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While Many Decry Margin Compression, Report Paints Sunnier Picture of Acquirer Profit
February 23, 2015

By John Stewart

Many merchant-services executives have complained for years about so-called margin compression, a relentless loss of profitability driven by competition on price per transaction. But now two researchers argue acquirer profitability, far from collapsing, is actually much better than widely thought.

“There has been a lot of talk about margin compression, but the reality is margins have been expanding,” Rick Oglesby, senior researcher at Centennial, Colo.-based Double Diamond Payments Research, tells Digital Transactions News.

Oglesby and Marc Cochrane, a researcher and consultant at Double Diamond, last week released a report called “Acquiring Acquirers: Why Insiders Are Bullish on the Acquiring Sector” that looks at acquirer profitability as one factor among many that make acquirers attractive acquisition candidates.

The authors acknowledge that independent sales organizations and merchant processors do indeed confront significant pressure on merchant pricing. In recent years, much of this has been brought on by the nearly 5-year-old Durbin Amendment, which not only capped debit card rates but also led to merchant demand for greater pricing transparency in the form of so-called interchange-plus pricing.

This form of pricing, which spells out the processor’s charge as distinct from interchange and other charges, allows merchants to ensure they are receiving from their acquirers the full benefit of the Durbin cap. Formerly, acquirer statements often blended the acquirer’s margin with other charges, blurring the acquirer’s actual pricing.

Based on interviews they conducted with 10 senior finance executives representing 15 acquiring organizations, Oglesby and Cochrane estimate 64% of merchants are now on interchange-plus plans, compared to 57% 12 to 18 months ago. They expect that proportion to reach 68% within the next two years.

The authors add, however, that the impact of Durbin has been largely absorbed by now, as have any effects of a massive credit card interchange class action case that was settled in 2013. By now, “pricing has stabilized and future impacts are predictable,” the authors write.

Moreover, they argue, much of the talk of margin compression is founded on a misimpression of what acquirers do. “Acquirers don’t sell transactions, they sell merchant accounts,” Oglesby says. Hence, while transaction margins may have been squeezed, rising transaction volumes have widened merchant margins, the authors say.

As evidence, they cite operating-income and EBITDA (earnings before interest, taxes, depreciation, and amortization) margins for acquirers that report publicly. The former grew from 26% to 31% in the two years from 2012 to 2014. The latter, from 36% to 39%. “Margin per merchant is up,” says Oglesby.

Beyond the publicly held firms, the authors talked to firms of varying size, including privately held ones. “We tried to get to companies of all sizes,” Oglesby says. “We got a fairly optimistic view. We interviewed a lot of guys who said, ‘I don’t have margin compression. I don’t know what everyone is talking about.’”

Indeed, Oglesby and Cochrane conclude the margin improvement is likely to continue. This is largely because not all businesses accept electronic payments and not all consumers use them, leaving plenty of expansion opportunity.

Despite the widespread popularity of credit and debit cards, less than half of all businesses accept cards and other forms of electronic payment, according to the report. At the same time, cash and checks still account for 47% of transactions and one-third of transaction value, the authors say, citing figures from the Cash Product Office of the Federal Reserve.

An executive with a mid-sized acquirer who has responsibility for merchant sales agrees with the authors’ conclusion. Speaking to Digital Transactions News on condition of anonymity, he said what is often called margin compression is simply a case of mispricing by ISOs or other representatives.

“Margin compression is what you hear when people don’t know how to price a merchant,” he says. “We’ve got a bunch of people out there who don’t know how to price a merchant.”

One big mistake he sees is a tactic in which representatives ask to see the merchant’s current statement, offering to save the merchant money. This tactic, he says, often angers merchants and leads to unprofitable pricing. “Compression is an excuse used by people who don’t know how to sell,” he says.

Still, echoing the report’s analysis, many other ISOs working for the acquirer executive’s company are doing quite well. “We have hundreds of ISOs that make a very good return,” the executive says.

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