Decomposing Octopus Card

While you are playing with your new flashy credit cards, how long has it been since the last time you appreciate your dull, featureless, Octopus card?

The Octopus card, aging inside our wallets would soon become fossil although we must sense its existence everyday. While credit card companies try their best to please us with fancy cards in whatever variety and generously extend our credit limits, the Octopus card company does nothing. The card design looks the least possibly attractive, without the least flavor of personality or social status identity. It doesn't even have an expiry date for us to care.

Why is there a world of difference between a credit card and an Octopus card?

The answer is: we are the golden goose of credit card companies, but not that of the Octopus company. We are merely the baits for Octopus' bigger preys.

Hong Kong has 14 million Octopus cards under circulation, the issuer claims. i suspect the statistics was an overstatement as there are a lot of cards being damaged or lost without reporting. Widespread rumors that one can magically increase the credit balance of the cards by heating the cards inside microwave ovens certainly help contribute to the "death rate" of the cards, albeit to an unknown extent. Anyway, anyone must have at least one Octopus card.

The cards bring us convenience, saving time of changing coins. They are accepted in many places such as public transportation, convenience stores, vendor machines, supermarkets and parking lots. It is great to see more and more places accept the cards. Eventually, we do not need the weighty coins.

One more reason why we like Octopus so much is that it doesn't cost much. Each card requires HK$50 for an upfront deposit, for good. From then onward, we use every cent the cards have debited us. The card service is free of charge although, strictly speaking, we forego the interest income while we could otherwise save the money in our bank accounts. Suppose our average balance in Octopus is HK$100, and the total cash being locked up is HK$150 (including the deposit). Further suppose the saving interest rate is 5%. Over a year, we forego HK$7.5, a tiny fraction of the total transactions going through the card. The actual amount foregone could arguably be even small if Octopus cards reduce our cash balance in wallets only, but keep our bank balance unchanged, which could be true.

Those foregone interest incomes do go to the Octopus company, an unlisted subsidiary of MTR Crop (66). Following our assumptions, the Octopus company should be holding HK$2.1 billion in cash or liquid assets. An interest rate of the same 5% would yield an aggregate interest income of HK$105 million, which is as good as a stable source of income can be.

However, the exciting part of the Octopus business is on the corporate side, what i have meant by the bigger prey. The company said transactions processed through Octopus amount to HK$77 million a day. The shops and public transportations, which accept Octopus cards, have to pay the card company a service fee, being a percentage of Octopus transactions, in addition to an upfront installation fee and a monthly rental fee for the equipment.

The card company does not disclose the service fee percentage although it has been reported that the percentage for public transportation is 1%. The percentage varies from client to client. Suppose the Octopus company charges a flat 1% for all transactions. The company collects service fees of HK$770,000 per day and HK$280 million a year, let alone the installation fee and rental fee. Incomes from corporate clients at present have already vividly outweighed incomes from the consumer counterparts.

What is even more exciting is the potential of growth and scalability. Octopus' corporate client base is ever expanding, soon to include taxis and other shops. The service fees will increase with transaction amounts. After Octopus feels that it has expand its client base to a saturated level, which could happen a decade later, it can comfortably increase the percentage level of its service fees, the installation fees, the rental fees or all of them.

To learn to appreciate Octopus like its corporate clients do, let's switch back to the consumer side. Octopus is not interested in pleasing consumer clients because it knows that it won't succeed. So far, the company has been charging cardholders with the "opportunity cost", of $7.5 a year under our estimation. Should the company introduce an annual fee of whatever amount, many people would simply switch back to coins and banknotes. Octopus' close rival, coins and banknotes, will take charge again because the substitution is so easy.

However, from the viewpoint of corporate clients, the emergence of Octopus is of great value to their businesses.

We talk about the rush-hour problems in the previous article. Hong Kong is no Wisconsin where people buy all goods they need once a week. Hong Kong people grasp what they want along the way. Therefore, during rush hours, there are inevitably booms of consumers to visit convenience stores, fast food shops, etc. For those shops, that's an all-you-can-win situation in fixed, yet short, periods of time. The question is how quick you can grasp the prizes. The quicker you close each deal, the shorter queues you have, the more revenue you earn.

Octopus systems that save a few seconds for each transaction become essential in such an environment. And there is not any other electronic payment system around for substitution. From this point of view, Octopus is a monopoly, given its mighty army of cardholders, its baits.

Consumers play an important role in Octopus' pursue of its own business because there must be a pool of cardholders large enough to justify the installation and rental fees paid by the shops and transportations.

There is no platinum Octopus card. They do have plastic watches that work just like an Octopus. If you are interested, those watches should last as long.

Copyright Quam