Acquiring: How To Fight Margin Compression

Acquirers don’t have to be locked in the classic race to the bottom. From referral networks to better training to integrated technology, here’s a raft of ideas aimed at taking the pressure off profits.

It’s a universal lament of many merchant-acquirer and independent sales organization executives: Selling credit and debit card processing services on price is a sure-fire way to erode profits.

Industry competition and merchant proclivity to shop on price can outpace the ability of new technology to reduce cost. There are scores of ways to counter margin compression, but some strategies and tactics have fared better than others for ISOs and acquirers, especially if they are used in combination.

Margin compression is one of the top issues facing the industry, says consultant Adil Moussa in his “Merchant Acquiring in 2014: Issues, Trends & Perspectives” report released earlier this year. A failure to bring innovation or value to merchants compounds the problem, he notes. It can be reversed with value, technology, and empathy for solving merchants’ problems, he says.

The alternative is ugly. As ISOs and acquirers vie for merchants, some payment providers lower their payment-processing rates, which reinforces the cycle of shrinking margins. “They believe wrongly that lowering the price will result in a Wal-Mart-like domination, but end up robbing themselves and the industry [of] healthy margins,” Moussa says.

To counter these trends, Moussa suggests specialization to stand out. Not only does he advise choosing a particular merchant category to court, but also that the ISO or acquirer learn that business so it can better understand merchants’ pain points, he says.

“You have to step outside of payment processing and look at the opportunity to help merchants grow,” Moussa says. “Your growth will be taken care of if your merchants grow.”

‘Let’s Get Deep’

Some common ways ISOs and acquirers counter margin compression are: serving merchants that might be overlooked by others; securing referral deals; focusing on software integration; offering business-management services; and approaching the relationship as a consultative one.

At 360 Payment Solutions Inc., Steve Ciabattoni, president of the San Jose, Calif.-based merchant-services company, looks to merchant categories that aren’t as susceptible to market forces. “Every rookie in the payments business is walking up and down Main Street trying to save restaurants and retail businesses money on their credit card fees,” Ciabattoni says.

Prospecting business-to-business clients and offering them valuable insight to achieve level 2 and 3 processing rates is one tactic he suggests. Level 2 and 3 processing is often used among B2B merchants to offer more data about transactions.

Pursuing tough-to-sell or overlooked merchant categories is a favorite tactic of Josh Brant, president of Allegiance Merchant Services, a Charlotte, N.C.-based merchant-service provider.

He likens the typical ISO’s approach to sizing up a set of prospects to skipping a rock across a lake. They see what’s on the surface, but “no one realizes the lake has a ton of depth,” says Brant. Allegiance’s strategy is different. “Let’s get deep,” he says.

That’s where a deft salesperson can help. Instead of focusing on price, Brant wants his salespeople to show how they can help the merchant. That requires understanding the complexity of the merchant’s business, such as knowing the number of locations, their card-processing volume, and how many methods the merchant could use to process a payment card, he says. Or, it could involve determining if the merchant’s sales staff doesn’t know how to use basic anti-fraud tools like address-verification services.

“I’m sure we can find something, some enhancement that takes this whole conversation of price not off the table, but to the side a bit,” Brant says.

Navigating Corporate Channels

Referral deals, where a bank or industry trade group suggests an ISO’s or acquirer’s processing plan to its constituents, have been around for a while. That’s because they work, and they remain a favored tool for acquiring merchants. In many instances, this can be a less expensive customer-acquisition tactic, which helps profit margins.

“Financial institutions, trade organizations, and buying groups are great sources of customer acquisition,” Ciabattoni says.

The downside is that the pool of financial institutions, particularly community banks, is shrinking because of consolidation, and some banks, even software vendors, are becoming ISOs, says Ciabattoni. For example, Mindbody, a San Luis Obispo, Calif.-based company that sells business-management software for health and beauty businesses, became an ISO in 2010.

Referrals from other merchants are essential, too. “Our salespeople are encouraged to cultivate relationships with our referral partners and clients, offering a truly consultative approach to payment processing,” Ciabattoni says. “We are not the cheapest processing company out there, but most of our clients enjoy working with a smaller company who knows them by name and steers clear of the unethical practices that have tarnished our industry’s reputation.”

Selling on a consultative basis requires more skill from the salesperson. At Allegiance, Brant looks for candidates without merchant-services experience. “I have yet to find an acquirer or competitor that has a sufficient training program,” he says. Hires with that experience would have to be untrained and then retrained in the Allegiance protocol, he says.

Brant doesn’t discount all sales experience, but he looks for candidates who understand businesses, such as those who have sold software in the business-to-business channel. “They understand how to navigate the corporate channels,” he says. Each new hire, regardless of experience, sits through a three-week training program where they are instructed in the Allegiance sales program.

“The salesperson has a very important role,” Brant says. If the salesperson can’t set the agenda of the sales call on the value of Allegiance’s services, the conversation could drift into the topic of price.

‘They Have To Adapt to Change’

The sales call, and the quality of the salesperson, are just as important for large acquirers, like Allentown, Pa.-based Harbortouch, which counts ISOs and agents as 85% of its sales force, says Jared Isaacman, chief executive.

As the payment-processing industry contends with having to provide basic services that yield minimal profit, it must find new services and products to sell. That means new technology, such as tablet point-of-sale systems, and that means training salespeople on these products.

Merchant-services salespeople must learn these new products and what they can offer merchants. “It’s something more complicated than credit card processing ever was,” Isaacman says. “They have to adapt to change. If they don’t, they are going to die.”

The transition has been challenging for some salespeople, Isaacman says. Whether or not a salesperson adapts tends to be self-correcting, he says. For example, the salesperson, or ISO, may be satisfied with the income from their share of the processing fees, but may notice it decreasing as time goes on, he says. “We’ve had a lot of our ISO partners say, ‘I wasn’t a believer two years ago, what can I do?’”

It’s not just tablet POS systems motivating ISOs and acquirers. Integrated software is quickly climbing as a sales priority for many. Witness Vantiv Inc.’s $1.65 billion deal to buy Mercury Payment Systems, or Global Payments Inc.’s $420 million deal to buy Payment Processing Inc. Both Mercury and Payment Processing specialize in integrated software services.

This approach anchors much of Harbortouch’s strategy, Isaacman says. “We are going to grow our business in ways that are sticky,” he says. That started in 2005 with a free POS terminal program. Added later was an electronic cash register before the launch of Harbortouch’s free POS system program in 2011. The equipment is free, but the processing services are not.

The very objective of this approach is to counterbalance the temptation of many merchants to shop on price. “It’s not that the merchant doesn’t want to pay as little as he can; they absolutely do,” Isaacman says. “It’s not that the merchant doesn’t want that $25 in savings, but when faced with replacing a POS system they ask what is that going to cost them. ‘Am I really going to replace the POS system and retain my employees?’ That’s just not worth it.”

‘The Nature of the Beast’

In the same way, business-management software is critical for merchants, and they’ll likely stay with that and may accept the payment-processing services coupled with it.

“As small-business owners become more reliant on business-management software, payment processing is becoming a secondary purchase based on which software solution they choose,” says Ciabattoni. “Many software solutions have one or two payment processors integrated, locking out the competition.”

In fact, Ciabattoni ranks offering software integrated with payment processing as the top tactic for countering margin compression. “Companies like Paypros and Mercury have proven this model to be extremely successful. Why did they sell for such high numbers? Because their software partners refer them, often exclusively. As a result, their portfolios have higher retention and higher margin.”

ISOs and acquirers will have to conjure new ways to sell merchants more than card-processing services. As Moussa says in his report, “The lack of innovation results from the rigid viewpoint that stops the majority of merchant acquirers from venturing outside of their core business (transaction processing), leaving the door open for software vendors to come up with solutions that merchants need and want, relegating processing to a mere commodity.”

Regardless of the mix of measures ISOs and acquirers use to earn higher profit margins, technology will play a key role.

“One thing is, if you agree it’s a commodity business you have to be able to rely on technology where it is appropriate to control costs,” says Larry Bouchard, senior vice president of business development and relationship management at Clearent LLC, a Clayton, Mo.-based independent sales organization.

Technology alone, however, is not enough to ensure an ISO or acquirer is equipped to fight eroding margins. “Somewhat more important than that is the ability to provide services and products that we believe are valuable to merchants, that make the merchant experience more pleasurable and have the potential to provide merchants with value to better manage their businesses, potentially increase sales, and control their own destiny,” Bouchard says.

Underlying that perspective is the acknowledgement that merchants view the acceptance of credit and debit cards as a necessary evil, Bouchard says. “Having said that, it’s not the merchant’s business to manage the credit card processing per se,” he says. Rather, the merchant-services provider is the payments expert.

For example, Clearent added a next-day funding service for some of its merchants. “It allows you to protect some merchants because at the end of the day you’re making his life easier,” Bouchard says.

Reversing margin compression isn’t easy. “It’s the nature of the beast,” Isaacman says. “It’s a commodity. We have all the same costs.”

For margins to improve, the task is straightforward, he says. “It has to be an integration of technology so you can provide more value so merchants don’t care about a $10 cost. That’s how you reverse the trend.”

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Ideas for Easing Margin-Compression Anxiety

1. Look for markets that others shy away from. Go where the majority of the competition is not willing or skilled enough to go, says Steve Ciabattoni, president of 360 Payment Solutions Inc.

2. Capitalize on referrals from existing clients and from partnerships with trade associations, software vendors, financial institutions and other entities. These can help lower the cost of acquisition, which boosts profit margins.

3. Work with independent software vendors to get them to offer your payment services an option with their business-management programs. Merchants using such programs tend to have great devotion to them.

4. Look for tools that merchants can use to interact with their customers, such as loyalty and rewards programs. These can help retain existing customers, increase their spending and potentially generate new business.

5. Avoid selling on price. Develop relationships with merchants, and be different from other merchant sales representatives, Ciabottoni says.