Balance of Power Shifts in the Smart Card Supply Chain

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1 Research Brief Balance of Power Shifts in the Smart Card Supply Chain Abstract: Suppliers to the chip card industry need to find new ways to make money. They are stretching beyond their core competencies and blurring roles, as silicon vendors, for example, expand into systems integration. By Clare Hirst Recommendations Traditional vendors in the chip card industry need to consider which elements of the smart card supply chain they will continue to provide in-house, and which they will outsource to keep costs low and take advantage of new industry participants offerings. Semiconductor vendors and chip card vendors should consider ways to increase their competencies beyond basic offerings, to gain a wider customer base and appear more attractive to potential customers. Chip card vendors must have strong relationships with systems integrators offering smart cardrelated services, or build internal competencies in one or more integration practices. Publication Date: 1 September 2003

2 2 Balance of Power Shifts in the Smart Card Supply Chain The Value of a Chip Card The chip card market is changing. Vendors of chip cards and silicon had a lucrative market in shipping subscriber identity module (SIM) cards to a booming mobile communications sector. This changed in Once unable to keep up with demand, chip card vendors may have needed to dispose of stocks of unused cards. Prices fell, both for cards and silicon. The mood in the industry still feels gloomy, and rumors abound regarding the future of even the key chip card vendors. However, chip cards are set to see rapid growth because of the migration to Europay, MasterCard and Visa (EMV) smart cards. But this will not guarantee large revenue, despite strong unit shipments, because the banking sector only needs lower-end cards. The wider financial market, on the other hand, demands more than just basic hardware. Financial software significantly increases the value of the card. This value is further increased when the card is integrated into a complete IT solution. But which vendors within the smart card supply chain will offer the component parts and make money from this now commoditized market? "EMV Easy": A Simple But Effective Partnership Gemplus has partnered with Compaq and ACI Worldwide to offer "EMV prime," a low-cost Europay, MasterCard and Visa (EMV) smart card migration solution designed for midsize banking institutions issuing up to 750,000 credit and debit cards. The solution has been developed to offer a low-cost, pain-free transition. Gemplus will offer the EMV-compliant smart cards, while Compaq will supply its Himalaya servers. ACI Worldwide will provide financial software, which will include an EMV simulator. All three companies will offer support and services before and during installation. This solution is aimed at financial institutions hurrying to meet the EMV deadlines of January 2004 in Latin America, and January 2005 in Europe, the Middle East and Africa. Breaking Down the Supply Chain The roles of the different players within the supply chain are less defined, as even silicon vendors are acquiring systems integration competencies. To survive in the difficult industry climate, all parties in the supply chain must be able to offer services beyond, and complementary to, their core competencies. Figure 1 shows the different players in the chip card supply chain, from silicon supply through to professional services. The different stages of the chip card supply chain are plotted on axes of time and value.

3 3 Figure 1 The Smart Card Value Stack and Supply Chain Value Integration Services Professional Services Vendors Personalization and Issuance Card Software Module Embedding Smart Card Vendors Module Manufacturing Chip Manufacturing Semiconductor Vendors Time Source: Gartner Dataquest (August 2003) Silicon Semiconductor suppliers own a large percentage of the smart card supply chain, in terms of time and value. The value and security of the chip card hardware depends on the type of microcontroller in it. Potentially high-value smart card applications such as IT security, need sophisticated leading-edge silicon, because these smart cards cover government, health and enterprise security applications and execute asymmetric public key algorithms (such as Rivest-Shamir-Adelman [RSA], and elliptic curve cryptography [ECC]). Network security and ID smart card microcontrollers can sell above $2.3, while microcontrollers for EMV credit and debit cards sell at just over $1.0. Silicon vendors can increase prices of microcontrollers for smart cards as they push further up the smart card value chain. They can include Java-friendly features onto the silicon, or build-in Java microcode, so the finished card is Java-enabled from the silicon stage. A more direct approach is to form partnerships with, or to acquire, companies further up the smart card supply chain, perhaps with software or professional services experience. Silicon vendors can then further increase capabilities and knowledge, and maximize revenue. STMicroelectronics (ST) is the most recent and notable example (see section titled "STMicroelectronics Acquires Proton World and Incard for New Competencies to Boost Revenue"). As silicon prices also dwindle, ST is acquiring competencies beyond silicon to establish itself as a very attractive player in the smart card industry. It acquired Proton World an established financial systems integrator and ST even went on to acquire a card manufacturer, Incard, ranked sixth worldwide according to Gartner's latest worldwide chip card shipment market share rankings. While ST's shipments of silicon for subscriber identity module (SIM) cards have fallen sharply, the company hopes these acquisitions will allow it to gain market share, particularly in the financial smart card sector.

4 4 Balance of Power Shifts in the Smart Card Supply Chain STMicroelectronics Acquires Proton World and Incard for New Competencies to Boost Revenue STMicroelectronics (ST) acquired Proton World, a systems integrator and developer of smart card system software in March In June, ST acquired Incard, an Italian smart card manufacturer. Both acquisitions allow ST to diversify into other smart card applications, and boost the value of its offerings to bolster selling prices. As a systems integrator in the financial sector, Proton World will give ST access to previously unavailable customers. ST can now offer complete chip card solutions, which will increase customer interest. Hardware Module production and module embedding are lower value elements. The value of the completed chip card alone is low, and chip card manufacturing is viewed as a commodity manufacturing process. Gemplus recently sold its basic plastic card manufacturing, choosing instead to outsource production of the blank cards. It is only once the card has been programmed with the appropriate software and integrated into an IT application that its value increases. Card vendors were once able to differentiate products by providing proprietary operating systems. Java Card technology has eliminated this differentiator. Opportunities for card vendors will be derived either from extending services further up the supply chain, or partnering with companies further up it, to offer additional services like software tools and integration services. Card Software and Operating Systems Java Card technology has prompted silicon vendors to take on the role of software providers. Many card vendors are also approaching specialist companies for software that can be integrated into their own offerings. Small, specialist application vendors stand to benefit from Java Card. Issuers could buy specialist applications from these independent companies. And these applications will run on any card from any vendor. Some card vendors will even develop in-house applications. This is especially true in the SIM card market, where operators are offering a greater number of applications to keep customers. As financial institutions seek to reap the full benefits of EMV migration, it is more than likely they will also approach third-party application developers. Many of these may even be able to offer their products at a lower cost than card vendors. In turn, card vendors are likely to offer cards carrying proprietary operating systems at a lower cost than Java-enabled cards. This competitive strategy could be part of the reason why true Java Card interoperability has taken so long. Java Card certainly marks another area where card vendors stand to lose ground in the smart card supply chain. It is likely that many card vendors are already using software development companies to produce operating systems and applications which then go out under their own brand. Major software companies have shown some interest in the market. Microsoft, for example developed Windows for Smart Cards (WFSC) as a competitor to Multos, Java Card and proprietary systems. But Microsoft ceased development of the product, because it was only involved in the IT security sector for smart cards, which seemed to offer less revenue potential than the overcrowded SIM and financial sectors. Microsoft also had little success in convincing smart card vendors to use WFSC, because it did not offer any technological advantage over other operating systems. Integration Systems integration remains the most unquantifiable element in any smart card project. However, systems integrators are now the major strategic technology partners in projects, replacing smart card suppliers.

5 In the smart card industry, "integrator" encompasses a wide range of technology specialists, from smart card vendors such as Gemplus and Schlumberger, to major systems integrators like EDS, IBM and Andersen Consulting. Enterprises writing software for smart cards consider themselves integrators, as do major consulting companies focused on "business integration." Several niche players, including ACI Worldwide and RSA Security, focus on specific applications, such as finance and IT security. Clients are asking integrators to create smart card solutions. Integrators, rather than clients, are more likely to approach silicon and card vendors. Strong relationships with integrators will be the key to gaining business for companies in the supply chain. Companies considering a smart card solution are more likely to approach their systems integrator that has put together the rest of their IT systems, than different smart card players. This strategy is most directly applicable to IT security smart card applications. 5 Schlumberger Delivers Dedicated Platform Solution for T-Mobile 3G Network Services Schlumberger announced on August the initial rollout of a dedicated next-generation universal integrated circuit card (UICC) smart card platform for third-generation (3G) Universal Mobile Telecommunication System (UMTS) networks, developed in partnership with mobile network operator T-Mobile Deutschland. Schlumberger will deliver a complete solution including the cards, software tools, specific applications, training, technical support, consulting and integration services. The project illustrates Schlumberger s ability to provide both smart cards and IT services capabilities. Gartner Dataquest Perspective Major players in the smart card supply chain continue to suffer from the industry slump, which began at the end of Revenue is not recovering, despite the advent of applications such as EMV, which guarantee increased shipments. If shipments are rising but revenue is falling, what do vendors need to do to guarantee their survival? Card vendors are certainly not making any money producing plastic cards. Silicon vendors, which occupy the largest part of the smart card supply chain, are also battling falling prices. At the same time, new, smaller companies in the market can offer individual blocks of the supply chain, perhaps with more flexibility, and certainly at lower cost, once again eroding the role of the major industry players. So chip card vendors need to consider ways to cut costs. This will invariably mean outsourcing some production, while still offering a complete solution. For silicon vendors, buying in additional competencies or partnering to gain them will increase their potential customer base. All vendors need to assess the best competencies to acquire, and those best gained in a partnership. The industry offers examples of less successful acquisitions Schlumberger's acquisition of Sema has not yet brought much success in the systems integration field. It is better to partner with a number of different, established integrators to maximize business opportunity with a larger number of customers. However, in the case of ST, as a silicon manufacturer, its acquisition of a single financial smart card integrator has opened up a wealth of business opportunity that would otherwise have been inaccessible.

6 6 Balance of Power Shifts in the Smart Card Supply Chain Gartner Dataquest expects to see the traditional smart card suppliers change considerably over coming years. With so little to choose between the major card vendors and the major silicon vendors, it seems that innovation and technological advancement will not be enough to guarantee success. How companies structure themselves both internally and externally to best take advantage of the changes in the supply chain will be central to future profitability. Key Issue How will electronic equipment production trends affect market growth opportunities? This document has been published to the following Marketplace codes: SEMC-WW-DP-0332 For More Information... In North America and Latin America: In Europe, the Middle East and Africa: In Asia/Pacific: In Japan: Worldwide via gartner.com: Gartner, Inc. and/or its Affiliates. All Rights Reserved. Reproduction of this publication in any form without prior written permission is forbidden. The information contained herein has been obtained from sources believed to be reliable. Gartner disclaims all warranties as to the accuracy, completeness or adequacy of such information. Gartner shall have no liability for errors, omissions or inadequacies in the information contained herein or for interpretations thereof. The reader assumes sole responsibility for the selection of these materials to achieve its intended results. The opinions expressed herein are subject to change without notice