Makers of Smart Cards Are Betting Big on U.S.

By EDMUND SANDERS

Feb. 28, 2000 12 AM PT

TIMES STAFF WRITER

In a tightly guarded former weapons components plant in Rancho Dominguez, French-owned Oberthur Card Systems is betting on a technology that has stubbornly refused to catch on in the U.S. The European manufacturer is investing millions in the plant here to build what it calls North America’s largest smart-card factory, capable of cranking out 25 million cards a year.

If experts are right, one day every person will carry these chip-embedded plastic devices to shop safely on the Internet, store medical records, and secure or personalize computers and cell phones.

But on a recent tour of the state-of-the-art facility--which begins with each visitor being photographed for security purposes--Oberthur’s energetic marketing director, Francine DuBois, stops unexpectedly at the plant’s “clean room,” where the sensitive chip-embedding process takes place. A frowning DuBois peers inside the darkened room and approaches an employee sitting alone at a desk. After a brief exchange--in French--the man shrugs and says in halting English: “No work.”

It’s a similar story around the country. Though smart cards are widely accepted in Europe and other parts of the world, Americans have been notoriously slow to embrace them.

Less than 2% of the global $7-billion smart-card industry is in the United States, where about 21 million cards were sold last year, generating less than $100 million in revenue.

“The U.S. will come,” said Philippe Tartavull, president of Oberthur’s U.S. division. “I don’t think we are wrong.”

But it has been a long, frustrating wait for Oberthur and two rivals, France-based Gemplus and oil-drilling giant Schlumberger, which has dual headquarters in Paris and New York.

Based upon the success of smart cards in Europe and mindful of Americans’ love of plastic, these three international companies were among a dozen or so that moved aggressively into the U.S. in the mid-1990s, paying eye-popping sums to buy their way into the low-tech, unglamorous business of plastic card manufacturing.

“Everyone came rushing in, all starry-eyed,” said Alyxia Do, analyst at Mountain View, Calif.-based Frost & Sullivan. “The next few years taught everyone a great lesson.”

Despite enthusiastic predictions, U.S. smart-card pilot programs in New York and elsewhere flopped. Outside of some college campuses and military bases, Americans found little use for the devices, which look like credit cards but function as mini-computers that can be used to carry virtual cash.

Retailers were reluctant to buy special smart-card readers when existing credit-card networks worked fine. And U.S. banks and other potential smart-card issuers balked at paying $2 to $10 per smart card versus 25 cents for the average magnetic-stripe card.

The resulting overcapacity in the U.S. spurred a retreat among European smart-card makers, and prices slid as much as 80%, Do said. Today, smart-card manufacturers in the U.S. run at only about 10% of their combined capacity.

The shakeout left Gemplus, Schlumberger and Oberthur with more than 93% of the U.S. smart-card market. Worldwide, the three companies control more than 60% of the smart-card market, with Gemplus leading the pack, according to the Oxnard-based Nilson Report, a card industry research firm.

But after investing more than half a billion dollars to develop a U.S. smart-card market, the three companies have yet to reap much in the way of profit. Oberthur and Gemplus estimate their North American operations broke even for the first time last year.

“It has been slower than we anticipated it would be,” said Remy de Tonnac, chief executive of Gemplus Americas, headquartered in Mountain View. He estimates that Gemplus has invested as much as $400 million in the U.S., buying operations, forging partnerships and trying to drum up interest in the technology.

“We are still in the evangelizing stage,” Tonnac said. “I wouldn’t say we are happy, but we knew this is what we had to do.”

Helping sustain the companies is their strong manufacturing position in that old-fashioned, all-American product: the credit card. As part of their drive to build a U.S. presence, the three companies swallowed some of the oldest, biggest names in credit card manufacturing.

A quick glance at the backs of most credit cards today will reveal one, if not all, of the three French firms.

“But we didn’t make this kind of investment to do mag-stripe cards,” Tartavull stressed. “We believe the U.S. will go to smart cards. The market is building every quarter.”

Amid analyst predictions that there will be 1 billion smart cards in North America by 2005, Gemplus, Schlumberger and Oberthur are counting on big profits because few U.S.-based companies are capable of handling large orders from banks or government agencies.

“When this market takes off, it’s going to be a tornado,” Tonnac said. “There is an advantage to being first. We’ve built the relationships with key customers. We’ve built the branding.”

Several recent developments suggest smart cards finally are beginning to take hold in the U.S.

American Express surprised the industry last fall by introducing its Blue Card, the first mass-produced credit card with a microprocessor. So far, cardholders can only use the cards to shop more securely on the Internet, but future applications could include loyalty programs or storing a cash value on the cards. The company has ordered 1 million to 2 million cards, but demand has been so strong that some applicants have waited six weeks for their cards, which Oberthur is producing. The success is expected to draw similar products from large banks, such as Citibank, Bank of America and First USA.

Meanwhile, software giant Microsoft Corp.’s Windows 2000 operating system is smart-card enabled, which means companies will able to use smart cards to secure their computer networks, rather than relying on passwords. Employees could use their cards to log on, protect the privacy of e-mail and store personal information, such as favorite Web sites or Internet passwords. And because the cards are portable, a user could insert one at another work station or at home, and automatically adapt that computer to his or her preferences.

The U.S. government also is helping drive the market, with a proposed $1.9-billion contract--currently out for bid--that eventually could put smart cards in the wallets of every government employee. The General Service Administration hopes to use smart cards as a multifaceted employee identification card, capable of granting access to secured buildings, logging on to computer networks and functioning as a credit card for government purchases.

But there are lingering doubts. Banks such as First Union and Wells Fargo Bank, both early proponents of smart cards, have pulled back, citing a lack of consumer interest or profit potential.

And U.S. card manufacturing companies scoff at the notion that they have fallen behind their European counterparts in the smart-card race.

“Those companies will get the early cream, but I question whether the early cream will be enough to repay their early investment,” said Al Vrancart, president NBS Card Services, a New Jersey-based card maker that has seen little need to invest in smart cards. “I don’t hear the U.S. market crying out for smart cards.”

Officials at Illinois-based Perfect Plastic Printing, the nation’s third-largest plastic payment-card maker, agreed.

“We are not going to seek that business until there’s a market out there that can turn a profit,” said Ted Liberkowski, the company’s marketing vice president. “We are a high-volume dealer. We’re not really interested in doing 25 cards here or a couple of thousand there.”

When and if smart cards take off in the U.S., Liberkowski and Vrancart said companies like theirs can easily jump in and grab market share. “It won’t take that long for us to ramp up,” Liberkowski said.

“There’s a lot of business to go around,” Vrancart said.

Officials at Oberthur, Gemplus and Schlumberger call such strategies naive, saying the traditional U.S. card manufacturers are making a classic mistake in the new technology-driven economy by betting that they can play catch-up. According to the Europeans, U.S. manufacturers have missed the gradual evolution of their industry from one that simply prints pieces of plastic to a more sophisticated business more like a software developer.

Today’s smart-card facilities require complicated programming and precise measuring in sterile clean rooms to prevent contamination of the microprocessors. It’s a far cry from the noisy, messy business of cutting plastic cards and embossing a customer’s name.

“It’s much more than being able to mix up plastic and stick a chip on it,” said Paul Beverly, vice president of smart cards and terminals for Schlumberger.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Credit Cards Get Smart

Credit card manufacturer Oberthur is betting that smart cards with computer chips holding credit, debit and identification information will gain in popularity in the United States. How they are built:

1. Make a Credit Card

Cards composed of five pieces. Assembled cards baked, sealed at 225* F for 15 minutes.

Smart cards get milled area for chip

2. Build a Module

A module, the chip and circuit board unit, built in low humidity, dust-free room. Workers wear gloves, booties and caps to protect chips. Procedures, too small to be observed by eye, controlled via TV monitors.

A silicon wafer, containing pre-made chips, cut.

Average wafer yields 500-10,000 chips.

Mechanical arm selects good chips, moves to roll.

Black dot: Indicates the 1 in 5 chips marked bad by the wafer manufacturer.

3. Chips sewn onto circuit board with gold thread.

Thread: 25 microns thick (not to scale)

How big is a micron?

500 microns would fit on the period at the end of this sentence.

4. Resin covering protects chip, board. Assembly baked at 107 F for 14 hours.

A chip holds 16K of memory.

A self-contained computer, it has a CPU, ROM and a hard drive.

5. Completed module cut from roll, glued, chip side down, into milled area in card.