Entrepreneurship & Innovation Strategy
Mini-project: Ecosystem Strategy
The Innovation of the Smart Card
Elizabeth Pomerantz; 33287K
Deeksha Mittal; 34047H
Melissa Brown; 34436P
Professor Adner: Section 1
Value Vision:
The value proposition of the chip-enhanced credit card is the provision of enhanced security for
transactions. The impetus for this innovation was growing identity theft and fraudulent
activity, which jumped to $48 billion in 2008 and affected 9.9 million adults in the United States
according to Javelin Strategy & Research. This statistic is even more astounding when
compared to its industry value back in 2003 of only $2.3 billion. While lost and stolen wallets,
checkbooks, and credit/debit cards make up 43% of all identity theft incidents, the transition to
an online retail environment served as a catalyst because it enabled a means to conduct
purchasing activity without having to disclose an identity or be in possession of the physical
card. Therefore, the world had finally evolved to a point where there existed a demand for the
innovation that the chip offered.
However, the chip faced several hurdles in its adoption due to the different relative value
proposition within its complex ecosystem. Part of this complexity stems from the number and
size of some of the players that are not the ultimate end user. This value chain is dominated by
the credit card companies, government and financial institutions who have great influence on
the world of the fragmented merchants and consumers. The challenges that were faced
however were not centered on the degree of execution risk or co-innovation risk since the
technology itself was incremental and not radical. The biggest hurdle was actually in the
adoption chain risk: these large significant players needed to adopt the innovation before the
end consumers were able to adopt it.
The Smart Card Ecosystem:
Following is a brief description of the major players in the credit card eco-system and the
relative benefit (if any) they can derive from Smart Cards. Please refer to Appendix I for an
illustration of the ecosystem, Appendix II for a cost vs. benefit analysis as well as Appendix III
for an innovation classification breakdown.
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The End Consumers:
(Power to influence adoption in eco-system: Low; Relative Benefit from Smart Cards: Moderate)
The change to a Smart Card is relatively painless for a consumer. There is a nominal change in
the technological knowledge required since consumers have the same interaction with their
credit card at the point of purchase. With no notional cost, there only exists a minor
inconvenience to contact and activate the pin number for the new card. Thereafter, the only
difference in their merchant interaction remains the shift to a four digit code instead of a
written signature. As this process replicates the information required by an ATM, an earlier and
widely adopted innovation, the learning curve is also exceptionally fast and seamless. As such,
the market knowledge required is also unchanged. Switching costs are also nullified because
consumers had full functionality of both the old and new process on the new cards, which
contained a magnetic stripe as well as a chip. Through this ‘hybrid’ design, users were caused
no disruption to the ability to purchase irrespective of any delay in adoption by some retailers.
This low total cost for a consumer is also enhanced by the net benefits the Smart Card provides.
The value of the Smart Card relates to the higher degree of security and confidence it provides
with purchasing activity. This is highly valuable to a consumer, given the time, anxiety and
inconvenience involved with being a victim of fraud. Finally, there is an improvement in the
Smart Card’s performance since consumers can easily transact while they travel internationally
with the same card.
Therefore, the innovation in its entirety provides a moderate net positive surplus. However,
the fragmented nature of consumers, they have little bargaining power to demand or speed up
the adoption of the Smart Card based on its unique eco system.
3
Merchants:
(Power to influence adoption in eco-system: Low; Relative Benefit from Smart Cards: High)
Merchants have a powerful reason to accept Smart Cards: they reduce fraud, which they
ultimately pay for. Currently, American law allows credit card companies to reverse potentially
fraudulent transactions and charge a fee. This means that for each fraudulent transaction, a
merchant loses the revenue generated, plus a processing fee charged by the credit card
company. Therefore, there exist significant benefits for the merchants through the increased
reliability of each transaction. Quicker transactions are also possible, because the merchant’s
card reading device does not need to use telecommunications to check the validity of the credit
card with the issuer.
One downside is that the merchant must invest in new card readers, which is not a small
expense for a large company with several checkout counters compared to the average
fraudulent transaction size of $484.1 While the process of taking credit card information using a
card reader device is the same as before, the merchant may still be required to integrate the
new card reader with their old technology systems as well, which could cause disruption.
According to the Market Knowledge/Technical Knowledge matrix, the new card reader should
be relatively easily accepted by both merchants and consumers. While both parties would need
slightly different technological knowledge to operate the device, the method of providing a
credit card and punching a pin code into the machine cannot be considered disruptive. Market
knowledge is completely conserved. The ultimate value to merchants, however is directly tied
to the volume of fraud to make the relative benefits exceed the total costs. In high-fraud
environments, Smart Cards provide a large advantage because fewer dollars are lost to
reversed transactions and credit card company fees. However, in fairly low-fraud environments,
such as the United States, it is only worth investing in the necessary infrastructure when a
critical mass of consumers have cards with Smart Cards. As that has yet to appear in the United
1
Calculated using the total fraud amount of $48 billion and number of U.S. fraud victims (9.9 million) in 2008,
according to Javelin Strategy & Research, February 2009
4
States, merchants have not upgraded. They have, however, preserved the option to upgrade in
the future.
Credit Card Companies & Financial Institutions:
(Power to influence adoption in eco-system: High; Relative Benefit from Smart Cards: Low)
Credit card companies such as Visa and Master Card as well as banks and financial institutions
issuing credit cards are the biggest players in the credit card ecosystem and hence have the
power to control the adoption of any new technology in the credit cards space. Credit card
companies such as Visa and MasterCard not only act as transaction processing agencies for end
consumers, merchants and financial institutions but also position themselves as agencies
providing secure payments processing, fraud monitoring and fraud prevention services.
Moreover, credit card companies make money by charging transaction fees and providing these
fraud prevention services.
Hence, in the current circumstances a Smart Card that can help prevent frauds does not have
any value proposition for the credit card companies. In fact, it poses a threat to the existing
fraud prevention services provided by these companies.
Also, the financial institutions have little incentive to switch to Smart Cards. According to the US
federal reserve regulation Z, federal reserve regulation E and the Electronics fund transfer act,
US consumers are protected against fraud by affording them the right to reverse any dubious/
fraudulent transaction on their debit and credit cards. In case of a transaction reversal, the cost
of investigating a fraud is usually passed on to the merchants in the form of a heavy penalty
called the ‘Chargeback fee’. Thus, financial institutions have little financial liability in the case of
a fraudulent transaction and hence little incentive to switch to a Smart Card.
Moreover, issuing and supporting Smart Cards also poses significant additional costs for the
financial institutions. A fully loaded Smart Card costs about $1.62 whereas a magnetic stripe
card costs around 50 cents.2 Thus, a bank wanting to enable millions of card holders will have
2
Source URL: http://www.sans.org/reading_room/whitepapers/authentication/identity-protection-smart-cardadoption-america_1122
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to pay a significant premium. This cost can be transferred to the consumers only if they see
significant value in paying extra for these cards. The cost for banks to convert to Smart Cards in
the U.S. would be in the area of $12 billion, according to Frost & Sullivan, the market research
firm.2 Also, fraud as a percentage of total Visa card transactions has decreased to 0.06% from
to about 0.15% in the early 1990s thereby making the Smart Cards even less attractive for the
financial institutions and credit card companies.
The US Government:
(Power to influence adoption in eco-system: High; Relative Benefit from Smart Cards: N/A)
The US government is not a primary party in this ecosystem. While the EU inserted itself into
the ecosystem by requiring credit card companies to issue cards with chips, the US government
is not making the same decision. While less fraud and more revenues for small businesses
would result in higher tax revenue for the government, this benefit is erased by the lobbying
campaigns brought by the credit card companies and financial institutions. The American
Bankers Association and lobbyists for Visa, MasterCard, and American Express have access to
tremendous resources and, before the financial crisis, had successfully killed bills aiming to
protect college students, require minimum payment disclosures, reinstate the usury ceiling on
credit card interest rates, prevent “baiting and switching,” and several other proposals. While
the Dodd-Frank Act successfully passed several of these regulations, the populist tide for
financial regulation seems to have turned and is no longer powerful enough to counter the
financial resources of the lobbyist groups. Additional regulation requiring chips in credit cards
is not likely to pass despite the pleas of foreign countries encouraging the United States to
upgrade. As these countries do not have a powerful position in the US credit card ecosystem,
their voices have fallen on deaf ears.
US credit card eco-system Vs. Europe credit card eco-system
Smart Cards have been extremely successful and popular in Europe. So much so that travelers
from US often face problems in Europe while trying to use their credit cards to make payments
at small shops, public transport and even toll plazas. However, there are several distinctions
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between the European ecosystem, which has universally adopted chips in credit cards, and the
US ecosystem, which has taken initial steps to begin issuing credit cards with chips, but not
made use of them. The first difference is that the level of fraud in the United States is
considered “manageable” compared to the level of fraud in other countries. Because
consumers are not worried when a waiter takes their credit card to put the transaction through
at the register, popular support for the changeover is relatively weak. The relative benefit is
much smaller in the United States, another hurdle for adoption. The economic split of fraud
charges in Europe also differs somewhat from the United States, where the merchant shoulders
the entire downside.3 Finally, the push toward deregulation in the United States also slowed
the movement, while in contrast, Europe had popular support and pushed the transition
through by law. Europe was also more concerned about expensive telephone calls the
merchant had to make every time a customer wished to charge an item, and saw the new
version of the reader, which was able to read the chip without communicating with its issuing
financial institution, as a large cost-saving opportunity. In the United States, airtime is relatively
cheap and even more reliable as compared to the cost of issuing cards with chips.
The future for Smart Cards in the US:
Although the current credit card eco-system in the United States does not seem very attractive,
the Smart Card technology itself has a promising future. Smart Cards can find multiple
applications such as –
Medical cards: Cards that can store all medical history of a patient that can lead to speedy
diagnosis and easy accessibility to critical information in case of medical emergencies.
National ID cards: Cards that can store biometric identification information, criminal history,
driving license and driving history of a person. These cards can act as one source of
3
This split also differs between countries in the EU. For example, under French law, no transaction may be
reversed unless the card was lost or stolen. (Source: http://ec.europa.eu/internal_market/finservicesretail/docs/onlineservices/chargeback_en.pdf). Therefore, the merchant is subject to far fewer chargebacks and
the economic split is between consumers and merchants, when comparing the European landscape to the
American (where consumers may simply reverse a transaction they regret).
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identification for a country’s citizens and provide security advantages for governments by
enabling easier tracking.
Integrated payment solution with mobile phones: Smart Cards can be attached with mobile
phones and be used to make payments for purchases instead of regular credit cards. This
provides even more convenience to the end customers who do not have to carry multiple cards
in their wallets.
Also, with increasing concerns on identity theft and credit card frauds, a government legislation
requiring financial institutions to issues Smart Cards or at least offer it as an option to it
consumers can help boost adoption of these Smart Cards in the US.
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APPENDIX I: The Eco-System Map
Government
Smart Card Technology
Innovator/ Manufacturer
Financial Institutions/
Credit card issuers
Credit Card Company
(VISA, MasterCard etc.)
Merchant
End Customer
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Appendix II: Benefit vs. Cost Analysis
Value Partner
Benefit
Consumer


Increased
Cost

Adoption time: Call
Surplus

Moderate
security/fraud
toll-free line; Select
incentive to
prevention
PIN and Switch card
adopt – less
Must remember PIN
hassle
transition given
every time they use
involved with
dual capability of
card
fewer frauds
Seamless

chip card (swipe
to report (and
and chip hybrid)
ease of travel

Convenience
to Europe)

Improved
reliability

Global use

Faster
transactions
Merchant

Improved

reliability


Faster
Adopt technology –

get a card reader

May need to
HUGE surplus
benefit

Will wait until
transactions
integrate new reader
consumers
Reduced
with old tech
have the
fraudulent
cards to
charges (liability
invest in the
of proof on
card readers
merchant, not
bank)
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Credit Card

Fraud reduction
* Credit card upgrades
Company

No


Reduced demand for
telecommunicati
fraud prevention
ons charges
services sold by cc
No benefit
surplus
company
Financial

Institutions
Reduced

Lost/stolen cards –
transaction costs
more expensive to
due to
replace (if they pay??)
automation


No Benefit
surplus
Possibly more
security software
US Government

Less fraud

More tax

N/A

Definitely a
revenue from
small businesses
Smart Card

Manufacturer
Increased
sales
surplus
Benefit
Old Credit Card
Technology


Possible
increase in
Cannibalization of
existing sales

A possible
loss in sales if
sales if same
cannot
manufacturin
switch.
g setup can be
Hence, no
used to
benefit
manufacture
new
technology
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APPENDIX III: Innovation Classification
Technology Knowledge
Market Knowledge
Conserve
Conserve
Disrupt
*Consumers
*Merchants
*Government
*Credit Card
*Financial Institutions
Companies
Disrupt
*Smart Card
Technology
APPENDIX IV: Power to Influence Vs. Relative Benefit
LOW
HIGH
HIGH
*Credit Card Companies
*Financial Institutions
Power to
Influence
*Merchants
*End Consumers
LOW
Relative Benefit
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*New Technology Manufacturers
References:









http://www.sans.org/reading_room/whitepapers/authentication/identity-protectionsmart-card-adoption-america_1122
http://www.creditcards.com/credit-card-news/outdated-smart-card-chip-pin-1273.php
http://www.nytimes.com/2001/08/12/us/credit-card-chips-with-little-todo.html?pagewanted=all&src=pm
http://www.pbs.org/wgbh/pages/frontline/shows/credit/interviews/mierzwinski.html
http://av.conferencearchives.com/pdfs/080503/17.pdf
http://en.wikipedia.org/wiki/Chargeback
http://en.wikipedia.org/wiki/Credit_card_fraud#United_Kingdom
http://en.wikipedia.org/wiki/Consumer_Credit_Act_1974
http://ec.europa.eu/internal_market/finservices-retail/docs/onlineservices/chargeback_en.pdf
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