable your institution to tap into important, new markets, answering the growing need for secure, convenient, low-value Internet payments, giving consumers who do not have a bank account their first payment cards, and enabling person-to­ person payment (both face-to-face and online), to name just a few.

2.1.2.3.2 Multi-Currency

Mondex can be a globally interoperable payment solution, with multi-currency support built in. A Mondex card can simultaneously carry up to five different currencies. Like MasterCard’s other global brands, Mondex uses a single solution architecture and brand acceptance mark around the world. Consumers may, therefore, be able to get their Mondex card in one country and shop with it in another when each country’s currency is loaded, and that is a key benefit of the global Mondex scheme.

2.1.2.3.3 Security

In September 1999, Mondex became the first and only smart card application to achieve an Information Technology Security Evaluation Criteria (ITSEC) Level E6 security rating. That is the highest possible rating achievable under the rigorous, internationally recognized, ITSEC security process. A set of criteria for evaluating computer security, ITSEC operates on a scale of ascending levels of assurance (level E0 to E6), that can be placed in the security functions, thus determining the rigor of the evaluation.

In 2001, Mondex again achieved another security milestone when it received an EAL4+ certification under the Common Criteria IT security evaluation system. No other e-cash system has received such ringing endorsements from the security community.

2.1.2.3.4 Risk Management

The Mondex team works side-by-side with its members to understand and meet their needs and regulatory requirements. In fact, close relations and regulators in virtually every major market have enabled Mondex to flourish in diverse markets around the world. Because regulatory requirements vary from country to country, Mondex offers a range of solutions for transactional recording and traceability. As transactional volume builds, our ‘partially traceable’ mode of operation becomes the most cost-effective option. In this mode, the overall flow of value is monitored by Mondex’s unique risk management mechanisms. In ‘fully traceable mode’, point-of-sale transactions are recorded and person-to-person transactions can be turned off.

Moreover, as regulatory requirements evolve, Mondex can be switched between these different modes of operation, so that issuers can be assured that their investments will be protected.

Referring to the interview with HKUST - Professor Tam, in 1997 he was conducting a survey/research/focus group with HSBC in order to study the market potential , consumer behavior and the feasibility of the use of MODEX. Following is a brief reason for the failure.

No killer application, unlike Octopus, which started as a Transportation Smartcard and is widely used in 1993, the MTR took the lead in reviewing its fare collection technology. Although well accepted by the public, the CSVT had reached the limits of its development capabilities. Contactless smartcard technology was subsequently recognised as the most appropriate platform for future systems.

In 1994, Creative Star Limited (renamed as Octopus Cards Limited in January 2002) was established to oversee the development and implementation of the contactless smartcard. It is a joint venture of five major public transport operators: the MTR, KCRC, KMB, Citybus and the Hong Kong and Yaumati Ferry. People can't transport without Octopus- that's become a “necessity" to HK people.

Second, Even though Mondex requires no password or pin for the transaction, it still need a confirmation from the central trading terminal before a transaction is completed. Long processing time ( about 1 to 2 minutes) which makes the Mondex not common . In additional, a high annual fee when compared to the ATM, general banking services is needed to be paid for the Mondex services. ^[3]

2.2 OCTOPUS

Octopus is the "touch and go" electronic payment system that offers users an easy and hassle-free way to travel around Hong Kong. Each Octopus card contains a built-in microchip that stores its owner's payment information. There is no longer a need for coins. Users simply "beep" their Octopus card on a fare-processing machine that automatically deducts the correct amount from the card. Currently, over 9 million cards are in circulation in Hong Kong, and over 7 million transactions are processed through Octopus each day, amounting to a total of US$ 2.2 billion (HK$ 17.2 billion) a year (Octopus 2003).

[...]

^[1] Though barter is still in use today, and was for example one of the dominant payment methods in the former USSR.

^[2] While it is acknowledged that the sample size (mainly from business students at the Hong Kong University of Science and Technology - HKUST) will by no means be representative of the whole HK population, it is argued that this population does however represent one of the main target groups of the new eOctopus, namely computer-savvy, highly educated, and soon to possess a certain amount of disposable income people.

^[3] For more information about Mondex and relevant case studies, please refer to Appendix IV.