Is It Too Late For Smart Cards?

Smart cards have become part of everyday life in Europe, and they're becoming a sizeable market in parts of Asia. But in the United States they've been a solution in search of a problem. Magnetic-stripe cards that swipe through card readers connected to phone lines have always been a cheaper alternative, and efforts to promote smart cards--sometimes called chip cards--as portable wallets have bombed.

That may change soon. Interest from banking and financial sectors has picked up following chip-card announcements by American Express and Visa International. Online security requirements are expected to boost card demand, and improved technology coupled with dramatic price cuts are rewriting the cost-benefit arguments that have traditionally weighed against smart cards.

Smart cards are in mobile phones in the form of subscriber identity modules used with the Global System for Mobile Communications architecture dominant in Europe. Each subscriber identity module is programmed with specific identification features for a unique user, allowing the phone that contains a module to be used for such things as online banking and purchasing that require a secure means of identification. They can be swapped between phones and other GSM devices, so the subscriber identity module owner isn't confined to a single phone.

The market for this type of application is on the verge of getting bigger. The first subscriber identity module-like card for Code Division Multiple Access cell phones, which lets a user switch between CDMA and GSM service, was introduced last year by Schlumberger. It also introduced a similar card for Time Division Multiple Access phones. CDMA is widely used in Asia, including in potentially giant markets in China and South Korea. TDMA is the most widely used architecture in North America.

That's not to say the U.S. will be dominating the global smart-card scene any time soon. A recent survey by Schlumberger Test & Transactions puts the total world market for smart cards, card readers and associated products at around $1.4 billion in 1998, rising to approximately $2.6 billion in 2000. By contrast, the U.S. and Canadian markets combined were just $50 million in 1998, double that last year, and moving to $150 million this year.

But despite the slow start, the U.S. market is starting to pick up. Some even feel this may be the breakout year.

Certainly that's what Oberthur Card Systems, a leading smart-card supplier, hopes. The company said last October that it was plowing another $5 million into its Rancho Dominguez headquarters facility in Los Angeles to double its output, to 200,000 cards a day.

"The chip-card business in the United States, contrary to what many people think, is starting to take off," says Thierry Burgess, executive vice president of smart cards at Oberthur. "It's beginning to generate significant revenue, which is why we've made this investment now in our U.S. manufacturing."

Smart cards got a significant boost when American Express introduced its hybrid magnetic stripe/smart chip Blue card in September 1999. With regular credit-card markets maturing, banks have been looking for ways to attract new types of customers. Blue is aimed squarely at a younger generation of affluent, tech-savvy users. Those customers need a credit card that can be used in stores and at point-of-sale systems in the physical world that also provides chip-card capabilities for shopping online.

Industry sources say that as many as 3 million customers have signed up in its first year for Blue, helped along by a 0% introductory rate. Amex won't reveal any figures.

Whether prompted by the success of Blue or not, Visa has been making its own smart-card news. During the past year, it's disclosed a number of deals with card manufacturers to obtain multiapplication smart cards for less than $3 apiece--half their previous price. That's an important breakthrough, given that one of the main drawbacks of smart cards is their high cost. A magnetic-stripe card costs 30 cents to 40 cents. Only two years ago, smart cards with less memory and processing power than the current generation were $10 or more each.

"Two or three years ago, the cards were single-function products, primarily used for stored-value applications," says Diana Knox, Visa USA's senior vice president for smart-card applications and market development. "Stored value is a very different kind of payment from traditional payment systems. Merchants found them cumbersome to handle and needed expensive new readers. Their customers couldn't find enough places to use them. Basically, we concluded there was no business case for single-function, stored-value cards."

Multiapplication cards, on the other hand, allow for a value-added approach by including such things as online authentication and access, as well as customer loyalty programs. That reduces the cost per application the card is used for, giving merchants the incentive to invest in the terminals needed to read the cards.

That incentive is needed because it's the merchants that will bear the brunt of smart-card rollout costs, says Theodore Iacobuzio, a senior analyst for market researcher Tower Group. An estimated $2 billion in investment is needed this year for smart-card deployment, and merchants will have to spring for around $1.3 billion of that amount to upgrade and replace card readers and other infrastructure, according to Iacobuzio. In 2003, when the greatest overall investment of $2.5 billion is expected, merchants will contribute almost 70%.

More card issuers are starting to push smart cards. In September, First USA, FleetBoston Financial and Providian Financial became the first Visa member financial institutions to say they'll issue the new "smart Visa" hybrid magnetic-stripe/smart-chip card. Knox says a "significant number" of other companies are interested in doing the same, and she predicts that millions of the cards will be in circulation by year's end.

One of the major potential uses for smart cards is in network security, particularly as companies build public key infrastructures. Cards are seen as the ideal vehicle for carrying the digital certificates and private keys that individuals will need to operate within a PKI. Gartner/Dataquest is projecting smart-card demand for this application will grow, to 155 million cards in 2004 from less than 10 million now.

But exactly where that demand will come from isn't clear since few companies have PKIs in place. Of those that do, many still prefer to put certificates and keys on PC hard drives, rather than pay the money for smart cards and the readers that go with them.

The federal government is the biggest user of smart cards for PKIs. It's been running PKI pilots for several years and is under a presidential directive to put smart-card technology into the hands of most government employees by next year.

The Defense Department began replacing its identification cards with smart cards in October and expects to eventually issue at least 3 million. Several other defense agencies are also putting smart-card programs in place. The General Services Administration recently awarded a 10-year, $1.5 billion contract for delivery of smart cards to federal agencies.

Even with all that activity, however, officials still aren't sure how smart-card demand will develop across the entire government.

"It's tough to tell right now how quickly interest will grow," says Mickey Femino, director of the GSA's Center for Innovative Business Solutions. "We have a good foundation in place and the technology appears to be all there. But people need the dollars in their budgets, and there needs to be interest in PKI and smart cards at higher levels in the agencies. Once people see smart cards in use, that's what will generate the interest."

The biggest driver, Femino says, will be the fact that there's nothing else that seems capable of doing the job-handling the security concerns, the need to house digital certificates and public keys, and biometrics.

Some universities have been using smart cards for several years and have fairly sophisticated programs in place. But support for the chip cards is by no means widespread, with only about 30 schools using them. The final decision comes down to what tradeoffs institutions are willing to make.

The University of Arizona started consolidating all of its campus-based cards into one CatCard in 1997 and issuing hybrid magnetic-stripe/smart-chip cards in March 1998. Students use the magnetic-stripe portion to buy food in the cafeteria and to pay for copying documents in the library. The smart-chip part of the card is used to store small dollar values up to $100, for limiting access to certain buildings, and for resource tracking. The card also lets authorized students use specific pieces of equipment such as computers.

The school has issued more than 80,000 cards and goes through 15,000 to 20,000 cards a year, says Suellyn Hull, the university's CatCard operations manager.

"It's certainly more expensive than the mag-stripe-only card, and the accounting and technology involved is certainly more complex because we have to manage more complex databases," Hull says. "But we also save money because we can be more certain about who's cleared to do what, and we find we use resources much more effectively now."

If there's any real threat to the growth of the U.S. smart-card market, it could be that it's not growing fast enough. Without equipment in place that can read the cards, potential shoppers will be reluctant to use them. If shoppers don't use the cards, merchants and other businesses won't want to spend the money to upgrade their card readers.

This chicken-and-egg problem is being tackled from various angles. American Express initially offered with its Blue card free readers that customers could plug into their PCs. PC makers such as Compaq and Acer America are building smart-card readers into their next-generation computers. Within a year or two, there should be a critical base of smart-card readers in place.

But that might be too late for fast-moving merchants such as online auctioneer eBay, which moves more than $5 billion worth of merchandise every year. The company loves the idea of using smart cards for verification for both buyers and sellers, says Janet Crane, CEO of Billpoint, eBay's online payment service for its 15 million registered users.

"The problem is, we need smart cards out there now," Crane says. "They have a lot of attributes that suit us, but we also believe the cost of the infrastructure upgrades is slowing the spread of smart cards. The smart-card industry has gotten far behind where it needs to be. In fact, it could be so far behind that the window of opportunity is actually closing on it."