TOKYO (Reuters) - Japanese office worker Satoshi Tada pays for shopping, wins free food and gets store discounts all by waving his cell phone.
"I use it pretty much every day," the 25-year-old said. "You can charge money on it right there if needed, and you don't have to run around trying to find an ATM. You can even get points because it's linked to credit cards."
The world's top firms such as Visa Inc and Nokia are still mostly testing phone use for payments, but in Japan, more than 50 million, or about half of all cell phone users, already carry phones capable of serving as wallets.
Japan has pioneered not just the technology but also the business models that will pave the way for wallet phones to become a standard payment method in the future. Some 700 million people worldwide are expected to own such phones by 2013.
"You can't deny that having such applications on a phone is convenient, and that will likely be the way that mobile phones are going worldwide," said JPMorgan Securities analyst Hironobu Sawake in Tokyo.
"People always carry cell phones on them, and they would find it useful to have a financial function there."
Success in Japan and in trials abroad have shown that the technology is ready for cell phones to replace credit cards, cash as well as serve as transportation and movie tickets and electronic keys for homes and offices.
But there are other hurdles; from breaking the psychological barrier for consumers skeptical about using phones as credit cards, to working out new business models as the lines blur between banks, financial institutions and cell phone companies.
Japan is leading the way in this regard.
KDDI, for example, is a Japanese telecom operator that has recently set up a bank along with Mitsubishi UFJ Financial Group. NTT DoCoMo, Japan's biggest wireless carrier, offers credit cards and lending services as part of a tie up with Sumitomo Mitsui Financial Group, Japan's third-largest bank.
Outside Japan, telecom industry and financial players are still in the midst of working out how the wallet phone payment business would operate, who would get a cut and when.
"Traditional financial industry met telcos by going mobile. Now telecom operators want to play a part in that chain. These talks are well under way," said Gerhard Romen, Director for Strategic Alliances & Partnering at Nokia.
The world's biggest payment card company, Mastercard, said last month it was in talks over commercial launches of phone wallets with several banks, and during the next two years it expects to see substantial activity from retail-focused banks.
"Now banks say: I have no doubt in the technology. We need to solve the business model between mobile and payments industries. It's not a trivial task," said James Anderson, a Vice President at Mastercard's mobile business.
"There is a very strong consumer pull for this service," Anderson added.
Tada, the Tokyo office worker, rarely pulls out his leather wallet these days as his cell phone does the job instead.
"For shopping, I use it everywhere I can ... and I also use coupons such as Gourmet Navigator Touch wherever possible," Tada said, citing services at some restaurants that offer coupons and free gifts when customers wave their phones at reader terminals.
NTT DoCoMo began the so-called "wallet phone" service in 2004 and rivals KDDI Corp and Softbank Corp have followed suit. Overseas, Nokia also has such phones on the market.
Nevertheless, despite Japan's relative success with payment phones, still only one-third of wallet phone holders use their cells for purchases.
Consumers in their 20s and 30s are the main users of wallet phone services. Research shows that once they start using, they tend to use frequently and repeatedly, making it a useful tool for companies to track their customers and shopping habits.
"For young people the phone is more important than the card when they leave home," said Nokia's Romen.
McDonald's Japan and 7-Eleven convenience stores have been testing mobile discount coupons, and FeliCa Networks, a joint venture of Sony and DoCoMo, have launched a mobile platform for retailers to offer such services.
"With many cell phones around and most of them being wallet phones, we cannot ignore them as marketing tools," McDonald's Japan spokesman Kazuyuki Hagiwara said. McDonald's plans to widen its mobile discount coupon offering nationwide next year.
The world's top cell phone maker Nokia has started selling wallet phones, though growth is hampered by costs stemming from an extra chip needed in phones for data security. As a result, Nokia's near field communications (NFC) version of devices costs far more than regular phones.
Near field communications (NFC) enables contactless data transmission at high speed and enables many functions at once such as various electronic money services, keys and coupons.
In contrast to Nokia, Japanese makers install Sony Corp's FeliCa chips in new mobile phones by default, and prices are competitive with other cell phones.
Globally, research firm Juniper Research says there will be 700 million NFC-capable phones by 2013, from some 50 million in Japan now, offering major growth for the phone payment industry and the companies that provide the hardware and software.
Credit card network Visa is developing an application to allow in-store contactless payments by cell phone for Google Inc's Android operating system, and UK mobile operator O2 is also testing wallet phones.
Security concerns are high among potential users but DoCoMo says a remote-lock system will protect it from being used by other people in case of emergencies.
One of the remaining hurdles to attract more wallet phone users is to expand the system network.
"It would be so useful if we can use it everywhere. For now we don't know where we can use it and we have to carry both a phone and a wallet," UBS Securities analyst Makio Inui said. "If we can spend a day with just with a phone, that would be big."
Additional reporting by Tarmo Virki in Helsinki; Editing by Megan Goldin