Home Depot (NYSE:HD), Kroger (NYSE:KR) and Canada's Wal-Mart (NYSE:WMT) are now fighting Visa (NYSE:V) and MasterCard (NYSE:MA) over how chip cards are being implemented, just as Visa celebrates its big win in bringing Costco (NASDAQ:COST) to the fold.
What's going on?
The fight, of course, is over money, both money to be made by the card networks and money that could be lost by the merchants to fraud. Networks want stores to implement both chip-and-PIN, making credit cards work like debit cards, as well as chip-and-signature, in which chip cards work like mag-stripe cards did.
The difference in price between the two methods is substantial. You can see it by analyzing debit cards. On a PIN-debit purchase of $100, a big merchant may pay just 25 cents while they would pay 72 cents on a signature debit purchase.
The reason is that there is greater risk of fraud with a signature. Merchants don't look at signatures. But machines do look at PINs. If someone steals your debit card and can't get the PIN, they can't use it. But they can steal with it using a signature. I know. A college student stole my debit card a few years ago and did just that. He didn't use my PIN because he didn't get it - I keep that in my head.
Now, what happens when chip-and-PIN is applied to credit cards? That's a transition that will take time because, quick, what's the PIN on your most-used credit card? OK, on your bank card? Exactly. You have memorized the bank PIN, but not the credit card one. This is something that will take time to turn into a habit.
Visa and MasterCard want to retain the old habits of using the card the way you used a mag stripe and then signing off on it. They know this will increase fraud rates, which were estimated at 3.72 for every 10,000 mag-stripe and signature transactions in 2013. Fraud on ATM cards, by contrast, was less than 1 in every 10,000. And that was before the changeover to chips. Chip-and-PIN will not eliminate fraud, but it could cut it by two-thirds.
Criminals are having to resort to fancy skimmers in order to steal both the data on the card and the PIN. This is transforming card fraud, from a crime of opportunity into one done by organized criminal gangs. It is still relatively small when compared with the vast number of transactions. But merchants pay for it in the fees to networks, and that is what is at stake here.
There is another, bigger issue at stake, and another reason for big merchants to fight. That is the "liability shift" that occurred once chip cards were issued. Back in the mag-stripe era, losses on your card were the liability of your bank. In the chip era, they will be the responsibility of the merchant's bank. So long as merchants are supporting chip-and-signature, they are liable to losses from this type of fraud, something that is not a risk at, say, a bank ATM, which only uses chip-and-PIN.
Merchants want to go to chip-and-PIN only because transaction costs are lower, and so are fraud rates. Banks, backed by Visa and MasterCard, argue that consumers are accustomed to using signatures, and that the security is in the chip card.
But it isn't. As my own example shows, a lost card can still be used to steal from any merchant through a fake signature, which offers no real security to the merchant. Fraud rates are lower with PINs, and it's not really that hard to memorize one.
This dispute is going to hit Visa and MasterCard in their top lines and in the costs of defending an indefensible argument in court until consumers are taught to memorize credit card PINs. Avoid these stocks until the networks cave.
Disclosure: I am/we are long COST, HD, KR.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.