Research Identifies an E-Commerce Premium, But How Long Will It Last?

A longstanding truism in the acquiring business is that smaller merchants tend to generate more profit than their larger counterparts. But now research has emerged to show that smaller online merchants are even more profitable for acquirers and processors than brick-and-mortar stores of the same size. In fact, across all volume tiers between $25,000 and $300 million in annual Visa and MasterCard sales, e-commerce merchants produce a higher net spread, or difference between revenue and costs, than do physical merchants, according to a study by First Annapolis Consulting, Linthicum, Md.

As might be expected, margins drop as volumes increase, but the e-commerce premium is actually greatest in the $50 million-to-$300 million volume tier, the largest one studied. Here, online sellers produce 23 basis points of net spread on average, more than doubling the 10 basis points generated by physical stores, according to the research, which examined some half a million merchant records. For the smallest merchants, by contrast, e-commerce merchants averaged 243 basis points, compared to 177 for physical retailers, for a 37% premium. These are merchants recording $25,000 to $100,000 in annual card-based sales.

Across the board, First Annapolis estimates that net spreads for e-commerce merchants are around 40% higher than the industry average for all merchants in the $25,000-to-$300 million annual-sales class, or some 80 basis points compared to 58 basis points.

Heather Pollock, a consultant at First Annapolis specializing in merchant acquiring, cautions that the firm is still examining factors that might account for the e-commerce premium. But she says some preliminary conclusions are possible. “Among other variables, risk, merchant vintage, and price sensitivity account for at least some of the divide,” she tells Digital Transactions News via e-mail. Online merchants incur so-called card-not-present interchange, which many acquirers might mark up more than the card-present rates charged to physical merchants, for example. Card-not-present rates are higher than card-present pricing to account for a higher perceived risk. Interchange is established by card networks and levied on acquirers, which pass the fees on to merchants.

Mobile transactions, however, don’t appear to carry the same kind of premium. While it’s early days in mobile acquiring, Pollock says pricing so far has been set low. “This would squeeze margins across the board,” Pollock says. Over time, that could affect the entire small-merchant e-commerce category as more and more consumers conduct Web-based transactions on handsets. “Although it’s too early to provide data, we expect smaller margins to result in a smaller e-commerce premium,” she notes.

Indeed, as competition and other market forces drive down pricing overall, acquirers and processors shouldn’t expect the e-commerce premium to last forever. “Because we expect net spread to decrease over time, we expect the e-commerce premium to shrink as well,” Pollock says.

But for now, with e-commerce booming by comparison to physical stores, processors and independent sales organizations that concentrate in physical-world sellers would do well to build up their online business. First Annapolis projects that online sales will average a 16% annual rate of growth over the next four years, well ahead of physical-store sales growth. “In general,” says Pollock, “acquirers and ISOs could capture value from the rising e-commerce trend by keeping a wide variety of merchants in their portfolios.”