Last month, I wrote about an emerging trend that I think is a big deal in the ISO business – free POS terminals. Some super ISO’s have started providing POS terminals at no up-front cost to merchants. Instead, the merchant pays a small fee or has cancellation penalties if he switches processors and stops using the terminal.
    I view this kind of program as a logical and inevitable extension of the price cutting which has been going on in our business since inception. But what does it mean for various players?
    It can’t be good for leasing companies. Their business is built on buying terminals and then renting them out to merchants. If a new player, the super ISO, is buying the terminal and building his compensation for it in the merchant’s pricing somewhere, then the leasing company basically has no role to play. Essentially, giving a terminal away is an acknowledgement of the market reality that the terminal has little or no direct monetary value. Why would you give it away if you could sell it? This trend can’t really be helpful to leasing companies.
    Super ISO’s who are not offering a free terminal program will probably be forced to start one in order to stay competitive. But this presents a problem - how do they finance it? Companies have been used to making a profit on terminals and now, those same terminals are going to cost them. All of a sudden, the economics of the business changed for the worse and in a big way. Moving from a $500 profit per terminal to a $300 cost is an $800 swing per unit. For a shop selling 100 units a months, that is a $80,000 per month ($1 million per year) hole to fill.
    There has to be a source of capital which is patient enough to pay the terminal vendor for the terminals today and wait for a return from merchant fees. New financial players will enter the market to answer this need. Super ISO’s will have to restructure their balance sheets to accommodate this change. Some will be able to do that, some won’t.
    Terminal manufacturers are probably neutral on the idea. They sell terminals to whomever is buying whether that buyer is a leasing company or a super ISO. This change probably increases the already stiff price pressure on manufacturers, but that is nothing new. As with any electronic product, there’s always the market expectation that functionality will go up while price goes down.
    Feet on the street salespeople, aka merchant level salespeople, should like this trend. For them, what could be easier than giving away something of benefit to the merchant? Sounds great! But how will they be compensated? If there’s no profit in the terminal anymore, then how will salespeople make money? Will they be paid based on some assessment of the merchant’s size? Expected merchant profitability? And where will the capital come from to do that? This is another change for sales organizations which are used to finance sales commissions out of POS terminal profits. Now, they will have to finance compensation out of cash flow, loans or asset sales.
    On the other hand, declining margins of the business may favor business models based on direct marketing methods without salesperson interaction. Internet, telephone and mail-based sales models are low cost direct methods of approaching merchants. ISO’s have used these methods for years. And, certainly, it’s cheaper to give away a terminal if you don’t have to pay a salesperson to do it for you.
    Merchants should love the idea – who wouldn’t want a price cut? A free terminal – or one that comes with early exit penalties saves new merchants cash during the critical start-up phase and for new merchants that is what matters. ISO’s offering free terminals will probably capture a large portion of the new merchant market. Of course, new merchants have a high attrition rate.
    This is the kind of trend that can slowly restructure an industry, company by company. It’s easy to look out a couple of years and ask where this trend leads. Any business model which depends on POS terminals sales for profitability and cash flow is going to be increasingly difficult to make work in this market.