Digital Transactions, November 2013
Nov. 1, 2013
Having invested in new equipment, payment card manufacturers are ready to churn out EMV cards by the millions in the U.S. But issuers that wait too long could be caught short.
Common in nearly all of the developed world, Europay-MasterCard-Visa (EMV) chip cards have been a long time coming to the United States. Now, with implementation deadlines set and consumer-awareness campaigns beginning, the last piece of the puzzle is whether card manufacturers can keep pace with an expected glut of orders from U.S. credit and debit card issuers.
By most accounts, leading payment card manufacturers, which already produce EMV cards for foreign markets, expect to be ready to meet the increasing U.S. demand for such cards over the next three years.
Orders for credit cards alone are projected to total 505 million during that period, according to Boston-based Aite Group LLC. Aite expects orders for EMV credit cards to peak in 2015 at 255 million.
Key to spurring card makers’ readiness is Visa Inc.’s October 2015 deadline for shifting liability to merchants for fraudulent transactions on EMV cards if they still use point-of-sale terminals that can’t process an EMV transaction. Petroleum merchants will have until October 2017 before they undergo a similar liability shift.
Historically, EMV mandates in other countries initially have allowed for issuance of EMV cards with magnetic stripes so that EMV cardholders traveling to non-EMV countries could still make purchases.
While that will certainly be the case in the U.S., in part to accommodate merchants’ plans to phase in EMV terminals as part of their terminal-replacement cycles, the 2015 liability shift is a major incentive for issuers to get EMV cards into circulation. That’s because it gets them off the hook for fraudulent transactions made at non-EMV-compliant merchants.
Tepid Demand So Far
But so far, issuer demand for EMV cards has been modest, with 2 million EMV credit cards coming into circulation in 2011 and the same amount in 2012, according Aite Group. Aite projects those numbers to jump this year to 8 million credit cards.
That’s a big jump, but there still is a long, long way to go. Issuers of Visa and MasterCard Inc. credit and debit cards alone currently have about 1 billion pieces of magnetic-stripe plastic floating around the U.S.
The primary reason card issuers are not rushing to put EMV cards into circulation yet has to do with their issuance plans. Rather than launch full-scale rollouts now, card issuers are opting to target certain segments of their cardholder portfolios first.
At the top of the list are business travelers frequenting EMV-compliant countries. Next are affluent cardholders and high-risk cardholders who have had their identities stolen, have been a victim of a data breach, or who live in geographic areas where skimming of card data from magnetic stripes is a major problem.
Finally, issuers plan to replace cards expiring just prior to the 2015 and 2017 liability-shift deadlines with EMV cards. Aite expects credit card issuers to crank out 120 million EMV cards next year.
“There are some issuers putting out EMV cards en masse, but most are concentrating first on business travelers and higher-risk cardholders,” says Julie Conroy, research director for Aite Group. “The next bump in order volume will come just ahead of the 2015 deadline.”
Fraud reduction is the crux of the business case for EMV, a security standard created by the card networks. Unlike mag-stripe cards, EMV cards are considered by security experts to be bulletproof when it comes to data skimming.
The chips also are programmed to authenticate card readers and EMV cards to one another at the point of sale, enabling each to detect whether the other has been tampered with.
Finally, in most countries, cardholders are required to authenticate themselves when making a purchase by entering a PIN, which adds another layer of security. In the U.S., the issue of requiring PIN authentication with EMV cards is a matter of heated debate.
‘Geared to Volume’
Card manufacturers’ readiness to meet the expected rush of EMV card orders before the 2015 deadline depends on their investment in new production equipment.
Manufacturing EMV cards re-quires that a section of the plastic card into which the EMV chip will be embedded first be milled down to accommodate the chip. New equipment is also needed to securely embed the chip into the card, as well as equipment to program and configure the chip to card issuers’ specifications.
For card manufacturers, equipment purchases must be planned for well in advance so the necessary funds can be budgeted. Card producers must also take into account equipment manufacturers’ lead times for delivery of new machinery.
Once the equipment arrives, card manufacturers will have to integrate it into their production lines, test it, and train machine operators to run it. They also must be ready to troubleshoot unexpected snafus that arise during the production process before they can start full-blown EMV card production.
For most card manufacturers, the planning process for new-equipment purchases started a few years ago when it appeared imminent that Visa and MasterCard were going to mandate EMV adoption in the U.S. Visa got the ball rolling in August 2011 when it announced an EMV-migration plan, a plan whose deadlines the other networks largely copied.
“New equipment is a capital expenditure that requires advance planning,” says Steve Montross, president and chief executive of Littleton, Colo.-based CPI Card Group. “We had been making EMV cards for foreign markets for some time, but knew we’d need more equipment to meet U.S. demand and began purchasing that equipment about two years ago.”
Manufacturers that have yet to purchase and install such equipment face a tougher row to hoe.
“Equipment changeover can be a painful exercise,” says Al Vrancart, industry advisor and founder of the International Card Manufacturers Association, a Princeton Junction, N.J.-based trade group.
Meeting the projected return on investment for new equipment, however, requires high volumes as card manufacturers’ margins are tied to production. Most producers’ operating costs are fixed, which means lower production rates reduce their margins.
“Manufacturers are geared to volume, that’s why critical mass is an issue for them,” says Vrancart.
A big part of the production costs for EMV cards is the price of the chip. Adding an EMV chip to a credit or debit card increases the cost by 75 cents to $1, depending on the amount of memory in the chip, when compared to the cost of producing a mag-stripe card, according to Dave Moser, director of sales for Perfect Plastic Printing Corp., a St. Charles, Ill.-based card manufacturer.
While higher than for mag-stripe cards, manufacturing costs for EMV cards have been coming down as more issuers place orders. Aite’s Conroy estimates it now costs about $1.60 to produce an EMV card in large quantities, compared to $3 only 18 months ago.
“As greater scale is achieved, those costs will come down further as production becomes more efficient and the cost of materials decreases,” says Conroy.
Nevertheless, one element of EMV production costs manufacturers have yet to fully get a handle on is whether issuers will order cards with large amounts of memory. The more memory in a chip, the higher the price is for that tiny piece of silicon.
Issuers determine the amount of the memory on a chip using such criteria as the number of applications they intend to load onto it and the additional security measures required to safeguard those apps. Consequently, chip costs vary widely.
“Plain-vanilla chips are the least expensive, but so far there have been no full rollouts using them,” says CPI’s Montross. “We are also hearing of tests involving more sophisticated chips, so it’s hard to tell where issuers are going with this right now.”
Ultimately, Montross expects the overall cost of EMV chips to come down, just as the cost of radio-frequency identification (RFID) technology that facilitates contactless payments came down as it became more widely adopted.
Prices aside, another lingering question is whether chip makers will be able to meet the expected runup in demand in the U.S. While card manufacturers say they are being assured there will be no shortage of chips, some are stockpiling inventory to make sure they don’t get caught short.
CPI, for instance, is keeping about a two-month supply of chips on hand, the majority of which are standard or low-memory chips.
“It’s tough to stock a lot of high-memory chips, because no one knows what the demand will be,” says Montross. “It is more likely card issuers will start with low-memory chips because of their lesser cost.”
Lead times for the delivery of EMV cards to issuers will depend on the size of their order. Larger orders are expected to require longer lead times. Current lead times for EMV cards are running about 14 weeks from the order date, according to Conroy.
“And they could get longer in 2014 if more issuers ramp up to put EMV cards into circulation,” she says.
While card manufacturers currently can only guess when and at what level issuers’ order volumes will peak, what they do know is that lead times for delivery could balloon if they are hit with a rush of unexpected orders from issuers waiting til the eleventh hour before the 2015 liability shift.
“There will be some ramp-up time to add processing equipment as demand increases. If that demand comes within a very short time, there could be supply constraints,” says Perfect Plastic’s Moser. “There probably would be chip-availability issues too.”
Another big question facing card manufacturers is to what extent issuers will order so-called dual-interface EMV cards. Such cards allow cardholders to complete a contactless transaction by waving or tapping the card in front of a POS terminal, and, for contact transactions, by inserting, or “dipping,” it into a card terminal to access and validate the apps on the chip.
Contactless technology uses radio waves so the chip can communicate with the terminal and transfer data back and forth.
Contact chip cards dominate in many EMV countries, and payments executives consider them to be more secure than the contactless variety because transaction and cardholder data are transferred directly between the card and the terminal as opposed to over less secure airwaves.
But the added tap-and-go payment feature of dual-interface cards is ideal for some environments such as transit and fast-food restaurants and can introduce consumers to the idea of making transactions with their mobile phones.
Indeed, some payment platforms, such as Isis, are betting heavily that contactless EMV chips embedded on a smart phone will accomplish just that.
“Dual-interface cards can potentially change consumer behavior when it comes to mobile transactions,” says Aite’s Conroy. “They cost pennies more at high volume and card issuers really don’t want to be perceived by consumers as not catering to their needs for increased convenience when making a transaction or not providing the latest payment technology.”
U.S. card issuers, however, are keeping their plans for dual-interface EMV cards close to the vest. In June, Aite released a report that showed that 58% of 66 financial-institution executives interviewed were undecided about whether they would issue dual-interface EMV cards or traditional contact-only cards. Thirty-three percent of respondents said they plan to issue dual-interface cards and 9% plan to issue contact-only cards.
As for what kind of margins card manufacturers can expect to earn on EMV cards compared to mag-stripe cards, they might as well throw a dart at the board and see what number it hits.
“It is too early to tell how the margins will stabilize on EMV,” says Moser of Perfect Plastic. “At this point, there have been mostly small pilots and small rollouts, so the current margins are probably not very indicative of future experience.”
As the U.S. inches closer to EMV adoption, card manufacturers need issuers that have not clearly spelled out their plans for EMV to do so. Issuers that wait too long will face longer lead times as card producers and chipmakers struggle to keep pace with an expected glut of orders.
“Card issuers want fast turnaround on EMV orders, but so far orders for EMV cards have been slow,” says ICMA’s Vrancart. “Once orders gear up, card manufacturers can shorten their lead times to produce enough EMV cards to put the U.S. on equal footing with the rest of the world.”
SPECIAL FEATURERead Digital Transactions Online