Trends & Tactics

 

The Concentrated World of ISOs

 

Reps from more than 1,200 independent sales organizations pound Main Streets, malls, and strip shopping centers in search of merchants interested in payment-processing services. That number suggests a wide-open industry, but a new study of ISOs sheds light on just how few players dominate merchant acquiring behind the scenes.

 

That the acquiring industry is concentrated is nothing new, but the study by Linthicum, Md.-based First Annapolis Consulting Inc., using information from Visa Inc., backs up perceptions with hard numbers. First Annapolis pulled data from Visa’s merchant Web site, which lists Visa-registered ISOs, the types of transactions they handle, and their sponsor banks.

 

In all, the Visa Web site includes 1,776 registered ISOs and so-called encryption-support organizations (ESOs). Many companies provide more than one service. Visa classifies 1,253 companies as “merchant ISOs” that sign merchants for acceptance of Visa-branded credit and debit cards.

 

Some 254 ISOs enable merchants to accept PIN-debit transactions on Visa’s Interlink point-of-sale network, and 338 link customers to the Visa-owned Plus ATM network.

 

Visa and MasterCard Inc. require transactions to enter their networks through banks, which means that, as non-bank entities, ISOs must find at least one sponsor bank. Many use two or more. First Annapolis found that 42% of the merchant ISOs disclosed their sponsor bank on their Web site, 24% did not disclose, and 34% had no site. (Visa requires sponsorship identification on solicitation materials, according to First Annapolis.)

 

Wells Fargo & Co. is by far the biggest bank sponsor, cited as a sponsoring bank by 46% of ISOs that name their sponsors on their Web site. Next are HSBC, 14%, followed by U.S. Bancorp, First National Bank of Omaha, Harris Bank and Merrick Bank in the 5%-6% range, and about 35 other banks claiming the remaining 18%.

 

“There’s a pretty small number of banks sponsoring the ISOs in comparison with the overall banking industry,” notes First Annapolis senior consultant Lacy Kridler. The U.S. has about 8,000 commercial banks.

 

The relationships between sponsor banks and third-party processors typically determine how many ISO sponsorships a bank has, according to Kridler. Usually the processors deal directly with ISOs, and leading processors such as First Data Corp. and Global Payments Inc. work with numerous ISOs.

 

Wells and First Data have a longstanding partnership, as does HSBC with Global. Thus, those banks’ dominance as sponsors “is likely driven by arrangements they have with First Data and Global Payments, respectively,” says Kridler.

 

Other banks own or have corporate ties with merchant processors that work with ISOs but may not have the same name as the bank. Moneris Solutions, for example, is owned by two big Canadian banking companies, RBC Financial Group (Royal Bank of Canada) and BMO Financial Group (Bank of Montreal), the latter of which owns Harris. U.S. Bancorp owns the big Atlanta-based acquirer Elavon.

 

The dominance of large ISOs is further exemplified when revenues are considered. First Annapolis used public sources, mainly the Hoover’s Inc. corporate information service, to estimate revenues for 43% of the merchant ISOs and divided the results into five categories. Only 31 companies have annual revenues of more than $20 million, but they account for 94% of all revenues in the entire group, according to Kridler.

 

Some 108 ISOs registered with Visa to solicit merchants, governmental units, and other businesses to sell, activate, or load prepaid cards on behalf of an issuer, according to First Annapolis. Another 160 are registered as cardholder ISOs that provide solicitation services, application processing, and customer support. The 286 registered ESOs perform services such as cryptographic key management, secure key injection, and loading of encryption keys into ATMs or point-of-sale PIN-entry devices and encrypting PIN pads.

 

 

 

PayPal’s Plastic Plans for the POS

 

You never know what you’ll find at a trade show. At eBay Inc.’s developers’ conference last month in San Francisco, we found a PayPal Inc. that’s close to getting into the card business. That’s real, as in plastic, cards.

 

Long a dominant processor of e-commerce transactions, PayPal has made no secret lately of its ambitions to move into the world of brick-and-mortar commerce. The only missing element was a physical token that account holders could use at the point of sale.

 

Now it appears that void will soon be filled. The PayPal Card, a mag-striped plastic card proprietary to PayPal (not cobranded, as with previous forays into plastic) will become available to the processor’s base of 100 million active users some time in the first half of 2012.

 

The unembossed card, which account holders will have to apply for, will carry the PayPal logo on its face, but will bear no other identifying information—no name, no account number. Transactions on the card will be protected by a PIN.

 

PayPal will also introduce at the same time a companion payment product it calls “Empty Hands,” a system that will let account holders pay the point of sale by entering a phone number, mobile or landline, and a PIN.

 

The card is intended to let users access the funding sources they have stored in their accounts, or digital wallets. These can include credit and debit cards, but also loyalty points, prepaid and gift cards, and demand-deposit accounts. In an interesting twist, users will have up to 14 days after the transaction to change the funding source, if they wish.

 

Working with a PayPal app, both the card and Empty Hands will include smart-phone-based geo-location and rewards functions. Users will receive notice of nearby merchants along with discounts or coupons they can store in their wallets and have applied automatically when they shop at those stores. Users will also be able to give merchants access to their shopping lists, and receive offers linked to items on those lists.

 

PayPal plans to test the card in a pilot that will start this year, says Sam Shrauger, vice president of global product and design for the processor. Some 20 merchants are expected to begin accepting it during the second quarter of 2012, he adds. PayPal’s merchant-sales team, which currently markets the company’s e-commerce service, will sell the card in an integrated effort aimed at large merchants with both online and physical stores, Shrauger says. “We view it as selling payment solutions,” he says.

 

Both the card and Empty Hands will work on most existing POS devices with integrated PIN pads, he says, with a software overlay. The reason for that software is that transactions won’t flow over existing rails. Instead, the terminals will have to be programmed so that they can link directly to PayPal servers for PayPal Card payments.

 

That raises a big question: What will PayPal charge merchants to accept this card? The short answer: Pricing hasn’t yet been established. “We’ll have a transaction-based pricing model, largely an extension of what we do now,” Shrauger says.

 

The card will be up against stiff competition from the likes of Visa Inc., MasterCard Inc., American Express Co., and Discover Financial. But it may end up priced close to at least some of these brands. Shrauger hints that the pricing will be competitive, pointing to the product’s ability to extend offers and build loyalty. “Merchants want value for their interchange,” he notes.

 

Despite the established competition, some observers say PayPal may not have much trouble attracting either merchants or cardholders. Allen Weinberg of Glenbrook Partners, a payments consultancy in Menlo Park, Calif., says the card offers value to both constituencies. “The real value of what they’re doing is revenue-generating offers for merchants, and if the consumer uses a PayPal Card, they’re better off,” he says. “They get to choose the funding mechanism up to 14 days after the fact, and they get offers. I think it makes a lot of sense.”

 

 

 

A Mobile App That Taps Bank Rewards Points

 

First, there were gift cards that existed only on the Internet—virtual or digital gift cards, they’re called. Now along comes CashStar Inc. with plans to roll out a mobile app that will let consumers tap unredeemed rewards points held at banks to buy digital gift cards from major merchants.

 

Planned for early next year, the app will also feature location-based alerts to let users know when they are near a merchant issuer.

 

Portland, Maine-based CashStar, which specializes in technology for e-coupons and digital gift cards, is in talks with banks for the commercial rollout of the app, called MobileGiftReward, says cofounder and chief executive David Stone.

 

With the app, which currently works on devices running Apple Inc.’s iOS with a version for Google Inc.’s Android system set to follow, users can convert unused rewards points into gift cards usable at CashStar client merchants. CashStar estimates more than $16 billion in rewards value remains unredeemed each year, largely because of difficult or inconvenient redemption terms. “Consumers love [rewards points] but hate the hassle to convert them to use,” says Stone.

 

The Gap, Starbucks, Williams-Sonoma, The Container Store, and Home Depot are among retailers that have signed on so far to accept the digital cards, CashStar says. The company counts about 200 retail brands among its clients. Users can choose the brand they want. The app then generates a bar code that can be scanned at any of that brand’s stores. In cases where the merchant doesn’t have a scanner at checkout, the clerk can key in a 16-digit number that appears with the bar code.

 

Stone, who won’t name the financial institutions CashStar is talking to, says banks can benefit by reducing their booked rewards liability and cementing ties with current customers. Once a bank has signed up, it can choose how to promote the app to its rewards customers. “It’s up to the bank how much promotion they’ll do,” says Stone.

 

CashStar will earn most of its revenue on the program by charging a commission to participating retailers, but will levy a “small issuing fee” to banks as well, says Stone, who won’t go into detail on pricing.

 

An additional feature of MobileGiftReward is a location-based alert that can tell users when they are near a store whose digital card they have selected. Stone says the app may also add the capability of extending offers from those merchants at the same time these alerts appear.

 

Observers point out that converting unused rewards points into gift cards is nothing new. But where CashStar may have an edge is in the links it is forging with financial institutions to tap into their rewards storehouses.

 

“Integrating to financial-institution rewards programs is a really clever strategy,” notes Tim Sloane, director of prepaid advisory services at Mercator Advisory Group, Maynard, Mass. While the app may or may not reduce costs for banks, Sloane says it should burnish their image with their best customers, those who earn rewards. “It’s an innovative way to burn points,” he says. “[Banks] want to show they’re on the leading edge.”

 

 

 

Small Banks’ Payments Jitters

 

Debit cards are mainstays of small banks’ payment operations, but with the Durbin Amendment now in force and the need to keep up with mobile payments and other new technologies, many community bankers are bracing for declining revenues and higher expenses.

 

According to the Independent Community Bankers of America’s latest bi-annual Payments Survey, 30% of respondents said annual gross revenues from consumer payment products declined slightly in 2011 and 9.8% said they declined significantly. Respective figures for 2009 were 15.9% and 1.5%.

 

Some 28% of respondents in the 2011 survey said their consumer payments revenues increased slightly, and 1.9% said they increased significantly. That is down from 2009, when 46.9% of respondents reported a slight increase in consumer payments revenues and 6.8% claimed a significant increase.

 

The trade group sent the survey to 7,000 members in June and received 713 responses for a 10.2% response rate.

 

Cary Whaley, vice president of payments and technology policy at the Washington, D.C.-based ICBA, said respondents likely figured in higher compliance and fraud expenses when they gave their responses about which way revenues were going. “One of the things that came out loud and clear was regulatory,” Whaley says.

 

When asked to name the top three threats to their banks’ payments strategy, “cost of regulatory compliance” came out on top by far, cited by 77.2% of respondents. Next was “loss of revenue due to regulated debit interchange,” cited by 56.3%, and “constant change, rapid rate of obsolescence,” 40%.

 

Small banks and credit unions have mostly opposed the Durbin Amendment in 2010’s Dodd-Frank Act, an amendment that imposes debit card interchange price controls on banks with more than $10 billion in assets. The Federal Reserve set a cap of 21 cents plus 0.05% of the transaction for regulated issuers, with another penny possible for fraud control. The cap, effective Oct. 1, is shaving about 45% off big banks’ pre-Durbin debit revenues.

 

While small banks enjoy an exemption, Whaley says they worry that Durbin’s new ban on cards accessing only affiliated debit networks and greater transaction-routing freedoms for merchants will enable retailers to send more debit transactions to networks with lower interchange rates. That could mean less income for small issuers.

 

“Our concern is that now that it’s the merchant who’s going to decide who’s going to win that transaction, the market forces are going to drive it down to 21 cents or maybe below,” says Whaley.

 

Among 11 payments products, small-bank executives ranked debit cards second behind overdraft services and overdraft lines in profitability. Some 78% of respondents rated their debit cards as somewhat or very profitable.

 

The Durbin Amendment’s effect on the bottom line is only now beginning. But many banks are feeling the pain of fraud. Ninety-two percent of respondents said they have been forced to reissue debit cards, and 61% said their spending for fraud control increased over the past year.

 

Not surprisingly, bankers are looking for ways to control their rising payment expenses. One way for some might be to dump debit card rewards programs. Only 19% offer such programs, but 77% plan to re-evaluate whether to offer such programs over the next two years.

 

Small banks, however, are keeping their eyes on new technology and services. While only 14% currently offers mobile payments, that number is up from 6% in 2009. Whaley estimates that the number of customers actually using such services at those banks is probably quite low, however.

 

Some 47.3% said they plan to offer mobile payments before 2013, and 33.4% plan to offer electronic person-to-person payments. Some 20.7% plan to offer remote deposit capture to consumers by 2013, while 13.8% expect to add prepaid cards.

 

With less technology capital to play with than big banks, community banks are content to wait to see which technology and systems will win consumers’ favor. “With community banks, they don’t have time for a do-over,” Whaley says. “A lot of them are looking at the marketplace with their eye on being a fast follower.”

 

 

 

Letter to the editor

 

In your September [Gimlet Eye] editorial, “Speeding Up the ACH,” you perpetuated a falsehood that has been floating around since the Federal Reserve’s original announcement about same-day ACH. You and others (including “From Tomorrow to Today” in the same issue) have referred to same-day ACH as the first substantial change in settlement windows in 37 years. That statement is simply incorrect.

 

When the automated clearing house (ACH) was conceived in 1974, all transactions, debits and credits, were two-day items. In 1980 or ‘81, the ACH network introduced a night cycle for high-dollar debits with next-day availability to clear transactions that had previously been cleared through depository transfer checks. This night-cycle window was premium-priced, but it was a big step forward for the network to have the potential for next-day availability, and that was our first major change in settlement windows.

 

The night-cycle surcharge eventually went away, and all debits were eligible for next-day availability by the late ‘80’s. That was a second material change to settlement. With the advent of the all-electronic ACH on July 1, 1993, we were able to move to one-day credit processing on a national basis. That was the third material change. I should also point out the progressively later deadlines for input to the ACH operator. While not a major settlement change, moving the input deadline from 9:00 p.m. to 3:00 a.m. the next morning as technology evolved greatly enhanced the utility of the ACH network.

 

As someone who has been involved with the ACH since 1980, I think it is important that we not lose sight of these improvements. Have we had a significant change in availability since the mid-90’s? No, and that’s still a long time for a network to remain in one place. However, to state that nothing has been done in 37 years is an affront to the hundreds of people who worked on the rules changes and the technology changes needed to get us where we are today.

 

J. Steven Stone

 

Senior Vice President/Treasury Management Operations

 

PNC Bank Treasury Management