It feels like the acquiring business is getting more complex by the day. PCI compliance, free terminals, compliance audits, intense price competition and the impact of private equity – the list could go on. However, taking a step back and thinking about the core economics of the business, there are really only nine levers an acquirer can pull to improve financial performance:
 Sales Throughput
The production of the sales organization, a function of sales management.
Same Store Growth
The growth in sales volume from period to period at existing merchants, a function of target marketing.
Retention
Preventing the attrition of merchants.
Acquisition Cost
The cost of selling to and boarding a merchant.
Pricing
The discount, transactional surcharge and fee based pricing.
Operating Expense
The costs of processing transactions and serving merchants.
Losses
Write offs from merchant failures and fraud.
Overhead
The costs of administering an acquiring business.
Other Product Penetration and Pricing
Economics of products other than core transaction processing – equipment, merchant cash advance, on-line reporting, gift cards, etc.
These categories, shown above, are admittedly a little stylized and simplified, but we have found them useful as a strategic lens through which to view where the industry is going and how individual acquirers are performing. The trajectory of these items illustrates some of the challenge.
There are a series of critically important levers, all of which are deteriorating – the productivity of many sales organizations and channels is falling in the face of intensified competition. This and the competition for sales staff, in turn, tends to drive up acquisition costs to sell to and board merchants. Pricing continues to be a strength of the acquiring business but is under pressure from intensifying competition. Same store growth (e.g., the general rate of growth in the business) has cooled since the heady days of the 1990’s and will continue to do so as the industry matures, making it less of a contributor to overall growth of individual acquirers. Large acquirers will increasingly find it hard to overweight their portfolio in high growth merchant categories and will increasingly reflect industry growth rates.
We’d argue that retention has not been as critical a lever as others in the past and has been pretty favorable (in what other industries can a player be wholly uncompetitive on every dimension and generate only 20% to 25% gross attrition?); however, we believe this lever is both becoming more important as the sales model in the industry tightens and becoming less favorable as competition intensifies.
The expense side of the equation (excepting acquisition costs) is both of increasing importance and is improving as acquirers continue to drive unit costs lower through scale and efficiency. Low cost players will be able to sustain lower pricing in the years to come and maintain highly attractive margins whereas high cost players are going to feel a pinch.
The economics of other products are going to be of greatly increased importance to our industry. However, in our estimation, other products have not historically been the financial contributor often attributed to them. A careful examination of the economics of the acquiring business confirms the overwhelming majority of revenue has been and continues to be driven (directly or as an inseparable
adjunct) by pricing that is a function of core transaction processing and specifically Visa/MasterCard transaction processing.
The most important ‘other product’ is point-of-sale equipment, and its economics are deteriorating badly as acquirers use ‘free terminal’ programs effectively to price compete in different contexts. Gift cards have exhibited huge growth in penetration, for example rising from 2% to 28% of small merchants in the U.S. and Canada from 2003 to 2007, according to recently updated First Annapolis research. However, gift card economics are somewhat marginal for most acquirers.
Products like merchant cash advance have intriguing revenue dynamics,
but it is hard to view this product as an anchor for the industry.
It is entirely possible that of the players, the small startups in the business will simply evaporate in the next recession, given the risk characteristics of the product, not unlike other sub-prime lending products. Likewise, other products, like remote capture, which can be delivered through a merchant services model, are very interesting but extremely developmental. Products like dynamic currency conversion and mobile phone top up are proven business cases in Europe, but have yet to make a strategic-level impact in the U.S.
and many other markets. Core banking products are synergistic with acquiring, but few banks have proven effective at marrying banking and acquiring offerings without losing the specialization necessary to compete in acquiring.
Furthermore, these levers interact with each other, in some cases.
For example, as pricing decreases and attrition increases, the relationship to acquisition cost becomes a central, driving, economic issue. When an acquirer crosses that inflection point where the net present value of a new merchant falls below the acquisition cost, it is lights out for that acquirer.
If these observations seem all rather dark and sobering, our primary conclusion is that the acquiring business is in the process of transitioning from an outstanding industry to merely a good industry. Moreover, the more the large acquirers are engaged in restructuring rather than engaged in competitive strategy to hasten the maturation of the business, the longer the timeline. So in that sense, events like the integration of legacy NPC into Bank of America, the combination of Chase Merchant Services and Paymentech, and most recently the proposed acquisition of FDC by KKR are very helpful to the rest of the business. The acquirer, however, who ignores these long-term trends in its strategic thinking, does so at its own peril.
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