BUSINESSWEEK ONLINE : AUGUST 28, 2000 ISSUE
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INTERNATIONAL -- EUROPEAN BUSINESS

The U.S. Is Wising Up to Smart Cards (int'l edition)
As e-commerce flourishes, Europe's information-packed plastic is crossing the pond

Until recently, workers in the hillside headquarters of Gemplus in Gemenos, France, were about as relaxed as the sunbathers on the Mediterranean beach down below. Gemplus is the world's No. 1 maker of smart cards, the pocket plastic with an embedded chip that stores reams of financial and other information. But for 25 years, the smart-card industry remained pretty much a European thing. Not any more. Research firm Dataquest predicts world sales will climb from $2.4 billion this year to $8.1 billion by 2004. And much of that growth will come from the laggard U.S. market. Suddenly, those Gemplus buildings in France's sunny south are hives of activity.

Chalk another one up to the Internet. The cyber-revolution is giving smart cards a new list of converts--especially across the Atlantic. Microsoft Corp. is using them to foil computer hackers. Couch potatoes can shop through their TVs with them. Since American Express Co. launched the first major U.S. smart card last year, an estimated 2 million consumers have signed up for it. Next is the wireless Web. Mobile-phone operators in Europe and Asia are testing handsets that use smart cards for banking and e-commerce. Says Marc Lassus, Gemplus' 52-year-old chairman: ''The beauty of our product is it can be used almost anywhere.''

ON THE ASCENT. For years, smart cards were a bit ho-hum--a credit device with a past but not necessarily much of a future. Now, cardmakers are redefining themselves as purveyors of a high-margin technology on the front lines of e-commerce. And investors are clearly impressed. French manufacturer Oberthur Card Systems has seen its share price climb 18% since listing in Paris on July 12. Gemplus recently landed a $500 million investment from U.S. private equity fund Texas Pacific Group; it plans to list later this year on the Nasdaq. Gemplus' profits grew 35% last year, to $35 million, on sales of $817 million. Signaling its global ambitions, the company has just named Antonio M. Perez, formerly a top executive at Hewlett-Packard Co., as its CEO.

Although millions of Europeans use smart cards for daily shopping and telephoning, sales outside Europe were scant until recently. Most U.S. cell phones don't use smart cards, and U.S. credit-card issuers spurned them because they cost more than magnetic-swipe cards. U.S. sales last year were 2% of the global total; Europe accounted for 60%.

But as commerce moves into cyberspace, the skeptics are taking another look. Consider what happens when you use your credit card to make an online purchase. A secure server will probably encrypt your account number, but the merchant may store it on a vulnerable computer network. Last winter, a hacker stole 300,000 credit card numbers from online music retailer CDUniverse. If, however, you slid a smart card into a reader on your PC and typed in your password, the merchant would never get your account number--only a code authorizing the sale. Amex's Blue Card comes with a card reader.

U.S. mobile operators, meantime, are switching over to chip-based cards. And the card manufacturers are betting that as wireless e-commerce grows, their cards will prove indispensable because they can store personalized information--from account numbers to favorite pizza toppings--so that transactions can be carried out quickly as well as securely. Gemplus recently signed a deal with Britain's Virgin Mobile, under which Virgin's 300,000 subscribers will be able to replace the smart cards in their phones with a Gemplus product that will allow them to surf and shop on the Web.

An even faster-growing market for smart cards, analysts say, is in computer network security. The U.S. General Services Administration recently announced a $1.5 billion security program that will use smart-card technology. Microsoft includes software for smart-card readers in its Windows 2000 package for business and professional users. ''As organizations upgrade their operating systems to Windows 2000, those will all be smart-card ready,'' says Andrew Phillips, a Dataquest analyst in London.

There are still hurdles to clear. Visa International and MasterCard International Inc. stand on a chicken-and-egg argument: Because few U.S. merchants have card readers, the companies have no plans to issue smart cards in the U.S. Even in Europe, the cards are seldom used in e-commerce because few consumers have card readers for their computers. And except for experimental models, cell phones don't accommodate extra cards. ''At the moment, the smart-card industry needs mobile telephony a lot more than mobile telephony needs smart cards,'' says Duncan Brown, a consultant at Ovum Ltd. in London.

SMART ENOUGH? All that may change as smart cards catch on. But then comes another potential threat: What if mobile operators and other big customers cut deals with chipmakers to make their own smart cards? To discourage that, cardmakers are raising the technological bar with more sophisticated devices. ''We are not just making smart cards, but smart objects,'' says Gemplus Senior Vice-President Jean-Pierre Gloton, gesturing around a conference room where new products are arrayed. Among other things, engineers are developing chips that enable watches and even eyeglasses to receive and process data.

For all their high-tech appeal, smart cards started out as a technological crutch. Because European phone charges are high, and there's no third-party billing, callers had to feed piles of coins into pay phones--which in turn attracted vandals. Prepaid calling cards with an embedded chip were the answer. High phone rates also hindered credit-card usage in Europe, because merchants didn't want to dial into a computer to authorize each sale. Cards with chips were again the solution.

Gemplus got started in 1988, when Lassus and a group of engineers quit Thomson Microelectronics, then state-owned, after failing to persuade it to make cards for France Telecom. All the major makers are European, including France's Schlumberger and Germany's Giesecke & Devrient.

They've come a long way from phone cards. Gemplus now sells a scanner that matches a computer user's fingerprint against an image stored on a chip. Singapore's national library attaches Gemplus cards to its books: Tiny antennas embedded in the cards make the books traceable with a handheld radio device.

At this point, prepaid phone cards and programmable cards in cell-phone sets still account for two-thirds of Gemplus revenues. ''But in five years that could completely change,'' says business development manager Frederic Laporte. So it could. And that means a lot of hard work for Gemplus--even at the height of vacation season.

By Carol Matlack in Gemenos, France

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