Cover Story: I Want You For EMV

The U.S. is in the throes of adopting chip cards, but the immensity and complexity of its payment card industry ensures the migration to chip cards is no easy task. The biggest issue is getting all merchants on board.

By Kevin Woodward

Naiveté is not a trait payment card industry professionals can afford, especially when the challenge ahead is converting the U.S. payment card infrastructure from one that relies on magnetic-stripe data to a more sophisticated system using chip cards.

It’s an infrastructure of more than 1.2 billion payment cards and 8 million point-of-sale terminals, according to research firm Javelin Strategy & Research, Pleasanton, Calif. Not until 2018 does Javelin predict nearly all—96%—of U.S. credit cards will have chips in them.

This transition has its genesis in a Visa Inc. announcement three years ago that the liability for counterfeit card transactions at the point of sale will fall on the party not equipped to process transactions adhering to the Europay-MasterCard-Visa standard, which requires chip cards and payment terminals able to communicate with these cards. The liability shift is set for October 2015.

The other card brands, MasterCard Inc., Discover Financial Services, and American Express Co., have generally aligned their chip card programs around the Visa timeline. Neither MasterCard nor Visa envisions additional incentives, such as an interchange break for merchants. And so far, according to Visa and MasterCard, the conversion process is on pace overall, but several elements are moving at different speeds.

In other markets, like the United Kingdom and Canada, the migration to chip benefited from a less complex payments environment. There were fewer banking organizations, merchants, terminals, cards, and consumers to educate and equip. While there are many lessons in these migrations that U.S. payment card organizations can look to, not all are applicable. There simply is no other market like the United States with its decentralized payment system.

There are benefits to the uniqueness of the U.S. payment card market, says Carolyn Balfany, group head for U.S. product delivery at MasterCard. Payment terminals and cards tend to be cheaper than in other markets, she says. Also, U.S. players can benefit from the experience in countries that have already adopted EMV. “There’s more knowledgeable resources from those other markets,” Balfany says. “There’s a really nice cumulative effect of that knowledge and scale that works to the benefit of the U.S. All of those factors are going to pay off for a more efficient migration in the U.S.”

Her assertion is echoed by David Whitelaw, a director at Edgar Dunn & Co., a San Francisco-based consulting firm. “Certainly the size of this market is a whole different scale than what I’ve seen in other markets,” Whitelaw says. “On the other hand, there’s a greater infrastructure out there supporting terminals already.”

‘A Lot of Pushes’

The three major elements of the EMV conversion involve consumers, merchants, and the financial-services industry, including card issuers, payment processors and merchant-services providers. Some are more ready than others.

“EMV adoption in the United States is going to take a lot of pushes,” says John Berkley, senior vice president of products at Mercury Payment Systems LLC, a Durango, Colo.-based independent sales organization owned by Vantiv Inc. “It takes awareness on the consumer side, momentum on the issuer side, and either interest or a forcing of the hands on the merchant-acceptance side.”

Payment processors, acquirers, service providers, and sub-processors had to certify by 2013 their ability to process EMV transactions, which they have done, Visa and MasterCard say. The system is ready, but consumers need chip cards and places to use them.

Many merchants, especially smaller ones, are not ready to spend the money to upgrade their POS equipment. Some are simply ignorant about EMV, while others don’t see a need until more consumers have cards to pay with.

On the issuing side, aside from Wal-Mart Stores Inc.’s plans to offer Sam’s Club and Walmart-branded chip cards this summer and Target Corp.’s plans to convert its Redcard products to chip early next year, no issuers have yet announced large-scale plans. Even so, the EMV Migration Forum, an affiliate of the Princeton Junction, N.J.-based Smart Card Alliance trade group, last month predicted that more than 100 million EMV payment cards will be issued by year’s end.

That is about 10% of cards, says Randy Vanderhoof, executive director of the Smart Card Alliance. “In 2015, we expect the momentum will kick in,” Vanderhoof says. The forum estimates there will be 450 million chip cards issued in the United States by the end of 2015, he says. “It’s still very hard to predict the outcome two years out because many of the plans are being put into place and just starting to get implemented,” he says.

The forum also forecasts that 4.5 million EMV-capable POS terminals will be installed by year’s end. By the end of 2015, that will swell to about 7 million terminals, Vanderhoof says.

‘That’s a Problem’

Currently, those banks issuing chip cards do so for their consumers who have a high net worth or who frequently travel internationally.

“This technology is still in its adoption phase, and EMV continues to be most important for international travel,” says a spokeswoman for San Francisco-based Wells Fargo & Co. “For customers who travel to countries where EMV technology is more prevalent, we offer Visa consumer credit card customers the option to call and request their card be reissued with this technology. As merchant chip card acceptance gains popularity in the United States, we will evaluate the best way to support our customers’ credit card and debit card needs.”

At Visa, Stephanie Ericksen, vice president of risk products, says the number of Visa-branded U.S. chip cards was 12.7 million at the end of March, a 72% increase from 7.4 million at the end of December. “We have issuers who have already certified, primarily credit, and primarily for international traveling profiles,” Ericksen says. Overall, there were 288 million Visa-branded credit cards and 439 million debit cards in the United States as of December.

In addition to the technology change and the additional cost of chip cards—which Javelin estimates cost $3.50 each compared to about 50 cents for a mag-stripe card—issuers also have to contend with the Durbin Amendment, the federal legislation that regulates debit card transactions. This legislation is a complication for EMV cards (“Durbinizing EMV,” March 2013).

The Federal Reserve Board’s 2011 rule implementing that amendment requires merchants to have access to at least two unaffiliated networks with each debit transaction. The Fed’s rule said a major brand such as Visa or MasterCard for signature debit as well as an unaffiliated network for PIN-debit transactions would fill the bill. But EMV technology was not designed for network choice and Visa and MasterCard are major owners of it, which makes implementing Durbin’s transaction-routing provisions much harder than with magnetic-stripe cards.

The matter has mostly been resolved with the adoption by all of the larger debit networks of a common application identifier necessary for EMV debit transactions. Now, these networks, and issuers using them, have to develop the debit application to run on the chip cards. Ericksen expects more EMV debit cards to launch at the end of this year and beginning in 2015.

Wells Fargo, for example, says it is developing the EMV technical component for its debit cards. “Once the development is complete, and we have had a chance to test cards with participating merchants, we’ll begin the process of issuing EMV cards to new and existing debit card customers,” the spokeswoman says.

U.S. EMV debit is complicated for payment processors, too. “That’s a problem in the post-Durbin environment where every debit card has to have two networks,” says Barry McCarthy, president of financial services at Atlanta-based First Data Corp.

“When the EMV identifier for a debit transaction is presented to the processor, the processor has to build intelligence and routing capability to identify it,” McCarthy says. “That ID is additional work to be able to recognize two different networks.” McCarthy expects the technology will be in place at First Data well in advance of the October 2015 liability shift. McCarthy also expects large-scale chip card issuance to begin in the fourth quarter and carry on through 2015 and into 2016.

Even as issuers send out chip cards, and processors are ready to work with EMV transactions, consumers need places to use their cards.

Getting EMV-compatible EMV terminals onto merchant countertops is a herculean task. Many of the largest retailers, like Walmart and Target, are well under way with their terminalization plans, but many mid-size and small merchants have yet to plan the move, and a portion are even unaware of the looming migration.

Indeed, 53% of micro-to-small merchants do not know about the EMV migration, according to the Javelin report released in May, “EMV in USA: Assessment of Merchant and Card Issuer Readiness.” It’s going to take a lot of work just to get to the point where these merchants can understand why they might want an EMV-capable terminal.

Small merchants will have to be educated about EMV, says Marc Castrechini, vice president of product management at Merchant Warehouse, a Boston-based merchant-service company. “To get them to move, it’s telling the story of EMV,” Castrechini says. That includes telling them about the liability shift and that criminals, more important, always seek the point of least resistance.

One strategy to aid small merchant adoption of EMV that has worked well for North American Bancard, a Troy, Mich.-based merchant-services company, is to include an EMV-capable POS terminal in its free-terminal program.

Started last fall, the tactic appears to be working. EMV-capable devices account for more than 90% of the terminals shipped, says Marc Gardner, NAB president and chief executive. “Our sales partners have gravitated to selling a product set that is future-proof, at least for the foreseeable future,” Gardner says.

While that works well for new NAB merchants, which have to get new equipment anyway, it does not alleviate any difficulties that may arise when switching existing merchants to new devices.

“The big unknown is what’s the incentive to change out their hardware,” Gardner says. “For new customers, it’s a no-brainer because we can afford in our business model to get that business. However, re-terminalizing the installed base is something we aren’t even modeling because there’s no economic reason to do it right now. There’s no demand from merchants, no cards in the marketplace, no economic reason.”

‘Necessary Evil’

Most of the POS terminal makers have been selling EMV-capable devices for a few years. Equinox Payments LLC, a Scottsdale, Ariz.-based device maker, has been selling its EMV-capable L5000 multilane terminal for the past three years, says Stuart Taylor, vice president of payment solutions. The outstanding question is what retailers are going to do, he says.

“All of the acquirers are working on their EMV host applications,” Taylor says. “Some are complete, some are works in progress.” When that work is complete, it should accelerate the potential for terminal replacement, he says.

So there are merchants that are required to get new terminals because they switched merchant-service providers or are new to payment card acceptance. And there are those that bought EMV-capable equipment in the past few years. A third category are those whose equipment is three or more years old and working fine.

“The tricky ones are the ones who did an upgrade or refresh maybe five years ago,” says Mercury’s Berkley. “They still remember spending a bunch of money on equipment.”

And some merchant categories may adopt EMV quicker than others, creating yet another fragmentation in the marketplace, at least for a few years until most retailers accept chip cards.

According to the Javelin forecast, 53% of U.S. payment terminals will accept EMV cards in 2015 compared with 24% forecast for this year. By 2018, that percentage will grow to 92%.

For its part, POS-terminal maker VeriFone Systems Inc. currently ships about 70% of its products with EMV capability, says Erik Vlugt, vice president of product marketing at the San Jose, Calif.-based company. “We’re tracking well with regards to hardware and product readiness,” Vlugt says. “There is still a large part of the merchant base that needs to be educated.”

Merchant education is a major hurdle to EMV migration. Many need help determining their hardware plans, he says. They’ll also need help with training their staffs.

Mid-size merchants, in particular, may need the most assistance. While the largest merchants have the resources to move ahead on their own, and smaller merchants likely only need a terminal swap, it’s the mid-size ones that may need the most assistance, says Marc Abbey, managing partner at First Annapolis Consulting, an Annapolis, Md.-based payments-advisory firm.

Mid-size merchants don’t have large budgets, yet their payment-equipment needs are more complex than small merchants content with countertop terminals. For example, many of these merchants use integrated software to manage their daily operations as well as accept payments. Abbey says there are more than 10,000 integrated-software providers. “They’re all different in terms of stage of readiness,” Abbey says.

That’s the experience of Merchant Warehouse’s Castrechini. “The biggest challenge for these POS developers is that payments aren’t their specialty,” Castrechini says. “Payments has been the necessary evil to exchange currency across the countertop.”

‘The Pressure Is on’

Terminal makers are trying to make it easier for POS developers. VeriFone says it is working on products for them that will provide a simple interface between their software and the payment application.

“The open item in the middle market is the sheer number of [independent software vendors] and integrators selling into that marketplace,” says Equinox’s Taylor. Because so many acquirers service those products, they’ll have to ensure the payment modules used by these developers are EMV-compliant, he says. “The pressure is on the acquirers to get the various applications all certified on EMV.”

But the greatest spur to merchants to accept EMV transactions may not necessarily be related to the benefit from the liability shift. Rather, it could be the loss of a sale.

“As a company that has a global footprint, it’s important to consider the customer that perhaps is visiting New York or Las Vegas and discovering our brand for the first time,” says Ryan Bonifacino, vice president of digital strategy at Alex and Ani LLC, a Cranston, R.I.-based jewelry and accessories retailer. “The last thing they should worry about is payment acceptance and the last thing we should worry about is losing a sale.”