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I have studied and written about merchant attrition for the last ten years or so. Attrition is a fact of life in any business. Unfortunately, customers don't last forever. For the merchant acquiring business, attrition is a key driver of both management decision-making and company value. Without a clear understanding of attrition, it's impossible to make intelligent decisions about company strategy or sales management because management can't tell what's working and what's not. In short, attrition governs behavior in this business because it reveals whether or not a company is creating value as a result of its activities.
Merchant level attrition in a processing portfolio is composed of two variables — merchants going out of business and competitive poaching — usually based on price competition, but sometimes based on service issues. From what I have been able to determine, price competition and merchant failure each account for about half of the attrition in any given portfolio. Most frequently, merchant failure correlates highly with low Visa/MasterCard charge volume. That is, merchants driving low charge volumes attrite at a higher rate than higher volume merchants.
This conclusion from the data, observed time after time across a wide range of portfolios, stands up against the common sense test — merchants driving low sales will not survive.
Now, we're entering a phase during which this observation will be tested. Why? Because in the last 6 months charge volumes across industry categories of merchants are down from last year, but the number of merchants in the portfolios has not fallen at the same rate. In other words, credit card sales are off, average volumes per merchant are down, and therefore revenue to merchant acquirers is off. The amount of the volume decrease varies but ranges from the 1-2% range to as high as
8-9% year over year.
For most of its history, the acquiring business has taken same store charge volume growth for granted. Acquiring basked in the benefits of a massive marketing effort from the issuing side of the business. During that last 50 years, card issuing has steadily increased the number of cards in consumersÕ hands and the credit limits on those cards. Further, issuing innovated new products such as check card that increased volumes at the expense of other payment types. Even better, various card types carried with them higher margins on each transaction. On top of all that, the big associations, VISA, MasterCard, Amex and Discover paid for one of the largest consumer marketing campaigns in history. Acquiring was the unintended beneficiary of all that effort.
But now, the lift acquiring received from issuing is at least waning and may be pulling back. Issuers have slashed marketing and advertising budgets. They are cutting consumer credit limits. A number of smaller issuers are having difficulties securitizing their consumer receivables, especially for business credit cards. Some small issuers may fail if they are dependent on consumers or businesses with weak credit. Further, a number of small retailers tell me that consumers are shifting purchases from credit to cash in a return to tighter spending management. Over the last few years, "credit card" has become a dirty word as consumers become more conservative.
Lately it's been clear that the economy as a whole is entering a new phase of its life cycle — a downward phase marked by falling consumer spending, rising unemployment and a slowdown in business activity overall. No one knows how deep this down cycle will be or how long it will last. My best guess is that we're in for a rough ride for at least the rest of 2009 and on into 2010. Unemployment
could rise to nearly 10% by year end with falling GDP. I don't expect a depression-level downturn, but it will almost certainly be a severe recession. To match the Great Depression of the 1930's, unemployment would have to hit 25% and I do not expect anywhere near that level of distress.
I don't know how long these trends will persist, or how deep they will go. In any case, in the face of bleak economic news,I do expect issuers to scale back the number of cards issued and the credit limits overall. Combine that with a consumer pull-back and a concerted effort by merchants to avoid processing fees by encouraging consumers to use cash, and you wind up with persistently lower charge volumes per merchant.
Lower charge volumes by themselves do not necessarily mean that the merchant is in trouble or at risk of failure. It does suggest that overall sales are down, but more data would be required to know for sure. If consumers are still buying but substituting cash for cards, the merchant will be fine.
When it comes to evaluating attrition in our business, it's time to add some new analytical points. The days of charge volume being steady to rising are over—at least for a while. I think we can expect lower volumes and therefore lower revenues per merchant for at least the remainder of this year.
It used to be the case that for virtually any given portfolio of merchants, the weak merchants attrited out and the strong remained. Over time, the average processing volume per merchant in a given portfolio almost always rises. Not so during the last six months. I did some portfolio analysis and found that average volumes per merchant were down during the last six months in portfolios that for years always had rising per merchant average volumes. This indicates that while the merchants may be survivors, their charge volumes are off, and that means they're not producing as much residual revenue as they used to.
There are a number of issues related to soft charge volumes which could profoundly affect acquirers. Obviously, low charge volumes mean lower revenue and residuals. Moreover, if the residual revenue per merchant declines, but the merchant doesn't leave the portfolio, then the customer service and risk burden of having that merchant in the portfolio still remain. Less revenue combined with the same costs and risk levels means lower gross margins and profits in the industry as a whole. Lower margins means tighter performance measures for anyone with debt on their business. Debt covenants in this industry are usually written in relation to revenue, gross margin or earnings in some way. Often, when lenders feel threatened, their first response is to raise interest rates, thereby increasing the yield on a given loan to compensate for the increased perceived risk. If that happens, there's less discretionary profit for management teams to use in the business or return to shareholders. Ironically, increasing interest rates on risky loans means there's less discretionary cash to pay back the loan itself, thereby extending the payback period and (at least in my view) increasing the risk of an eventual default. If you really think consumer spending is headed down by, say, 10% - and there are economists who do — then a lender should want his money off the table as fast as possible.
Per merchant charge volume is a performance measure that acquirers could rely on to increase without fail over the history of the business. We are entering a period where that's no longer the case and the consequences will be far reaching. 
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