Common Ground
UNDERWRITING
VS
RISK

How Do you manage the Funnel?
by Gregory C. Cohen

   This issue of Transaction World focuses on partnerships and without a doubt, the most important partner a salesperson or an ISO has is their upstream acquirer. One of the keys of a great acquiring partnership is understanding what I call the acquirer's "Underwriting Risk Funnel," especially if you are relying on them to provide underwriting and risk management functions. In this past month alone I had conversations with the principals of ISOs who have asked or stated:

  • How do I "take everything,"
  • They have too many merchants on reserve
  • We want to bill all their merchants monthly for discount fees
  • What do I do about the potential loss of hundreds of thousands of dollars
  • How do I stop the fines due to excessive chargebacks?

   In all of these cases, the question or issue can be driven back to the individual not having a clear understanding of the importance of the underwriting / risk relationship. As a stakeholder in the payment space, it is important to understand the correlation between the underwriting team and the risk management group and how their interaction and policies affect you and your livelihood.
   I call the relationship between underwriting and risk a funnel because of the way a prospective merchant is handled. Obviously, the first group that touches a merchant is the underwriting/credit department. If the underwriting group has an extremely liberal policy, they will tend to approve most all the merchants they see. In order to protect the acquirer from losses, a company with a liberal underwriting policy must have strict risk management procedures and be much more aggressive in putting merchants on reserve and shutting them off. This resembles a funnel as it is open at the top and very tight or closed at the bottom. This type of model is generally employed by your higher risk acquirers. It enables them to board a large quantity of merchants with very little work; many approvals may even be automated without any human intervention and most merchants are placed on "daily discount" (discount fees are deducted from the merchants deposits on a daily basis) and set-up for automated reserves when chargebacks or rejects occur. For this model to be effective, these organizations must be staffed with large risk departments or else risk tremendous losses and potential fines as they are traditionally approving higher risk merchants (credit or business type). Many small acquirers utilize a very "open funnel" model as it allows them to approve many types of merchants and be more "sales friendly." However, as an acquirer grows, their funnel tends to close up or even go "inverted" as managing risk at this heightened level starts to become cumbersome and costly and they realize the valuation of a higher risk portfolio is less than a lower risk portfolio.
   In an "inverted funnel" acquiring shop, underwriting is much more conservative and is generally well staffed with larger quantities of merchant information (financials, tax returns, etc) to sort through. The underwriting team is the key to risk mitigation. For these acquirers, the risk department is still a crucial element in the business, but does not clamp down as tightly on an ongoing basis as they are generally dealing with a lower risk (more established merchant) portfolio. The larger the acquirer, the more likely you will see an "inverted funnel" scenario. The reason is simple, it is purely economic. The larger acquirers' direct sales forces traditionally deal with larger, better credit merchants and underwriting sees a merchant only once, while risk must deal with them every day. It is more cost effective to manage in an inverted funnel scenario. It is also important to note, an "inverted funnel" will tend to protect ISO's from losses and being fined by the associations for excessive chargebacks or very risky merchants as these merchants are generally eliminated up-front.
   Extremes are always a mistake. In an "upright funnel" model, in its purest sense, your merchants will be complaining about always having their money held. You will have customers who will buy or lease equipment only to have their accounts closed or frozen shortly thereafter. The Acquirer also is more susceptible to losses and fines and a de-valued portfolio. In an "inverted funnel," sales reps will have difficulty selling certain accounts or become frustrated with declines or requests for greater information. Just as extremes are a mistake, there is no right answer. Acquirers are different and based upon core competencies, risk tolerances, business line synergies, and distribution channels they will decide how they will create their own "funnel."
   If you are a liability taking acquirer, develop a model that you are comfortable with and that is in line with your goals (short and long-term). I have seen too many acquirers bend for a sales rep or for a very "profitable" opportunity, only to lose hundreds of thousands as they ventured outside of their comfort zone. As a non-liability taking organization looking for a partner, it is in your best interest to find one that has a "funnel" that coincides with your sales and operations strategy. The last thing you need is to sign a major account and then have their money frozen the next day or focus on internet business and only get a small percentage approved. The most liberal underwriting policy or the best price in the world means nothing if you are moving in opposite directions or even yet, your partner disappears from the acquiring world. Remember, a good partner does not facilitate decisions that put your business and livelihood in jeopardy.