Industry Trends
The Price Wars

Part II
by Lisa Dowling

   Last month, Transaction World looked at the players in the theatre of the price wars, specifically the manufacturers. Their strategies were presented and predictions were made. This month, the other side of the stage is being showcased. Take a look at those organizations that are literally in the selling trenches and gallantly responding to the battle plans of the manufacturers, namely the ISOs and processors.
   One of the largest and most respected of those groups is Chase Merchant Services, an LLC-structured merchant account acquirer formed from the camps of two formidable entities, First Data and Chase Manhattan Bank.
   Drew Freeman, Senior Vice President for Chase Merchant Services, is a chief strategist for the group and has witnessed the rise and fall of pricing. When he first joined the fight, ISOs made the bulk of their money on terminals. That landscape has changed, due in part to competition among manufacturers, advances in technology and the emergence of the electronic superhighway‹the Internet.
   "Where there was once one vendor who dominated the marketplace, now there are a variety of terminal manufacturers," says Freedman. "That has brought the price down and it works for the buyer. Technology as well has brought down prices. And the Internet has played a big part as well. It provides a venue for interested parties. Educated buyers know where to go to get products at the lowest prices."
   Does the present pricing structure pose challenges to organizations such as Chase Merchant Services?Undoubtedly so, but Chase responds to those challenges with well-thought out and well-executed strategies.
   "When it comes to dealing with pricing, our biggest challenge is understanding the feature functionality and translating it into value for the merchant," says Freedman. "It is creating revenue that everyone looks for and benefits from. Price does not dictate what brand of terminal we buy. We have a unique value proposition in that we connect with virtually any terminal via different networks. We are more customer driven than price driven. We make our offering based on whatever the customer wants."
   Obviously Chase is listening to the needs of its customers. But does Chase feel the manufacturers are listening to the needs of the ISO community? And how much of an effect do ISOs have on pricing structures and strategies?
   "Manufactures have a dilemma because, for the most part, they don't deal directly with ISOs and processors," says Freedman. "Yet, the ISOs are major players in our marketplace and are major buyers. They are the customers to the manufacturers. Because of this, the ISOs play a major role in determining price. They have to compete with processors who buy in huge volume. Here at Chase, we partner with First Data and can provide good pricing to ISO clients. That in turn means they can make some decent pricing margins. "
   Freedman touches on another major component of the price wars‹the competition among ISOs to get the best price for the best value. In other words, to beat out the other guy.
   "Competition is fierce," says Freedman. "A lot of ISOs tend to rely on single sources for terminals. It's still very competitive when it comes to offering merchants what they want. With the Internet becoming a major resource, now is the toughest time I've seen. On the other hand, if I am an ISO and want to put together a complete payment option with numerous products and applications, the terminal is just one piece of hardware that can be enhanced with software to create a total solution. It's like a frame of a car. What you put on that frame is what differentiates it."
   At Chase, they like what the manufacturers are putting on their frames. And because of it, Chase is well positioned in the price war arena.
   "We work with very responsive manufacturers who pay a lot of attention to us," says Freedman. "We rep our ISOs to those manufacturing channels. That puts us in a unique position. It is one of strength because of our sales and market leadership."
   Needless to say, Chase intends on maintaining its stronghold on the battlefield. However, like the winds of war, the landscape will inevitably change and new strategies will come in to play to combat those changes. What does Drew see happening on the price war battlefield?
   "I think that one of the things we will see is virtual terminals," says Freedman. "The manufacturers may not want to hear it but virtual terminals will be a major player. The manufacturers will be challenged to create different value in software to keep buyers locked in."

   Another industry veteran who closely watches the combat is Joe Kaplan, President/CEO of Innovative Merchant Services.
   When Kaplan first enlisted in the payment processing industry, he recalls how merchants were uneducated and inexperienced, using bulletins to process transactions. When electronic terminals hit the marketplace, it was a new service that was an easy alternative to sell. ISOs conducted their business face to face. It's a different war game now and Kaplan sees the lack of personal contact as a major factor in the decline in price.
   "In yesteryear, you had salespeople who were always seeing merchants," says Kaplan. "Today with emails and the Internet, acquirers are taking risks in not seeing merchants. Because selling bankcards has become an impersonal relationship at the front end, salespeople have nothing to hang on to other than price. They have driven the prices down because they have nothing more to talk about. What else could they say other than my price is better than yours. Merchants now have more access to lower priced equipment."
   Luckily for Innovative Merchant Services, lower prices have not had a damaging effect on its business. Why not? Because Kaplan stresses they've always been a service company.
   "Production is the by-product of quality service," says Kaplan. "We capitalize on referrals and tout our service as the main indicator of decision and choice. A merchant will pay more money for service if the value they get exceeds the cost. For instance, we have live operators answering their calls. We call merchants on their birthdays. We check in regularly with them. We make an impersonal relationship a personal one. We have learned how to build value propositions with services to make the price the merchants pay acceptable."
   If the presence of lower prices on the battlefield isn't a challenge for the sales professionals at Innovative Merchant Services, than what is?
   "Getting past the mindset that cheaper is better," says Kaplan. "That's our biggest challenge. It's like taking your clothes to a drycleaner. You can find the cheapest one but they won't necessarily do the best job. Until a merchant can experience added value, you have to educate them. Sales people who are weaker don't spend the time talking about value. They just push price. We are all so price conscious, but if given the choice, most people will pay for service...if they can get it."
   Kaplan feels the terminal industry has become a commodity and it needs to change battle tactics and truly become one of service.
   "Equipment is strictly a vehicle to get money from Point A to Point B," says Kaplan. "If there is something wrong with the processing or chargeback and you need help, that's where the value comes in. At the end of the day, we are a partner. Price may dictate what brand sales reps provide, but for me it's all about the relationship."
   Kaplan recognizes that sales reps ultimately look for a knowledge base when it comes to terminal choice.
   "What makes them gravitate initially to one model may be the price but what keeps them there is comfort," says Kaplan. "It actually has to perform, as do the manufacturers. ISOs are interested in knowing that the manufacturers will work with them on value applications and other items. By their own admission, manufacturers believe they are a commodity as well. They all may be listening to ISOs, but only some are reacting"
   What is Kaplan's response to the statement some manufacturers made in last month's article that ISOs clearly dictate the market's pricing structure? It is more of an extension of that philosophy rather than acquiescence.
   "Yes, ISOs may dictate price but merchants dictate what they pay," says Kaplan. "ISOs give merchants the introduction and the education. In that respect, they are very influential."
   That introduction and education translates to a myriad of merchant choices. Today's ISOs are hard-pressed to differentiate themselves from each other. Price is just one aspect of the fight. A fight that Kaplan doesn't see as a major confrontation in the price war.
   "I don't believe in competition," says Kaplan. "I believe it is just a creation in one's mind. The reason you don't get a deal is not because of price. It's because you didn't create a bond. You didn't provide an opportunity. All too often I hear that it's so competitive out there. For me, I am a benchmark. I want people to look at us and strive to be like us. Sales reps need to do the same. Sales reps need to go knocking on doors. The face to face is gone. We have lost focus and we're not teaching reps the basics. They think it's more efficient to send emails. They have lost sight of the cornerstone of what our industry is about. Price has nothing to do with competition."
   While Kaplan agrees it might not be easy to start up in this business without capital and large equipment sales, he believes the approach is key, not cost. His winning battle plan is all in the head.
   "If you have no mental barriers to sales, a rep can out and write deals," says Kaplan. "It's all about mindset. Unfor-tunately, once in business those same reps learn about competition and their mindset changes. If we allow our mindset to change, if we lose our focus and concentrate on other things rather than selling, we lose it all."
   As for future predictions, Kaplan bases his opinion on keen insights and proven precision-based strategies.
   "I think equipment in general is going to be utilized for more than just credit card processing," says Kaplan. "But I also think prices are eroding as much as we want to sell value. Over time it becomes more difficult to sell at top line prices and even though we sell value with that equipment and the price is higher, it is still lower than it used to be. You can't only justify certain practices. The more they keep talking and fighting over prices, the lower that bottom line will go."
   Kaplan predicts the bar will be lower and at some point there will be a leveling off. He also predicts the manufacturers that respond to that movement will be the victorious ones.
   "The thing about manufacturers is that the ones who are at the top of their game and look to tomorrow are going to be more successful than those who rest on their laurels and don't look forward," says Kaplan. "Manufacturers need to listen to ISOs and merchants. They need to build value again. The market leaders will drive innovation. Price will be important but they need to watch more. Are prices going to be reasonable? Reasonable is relative. It's unfair for me to say what is fair. The key to this market is everyone making money. It is my choice to use whoever I want and as long as they are not collusive in their price, as long as the market will bear it and I find what I want, that manufacturer will get my business. For me, that business is not about the price, it's about service. Merchants may not demand service at the front end, but they definitely demand it on the back end. ISOs and merchants can talk price all they want, but at the end of the day, it's all about service."

   U.S. Merchant Services is another independent sales organization whose leader is heavily engaged in meeting the challenges of price and quality of product. Steve Norell, President of U.S. Merchant Services, recalls that when he first joined the movement, terminal prices were much higher than they are today. He credits that to fewer sales channels, the non-existence of the Internet and a shift in revenue stream.
   "Years ago, prices were extremely high," says Norell. "There wasn't as much competition and the Internet was nowhere near what is today. The Internet has opened doors to merchants buying equipment on line. Selling may be less expensive because of that but at the heart of it all is another reason for the decrease in prices. Ten years ago, ISOs and processors had reps whose income was derived 99% from the sale of equipment. There was not much revenue from residuals. Processors paid over the buy rate and reps didn't get a lot on the transaction. The revenue being generated by residuals was so low that sales reps were forced to make it on equipment. But as time has gone on, processors are sharing more in the revenue to maintain their sales reps. The smart guys have figured out where the money is in the long term...and it's not in equipment sales."
   Norell sees the price wars as coming full circle. Equipment prices went through the roof but now everyone is back to square one with prices down dramatically.
   "The prices are now almost at a giveaway in order for manufacturers, distributors and processors to get the accounts," says Norell.
   Has it affected U.S. Merchant Services' strategies? According to Norell, not in the least. Theirs is a strategy that counterattacks price with a unique selling position.
   "I was ahead of my time," says Norell. "I always thought I would be residual-centric rather than equipment. Granted, unless you have good capital to start up and establish a base, you have to sell equipment to get that capital. The small guy had to sell and some merchants have gotten stuck in bad deals. They've been lied to and the truth may have been stretched. When you remove an independent agent and put an employee in his place, you reduce your fraud rate. An agent has to sell a piece of equipment no matter what in order to make his car payment or meet his mortgage. He may fabricate some part of the process to do so. Employees get a guaranteed salary plus commission, so they don't have to make scared money. Scared money never wins."
   Norell is clear in his combat approach. At U.S. Merchant Services, they don't concentrate on price.
   "Our direction is basically we give the equipment away," says Norell. "We sell at cost or less. The price of equipment is not a major factor in our business. Our strategy is the cheaper the equipment, the higher the discount rate. We tell our merchants it is not the lowest rate, but we explain we save merchants money through the price of the equipment and the lease they might get locked into with another agent."
   Since brand price doesn't seem to dictate which manufacturer gets to engage with U.S. Merchant Services, what does make the difference?
   "Three things matter," says Norell. "One, the relationship with the vendor. Two, how many bells and whistles are in the box, how many applications it can support. And three, how easy it is for all parties concerned to make it work."
   When it comes to supporting the manufacturer's theory that ISOs are setting the battle scene when it comes to pricing, Norell has an interesting take on the subject.
   "The manufacturers have allowed it," says Norell. "Think about it. Who is the guy who uses the machine‹it's the merchant. At what point does he meet someone from a manufacturer like Verifone or Hypercom. The merchant doesn't talk to them. He doesn't even know who they are. The only contact manufacturers have with merchants is through an ISO. In the old days, they sold to banks. Now 80% of merchants are serviced by ISOs. The manufacturers have created their own monster. They now have to bring out cheaper and cheaper machines to get ISOs to buy their products."
   Like many other ISOs, Norell believes if the manufacturers move to increase pricing, they are going to have to bring out a better product with better service on the back end. Service is what will make the most impact on the price wars...and on the cutthroat ISO competition.
   "Competition among ISOs is as tough as it has ever been," says Norell. "The industry is in for a cleansing, all because of this equipment situation. Say there's a guy who worked for an ISO and got screwed. So he goes out on his own, sells equipment to make money but doesn't have the ability to go the distance because he doesn't have capital. With equipment prices down, what sales rep can go out and compete with a company like ours. Those individuals will leave the industry.
   Norell sees the manufacturers in just a precarious a position.
   "They have their fingers in the dike," says Norell. "They are all fighting the same battle. Basically there are four or five guys making the same box. They're all fighting for the same hill. But they are going to have to change their tactics. One manufacturer's attitude was so aloof towards ISOs. Another has had serious internal problems. Then there are ones like Lipman who rolled up their sleeves and got in the trenches with the ISOs. They're working with them and that's what it's going to take to win the war."

   Norell feels strongly about the need for the manufacturers to really hear what the ISOs are now saying.
   "ISOs are talking about service. They're talking about features," says Norell. "They can only talk about price for so long. If the manufacturers had half a brain they'd get in touch with ISOs and provide more service. Not every processor is good at what they are doing and not every guy out there is getting good service. ISOs would be willing to pay more money to get support and service."
   Does Norell see this happening? Does he envision an end to the battle?
   "Two things will happen," says Norell. The big players will hold the line but there will always be somebody coming in with a cheaper box to challenge them."

   A much smaller organization that, despite its size, is winning ground is Electronic Money. President Ginger Hollowell has weathered many battles and still fights the good fight.
   "When I first started in the business years ago, the average price was $2500 for a credit card terminal/PIN pad," says Hollowell. "It wasn't worth my time to sell it for less. I took less then but I was looking for clients to sell them. Now the prices are down more than half. The market and the Internet are the reasons. Leases are also lower. Merchants can buy a machine off the web for $400 instead of $1,200. It's hard to sell to that merchant so you just have to move on."
   How does Hollowell move on past that type of merchant? How does she attack that barrier? Like others, Hollowell tries to educate the merchants to what they actually get for that lower price.
   "We stress there is something missing when buying over the Internet," says Hollowell. "They can't get their account serviced. An Internet seller will ignore them once the sale is done. If they have a problem with their machine on a Saturday afternoon, who are they going to get to service them."
   On paper, that strategy sounds sound. But how does it translate to the trenches? Are merchants getting it?
   "Some do, some don't," says Hollowell. "If they are looking on the Internet, they are only looking at price and we ultimately move on. I am looking for merchants who are hungry for customer service. When you run a business you need immediate service and some merchants are willing to pay for it. You just have to find them."
   Hollowell admits not all merchants are aware of the Internet price position but so many are getting solicited by countless agents that they are all aware of rates. For that reason she sees solicitation as playing a big part in pricing. How does that affect her business strategies?
   "We are more concerned about residuals and price of equipment than we used to be," says Hollowell. "It makes it harder to bring on new salespeople because they don't have a residual base, even if you're sharing it with them. But compared to other products, if you can make $500 on a commission, that's pretty good. And in our business, you can still do it. The marketplace has not dropped to Internet wholesale pricing. It still has margins but they aren't as fat as they used to be."
   It's not the price that represents the biggest challenge to Hollowell. It's more about the service she receives from all her allies in the price war.
   "Manufacturer's prices really don't affect us," says Hollowell. "It's not a big deal if the price goes down $10 or $20. My concern is that the company I represent provides customer service and because of that I have to get that service from my bank and processor so I can do deals quickly and stay on the street. Price is not a big factor in what brand I buy. What dictates my choice in equipment is the service I receive from the processors."
   Hollowell makes a valid statement when she points to the need of ISOs to be able to rely on tech departments of their processing partners.
   "For us as ISOs, it's who you are writing business for, who their tech department is," says Hollowell. "Merchants are buying processing. They're not buying equipment. They don't know the difference between one brand or another. They just want to swipe a card and know how much it will cost. Technical departments are more important than price. If you are out on the field and it takes hours to get service, you become very frustrated. If you have a reliable, trained tech department, you can spend more time in the field and crank more sales out."
   This is a message Hollowell feels needs to be heard. Like others in similar trenches, she doesn't think the manufacturers are really hearing everything the ISOs are saying on their side of the battleline.
   "I don't think manufacturers are listening to us," says Hollowell. "I have no connection with the manufacturer. My only connection is with the processor and it their relationship that I rely on. It is crucial."
   If Hollowell could get the attention of the manufacturers, what would she recommend they change as regards to strategy? It all comes back to service.
   "They need to sell," says Hollowell. "They need to make things simple for us to get tech support. ISOs switch processors because they are not getting the right service from their machines. The simpler the manufacturers can make it, the more it will help the processors and the ISOs. Pricing doesn't enter into the equation. If one machine costs more, it just isn't as important as support time. In an ideal world, I'd write the application, install the machine and be done in a short period of time. That's not happening. The time we are spending on getting one up and running, we could be selling 10 or 20 others. Maybe manufacturers need to put more emphasis on training of tech support rather than pricing. If support went smoother, it would be a no-brainer to pay more."
   Speaking of processing, one of the major players in that arena came forward to showcase their strategies. For years, Vital Processing has been up front and center in the ongoing fight for market share and delivery of service. They have witnessed the repercussions of the battle over pricing and have consistently maintained a strong and customer-centric approach to the situation.
   "Years back, people were price sensitive but not overly so because the majority of equipment was sold in distribution chains," says John Marshall, Executive Vice President, Sales and Client Relations for Vital Processing. "The chain was marking up substantially, but it was hidden by leasing. That was the fuel that created the difference in the market. Packaging was done. Leasing was done but the cost wasn't as sensitive as it is now."
   According to Marshall, the new approach to pricing has brought about great change, especially in the executive washrooms.
   "How many chief executives are still around today," asks Marshall. "It's called financial performance. If you didn't make it, you had to find money somewhere. So suppliers started getting squeezed. That has brought about a lot of change in the market. Price wars are interesting. Everybody in business this last 18 to 20 months knows it is a tough economy. Everyone has to make numbers and they've had to squeeze suppliers and improve efficiency. The hardware guys are the squeezed end."
   In retaliation to that squeeze, Marshall defines current manufacturers' battle strategies in three ways. One opts for direct sales to high-end retail chains. Another chooses the distribution channel that works with the larger ISOs. Then there's the newer approach to solicit the smaller independent agents. But that new approach may present a conflict of sorts.
   "Manufacturers are looking to sell directly to ISOs because they are trying to get units out on the marketplace," says Marshall. "They are competing against their own distributors and wasting their money. The smaller market is better served by wholesalers and has been very well done so in the past."
   Marshall sees the drop in pricing changing the landscape of the manufacturers' operations. In order for them to maintain profit margins, they have had to develop software to meet accounts' needs. The demands for more applications at the same equipment price meant the manufacturers had to restructure their troops.
   "All of the manufacturers have moved to systems to allow people to write software for their own systems," says Marshall. "Manufacturers are not as protected as they used to be. They just can't afford it. They need partners to maintain their margins. Their margins on hardware sales have lowered but they have managed to lower their operating costs as well."
   Like the ISOs who feel their message isn't always getting out, Marshall lays out the problem facing the processors when it comes to pricing and cost.
   "A little known cost to manufacturers is that every processor has a rigid, complex and serious approval process for each terminal and application," says Marshall. "When they change a terminal, the processor has to go through that process each time for each terminal and each application. The marketplace has seen new apps, new features, new screens, faster modems, more memory, smart cards. The manufacturers have done the best job in the food chain to create transactions. But consider that every component is designed to a tolerance. Put components together with the wrong tolerance and you have a problem. As processors, we have to keep it all running 24/7 by 365 year after year. It costs a fortune. We apply as much energy and resource and time to make sure these apps get through as the manufacturers do on their end trying to comply and meet the market's needs."
   Marshall doesn't believe lower pricing has greatly affected the ISO community. He credits the increase in intelligence on the part of the merchants as more challenging.
   "The Internet has opened another avenue for merchants," says Marshall. "But service is key. A good rep establishes clearly that he knows the merchant has to be competitive but also knows he needs service when he has a problem. Service is more important than price. Merchants don't understand price. Price pressure is created by people buying terminals through the distribution channel. If you suffer price compression on your merchant and transaction fees are down, where else can you look for a difference? You look to the terminal price but your merchant cares more about service."
   Marshall sees software as making a much bigger difference when it comes to overcoming competition. The philosophy is that the smart ISOs appeal to merchants about other issues, applications and features as opposed to sticker price. Because of that, Vital is application-functionality focused. It is that focus that enters into the processor's rules of engagement.
   "Every guy out on the street thinks every processor supports every line of code," says Marshall. "Say the top manufacturers each have four models with each model having at least six variations. That's four times six, times the number of major players out there. That's a costly approval process. Of over 400 of those applications approved, maybe 100 are Class A, another higher priced process. On top of that there's all kinds of co-activity on new apps coming on the system. And once approved, if a bug is found on that model and it has to be returned and changed, the whole approval process starts over again. That's why our costs are so enormous. It's the model times the revisions times the changes to the system times the equipment enhancements times the compliance issues. One terminal model may have 14 revisions during the life of its manufacturer. Their operating system may have 9 reviews and one application can be modified 12 times. You do the math. Yes, the ISOs are feeling the pain of this war but it's there because of the number of suppliers, applications and modifications to all that equipment. "
   Marshall is just as strong on his view of who sets the price. "Manufacturers may say ISOs dictate the market's pricing but I think that's backwards," says Marshall. The ISOs only dictate retail price. Ask the manufacturers what the difference is between their First Data price and what they charge Joe Blow in Seattle. Their internal policies set the price. Don't get me wrong. The hardware guys have done a super job. Putting more pressure on price is not the real issue. Most manufacturers are just caught up in bids to sell lower prices to bigger players."
   Marshall predicts that at the end of this war, probably four or five of the top manufacturers will be left standing. He doesn't see prices going back up since he views the market as so driven by scale now that prices will stay down. And he definitely sees the emerging strategy of selling direct to ISOs to establish a distribution channel as flawed. What he predicts will win over all is supporting existing channels.
   "It is how you manage your terminals that will make the difference," says Marshall. "It's about staying in compliance, fixing bugs, keeping them running and preventing help desks from becoming inundated. The cost of the terminal doesn't even enter into it."