COMMENTARY: The Real Significance of Vantiv’s $1.65 Billion Deal for Mercury

Vantiv Inc.’s deal to acquire Mercury Payment Systems LLC was noteworthy for its size—the deal carried a $1.65 billion price tag—but it was also exemplary of a key industry transformation from distribution-centric to product-centric acquiring.

For decades, the merchant-acquiring industry has revolved around selling the services of barely differentiated payment processors packaged in barely differentiated payment terminals. Independent sales organizations (ISOs) became the prevalent model for selling payment services, and distribution reach became the primary differentiator.

Over the years, differentiation by distribution reach became a very problematic model. Distribution reach was achieved by hiring independent sales agents in every corner of the country, and, once these sales agents became established, they could simply sell their services to the highest bidder and take an ever increasing portion of the profits.

At the same time, once payment services were generally available to merchants, the industry did a poor job of creating new value drivers. That meant that payment services would be sold based on cost, setting the stage for declining prices over the long term.

Acquiring executives have been complaining about this for years, saying they are selling a commodity that is always declining in price. At the same time, they are locked in a heated competition to attract top sales agents, which drives sales compensation levels higher.

This race to the bottom on price coupled with a race to the top on sales compensation created ongoing margin compression. This has reached the point that many acquiring executives declare both races are now over, not because someone has won, but rather because they have run out of track. There is simply no more room to lower merchant prices and/or increase sales compensation.

But not everyone got locked into these races. Beginning in the mid-to-late 1990s, a small group of acquiring firms decided to get involved in a different race altogether. Their race was the technology race, where software was transforming the way merchants ran their businesses. By providing software-centric payment solutions to independent software vendors (ISVs), these firms became the payment processors within a series of highly differentiated business- management software products that were sold on value, not on cost.

Recent advancements in cloud and mobile technology have dramatically lowered the cost of software product delivery and created a booming ISV marketplace. ISV-focused payments firms achieved growth that far exceeded that of traditional acquirers. Due to the value created by the software, they also achieved below-average attrition rates and paid below-average sales compensation. Naturally, they rapidly climbed the acquiring ladder from tiny startups to highly relevant, competitive and valuable firms.

Not only that, but the software race is far from over.

Since August 2012, Global Payments Inc. and Vantiv have been taking turns acquiring the largest of the ISV-centric payments firms. Global struck first by buying Accelerated Payment Technologies for $413 million. Eleven months later, Vantiv acquired Element Payment Services Inc. for $163 million. Five months after that, Global acquired Payment Processing Inc. (PayPros) for $420 million. And then, on Monday, Vantiv acquired the largest of them all, Mercury Payment Systems.

Braintree Payments Solutions LLC and Stripe Inc. have achieved extremely rapid growth and high valuations by delivering online and mobile versions of a similar business model, and a variety of other payments players such as MerchantWarehouse.com LLC, EVO Payments International, and even Visa Inc. have jumped into the ISV race, as well.

So if you haven’t yet gotten the message, it’s now ISVs—not ISOs—that have the superior payments-distribution model. If you want to make money in payments, the lesson is clear: You must either sell through the ISV, or you must be an ISV. Both require a new product strategy. Neither requires an ISO.

Rick Oglesby is a senior analyst at Double Diamond Payments Research, Centennial, Colo. Reach him at rick@doublediamondgroup.com.