Super ATMs to fuel smart-card revolution

Is the perfect storm on the smart-card horizon?

By Arthur Gingrande

The U.S. banking services industry is in the middle of a quiet but persistent revolution regarding its role in the financial services industry and the automation of consumer financial transactions. To retain existing clients and expand their base of customers, banks have started offering nontraditional services, such as mutual funds brokerage and stock portfolio management.

At the same time, changes in banking laws permit financial institutions other than banks to offer banking services to their customers, electronically and otherwise. In the realm of electronic commerce, EDI or Internet-based electronic banking is available to any business or household with a PC and is growing commonplace. In the world of consumer banking, the automated teller machine (ATM) is rapidly becoming the vehicle of choice for people who prefer banking solely at their own convenience--whether it’s with a bank, a brokerage house or a credit organization.

The major e-commerce providers have made a huge investment in building a national and global e-commerce infrastructure. The banks, investment houses and retail sites have spent billions of dollars laying the foundation for the new generation of cashless transactions and electronic payments, whether by Internet, smart cards, telephone or dial-up bulletin boards and extranets.

The World Information and Technology and Services Alliance (WITSA,) and IDC state that global high-tech industry spending reached $2.1 trillion in 1999 and will surpass $3 trillion in 2003. The information and communications market is growing at an annual rate of 9%. Ninety million Internet devices were added worldwide in 1999, bringing the total to 260 million. The number of PCs reached nearly 400 million. Despite the recent dot.com implosion, the new electronic infrastructure is growing at an explosive rate: Online sales of $90 billion are estimated worldwide for this year, and more than 50% of those e-commerce transactions will be facilitated by smart cards, either at point-of-sale terminals, personal computers or ATMs.

Very few of those transactions are projected to take place in the United States. Use of smart cards is prevalent in Europe and Asia, but is in its embryonic adoption stage in the United States. Analysts estimate that only 2% of all smart cards are used in the Americas, while Europe claims 90% marketshare. Due to powerful market forces that will require the rapid adoption of smart-card use, the net effect is that in the world of automated financial transactions, the United States could be sailing into the midst of a perfect storm.

Failure of online banking in the United States One of the primary reasons for the extraordinarily rapid growth of e-commerce is the low cost of transaction fees. At just a few pennies per item processed, electronic cash transfers over the Internet are by far the least expensive means of making an item payment, whether it is for a phone bill or for goods purchased at an online auction site. The dot.com, Internet-based e-commerce companies, of course, have been quick to exploit that cash transfer medium. But the banks have been slow to adopt online transactions. They mistakenly followed the advice of e-commerce analysts too closely by treating retail banking the same as retail commerce, often disregarding their own banking intuition when developing online strategies. Their reasoning was that because online retail trading succeeded, online banking would succeed also. They thought that the affluence of Internet users would automatically translate into profitability for Internet banks.

They didn’t realize that the vast majority of Americans find ATM banking to be more convenient than Internet banking. They failed to realize that the key to online banking could be found in the marriage of the ATM, the Internet and smart card technology. As a result, Internet banking accounted for only .02% of the $9.6 billion found in FDIC-insured deposits by the beginning of 2000. In the area of bill payment, only $4.2 million of more than $18 billion in bills paid in the United States were through online bill payment services in 1999. Internet-based banks accounted for a mere $9.6 billion of the $4.5 trillion FDIC-insured deposits in 1999.

In April 2001, 39% of households that participated in a TowerGroup (towergroup.com) survey reported that their primary banking institution offers online banking services, but only 18% had used them. Just 13% of all respondents said that they had used online banking during that month, compared to 92% who had gone to brick-and-mortar branches during the same period. Although bank service providers may be Luddites when it comes to technology adoption, their financial strength and installed base automatically make them prime candidates for driving technology growth in the areas of e-payment and online transactions. Indeed, replacing a human with a machine was viewed as a radical departure from conventional banking methods when the ATM was first introduced. Now, ATMs account for the majority of human teller transactions; customers who travel to a brick-and-mortar bank often end up transacting deposits, account transfers, mortgage payments and cash withdrawals on the bank’s indoor ATMs.

ATM evolution Like the Internet and the Web portal, the ATM is in a process of evolution. It is changing from a passive vehicle that only receives deposits or dispenses cash into a robust transaction platform that will allow an ATM customer to interactively cash checks, pay bills and wire funds. With the aid of a smart card, the ATM will soon take the place of a customer service representative as well as a bank teller. A smart card-enabled ATM terminal will be capable not only of automatically cashing checks, but will facilitate paying bills, wiring money and transacting purchases.

The next stage of development will occur when the ATM enables the customer to become an interactive part of the business process. By interacting with an ATM, customers will be able to set up reminder notices about scheduled financial transactions, the ATM will present bills to him or her, it will enable the customer to regulate and budget the bill paying process, it will consolidate lines of credit, and it will balance his or her electronic checkbook. Those benefits are already being made available to European smart card holders. They will happen in the United States when the bank networks connect to the Internet and turn the ATM into a remote computer terminal, capable of conducting Web-based e-commerce.

The new breed of ATMs has been dubbed the “Super ATM,” a term that has been trademarked by Capital Security Systems (CSS) of Chicago, but will probably become generic when Super ATM-based, consumer transactions hit their stride. CSS is the firm that holds significant patents on user authentication and the use of smart cards in ATM environments that allow cash to be safely dispensed to a consumer when wiring funds, cashing payroll or third-party checks and remittances, or when paying bills.

Those upscale bank customers who already do their banking by personal computer may not immediately see the wisdom of using an ATM to deliver financial services to consumers. The fact remains, however, that the ATM distribution network is the most widely accepted method of delivering financial services to the general public. It can reach a larger customer population faster than the desktop PC. Although it started out as a means to replace human bank tellers, the ATM has become commercially omnipresent, showing up at supermarkets, parking garages, the U.S. Post Office, etc., and is being used to sell everything from money orders to stamps to movie tickets. Moreover, using the Internet in a smart card-enabled ATM environment will open up new cost efficiencies in e-commerce transactions, plus provide the security that comes from a protected, value-added network (VAN). Most importantly, the multifunctional Super ATM offers to financial networks a larger potential for increasing fee income than does any other customer self-service vehicle currently in use.

The smart-card market Since 1998, the industry has been growing at the tremendous rate of more than one billion cards per year. Continued growth in 2001 is a sure thing, say industry executives, because of the explosive growth in demand for GSM mobile phones that carry smart cards inside each handset to identify consumers to their mobile phone operators.

The seemingly insatiable demand from telephone companies for those subscriber identity module (SIM) smart cards will be the primary reason that unit demand for smart cards will surge an estimated 22% to 23% in 2001, agree analysts from market research firms Dataquest (a unit of Gartner ) and Frost & Sullivan. Because SIM cards are among the most expensive smart cards, chip card revenue for vendors will grow even faster. In fact, Frost & Sullivan predicts the worldwide smart-card market will generate nearly $2.8 billion in revenue this year, up 34% from $2 billion in 2000.

High-volume smart-card market segments are based on applications that use smart cards’ unique memory, storage capabilities, programmability and portability. The primary ones are mobile phones, satellite TV, financial services, banking, healthcare, government entitlements and military installations. Other applications for smart cards include computer/Internet user authentication and non-repudiation, retailer loyalty programs, physical access, resort cards, mass transit, electronic toll, product tracking, national ID, drivers license, passports and student ID cards that serve multiple functions: dormitory key, parking lot key, cafeteria pass and medical record archive. The list goes on.

As electronic commerce gains steam, smart cards will provide a critical link between the Internet and the physical world. The same digital money used to buy things over the Web--including purchases under $5 for which credit cards are prohibitively expensive--can be downloaded from a personal online bank account onto a card. (Because money loaded onto a smart card is a direct and immediate cash equivalent, there are no postings back to a debit or credit card issuer, generating enormous savings in administrative costs.) That same card can then be used to buy groceries at the corner convenience store.

Contemporary ATM distribution channels Originally installed in banks to replace human tellers in 1967, ATMs have become virtually ubiquitous, available everywhere from airports to shopping malls to variety stores to street corners. Over the coming years, convenience stores and supermarket chains are expected to become a major distribution channel for smart card-enabled Super ATMs. With more than 5,000 stores in the United States and more than 19,400 worldwide, 7-Eleven is the world's largest provider of retail ATMs, prepaid phone cards and money orders. Beginning in 1993, 7-Eleven embarked on an ambitious undertaking to provide financial services at every location.

Nearly three years ago, American Express began buying ATMs that were already installed in retail sites as a way to add value for both their merchants and retail customers. It now owns more than 4,000 ATMs, most of which accept its smart card. Driven by their overlapping interests, in 1999 American Express and 7-Eleven announced a strategic alliance to introduce interactive, state-of-the-art smart card and ATM-based “financial service kiosks” at 200 Dallas/Ft. Worth-area convenience stores during 2000. That venture was successful enough to justify a national rollout, which is now in progress.

Other alliances are being created between financial institutions and convenience stores. E-TRADE Group recently announced that it has signed an agreement with Target, under which E-TRADE will become the exclusive ATM network for all traditional Target stores and Target Greatland stores nationwide, through its E-TRADE Access subsidiary.

Through the deal, E-TRADE is significantly expanding the reach of its ATM network, installing more than 1,000 E-TRADE-branded units over the next two years. E-TRADE currently operates ATMs in 110 Target stores, and in more than 10,000 other independent locations nationwide. In addition, the companies have completed an agreement to open E-TRADE Zones in 20 additional SuperTarget stores during the year, based on the success of a pilot first launched in September 2000 in Roswell, GA. E-TRADE Zones are 400 square-foot E-TRADE stores, staffed with E-TRADE licensed sales and service representatives, located within SuperTarget stores.

Electronic benefits transfer Another powerful driver of smart-card use in Super ATMs is electronic benefits transfer (EBT). At present, America transfers more than $750 billion in benefits annually to its citizens. That figure is currently estimated to reach $1.3 trillion by the end of 2002. More than 20% of that sum goes to citizens who do not have bank accounts. In 1993, the Federal EBT Task Force launched National Performance Review, an initiative to develop a nationwide electronic benefits transfer system to deliver government benefits to recipients electronically. The vision of the Federal EBT Task Force was to “make EBT nationwide in the fullest sense--one card, user friendly, with a unified delivery of government funded benefits.”

That approach relies on a single plastic smart card to access cash and food benefits at ATM and point-of-sale locations, in the same manner as would other debit or credit card users. EBT smart cards bring their users convenience and safety, dramatically reducing theft, fraud and abuse of benefits.

Under the law, an EBT account must be an individually owned account at a federally insured financial institution. It must be available to any individual who receives a federal benefit, wage, salary or retirement payment. It must accept electronic federal benefit, wage, salary and retirement payments, and such other deposits as a financial institution agrees to permit.

The U.S. General Services Administration (gsa.gov) supports the development of a nationwide standard EBT system to electronically deliver government benefits such as food stamps and cash entitlement programs. Today, 39 states and the District of Columbia are operating EBT systems—29 statewide. They are providing benefits to about 4.25 million families, representing a dollar value of $1.35 billion per month in food stamp benefits alone. That represents over 54% of the caseload served and a higher percentage of the dollar value of benefits disbursed. All states must have systems in place by the end of 2002.

Marketing to “fringe-banked” EBT customers One of the key smart-card markets that EBT will open up is that comprised of the unbanked and “fringe banking” customers--people who have never had a bank account or have opened one but don’t use it or have closed it out. They still have a need to cash payroll and other checks, and often end up paying exorbitant fees to storefront operations that specialize in cashing them. Not unsurprisingly, many of them are EBT recipients. By giving them a smart card that can produce positive and secure proof of identification on demand, financial service providers can offer unbanked and fringe banking customers a way to cash checks, pay bills, wire money, buy items and otherwise conduct transactions that lack of a bank account had prohibited them from doing or had made costly for them to carry out.

By issuing members of government entitlement programs smart cards to facilitate over $1.3 trillion of annual EBT transactions, a significant part of the population will be using smart cards regularly at Super ATM terminals, where they will be presented with a variety of possible transactions and buying opportunities that they might ordinarily miss. In that manner, smart cards promote not only convergence of technology but also convergence of three markets--the banked, unbanked and government entitlement recipients--through the common use of one technology platform.

The use of a common platform will present the banks and financial services institutions with an unparalleled opportunity to convert unbanked and “fringe banked” ATM users to customers of banks and/or financial institutions, where they will be greeted with manifold opportunities to purchase banking and financial services. The idea is that repeated use of ATMs will breed the familiarity necessary for banking service providers to gain the trust of the unbanked population. Certainly the incentive will be there for those potential converts. The reason: Fees charged at ATMs for conducting check cashing and other financial transactions will be a lot lower than those currently levied by the storefront check cashing operations, neighborhood pawnshops and other service centers that traditionally cater to unbanked and “fringe banked” customers.

Increased fee income from marketing value-added services Presently, there is consumer resistance to paying banks what are perceived by users to be excessive fees for ATM withdrawals and transfers. Thus, the key to success for the ATM-based smart-card program will be to produce revenue by offering an array of compelling fee-based transactions that customers perceive as value-added services, and therefore will be happy to pay for.

For example, check cashing, wire transfers and money orders fall into that category. So do Internet account access, traveler's checks, prepaid phone cards, stored-value cards, electronic gift cards and general admission and event ticketing. Once a fee-based revenue stream is generated by consumer use of those services, bank service providers and smart-card vendors will have a way to start retrofitting existing ATMs for smart-card use. Clearly, the road to successful ATM innovation requires total overhaul of the legacy environment--from technology and operations to marketing and customer service.

Obviously, that overhaul will include a large-scale hardware and software upgrade. Higher-end processors must be installed, and the software platform must shift from proprietary OS/2-based code to flexible operating systems and languages. However, starting in the near future, around 2004, because two-thirds of the ATMs that will be shipped will be replacement machines, considerable scope exists for manufacturers to introduce innovation and developments. The issue of retrofitting will be minimized, and modernization will become more cost-effective.

In fact, it turns out that American Express and Ace Cash Express are already building multifunctional, next-generation Super ATMs. For example, Ace has installed ATMs in nearly 1,000 retail locations under the brand name RPM, which stands for rapid pay machine. They perform check cashing (in essence, cash advances of payroll and other checks) and traditional ATM functions, and they provide advertising and targeted content.

The RPM uses an advanced technology platform, combines facial biometrics with traditional PIN-based identification, and is linked to a call center for real-time customer support and product underwriting. Several new products will be added to the RPM, including money orders, money transfers and loans.

Advantages for both the retailer and customer Field experience with the RPM suggests that customers overwhelmingly prefer multifunctional ATMs to traditional alternatives. Before installing RPMs at one national grocery chain, the retailer cashed customers' checks for free. According to Ace, after installation (and after the grocer shut down the free service), the average number of checks cashed doubled--even after the machines started charging for the service. Customer surveys indicated that 89% of check cashers felt that the RPM was a better experience than the staffed counter.

Retailers also prefer Super ATMs. Whereas a standard teller machine in a convenience store may generate 600 transactions a month, dispensing $60 per transaction, a multifunction check-cashing teller machine generates well over 1,000 check-cashing transactions per month and dispenses $250 per transaction. Cash to the floor (and consequently to the retailers' bottom line) shoots up from around $30,000 to nearly $300,000 per month.

Research from one retailer has shown that RPMs can generate an annual bottom-line impact of $100,000 per store from the combination of increased foot traffic and in-hand cash, revenue share from the devices and elimination of check-cashing expenses (including losses). Ace reports that convenience stores typically report a 15% to 30% uplift in sales. With results like those, it is clear that Ace has already proven the case for a Super ATM network that can provide highly optimized customer access to new financial products and services that offer convenience and added value to customers. Given the powerful forces being generated by government mandate as well as by the hand of the free market, it is clear that U.S. smart-card adoption will soon gain momentum. Given their relative unawareness of the phenomenon, the banking and financial services industries would be well-advised to begin preparations for a journey through the perfect storm.

Arthur Gingrande is a founding partner of IMERGE Consulting, 781-258-8181 or e-mail arthur@imergeconsult.com. This article was compiled from a much larger report entitled “Market Research Report on the Super ATM Platform,” available from IMERGE Consulting.