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It’s All POSsible with EMV
By Aravind Vanchesan

The EFT POS terminal market is fairly saturated in many regions such as North America and Europe in the tier I retail segment and to an extent the tier II retail segment. Vendors are now looking for the killer application that would drive massive re-terminalization and increase uptake. IP looked like the answer but it does not necessarily mean replacing a terminal. Wireless/mobile capabilities come with high costs which make it unattractive for a large section of the intended audience. So where do the big four – VeriFone, Ingenico, Hypercom and Lipman, along with some smaller vendors, go from here?

The answer could be EMV, an acronym for “Europay, MasterCard and Visa”, a smart card transaction system. Target’s announcement in early 2004 that it would halt the implementation of smart cards in its stores meant that EMV in the US had been dealt a severe blow and is not expected to take off in the near future. Contactless EMV is a possibility a few years down the line. Asia-Pacific and Latin America are growing markets but the volumes tend to be comparatively low. Thus, with respect to EMV, the best bet was Europe. Deadlines for conversion from magnetic stripe to chip card were set for each geographic region. Those who failed to make the switch in time would have to bear the liability of fraud.

Though it looked promising initially, EMV took off in very few countries in proper earnest. Western and Eastern Europe displayed different EMV adoption characteristics. Understandably, UK has showed the greatest enthusiasm since it suffers heavily from card fraud and is widely acknowledged as the fraud hot spot of Europe. In 2003, losses were estimated to around 500 million pounds and this figure was expected to double by 2008. Realizing this, the government decided to tackle the menace with the chip and PIN system introduced in the UK by the card payment industry. The new chip cards are much harder and more expensive to counterfeit. The PIN helps reduce the number of lost and stolen cards being used fraudulently. When fully implemented, the chip and PIN verification system is anticipated to more than halve UK’s fraud losses. Further, chip and PIN represents a major shift in liability for fraudulent transactions. A non chip and PIN compliant retailer would be liable for any fraud at the point of sale after the deadline. This led to a large uptake of EMV compliant terminals in the UK over the last 2 years, which was terrific for the terminal vendors. But now that the UK is almost done with its implementation, they must look for other pastures.

France is another country with a large installed base that has shown a reasonable inclination to make the switch. Of course, France was the pioneer of the chip card in Europe, when it witnessed a reduction of more than 50% in fraud losses following the introduction of PIN-based smart cards more than a decade ago. With fraud levels back up again, by the end of 2004, all ATMs and large retailers in France plan to be EMV-ready, while 80 per cent of smaller retailers will meet the compliance deadline and by the end of 2005, migration will have concluded.


So far, so good

Other than these two countries, EMV terminal demand has been fairly disappointing in Germany, Italy, Spain and some other major countries in east Europe. The reasons? One of them is the concern that smart cards might not necessarily be universally accepted for payment in the future. The lack of an industry consensus on security has created many barriers and slowed the pace of adoption in many regions. Each individual country or acquirer sets its own standards. Vendors are faced with increased security requirements for terminals, such as PCI, as well as local security schemes such as UK PP, ZKA, EPCI, etc. These new security requirements play a key role in combating fraud, but have an impact on time to market as well. The certification process for terminals that conform to these different standards can cause an enormous delay, sometimes even months. This is not only a challenge for the industry but can affect ROI on R&D and impact the bottom line of terminal vendors. By end of 2004, less than 10 percent of the installed terminal base was EMV compliant in most European countries.

Card issuers and associations are finding it tough to build a convincing business case for investment in anti-fraud technologies where fraud levels are currently low. For instance, Germany, Spain and Holland are countries where falling fraud losses have resulted in the lack of progress towards EMV compliance. The banks are prepared to accept a certain level of fraud rather than investing in an entirely new chip card infrastructure which would offset the amount of fraud prevented. The high cost of migration is a key concern since the majority of the banks and financial institutions have budgetary restrictions.


Now, the turnaround

With many countries in Western Europe actively shifting to a chip based system, the neighboring countries are beginning to feel the negative impact of fraud. This is because smart card-based payment cards are difficult to tamper and fraudsters or criminals tend to move bases to countries that are late in migrating.

For instance, card issuers in Germany are reconsidering the business case for EMV by enabling a percentage of their portfolio, as they want to guard against the surge of counterfeit fraud on skimmed cards, which France faced last year. Fraud on cross-border transactions in France grew by more than 50 per cent in 2004. The main reason for this being the EMV roll out in neighboring United Kingdom.

Hence, Landesbank Berlin, expects to EMV enable around 25 percent of its credit cards upon expiry, and anticipates that through 2005, rising fraud levels will make acquirers realize the actual business case for EMV. In Germany, January 1, 2006 has been nominated as the local liability shift deadline for fraud on non-compliant systems, instead of the official deadline of January 1, 2005.

Similarly, Italy, which has over 30 million payment cards in issue, has seen fraud losses increase by 48 per cent in 2004, which has highlighted EMV as an anti-fraud solution. Clearly counterfeit fraud is the biggest threat to Italy. Hence, Italy is planning to convert all its debit cards from magnetic-stripe to EMV chip by January 1, 2006 under a mandate by the Associazione Bancaria Italiana (ABI). With 1 million chip cards predicted to be in circulation by the end of 2005, Italy’s major banking groups are to issue EMV cards in partnership with vendors such as Gemplus, Giesecke and Devrient. For substantial opportunity for EFT POS terminal vendors in any country, it is essential that at least 30 – 40 % of the total installed base of bankcards is EMV compliant.
Usually, the barriers to switching vendors is high, more so in a multi-lane retailing environment. This is because most multi-lane retailers own their terminals and have made considerable investments into the same in the past. Switching costs in multi-lane depend on the level of customization, the business needs, specific application requirements, and back end integration and support requirements. As a broad guideline, vendor-switching costs in multi-lane could vary from $15000 to as high as a million dollars and upwards per store based on the specifics of the retailer type. This could translate into larger dollar values if a new vendor is involved. Hence, it is more cost effective to manage with the existing vendor.

However, this could potentially have long term implications for a vendor once a multi-lane retailer account has decided to switch vendors. Whether retailers are switching vendors or switching equipment for EMV compliance, cost is likely to be more or less the same. This is typically almost like a rip and replace and not a minor upgrade. Thus, retailers tend to float a tender versus just consulting their current vendor. The choice of the new vendor would depend on the total value proposition which each of them brings to the table. This is a huge opportunity for terminal vendors to re-define their installed base in Europe and increase market share.

The long term strategy should be to understand the business and the POS requirements of their merchant end-users and provide value-added applications and services to expand sales to these customers over time, rather than engage in one-time sales. With more than 5 million terminals waiting to be replaced in Europe over the next 2 years, the vendors who proactively grab this opportunity will enjoy significant revenue growth by virtue of the long-term relationships they will establish with their customers.

Aravind Vanchesan is a Research Analyst, Retail Systems Group, for Frost & Sullivan. For more information on this report, contact Tori Foster at tori.foster@frost.com.