If you’re a processor, you can distribute payment services a variety of different ways. There’s the ISO channel, the agent bank channel, direct sales, office supply and other retailers like Sam’s Club, internet, etc. And of course, you’ll use any and all channels that work for you. Out of all those, the two that have historically had the biggest impact on our industry are the ISO channel and the agent bank channel.
But which one is the most effective for processors? There’s lots of ways to measure that, but the most direct is the economics of the channel. In both cases, processors essentially get their merchants for free from the channel – both channels receive their compensation through a revenue sharing arrangement. Banks tend to generate merchants that are also bank customers for loans, credit card savings accounts, DDA’s, cash management, etc. For this reason, the bank channel tends to produce merchants that have lower attrition records over time - probably due to the durability of the merchant’s business model and the overall relationship with the bank. Banks usually require merchants who get loans to process with the bank to provide an added layer of security for the loan.
Unfortunately, ISOs don’t have any of these tools to slow attrition and the portfolios generally reflect the fact that merchants feel free to switch services when the vendor relationship is one-dimensional. But ISOs make up for it by being more aggressive and productive in their efforts. Instead of waiting for a loan customer to show up, ISOs are actively chasing customers, often using merchant cash advance to fill the loan need when banks won’t. ISOs reach into niche businesses and geographic categories that banks don’t and will stretch to the limit to close a deal. They are almost always the merchant’s first processing relationship, which is a key thing to note.
Of course, for all that effort, ISOs expect to get paid, and they do. Here’s a comparison I developed of one processor’s experience with the ISO channel vs. the agent bank channel:
You can see that for the processor, the bank channel is much more profitable due to the pricing the merchant pays and the low share to the bank. In fact, it’s almost ten times more profitable than the ISO channel – at least as measured by basis points over interchange. The absolute amount of dollars is probably higher for bank-derived merchants as well. My research shows that bank-derived merchants generally process larger volumes than ISO merchants.
The two channels derive different kinds of merchants. ISOs tend to recruit smaller, more entrepreneurial merchants while banks attract more buttoned-down types. Generally, the merchants ISOs bring in won’t come in through the bank channel and vice-versa. So processors look at the ISO channel and think it’s expensive, but the fact is that it’s two separate merchant bases that a substitute for one another.
Processors really need both channels. For this reason, I think many processors look at the ISO channel as high cost relative to the ISO channel, but changing the ISO channel is risky.
I said earlier that processors have been getting merchants for free from both channels and that’s true if all we’re discussing is up-front cost. If you think about it, the way our industry is structured, processors pay an enormous amount to ISOs and agent bank to acquire merchants – they just pay it over a long period of time through a revenue sharing arrangement.
Another big difference between the two channels is that ISOs are much more aggressive in their approach. Banks in general are not that great at sales – they respond when asked, but have a hard time initiating anything. They fill orders when customers come in and ask for processing. Consequently, typical agent bank branch production numbers are measured in single digits per month. For banks, processing service is an add-on that doesn’t get much attention. The staff don’t necessarily understand it and need to re-learn the specifics of pricing and other details each time they are asked. It’s not any one person’s priority and usually no one is incented to close a deal.
For ISOs the situation could not be more different. Their existence depends on getting the next merchant and so they are much more aggressive rooting out market segments and new customers anywhere and everywhere. It’s no wonder they are more productive and enterprising. It’s no wonder they negotiate better and give up less to processors – they care more.
ISOs will continue to be a feature of the payments world for a long time to come because they do a job that no one else does. There’s no other way to reach the merchants that ISOs originate and manage.