Putting Pizzazz Back in Profits

Offering value-added services and focusing on the right merchant categories can boost profits and take the sting out of portfolio attrition.

Talk of margin compression is nothing new for merchant acquirers. The ongoing race for merchants between acquirers, independent sales organizations, and merchant aggregators has led many players into a vicious cycle of trying to win merchants’ business strictly on price.

Competing on price alone is a classic margin-degradation strategy, payment experts say, because merchants will inevitably ask, “How low can you go?” and then demand an even lower price.

Rather than winning large chunks of market share, acquirers competing on price find themselves constantly being undercut by lower-cost competitors and scrambling to replace merchants, which costs a lot of money and time. Plus, the more time sales representatives spend prospecting for new merchants, the less they have to service existing clients, which helps fuel attrition and the vicious cycle of selling on price.

The cost to replace a merchant can be six to 18 months of its revenue, says Ian Drysdale, executive vice president of sales for Atlanta-based processor Elavon Inc. Some of the costs associated with landing a new merchant include salaries for field-sales representatives and marketing costs, such as free terminals. Even if an acquirer can replace all the merchants lost to attrition, growth typically remains flat, unless it adds more volume than it lets slip away.

The good news for acquirers is that there are numerous opportunities for growth—and better profitability—if they seek out markets offering rapid growth in card volume and provide services that can help merchants run their business more efficiently. The key is to resist the temptation of playing the pricing game, payments experts say.

Less Wiggle Room

Value-added services that help merchants run their business more economically, such as payroll services, employee time-and-attendance applications, or security solutions that encrypt cardholder data, are projected to increase acquirer revenues by 10.5% on average in 2016, according Timetric, a London-based market-research firm.

“Value-added services help acquirers improve merchant retention,” says Utsav Vatsyayan, an analyst for Timetric, in an email. “For example, in 2014 Vantiv reported that it was able to gain more business from one of its merchants through its gift card program and a personalized approach to become more relevant to the merchant’s needs.”

According to Vatsyayan, MissNow Mrs.com, a site that advises new brides on how to change their name on important documents like government forms and creditor accounts, was looking for a way to expand distribution of its gift cards, which at the time were available only on its site. The company received interest from pharmacy chain Rite Aid to offer the gift cards in Rite Aid stores.

The services offered by Vantiv paved the way for MissNowMrs.com to seal the deal with Rite Aid and in the process win the company’s processing business, Vatsyayan wrote.

The longer an acquirer can keep a merchant in its portfolio, the higher the profit margin for that merchant, because it reduces attrition and subsequent replacement costs. “Getting a merchant to stay longer than the industry average can provide a significant boost to profitability,” Drysdale says. “The longer the merchant stays beyond the average, the bigger the boost to profitability.”

In 2014, acquirer revenues averaged 48 basis points, according to a first-time study of 37 acquirers and ISOs by Omaha, Neb.-based Adil Consulting LLC. Average revenues vary among acquirers of differing sizes, as those with annual volume above $30 billion have the lowest average revenue at 41 basis points.

The reason, according to Adil Moussa, principal of Adil Consulting, is that acquirers in that segment typically service the largest merchants, which command the lowest prices because of the huge volumes they generate.

“The biggest acquirers handling the largest merchants can only charge them a fraction of a penny per transaction,” says Moussa. “Smaller acquirers usually compete for merchants with a lower volume and the margins are much higher.”

Regardless of its size, whether or not an acquirer suffers from margin compression depends on its business model. Acquirers that don’t specialize in any particular vertical market or offer any kind of value-added service typically end up competing on price. In many cases, most of these acquirers lack the volume to get the lowest possible rate from their processor, which leaves less wiggle room when it comes to maintaining margins.

‘Purchasing Trust’

One value-added offering that’s catching merchant’s attention these days is tokenization. With each high-profile data breach suffered by merchants, consumers become more concerned about the safety of their account information.

Tokenization removes consumer card-account information from a merchant’s point-of-sale and back-office systems and replaces it with a randomly generated sequence of letters and numbers known as a token.

While the technique is commonly used to secure e-commerce transactions, some acquirers see tokenization at the physical point of sale as a way for merchants to demonstrate to consumers that their POS systems are secure and to build greater consumer trust in their brand. It is also an opportunity for acquirers to charge more for their services.

Elavon, for example, is positioning tokenization as part of a layered security approach to protect data stored in a merchant’s back office systems, since it eliminates the potential for hackers to steal sensitive credit card credentials and sell them to other criminals.

“While EMV is intended to reduce fraud at the point of sale by authenticating the card to the terminal and vice versa, it doesn’t encrypt the data around the transaction, which criminals can steal and then use to commit online fraud,” says Drysdale. “Providing a security solution that replaces cardholder data at rest with a token, makes sure cardholder data is secure if the merchant is hacked.”

Encryption is another security solution some acquirers and processors are offering as a value-added service. With this technology, account data are replaced with strings of digits derived mathematically from the actual information.

Elavon, a subsidiary of U.S. Bancorp, inked a deal in early October with AthenaHealth Inc., a provider of cloud-based services for electronic health records, revenue cycle management, patient engagement, care coordination, and health-management services, to provide EMV point-to-point encryption through its Simplify software. Simplify bypasses AthenaHealth’s POS system and sends encrypted cardholder data directly to Elavon.

“Merchants are purchasing trust with security solutions, which is important to them because a breach negatively impacts their brand,” says Drysdale. “Security solutions are a way for acquirers to expand margins because they offer the merchant greater value.”

‘Tricky Proposition’

Value-added services can also help acquirers boost margins in mature markets, such as restaurants, where margin compression is quite common. Princeton, N.J.-based Heartland Payment Systems, for example, offers a reservation application that restaurants can add to their Web site.

“Consumers are using the Internet more on their purchasing journey, and developing applications that can be tied into a merchant’s Web services adds value to an acquirer’s services,” says Heartland chief executive Robert O. Carr.

More information about what and how consumers purchase can help merchants improve the customer experience and is another way for acquirers to add value. For example, consumers’ use of mobile apps to help with shopping and other tasks has opened the door for acquirers to integrate mobile apps into their payment services.

Heartland has invested in TabbedOut, which has created an app for restaurants that enables consumers to access and pay their bill from their smart phone. In addition, the app tracks customer behavioral data, such as frequency of visits, items purchased, and whether a customer redeemed a coupon when paying for his meal.

Restaurants can use that information to develop special offers and other promotions sent to the customer via the app to increase frequency of visits or increase average ticket size.

Restaurants can also use TabbedOut to provide customers a forum for commenting on their dining experience. Restaurants can respond directly to any negative comments to ease the customer’s dissatisfaction. The feature also provides insights into what is working and ways the customer experience can be improved.

As in-store beacons and Bluetooth technology become more prevalent, Carr says merchants are likely to become interested in partnering with acquirers that can integrate these technologies into their point-of sale systems. That’s because such information-gathering capabilities can be a real boon to retail marketers.

One downside to an app strategy, however, is the app only provides value if it’s adopted on a large scale. “How is the app going to be marketed and who will pay for it when it’s downloaded are two primary questions surrounding the use of apps integrated to the point of sale, which is why apps can be a tricky value-add proposition for acquirers,” says consultant Moussa.

Geographic expansion into high-growth emerging markets is another way acquirers can boost profitability. Promising international markets, to Timetric, include China and Russia, which posted compound annual growth rates of 40.2% and 27.2%, respectively, in card payments between 2010 and 2014.

“China is the world’s largest e-commerce market by dollar value,” Timetric’s Vatsyayan says. “In 2014, e-commerce in China was estimated at $417 billion.”

Identifying niche markets where merchants are not as price-sensitive, such as education, can also boost margins. Merchants that are less price-sensitive tend to maintain longer relationships with their acquirers, says Mike Strawhecker, partner with The Strawhecker Group, an Omaha, Neb.-based consultancy.

Gambling and adult entertainment are two other high-margin niche markets. Margins in these two markets can be as much as 10%, Vatsyayan says.

While merchant aggregators such as iKettle can help acquirers sign micro-merchants that are still cash dependent, Vatsyayan cautions the risk of partnering with aggregators is that acquirers can end up ceding control over the merchant relationship to the aggregator. “Aggregators act as both opportunity and threat for acquirers,” he says.

Benefiting From the Math

Sometimes the math just works in acquirers’ favor. The average merchant rate charged on total volume was 2.6% in 2015, down from 2.8% in 2011. But annual card volume for small and mid-sized merchants has risen to $188,000 in 2015 from $147,000 in 2011.

That’s a big enough increase to offset the loss of net revenues on a per merchant basis from lower merchant rates, according to Strawhecker, whose firm uses information from a database of 3.2 million merchants to track acquirer profitability.

“Margin compression is a given in mature markets, such as restaurants and supermarkets,” says Strawhecker. “But when an economy is strong, consumers spend more on cards, which drives up acquirer profits.”

That effect can be magnified with a conscious strategy to boost profitability, he adds: “Acquirers that focus on verticals with low merchant attrition, geographic areas with fast-growing card volume, or provide value-added service that aid a merchant’s business, can keep merchants in the fold longer and increase their overall profit per merchant.”