DT, February 2011
February 1, 2011
The War on Attrition
High attrition rates are likely to continue as the economy finds its footing and competition among acquirers for merchants remains fierce.
After being rocked by recession and weak recovery for several years, merchant acquirers may have felt like they turned the corner in December as shoppers finally hit the malls in force. U.S. retail sales rose to $584 billion from Nov. 5 through Dec. 24, the best performance in five years, according to MasterCard Advisors’ Spending Pulse report.
Though signs at 2010’s end pointed to better days ahead, acquirers are still reeling from very tough times. Despite the recent upturn, retail sales generally have been slow. Numerous stores have gone bankrupt. And merchant attrition rates have remained relatively high.
Added to that, unemployment stands at a crushing 9.8%, a sharp drag on consumer spending and confidence. Plus, the housing market remains very weak.
Amid the uncertainty, acquirers wonder whether high attrition rates will continue, and whether business formation will pick up. Margin compression is a major concern in a fight for market share that continues to intensify amid changing payments models and new government regulations.
And, as discount rates soften for many merchants, new product add-ons are becoming even more important to acquirers as a way to boost profits, hang on to merchants, or attract new ones.
Meanwhile, acquirers have cleaned house. They’ve slashed expenses, modified their business models, and changed their underwriting criteria, carefully monitoring their merchant clients. They’ve culled their ranks of risky and unprofitable merchants, which while temporarily raising attrition could more than compensate by boosting profits.
“We are in a better place than we were two years ago,” says Jim Contardi, senior vice president of strategic alliance accounts at the big processor First Data Corp., Atlanta.
The New Norm
The industry certainly faces a changed landscape. Annualized attrition rates, as measured by portfolio charge volume, hovered around 16% back in 2005, according to Jamie Savant, a partner at Omaha, Neb.-based payment-processing consulting and research firm The Strawhecker Group (chart, page 16).
But the downturn has created a whole new attrition model where net charge-volume attrition rates range from 20% to 23%. “The new norm is around 20%,” says Savant. In other words, acquirers each year need to replace merchants generating about a fifth of their volume just to stay even.
Fortunately, business bankruptcies, a big source of attrition, have slowed. Business bankruptcies hit a 16-year high of 60,837 in 2009, according to The American Bankruptcy Institute. But the 43,016 business bankruptcies recorded during the first three quarters of 2010 (Jan. 1-Sept. 30) represented a 5% drop from the 45,510 filings during the same period in 2009.
Business filings during the three-month period ending Sept. 30, 2010, totaled 13,957, down 8% from the 15,177 filings in the equivalent 2009 period.
But entrepreneurs are forming fewer new businesses. A November report in The Wall Street Journal, citing U.S. Labor Department data, said business formations are not keeping up with business closures. The number of companies with at least one employee fell by 100,000 for the 12 months ended March 31, 2010, the second lowest such pace in 18 years.
No wonder that acquirers, while feeling slightly more positive, are still quite guarded in their predictions for 2011. “We are cautiously optimistic, with emphasis on ‘cautious,’” says Bob Baldwin, president and chief financial officer at Princeton, N.J.-based Heartland Payment Systems Inc., a large merchant acquirer. “We are bumping along slightly above the bottom and we expect that to continue.”
Heartland provides a good example of where the industry has been and might be headed. In Heartland’s small and medium-size merchant portfolio, attrition has not improved much. But card-processing volume is substantially better than it was a year ago, according to Baldwin. Same-store sales from merchants were down 7% to 9% for much of 2009, compared to the prior year. Combined with a merchant attrition rate of about 20%, the business suffered a “double whammy,” notes Baldwin.
Same-store sales started to improve in 2010. By the third quarter, same-store sales were up 2% over the same period in 2009. This uptick helped to offset merchant attrition, says Baldwin.
First Data’s SpendTrend report tracks same-store consumer spending via credit, signature debit, PIN debit, and electronic benefits transfer cards at U.S. merchant locations. November 2010 same-store dollar-volume growth, excluding automobile sales, was 8.1% versus a year earlier, and up from 6.7% in October. Consumers remained concerned about the overall economy. However, they were willing to spend when the price was right, the report says.
BCC Merchant Solutions lost 10% to 12% of its merchant base during the downturn, according to Richard W. Noble, chief executive at the North Kansas City, Mo.-based independent sales organization. Card-processing volume declined 23%. Noble declined to provide current processing figures, but he notes that volume has been increasing.
At Moneris Solutions U.S., recent same-store sales volumes are up 10% to 12% over year-earlier figures. Merchant attrition has leveled off, but remains high in certain geographic regions and business segments, according to Greg C. Cohen, president of the Schaumburg, Ill.-based acquirer.
“We are still seeing attrition rates 50% greater in California and Nevada than in the Midwest and Northeast,” he says.
Small merchants in other troubled pockets such as Florida still have about a 20% attrition rate, Cohen notes. Regional retail chains and businesses tied to the real-estate market, such as furniture stores, saw huge card-processing volume drops during the recession. It’s still too soon to tell if this type of business is ready to roar back.
Some retail segments, such as sporting goods and auto parts, have shown improvement. But attrition rates also have been hurt by the fact that acquirers, as the recession deepened, pushed to increase sales among very small, risky merchants.
While these new signings raised volumes and merchant counts, the effect was short-lived as many of these businesses failed or were pruned by their acquirers. An effort to sign so-called micro-merchants, those that generate as few as one card transaction a month, also impacted attrition.
“We attracted a lesser-quality merchant during the downturn as we tried to keep sales afloat,” says Henry Helgeson, co-chief executive at Merchant Warehouse, a Boston-based ISO.
The overall pace of retail sales volume and card processing “won’t pick up magically,” notes Adil Moussa, a merchant-acquiring analyst at Aite Group LLC, Boston. “Any growth will be incremental.”
The downturn did force acquirers to sharpen their business practices, which has had an impact on attrition. Prior to the recession, acquirers typically conducted annual reviews of the financial health of their merchants. But now acquirers are more likely to review merchants semiannually, or even quarterly.
Moneris changed its review process of so-called future-delivery merchants. These are merchants that sell a product, such as furniture or airline tickets, that is delivered well after the purchase. That opens acquirers to a loss risk if the order is cancelled since they could be liable for the purchase. Moneris now reevaluates these merchants every three or six months.
“It was a shock to realize some of us got too lax,” says Cohen. “Our exposure model has changed.”
At Moneris, employees are focused on retention of existing merchants instead of finding new customers. Merchants are contacted frequently. Analytics help flag accounts that may be attrition candidates. For example, a merchant that requests a statement could be sending a warning that it might switch acquirers.
“So much time is spent trying to get new merchants, we want to focus on current customers,” says Cohen.
BCC Merchant Solutions has tightened its underwriting standards. The ISO no longer gives troubled merchants a second chance. “Every time we do that, it bites us back,” says Noble.
Like other acquirers, BCC also has cut expenses, reducing overhead by 50%. Some workers were laid off. The company also moved to office space that is 20% smaller but costs only half as much as its previous quarters did.
In 2010, Merchant Warehouse purged 4,000 merchants from its rolls. The company has a portfolio of about 75,000 merchants and processes MasterCard and Visa volume of about $5 billion annually. Processing volume was up about 11% in November 2010, compared to the same period the previous year.
To streamline operations, low-revenue-producing merchants were given 60 days notice of a fee increase. Alternatively, a notified merchant could close its account. The opt-in type approach resulted in back-end savings on the cost of servicing the merchants that closed their accounts. Accounts that were kept open produced more fees.
“Few ISOs can say we saved money by cutting 4,000 merchants,” says Helgeson.
Going up the chain, bigger processors that in better times were somewhat lenient with partner ISOs if they didn’t perform according to plan are now enforcing contract penalties, some sources say.
The weak economy did accelerate the introduction of new products by acquirers. These include programs and services that offer new revenue streams, though acquirers won’t say how much revenue the programs produce.
The add-ons also serve as a way to make the merchant’s relationship with the acquirer “sticky,” or difficult to exit. Popular offerings include mobile-commerce capabilities, card-not-present features, new analytics and reporting tools, loyalty and gift card programs, and security products.
In 2011, First Data plans to introduce more mobile-payment products. Its trusted-service-manager platform allows any card account to be put on a mobile handset.
“We intend to sell add-on products to merchants,” says First Data’s Contardi. For example, a merchant with a closed-loop gift card program might be a candidate for First Data’s eGift Social electronic gift card product available to consumers through Facebook or e-mail. “We have many different areas to help merchants increase revenues, or the efficiency of their back-office operation,” he adds.
Two years ago, Heartland Payment Systems bought Chockstone Inc., a company in the gift card and loyalty business focused on large national clients. Heartland reconfigured the Chockstone platform to also handle small and mid-size gift card programs. Chockstone now accounts for a meaningful portion of new merchant installations each month, says Baldwin.
Acquirers also are offering more joint promotions with banks and the card networks in order to retain and attract customers. For example, Moneris features a “small business in a box” service. The package, offered in conjunction with Moneris’s bank partners, includes a business bank account, merchant services, and a business credit card.
No. 4 payment card network Discover Financial Services, Riverwoods, Ill., rolled out a new acquirer model in 2006. Since then, Discover has enlisted all of the top 100 U.S. bank card acquirers to sign small and mid-sized merchants for Discover acceptance when they book Visa/MasterCard accounts.
Discover also offers a number of programs to spur sales at its merchants. The network ran a yearlong sweepstakes in 2010 for cardholders who used their Discover cards. Discover awarded 75 prizes each day in addition to a $1 million grand prize at the end of the year. Merchants also were eligible for prizes.
“Value-driven programs result in less attrition,” notes Gerry Wagner, vice president of global acceptance at Discover.
Pricing remains a key attrition factor since merchants often leave an acquirer because another supplier offers a better price.
In the last 18 months, pricing has generally risen slightly for small merchants and declined for large ones, industry observers say. With retailers generating annual bank card volume of less than $1 million, net acquirer revenue ranges from 90 to 300 basis points (0.9% to 3% of charge volume), according to Brooke Ybarra, a consultant at First Annapolis Consulting Inc., Linthicum, Md. Merchants with $10 million or more in volume have spreads ranging from 10 to 30 basis points.
Ybarra doesn’t foresee further price drops for large merchants because prices are already so low. Nor, because of intense competition, are prices for small merchants likely to rise.
Contardi at First Data believes merchants are aware that the point-of-sale experience involves more than card acceptance and its attendant costs. Loyalty and security programs also play a role. “Merchants are allocating more to the overall payments side of the business,” he says.
The key to lower attrition rates is not pricing, but good customer service, says Savant at The Strawhecker Group. Sales reps need to be aware of equipment issues and special programs, he says.
But one big pricing question that has emerged lately is passage of the so-called Durbin Amendment, which is included in the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Among other things, the amendment sets tight parameters on debit card interchange and charges the Federal Reserve Board with developing regulations to implement its provisions (“Rewriting the Transaction-Routing Rules,” January). The Fed’s initial proposal calls for a 7- to 12-cent interchange cap, a cap that could chop 70% or more from large debit card issuers’ interchange revenues. The Fed is still drafting its rules, and no one knows how they ultimately will affect merchant attrition.
Some acquirers believe they will get a margin lift from the new rules because, as the ones that directly pay interchange, they don’t plan to pass the full decrease in their costs on to their merchant clients. Heartland Payment Systems, however, does plan to pass price reductions through to merchants.
“We hope to benefit through increased market share,” says Baldwin. “We think it’s a good competitive edge.”
Despite all the uncertainties surrounding attrition, acquirers are generally optimistic about business in 2011. They admit the industry will remain somewhat volatile. But as Helgeson at Merchant Warehouse says: “It will be a banner year for those with cash on the balance sheet and a good business model. They’ll leave the competition in the dust.”
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