Lately I’ve read many articles about Contactless and Near Field Communication (NFC) payments, the prospects for merchant and consumer adoption, bridge technologies and market trials. Contactless payments, which feature speed, convenience, security and more functionality that leverages the mobile network, can outperform legacy mag-stripe payment technology. NFC promises smart phones as payment devices, which in turn promise to change consumer expectations about buying everything from mass transit, fast food and concert tickets, to the retail brands themselves.

At the same time, U.S. cardholders increasingly find it difficult to use mag-stripe cards outside the U.S.  As we discussed here, the U.S. EMV strategy hinges on contactless / NFC adoption.  Some believe EMV 2.0 in the U.S. will be contactless and mobile payments and serve as a disruptive technology that will usher in even more payment players from mobile carriers to Apple and Google.

Yet contactless and NFC payment technologies face the classic “chick or egg” dilemma. Payments is a platform business and the principal of network effects is required to build a two sided market where both card issuing and merchant acceptance must compel each other forward with the prime objective to encourage use.

So what will be required to advance contactless payments? Will it take millions of additional contactless cards to be issued (or will it take NFC smart phones to replace cards) or will it take hundreds of thousands of U.S. merchants installing devices to accept contactless payments?

From most accounts the lack of merchant acceptance of contactless payments is a key barrier blocking NFC contactless payments. Without the widespread installation of readers, contactless is stalled. A Javelin Strategy & Research report estimated the basic cost to deploy EMV POS terminals at $6.75 Billion, not including the cost of implementation. The low percentage of merchants that accept contactless payments (I’ve seen figures from 70,000 to 200,000 U.S. merchant point of sale payment terminals that accept contactless payments) reduces the incentive for banks to issue chip cards, NFC phones, tags, stickers, etc.

What will it take to get merchants to upgrade, replace or add devices to their existing terminals and POS systems to accept contactless payments? What’s the incentive for merchants to invest in contactless readers? The business case has evolved over the years from faster lines and replacing cash, to enabling no signature required and chargeback liability, to loyalty programs that create a more informed shopping experience. But the real fuel that contactless payments needs is in the form of incentive Interchange rates. Nothing works like financial incentive.

Another main problem is the lack of consumer awareness, with no aggressive campaign by merchants to steer consumers who have contactless cards to use them. The presence of contactless devices alone will not guarantee usage. Merchant staff must become more adept at facilitating contactless transactions. Merchants must support effective training of employees who can in turn show and tell consumers how pleasant and easy contactless purchases can be. Think about how merchants installed PIN pads and were instrumental in steering consumers to enter their 4 digit secret PIN by asking credit or debit? Why did they do this? There was a financial incentive to do so.

Contactless payments derailed by government intervention

The Senate passed S. 3217, the "Restoring American Financial Stability Act" on May 20, 2010. This legislation attempts to overhaul the regulatory structure of America's financial system through increased regulations and the restructuring of our financial regulators.  Then along comes the Durbin Amendment. The Durbin Amendment attempts to impose government regulation of Interchange, setting different pricing for the same service and then trying to legislate out competitive market pressures that would naturally bring these together. Considering the importance of the payment system to our economy, consumers, businesses and banks, I feel any Interchange regulation should warrant a stand alone comprehensive approach and its own legislation (if any), not a last minute political earmark amendment. 

The unintended consequences of Interchange legislation should be a concern for all parties, but particularly for small businesses as I’ve discussed here. As it relates to disrupting contactless payments, the Durbin Amendment provides for the setting of minimum charge amounts and challenges the business case of banks issuing and managing debit card programs.

A preemptive strike by the card companies could change the debate and advance the next generation payment technology. Instead of solely a defensive strategy against legislation and litigation, Visa and MasterCard should set a voluntary and substantial reduction in Interchange in exchange for contactless payment acceptance.

This was the strategy in the late 80s when I first entered the payments industry. Back then merchants were using a knuckle buster to manually imprint cards and paying a 4% paper draft rate to carry them into the bank teller. We would reduce a merchant’s rate to 2% by investing in a VeriFone Zon electronic draft-capture (EDC) terminal. Sure the terminal was faster and more efficient but that’s not why merchants adopted them, they adopted them for the savings.

Before government or court ordered Interchange intervention, the card companies would be wise invest in contactless. Visa and MasterCard could make the case that continuing to use old payment technology (mag-stripe cards) carries more risk; and therefore, justifies higher Interchange.  And merchants should realize that mag-stripe payment technology will not serve their best interest in the future and that issuers who rely on Interchange income will play an important role in advancing the next generation of payments in the U.S.

In an article on Digital Transactions “Could Visa’s New No-Signature Rule Hurt Contactless Payments?” it was argued that Visa’s expansion of its policy to no longer require signatures for transactions less than $25 for most U.S. merchants would undermine contactless payments.

In our blog post Visa Changes Debit Debate, Backs Contactless, we suggested that extending Visa's No Signature Required (NSR) program (on transactions <$25) to most merchants (along with converging signature and PIN debit rates and expanding small ticket Interchange on transactions <$15) were policies that supported contactless payments.

Changing ingrained behavior takes time and doing it in steps makes sense.  Step one, training merchants and cardholders that neither a signature nor PIN are needed to authenticate a transaction.  And we agree with Visa who states “the No Signature Program is often an initial first step, while an upgrade to contactless acceptance offers merchants the ability to accept a new generation of chip-enabled payment products…that also offer speed and convenience at the POS.”

As consumers become accustom to faster transaction times, they will come to expect a different experience at the POS.  Ultimately I believe that consumer demand will drive merchant adoption of contactless payments.  And innovation will accelerate as consumers continue the rapid adoption of smart phones and social networking combined with continued investments in contactless and NFC technology in both payment and identity management.  Finally contactless will be needed in the U.S. to advance security and global interoperability issues.  These important issues will continue to drive policy.

Visa changes the signature vs. PIN debit debate with policies to support contactless payments. 

In an interview in the June/July 2009 issue of Cards&Payments magazine, Ellen Richey, global head of enterprise risk for Visa, discussed the adoption of chip technology to make purchases more secure. Richey said “the U.S is not going to be adopting a chip-and-PIN credit card or debit card any time in the very near future” suggesting that in the U.S., the deployment of a contactless-chip card network may not include a PIN component.

In October 2009, Best Buy announced that it would discontinue it’s acceptance of Visa contactless payment cards. Why?  Best Buy reportedly took issue that Visa contactless lacked the option of PIN acceptance, while payment industry analyst pointed to the controversy of Visa allegedly pushing signature-based transactions over PIN transactions in an effort to generate higher Interchange fees.

In an interesting twist, Visa announced that signature debit and Interlink PIN debit rates will both change starting April 2010 – they will be priced the same.  Additionally, Visa is set to expand its small ticket Interchange (on transactions <$15) as well as extend its No Signature Required (NSR) program (on transactions <$25) to most merchants. 

This certainly is an effective strategy for changing the debate on steering purchases to and from signature debit or PIN debit.  And if Visa’s strategy to deal with security and global interoperability issues is for the U.S. to adopt contactless-chip technology, then eliminating price differences between signature and PIN debit will also alleviate the need for contactless to have a PIN option (Best Buy’s concern).

Many were already predicting 2010 to be a breakout year for contactless payments (from contactless stickers to NFC enabled phones).  With these Visa developments, merchants may want to consider adding contactless card readers over PIN pads at their point of sale.

While the payments industry is trying to improve security measures around the existing mag-stripe technology, its inevitable that an entirely new technology will be needed.  Right now the focus is on updating from one outdated mag-stripe terminal to a new, better, more secure, mag-stripe terminal.  However, as discussed in Smart Card Talk, there is almost unanimous agreement that the security model for payments in the U.S. is broken.

The main fundamental weakness of the industry: we have no way to prove identity between the consumer and the merchant.   Fraud rates in the U.S. are on the rise and the situation is only getting worse.  Law enforcement cannot keep up with growing and more sophisticated cross-jurisdiction investigations or prosecute offshore criminal gangs.

With the handwriting on the wall, the basic question is the timing for this eventual shift from today’s legacy magnetic stripe infrastructure to a new standard, be that a chip and PIN, contactless EMV, or something else.  The U.S. payments industry will be undergoing changes in infrastructure for years to come from all stakeholders including the card issuers, POS software and terminal vendors and the networks that process the transactions.