Acquiring: Is the National Merchant Market Near an End Game?

Marc Abbey

Competition in acquirer fees for large merchants is declining, cementing market shares in place. Here’s why.

It has long been the conventional wisdom in U.S. acquiring that the large merchant market was the most difficult, lowest-margin, most commoditized part of the business. Large merchants ranging from the lower mid-market (say, $50 million in annual volume) through large corporates (billions in volume) earned a reputation as brutally price-sensitive businesses that were not particularly loyal to their acquirers and not particularly value-centric.

To a large degree, these characteristics continue to be pretty descriptive of national merchants. However, there is a contrary view.

For scale-driven acquirers, the cost to process for a large merchant depends on the specific circumstances. But it would not be uncommon for costs to be 100 to 150 milles, and if the market will bear a few pennies per transaction in acquirer fees, the acquirer can generate a nice margin.

For the most part, large merchants continue to be the foundation on which much new-product development is based. In other words, acquirers disproportionately develop products for large merchants and then commercialize and roll the products out to smaller merchants. Further, though the acquisition cost related to a large merchant is often much higher than that for a small merchant, the acquisition cost per dollar of revenue generated is generally more favorable for national sales.

Finally, in some merchant industries, the large merchants have been the disproportionate beneficiaries of growth in the industry (e.g., a series of merchant industries were consolidating), and the acquirers serving the share-winning merchants have had better growth.

These are all long-standing observations, and serve as counter-arguments to the difficulty of serving large merchants. But now there is a new argument to add to these older ones: The large-merchant market is reaching an end game.

Lifetime Value

It is a well-established phenomenon that the attrition rates in large-merchant segments are well below the rates in small-merchant segments. It has not always been this way. There was a period in the 1990s when large-merchant attrition for most acquirers was very high as a small number of specialized acquirers consolidated market share.

However, for over a decade, attrition rates and merchant size have had an inverse relationship. Small-merchant portfolios routinely generate account attrition rates above 20% and as high as 30%, but large merchant segments rarely generate higher than single-digit attrition rates.

Combined with the fact that there are just not that many new $500 million merchants each year, it is easy to conclude that processing for large merchants is a game of merchant lifetime value and a very long effective life.

Almost a decade ago, First Annapolis completed a research effort in which we identified 337 merchants that had annual volume greater than $50 million and as high as many billions per year and that had had a change in acquirer fees per transaction in the period 2000 to 2004. Consider this a non-random sample, but on the other hand, the data were actual rather than estimated, as we had documentary evidence in every case of what the merchants’ pricing was.

We recently recreated this research, examining 487 merchants that had a change in their acquiring fees per transaction in the period 2009 to 2012 and that processed $50 million or more. There were 10 underlying acquirers that processed for these merchants, reflecting the fact that the large-merchant market is more concentrated than the small-merchant market.

Overall, comparing the two time periods, the rate of change in acquirer fees per transaction has come crashing down. In other words, acquirer-fee competition has abated.

Special Circumstances

This conclusion is probably counterintuitive for most readers, so let me explain. In the period 2000 to 2004, the weighted-average reduction in acquirer fees per transaction for the merchants we studied was 18%. (Not all merchants of this size had a change in acquirer fees in this time period, of course, but for the ones in our study that did, the average was an 18% reduction.) By contrast, over 2009 to 2012, the weighted-average reduction was only 1%.

Of the 487 merchants in the recent research, 273 actually had an increase in their acquirer fees per transaction. These increases resulted from several factors, including acquirers unbundling and pricing discretely component services they hadn’t priced for before, the introduction of new products or services, and, most frequently, the increases in pricing (through a series of common mechanisms—the introduction of fees, the unbundling of payment-network fees, and so on).

Incidentally, this is not a new phenomenon. In 2000 to 2004, 139 of the 337 merchants had an increase in acquirer fees per transaction, even though in both time periods the weighted average was a decline.

The weighted average reduction in acquirer fees per transaction overwhelmingly reflects renewal pricing as opposed to the pricing an acquirer would have to offer a merchant for it to migrate from a competing acquirer. Isolating the merchants in both time periods, however, that moved from one acquirer to another shows that the pricing incentive must be considerable to compel a merchant to move, but also shows substantial change over time.

In 2000 to 2004, a $50 million-plus merchant commanded nearly an 80% reduction in acquirer fees in moving from one acquirer to another. In this era, the merchants receiving this benefit tended to skew to the very large merchants and had the character of merchants moving from a tier-two acquirer to a tier-one acquirer (an acquirer that specializes in the large-merchant niche).

Between 2009 and 2012, merchants moving from one acquirer to another commanded just over a 45% reduction, and, unlike the earlier period, merchants that moved often did so because of special circumstances—an extraordinary event at their incumbent acquirer, a merger between two merchants, or some other factor.

Subsidiary Impacts

Nevertheless, the 1% reduction in acquirer revenue per transaction from 2009 to 2012 overwhelming reflects renewal pricing. Why is this happening? Why has the rate of change in acquirer fees fallen so much? Acquirers intensively service their large merchants almost universally. Acquirers also tend to integrate more deeply with large merchants and to customize processing and service elements for large merchants. These sorts of tactics tend to create some level of inertia and stickiness to the relationships between acquirers and their large merchants.

However, in addition, as a general statement, the level of acquirer fees for sizable merchants has been beaten down to a sufficiently low level that the further price reduction an acquirer can offer is not a sufficient nominal amount to compel a merchant to change acquirers.

Our hypothesis, stated another way, is that even a large percentage reduction in pricing is not enough in raw dollars for merchants to want to incur the operating risk and distraction of a migration to another acquirer. A 25% reduction, for example, in an acquirer fee of a penny or two per transaction may be chump change to the merchant.

Now, we’re talking in generalities, and, of course, there is a huge range of prices out in the market. And there still are many, many merchants that will have a business case to move. But the average large merchant increasingly does not.

The larger the merchant, the more descriptive of its behavior our hypothesis is, of course, but we have seen with our own eyes our merchant clients turn down a challenger-acquirer that had offered a big percentage reduction in acquirer fees because the raw numbers were not compelling. This phenomenon may very well make market shares stickier in the large-merchant space, which is why we think of it as an end game of sorts.

It certainly highlights the maturation of competition and underscores the need for truly differentiating capability, an elusive and short-lived advantage, mostly. It also highlights the need for a competitive intelligence-based sales strategy, to compete against acquirers with special circumstances.

This phenomenon may make players that are in adjunct business lines or have adjacent products more competitive as they may have a bigger economic pool with which to make a compelling business case for a large merchant (think Square/Starbucks or an offers company like Groupon, or PayPal’s demand-generation capabilities, for example). This phenomenon may put into a certain perspective the recent JP Morgan Chase initiative with Visa to create Chase Merchant Services with the objective of providing merchants (and cardholders) with an enhanced experience and additional sources of value.

It is likely that there will be subsidiary impacts as well. For example, acquirers that have traditionally focused on large merchants may have a particular need also to focus on smaller merchants down market. Vantiv’s moves over the past few years and First Data’s moves over a longer time frame may make particular sense in this context.

As with all aspects of acquiring, large-merchant competition continues to tighten, and time will tell if the raw economics of acquiring for large, thinly priced merchants are reaching the inflection points we think we see in the numbers. For those acquirers with an existing market position in the segment, however, this could be quite a favorable turn of events.

Marc Abbey is the managing partner for Baltimore-based First Annapolis and is responsible for the firm’s acquiring practice. Reach him at marc.abbey@firstannapolis.com.