Smart and Personal

By Lauri Giesen

Smart cards may have a better chance of mass acceptance in the U.S. now that issuers are combining multiple applications with personalization.

Will this be the year that U.S. consumers finally take to smart cards? They certainly will be given every chance to do so, judging by recent developments. Many of the top credit card issuers have announced major smart card ventures. Picking up on the trend, some research and consulting firms are predicting 2002 will be a watershed year for smart cards.

Skeptics might respond: Show me the money. Despite their longstanding success in Europe and Asia, smart cards have never achieved mass acceptance in the U.S. High-profile tests at the 1996 Summer Olympics in Atlanta and in New York City in 1998 raised expectations that were dashed in the face of weak consumer and merchant interest. Banks that experimented with their own programs at army bases and college campuses have likewise let the programs quietly lapse.

Despite this uninspiring track record, smart card boosters believe that a shift in strategy by issuers may lead to a breakthrough this time around. Instead of trying to base their case on one "killer application" to win consumer acceptance, issuers now plan to incorporate several applications that can take advantage of the cards' intelligence.

Major payment players such as American Express Co., Citigroup Inc., FleetBoston Financial Corp., Providian Financial Corp. and Bank One Corp. have jumped on the smart card wagon, forcing other issuers to consider their stance. Should they join in, or should they remain on the sidelines in the expectation that this effort, like all the previous ones, will fizzle out?

Critics note that projections of usage still outrun actual customer adoption rates and that smart cards remain more expensive than traditional credit cards. Advocates respond that chip card prices will decline as U.S. programs reach critical mass. At that point, the undeniable advantages of smart cards — personalization, multiple applications and reduced fraud — should tip the scales.

"If the banking industry has the capacity to reduce fraud, as well as take advantage of some new business opportunities, it seems inconceivable to me that anyone would pass up this opportunity," says consultant James Wells, president of Wellspring Consulting, Glen Head, N.Y.

No Killer App

For at least a decade, the U.S. smart card has languished as a technological application in search of a business case — a stark contrast to Europe and parts of Asia, where smart cards flourish.

The difference lies not with marketing, but with the market itself. Because fraud rates were high with traditional cards in Europe, the smart card's stored-value application quickly won over financial service providers, merchants and customers. The microprocessor chip imbedded in the smart card can hold a lot more information than the magnetic stripe, facilitating an application in which funds are loaded onto the card and users then make small purchases from vending machines, stores and telephone kiosks.

The U.S., by contrast, enjoys a relatively low-cost telecommunications infrastructure that facilitates quick authorization for traditional magnetic-stripe cards. Card fraud is not as serious here, at least not to the point of justifying the cost of replacing all the mag-strip cards and their supporting infrastructure. This, plus widespread acceptance of traditional cards, kept smart cards from going beyond a few high-profile experiments in the early days.

Following the failure of the stored-value trials in Atlanta and New York, the smart card appeared moribund in the U.S. until New York City-based American Express Co. introduced its "Blue Card" in late 1999, promoting it as a means of enhancing online security. A digital certificate imbedded in the chip can be used, for example, to authenticate the identity of the person visiting a Web site or making a purchase. AmEx also initially gave cardholders a free card reader to be attached to their home PCs.

At the end of 2000, American Express announced it had four million cards in circulation. AmEx hasn't updated its numbers since then, but TowerGroup reckons the total reached 7.5 million by the end of 2001 and projects 12 million by the end of this year.

Do these figures suggest that online authentication, then, is the long-awaited killer app for smart cards? Not necessarily. Blue Card holders have found the online utility of their cards limited by the small number of retailers equipped to process the payments.

To break through this barrier, AmEx and other issuers are hoping to woo merchants and consumers by combining multiple applications — stored value, online authentication, and merchant loyalty — on one card, which is then "personalized" for the user. This ability to perform a variety of functions based on information unique to each individual may be the application that rescues the card from commodity status and helps bind customers more closely to their financial institution.

"It is difficult for card issuers in the U.S. to differentiate themselves right now," says Mark Sievewright, president and chief executive of Needham, Mass.-based TowerGroup. "Chip cards give issuers a robust platform on which they can create multiple applications to distinguish themselves from everyone else."

As an example, AmEx in the summer of 2001 joined with Virgin Mega Stores for a "Blue for Music" promotion, which provided 30% discounts on featured artist recordings to customers making purchases with a Blue Card. The music store chain installed smart-card reader terminals in its 22 stores to support the pilot program. American Express executives describe this effort as the first in what is expected to be a series of ties between the card company and retailers to test loyalty programs that rely on smart cards, although a corporate spokesperson declined to elaborate.

Despite the lack of hard data surrounding the venture, Blue Card has clearly gotten the industry's attention. "Blue was a challenge to all card issuers," says Dan A. Cunningham, president and CEO of Potomac Systems and Technology, a card technology consulting firm in Potomac, Md.

In response, other big payment players such as Citigroup, FleetBoston, Providian, and Bank One have introduced their own smart card products and backed them up with marketing blitzes and attractive credit terms. Like American Express, some are giving out free online card readers just to get things moving.

But also like American Express, these other issuers are not building their business cases solely on online authentication. "The successful programs will involve a host of applications, including but not limited to payment, merchant loyalty, online security and data storage. And they will allow consumers to personalize their cards," says Francois Dutray, senior vice president of global smart cards, First Data Resources, a unit of Greenwood Village, Colo.-based First Data Corp.

Pick a Reward

Smart cards introduced by FleetBoston and Citigroup illustrate how the multi-application approach has become the name of the game in the post-Blue smart card world.

Fleet Credit Card Services, a division of FleetBoston, introduced a Visa U.S.A. product in October 2000 that uses the chip's memory to provide secure log-on at the credit card unit's Web site. Yet Scott W. Rau, senior vice president of emerging technology, acknowledges this application is not getting much of a workout from customers so far. "We wanted to come up with a technology platform that could handle future applications," Rau says.

One such application designed into the card, but not yet being used, supports merchant loyalty programs. In the near future, Fleet expects to team up with large national retailers who will use the Fleet credit card to store purchase points that could then be redeemed for discounts or gifts.

Beyond loyalty, Fleet hopes to enable customers to personalize their cards. For example, they could use the cards to retain personal information, such as passwords for other Web sites, or even work-related or health information, Rau says.

This personalization aspect may be essential to the success of smart cards. First Data's Dutray says it will allow consumers to create their own affinity programs and functions. For example, a busy executive could request a card with a high credit limit, create a rewards program tied to travel and entertainment, and use the card to store various Web passwords and URL codes. A college student, by contrast, might seek a card that provides stored value and Web access security and either no credit line or a very small one.

Citigroup is already trying to put this personalization concept into practice with its Citi.you product, introduced earlier this year. Like many affinity cards, Citi.you lets users accumulate purchase points that can be redeemed for rewards. But where other cards are tied to a single reward, i.e. free airline trips or groceries, Citi.you lets customers pick their own rewards.

"If we can find the reward and price it, the customer can request it," says Parris Hall, vice president and business manager of charge cards. For example, if a customer wants a trip to Hawaii, he would have to find the package he wanted and then Citi would determine the cost and how many points would be needed to collect the reward. Other customers might choose a new stereo system or furniture. The card can record the number of points needed for each reward and store those points as the customer accumulates them.

Another important feature of the Citi.you card is that customers decide whether they want to use the card as a charge card, meaning they will pay the bill at the end of the month, or as a credit card with a revolving balance. For example, a customer may set a limit on the charge-card feature. That amount is then not subject to interest charges as long as it is paid at the end of the month. Any amount revolved over the charge limit would be subject to interest charges. With most other credit cards, the interest is based on the average daily balance if any portion of the balance is revolved.

Like other card issuers, Citibank intends to increase its loyalty features, possibly partnering with merchants that accept the card for payment. "We're looking at loyalty and there are a lot of things we could do. We might work with just one large partner or we might work with several that fall within the category of frequent use — such as grocers, gas, or mass transit," Hall says.

With players such as Citigroup, American Express and FleetBoston in the game, smart card boosters believe momentum is finally building behind this technology. First Data's Dutray says he expects seven of the top 10 issuers to roll out smart card programs by the end of the year, up from the three that were out at the end of 2001. TowerGroup predicts 50 million smart cards will be used in U.S. payment applications by 2003, up from an estimated 17 million at the end of 2001.

TowerGroup further estimates that from 40% to 50% of the automated teller machines and point-of-sale terminals that accept debit and credit cards will be smart card-compatible by the end of 2002. Already in 2001, Phoenix-based Hypercom Corp. reported that 40% of the credit and debit card-reading terminals shipped in North America were smart card-compatible, up from less than 5% in 2000. Most of those terminals do not actually include the necessary application software to read smart cards. But the shipment numbers are viewed as an indication that merchants want to be ready to read smart cards when they start to see more usage.

Marketing Play

Despite the unmistakable momentum building behind smart cards, some critics remain unconvinced.

Celent Communications researcher Meredith Hickman Outwater predicted last fall that U.S. smart card adoption will continue to be slow. Currently, the U.S. accounts for only about 5% of all smart cards worldwide — compared with 84% from Europe — and she does not expect that percentage to exceed 7% by 2004. "The low interest rates and advertising push will propel adoption, not the merits of the chip. Finding a convincing business case, rather than any technical challenge, is still holding back the advancement of smart cards."

Along similar lines, consultant Jack Dale, president of Sterling, Va.-based Entandem, says the Blue Card's success derives more from skillful marketing than any particular application finding resonance in the marketplace. "You could argue that the real pull from Blue was the price," Dale says. "The introductory offer had extremely attractive pricing and a great marketing plan. But I'm not sure a lot of customers really wanted the chip card or intended to use it."

American Express introduced Blue Card with no annual fee and 0% interest charges for the first six months, going up subsequently to a still-modest 9.9%. Many of the early Visa issuers followed with similar introductory rates.

"I don't think anyone has yet figured out a business case for the cards," Dale says. "The killer application for smart cards has been a moving target. First it was fraud, then stored-value, now it's loyalty points. But most loyalty programs can be handled on the traditional mag-stripe card."

Fleet's Rau admits much of the appeal of his bank's smart card is "its cool look and low rate." But that's okay, he says. "The use of the chip will come later. We need to get the card into circulation and make sure our cardholders have a satisfactory relationship with Fleet first. More applications will come in time."

The idea of "more applications" is critical. While it's true that many loyalty programs can be handled by the mag stripe, smart cards are inherently more robust and flexible since they possess up to 100 times more memory to store information. Smart cards, for example, could allow multiple merchants to unite with a financial institution to create an entire loyalty package. Customers can store points from just one or all the merchants and get immediate discounts.

"Mag-stripe programs don't provide for electronic couponing or immediate gratification," says consultant Wells. "A lot of customers want that immediate reward at the point of sale."

Consumers may be picking up on these capabilities. TowerGroup estimates that smart cards issued in the last two years have a 95% activation rate, compared with 75% for traditional cards. Additionally, TowerGroup researchers believe the smart card promotions have increased the response rates for credit cards overall. In the summer of 2001, for example, response rates on direct mailings for credit cards hit a low of 0.3%. That number rebounded to 0.6% by early 2002.

While TowerGroup senior analyst Theodore Iacobuzio acknowledges he can't prove the smart card boosted response rates, he says he finds it more than coincidental that the increase came right after the Visa-member banks began their marketing campaigns.

Then there's the price issue. TowerGroup estimates the cost to the issuer of a smart card and the related software at about $3.50 per unit at the end of 2000, compared with 50 cents for mag-stripe cards. That unit cost is expected to fall to about $1.62 by the end of this year, mostly because of the higher volume of cards being produced. And Iacobuzio says the cost could plunge even more if additional smart card manufacturers enter the U.S. market.

Still, Celent's Outback argues the initial outlay for a bank looking to go the smart card route is not cheap. She estimates the first-year cost to deploy, market and support a smart-card program to be more than $37 million, assuming a distribution of 1.5 million cards.

On the other hand, the smart card does have the advantage of a longer life cycle, since the chip is re-loadable. "With smart cards you don't have to reissue the card every time you add new features or when the card expires," Dutray says. And there's a fraud angle: The U.S. credit card fraud rate may be lower than in the rest of the world, but it's still rising, a situation that can only be exacerbated as more and more consumers do their shopping online.

Do all of these factors tip the scales in favor of smart cards? The answer to that question should become clear soon. But if smart cards fail to take off this time around, it won't be for lack of trying by the top card issuers.

Ms. Giesen is a freelance writer based in Libertyville, Ill.

Copyright © 2003 by Banking Strategies, published by BAI.

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