Analysis & Commentary:

MARCHING INTO THE 'SMART' CARD ERA

The United States military is spearheading a switch to "smart" identity cards that could open up a new growth market as the world becomes obsessed with security after last month's hijack attacks.

The U.S. Department of Defense has ordered chip-based ID cards for 4.3 million military personnel over the next 18 months to tighten security on access to buildings, including the Pentagon, and to computer networks -- including access to encrypted e-mail and online transactions.

That may sound like a drop in the ocean for an industry that shipped some 600 million chip cards last year, mostly bank cards and mobile phone cards. But ID cards may eventually go to more of the 23 million names on the Defense Department's database, including family members, retired servicemen and contractors.

The plastic cards look like credit cards, but they combine a magnetic stripe and a barcode with a fingernail size embedded digital chip. They're well-protected from hackers, given that a thousand hours' hacking might at best give access to the information on one card, rather than a whole network.

U.S. smart card technology firm ActivCard, which provides the software, could see its sales balloon if the market takes off. It has reported a flood of fresh interest from governments worldwide since the September 11 attacks on the Pentagon and the World Trade Center.

The deal also could herald a new source of demand for card makers such as Gemplus, Oberthur and Schlumberger, whose sales have been stifled by a year-long slowdown in growth of mobile-phone sales and the slow takeoff of chip-based bank cards in the United States.

"This is extremely important, not only to us, but to the whole smart card industry. It's the biggest Java-based smart card order yet," ActivCard senior vice president Tom Arthur told Reuters at annual chip card congress Cartes 2001.

"The level of interest has clearly accelerated since the attacks. Before, we had about a dozen interested parties. Now we have a dozen government projects in the pipeline from Europe, Asia and the Middle East, a dozen more from U.S. federal agencies and state departments and a handful of projects from European and Asian militaries," Arthur said.

Digital ID companies set to benefit Smart cards have a three-year life span but can be updated any time to add new functions. Future versions will use biometric techniques such as embedded thumbprints, currently being tested by the U.S. Federal Aviation Authority, rather than PIN numbers. Iris-scanning is also favored by card makers.

While the market for ID cards will be dwarfed for years to come by the main markets, mobile phones and bank cards, analysts say interest in digital security is building.

"There's a greater level of awareness about security now, and that should positively affect the smart card industry, as smart cards are the obvious platform for any security solution," said BNP Paribas analyst Ikkla Rauvola.

"But there are a number of hurdles that have to be cleared before the markets will take off," he added, citing investments in card readers and reader software, which he said would need to be justified by a sound business plan.

ActivCard, which works alongside card makers and says it can charge up to $50 to fit each computer with smart card reader software, is scheduled to report third-quarter earnings on Tuesday.

While officials of the California firm say they expect losses of 10-12 cents per share on quarterly sales of $9 million, growth could speed up if a market for smart ID cards -- previously seen as years off -- were to become a less distant prospect.

The cost of the U.S. military deal, planned since 1999, will depend on how much chip card prices come down in the next year, but the Defense Department is set to spend in the region of $35 million on the cards alone, based on a value of $8-$9 per card.

Industry players are betting on a rash of future deals, speculating that governments, armies, airports, large companies and other security-sensitive employers will be keen for staff to carry watertight ID cards since the September hijack attacks.

Raging Debate

A debate still rages over whether the wider American public will accept an enforced smart card national ID system, which industry watchers say could be worth some $3 billion.

But contracts from governments and armies alone could add several percentage points of growth over the coming years to an industry, which is forecast to grow by around 33 percent this year to 793 million units, according to Gartner Dataquest.

"Chip cards provide the ultimate solution for validating credentials," said Robert Brandewie, deputy director at the U.S. Defense Department's Manpower Data Center.

"With a magnetic stripe or barcode, information has to be checked with a central system, but with a chip you are free from this dependence. This is the way we have to go to enter a kind of e-government mode with a more secure infrastructure and an improved business process," he said.

Around 1.8 billion smart cards were in use worldwide in 2000, half of them in Europe and 25 percent in the Asia-Pacific region, and the figure is set to double by 2004, according to U.S. industry consultancy and research group Frost & Sullivan.

The ID cards ordered by the Defense Department will be supplied by a handful of smart card makers, including Oberthur, Gemplus and Schlumberger. Inter-operability software from ActivCard means the different cards will be compatible.

"Other parts of the U.S. government are suddenly becoming interested in smart cards. Our project hopefully means they can hop on board without long development times," Brandewie said.