Although it has become the standard in Europe, Asia and Latin America, there has been relatively little interest in moving to EMV chip technology in the United States.
Banks have heard the various arguments for the chip, mostly those that warn what’ll happen if the U.S. payments industry doesn’t convert, that American issuers will fall behind Europe, or that U.S. issuers are losing out on revenue from transactions in foreign countries because their customers’ cards aren’t accepted by chip-enabled POS devices, or that continuing to rely on magnetic stripe technology will leave issuers (and soon, merchants) more and more vulnerable to fraud.
On their own, those arguments have not been sufficiently convincing for the industry to make the investment. So issuers are waiting to hear a compelling business case that would justify the approximately $5 billion to $13 billion expense of migrating to EMV chip-enabled credit and debit cards.
Without a business vision around how to leverage the applications of the EMV chip, issuers have been thinking of it as an infrastructure cost, rather than an investment in business growth; the arguments have been only about sticks, not carrots.
Being on a similar tech standard to the rest of the world is not a compelling business case. And with fraud at manageable levels on PIN debit, fraud has not tipped the balance towards chip, either. These “sticks” have so far not brought issuers to the table.
We think the carrot is more compelling than the stick. The answer lies much more in the potential business benefits of the EMV chip. Think of a smart phone. What makes it smart? The apps. What makes a computer useful? The software. And what is an EMV chip, after all, but a micro-processor, a miniature computer, similar to the secure chips now being found in phones and other mobile devices? The business case for the EMV chip and similar devices will depend on the development of profitable business applications for them.
One such application already exists, which addresses one of the great challenges in the industry: low value payments. LVPs are problematic because the cost to an issuer for processing a transaction is virtually constant, whether the transaction is for a $2 cup of coffee or a $100 pair of sneakers. If the issuer passes on the interchange fee based on the full variable cost of the transaction, the resulting merchant fee (close to 30 cents, including the acquirer fee) will cut too deeply into his margin, and pretty soon the merchant will start refusing cards for purchases under $10, which under the Durbin Amendment is permitted.
Previously, as an incentive to get merchants to accept cards for low value payments, issuers had created a two-tier interchange fee system under which the cost of LVPs was partially subsidized by a higher fee for higher-value transactions.
Durbin rendered that arrangement obsolete. The amendment, albeit unintentionally, exposed a situation that was untenable – high fees from high-value transactions were subsidizing the cost of lower-value transactions. But the moment that the lower-value transactions reached a tipping point wherein the cross-subsidy was no longer affordable, some other solution would need to be found.
Credit unions, of course, are exempt from the new interchange regulations, but that does not mean they’re not subject to the problem as the business model currently stands, namely that LVPs are too expensive.
LVPs represent the biggest opportunity for growth in the payment industry, but if each of those transactions represents a net loss to the issuer, that “growth” won’t do much good. In order for the LVP segment to be valuable, issuers will need to be able to price transactions at a level that merchants will be willing to accept but still delivers a profit.
The EMV chip makes it possible to apply a software solution to this problem. New aggregation technology, such as a software plug-in on the EMV chip, would allow a chip-enabled debit card to store value, just as a wallet holds cash.
In this scenario, a $50 debit withdrawal is loaded onto the chip in a single transaction while making a purchase at the point of sale. The cardholder can then spend that $50 in small increments, at multiple merchants, without further need to involve the issuer. Meanwhile, on the merchant’s side, all the individual LVP transactions are aggregated and submitted to the acquirer bank at the end of the business day. The result is that ten (or more) low value payments are processed at the cost of a single transaction.
Passing savings on to the merchant would encourage greater acceptance of electronic payments for LVPs, and with approximately 200 billion low-value transactions (adding up to about $1 trillion in value) currently transacted in cash annually, that could be processed electronically the growth in transactions processed would drive increased revenue and profits for all the players in the payment system.
Given that the current pricing system incentivizes small merchants to insist on cash for those payments, the attractiveness of a solution of this kind for issuers, acquirers and processors alike should be clear.
While this would be a revolutionary approach to handling low-value payments, EMV infrastructure enables this, and is just one compelling business case for migration to the EMV chip. Further, the application extends into the next major growth area in payments: contactless and mobile technologies.
Not that long ago, the idea that virtually every consumer would want his or her own computer – let alone the pocket-sized computer we call a smart phone – would have seemed absurd. What possible uses could personal computers have that would justify the cost?
But uses were found, uses were invented, to the point where they became absolutely indispensible. Now, with the payments industry facing the possibility of missing out on its fastest-growing segment, this application is the low hanging fruit that more than pays for the cost of conversion to EMV chip. And it is only the beginning.