The Big Bang It Ain’t

The EMV era in the U.S. officially started Oct. 1, and for the most part this is shaping up to be an underwhelming launch for chip cards.

It’s morning in America for payment cards, the accession of the EMV chip card as the successor to the half-century-old magnetic-stripe card.

The official start of this era came Oct. 1, when the payment card networks’ so-called liability shifts for the point of sale took effect. As sea-changes go, however, this one could hardly be more underwhelming.

As of August, somewhere in the neighborhood of just 4% of U.S. card-accepting merchant locations were live for processing chip card transactions, and only about 20% of general-purpose credit and debit cards sported the little square EMV microprocessor with rounded edges.

Still, it is indeed a new era. Evidence of the big shift is likely to grow rapidly as 2015 draws to a close, and in 2016 when retailers resume their EMV-terminal rollouts after putting them aside temporarily to get over the holiday hump, when they are loath to monkey with the point of sale as customers throng to stores.

Visa Inc., the largest U.S.-based payments network, started the EMV ball rolling in the summer of 2011. Visa outlined a multifaceted plan to move the U.S. away from fraud-prone mag-stripe cards and toward the EMV chip cards that most of the rest of the world had already embraced.

Visa said that from Oct. 1, 2015, forward, merchants that did not have terminals that could read a customer’s EMV credit or debit card would bear responsibility for counterfeit fraud originating from that transaction. Conversely, issuers that until now have borne most fraud liability will continue to eat counterfeit losses if the merchant has a working EMV terminal but the cardholder has only a mag-stripe card.

MasterCard Inc. and American Express Co. followed suit with slightly different rules but with a liability shift aligned with Oct. 1. MasterCard’s shift, for example, covers not only counterfeit transactions but also lost-and-stolen card fraud. Discover Financial Services also has a plan to adopt EMV.

EMV Laggards

So, how far along is the U.S. in its EMV conversion, which Javelin Strategy & Research last year estimated will cost almost $7 billion? Answer: Not too far, if one uses Visa data as a proxy for the entire industry.

As of late August, the latest figures for which data were available, 301,000 merchant locations were activated for chip card acceptance, according to Visa, up 2% from 295,000 at the end of July but still far short of the country’s approximately 8 million card-accepting locations.

But Stephanie Ericksen, vice president of risk products at Visa, cautions against any big-bang expectations. She says it typically took about three years after the liability shifts in other EMV countries before 90% of payment card transactions were “chip-on-chip,” or generated by an EMV card used at an EMV terminal.

“We really see Oct. 1 as the starting point, not the endpoint,” she says of the U.S. conversion.

Adds Steve Mathison, senior vice president of payment acceptance at leading payment processor First Data Corp.: “It’s a multiyear proposition.”

On the card-issuing side, some 141.9 million Visa credit, debit, and prepaid cards had an EMV chip as of August. That’s 20% of the 720 million Visa cards circulating in the U.S.

Terminal makers say most of their new products will support contact transactions in which the EMV card is inserted, or “dipped,” into the device and kept there during the transaction, as well as contactless transactions from so-called dual-interface cards. They also can support smart phones via near-field communication (NFC) technology.

Dipping is raising fears that transaction speeds will slow down, but a dual-interface card can cost twice as much as a contact-only card.

They may grumble about the cost and hassles of replacing their point-of-sale equipment, but the national big-box retailers are leading the conversion. Despite widespread testing, relatively few EMV terminals were turned on before Oct. 1, but now observers predict a rapid increase in live devices.

Target Corp. redoubled its EMV effort after its massive data breach in late 2013 and reported in August that its $100 million in-store retrofit was complete. Now the Minneapolis-based discount chain is turning its attention to reissuing its REDcard credit and debit card portfolios with chips.

Many other chains, including leading retailer Wal-Mart Stores Inc., also have added chip readers. And 50% of the big merchants in merchant acquirer Heartland Payment Systems Inc.’s portfolio, excluding petroleum merchants that have a 2017 liability shift, are activated for EMV, according to chief executive Robert O. Carr.

“There’s certainly evidence that the large nationals are making lots of progress,” says First Data’s Mathison.

In contrast, a host of studies and polls have shown that small merchants are the EMV laggards.

Only 49% of merchants that have up to $20 million in annual revenue and that accept payment cards said they were aware of the Oct. 1 deadline, according to a Wells Fargo/Gallup Small Business Index poll conducted July 6-10. The survey contacted some 600 business owners, of whom 41% accepted debit cards and 35% took credit cards.

Among the card-accepting merchants, 31% said they had installed EMV terminals. As for the other 69% that weren’t ready, only 29% said they planned to install needed equipment by the deadline. Just over one-third said they’d do it, but some time after October, and another 21% had no interest in upgrading at any time.

“Sometimes it’s difficult to find merchants that know how to spell E-M-V,” laments Mathison.

Surprisingly, however, 50% of the currently tiny volume of chip transactions is coming from small businesses, according to Visa. That’s because, for small merchants that have made the commitment, getting a chip reader installed and live for processing EMV transactions often is a “rather simple plug-and-play,” says Ericksen.

“The small businesses—once they’re doing EMV, they’re EMV,” she says.

“We’ll have about 20% of our small merchants live [activated for EMV] by Oct. 1,” Carr of Princeton, N.J.-based Heartland said shortly before the deadline.

‘It’s Really Nasty’

EMV conversions are going fastest among retailers most vulnerable to counterfeiting fraud, such as those that sell consumer products and other “high-ticket fenceable goods,” says Mathison.

Stores that sell prepaid cards, which also can be sold easily after being bought with fraudulent credit cards, also are motivated to convert.

But other industries, especially restaurants, have low fraud rates and are converting slowly, according to Thad Peterson, senior analyst at Boston-based Aite Group LLC.

“You’re not going to be using a counterfeit card to buy a meal in a restaurant,” says Peterson. “There are entire categories of merchants that are not significantly affected.”

The new POS terminals for merchants and cards for consumers will collectively cost at least $6.8 billion, according to Pleasanton, Calif.-based Javelin Strategy & Research.

“Issuers will bear the brunt of the upgrade cost, paying 62% vs. 38% for merchants,” Michael Moeser, Javelin’s director of payments practice, retail and small business, says by email. “Since this figure does not include the cost of training cashiers, providing consumer education, performing software integration, and future EMV transitions of ATMs [in 2016] and unattended fuel pumps [in 2017], this cost will surely be higher.”

Heartland’s Carr estimates his firm has spent about $5 million on EMV so far, and “we’re only in the third inning. Ten million would be fair [for total investment] and that doesn’t count petroleum.”

Besides the sheer expense, merchants and merchant acquirers are confronting operational issues in rolling out EMV. One of the biggest bottlenecks is processor certification that a merchant’s EMV system is doing what it’s supposed to do (“Where EMV Certification Is a Big Headache,” September).

“It’s a lot of steps, it’s really nasty,” says Carr. “It’s not just the hardware that has to be certified, but each application.”

Still, Carr adds that the certification problem “could be a lot worse than it is … I think the industry is doing a good job of dealing with it,” he says.

Capitalizing on EMV

The Oct. 1 deadline came as retailers were preparing for the fourth-quarter holiday sales surge, a time when they’re normally reluctant to fiddle with their POS and back-office systems for fear of disrupting checkout lines. Payments experts say many big merchants that already have installed and tested EMV terminals will turn them on this month. After that, don’t expect much EMV action until early 2016.

“October is still considered a safe zone, but once you hit November, I think the decision becomes a little more critical,” says Randy Vanderhoof, executive director of the Princeton Junction, N.J.-based Smart Card Alliance trade group.

Omaha, Neb.-based consulting firm The Strawhecker Group recently estimated that only 27% of U.S, merchants would be EMV ready in October—actually down from the 34% estimate TSG made six months earlier.

Meanwhile, the run-up to EMV has produced huge windfalls for some acquiring-industry vendors. Leading U.S.-based POS terminal provider VeriFone Systems Inc. last month reported that its North American revenues grew 61% to $208.6 million in the quarter ended July 31 from $129.8 million a year earlier.

The big growth in fiscal 2015’s third quarter exceeded North America’s 54% year-over-year growth in the second quarter and the first quarter’s 31% increase. A large part, though exactly how much San Jose, Calif.-based VeriFone did not reveal, can be attributed to the U.S. EMV liability shift.

VeriFone expects EMV to be the gift that keeps on giving for quite some time because of the slowness of many small and mid-sized merchants to upgrade.

“We’ll continue to capitalize on EMV in the United States,” chief executive Paul Galant told analysts in his quarterly conference call.

According to Galant, 8 million magnetic-stripe-only terminals at medium-size and small merchants—some 60% of the U.S. terminal base—remain to be converted. “Tier 1 may be 90% done, but these other folks are not,” he said.

A Simpler Rollout

Meanwhile, issuers have been buying chip cards by the hundreds of millions this year. Citing figures from First Annapolis Consulting Inc., card manufacturer CPI Card Group Inc. estimates its industry will produce 373 million credit cards and 366 million bank debit cards (excluding prepaid cards) this year, for a total of 739 million.

Next year the industry will produce an estimated 766 million cards, 392 million of the credit variety and 374 million for debit. It’s likely the vast majority of these new cards will have EMV chips.

The Visa numbers confirm what payments executives have been saying for months, which is that the credit card conversion is going faster than the debit one. As of July, according to Visa, some 80.8 million of its credit cards had EMV chips in July versus 46.1 million debit (including prepaid) cards.

Credit is a simpler technical rollout than debit. Credit cards don’t need a so-called common AID, or application identifier, that enables a transaction on a Visa- or MasterCard-branded debit card to access the PIN-debit networks, as required by the Dodd-Frank Act’s Durbin Amendment to give merchants more choices in debit transaction routing.

Accommodating EMV payments, which appeared nearly two decades before Durbin and were designed with one network in mind, to the routing requirements took several years of negotiations among the networks and untold hours of programming and back-office technical changes.

But with the common AID issue largely settled, debit EMV is gaining. Discover’s Pulse debit network, citing its own industry survey, recently estimated that about 25% of debit cards will have chips by year’s end.

“I think we’ve certainly seen a major uptick in debit issuance with the common AID supported,” says Ericksen.

‘Peanut Butter And Jelly’

Big banks reportedly are leading the conversion, but some smaller issuers are coming on strong. Des Moines, Iowa-based The Members Group, a service provider for more than 250 credit unions, reports that 95% of its managed credit cards and 30% of debit cards have converted.

“We’re able to move fast and furious,” says TMG product manager Nicholas “Chole” Casber.

Casber adds that “what’s even crazier” is that nearly all the new credit cards are of the dual-interface variety. Why are credit unions taking the more expensive route?

“[Dual interface] allows them to differentiate themselves,” says Casber.

POS terminals that can read dual-interface cards are expected to give a big boost to mobile payments because of their NFC capabilities.

“NFC and EMV are like peanut butter and jelly,” says Mathison of First Data.

As issuers and merchants confront EMV decisions, and consumers get familiar with chip cards, the U.S. can expect to experience “a very confusing time” in the coming months, according to Aite’s Peterson. But that’s what happens when any new era starts.

“We should expect October not to be a deadline, but a kickoff,” he says.