Value-added resellers have turned into very effective—but increasingly expensive—sales engines for merchant processors. When does it make sense to work with them—and just how much of a cut do they take?
By Peter Lucas
Ten years ago, value-added resellers looking to broaden their reach to merchants were aggressively pursuing relationships with processors. Payments, after all, was a ubiquitous application that found its way into every merchant category, some of which VARs could not yet reach.
Processors, for their part, liked the idea of bundling their products and services with the specialized front- and back-office applications developed by VARs. It provided a point of differentiation that translated into higher margins in a commodity business. Even better, most VARs were content with a small percentage of the transaction fee, and in some cases would even forgo that revenue just to get their foot in the merchant’s door.
How times have changed. Today, it is processors seeking out relationships with VARs that can help them sign and retain merchants. And because payments now is an integrated component of the merchant’s software platform, as opposed to being a standalone component, some processors are willing to pay VARs a hefty cut of their transaction fees—as much as 50%—in exchange for selling processing services with their software.
“VARs have become an important part of the processing business because they are the ones that make the solutions to which processors are integrating their products and services,” says Adil Moussa, a senior analyst for Boston-based research firm Aite Group LLC. “The competition among processors for relationships with VARs is getting so stiff that a lot of processors are paying a substantial portion of the transaction fee to become a VAR’s first choice for offering payments to a merchant.”
No Wow Factor
In 2011, VARs and independent software vendors (ISVs), which also provide specialty applications to merchants, were the third largest producers of new merchant accounts, generating an estimated 15% of them, up from 11% in 2009, according to Moussa. Direct sales forces led the way, signing 32% of new accounts; independent sales organizations netted 21%.
Given their growing influence in the world of transaction processing, VARs are projected to sign 24% of new merchants in 2013, supplanting ISOs for second place. Given their meteoric rise, it is possible that VARs may one day be responsible for signing the majority of the new merchant accounts, says Moussa.
To back up his claim, Moussa points to Mercury Payment Systems as an example of a processor that relies solely on VARs and ISVs as its sales force. As part of its deal with VARs, Mercury is pitched as their preferred payment processor.
“Mercury relies on VARs to be its feet on the street. Their strategy is to have VARs sell their products and services to merchants,” says Moussa. “The role VARs play in signing new merchant accounts is only going to get bigger with time, so the focus now for processors and acquirers is to partner with VARs that will recommend their services first to the merchant.”
Mercury declined to be interviewed for this story.
The growing influence of VARs in the acquiring business is directly linked to the commoditization of transaction processing. At its most basic level, processing is contacting a consumer’s card issuer for real-time authorization and routing the transaction to the merchant’s acquiring bank once the transaction is completed. There are no bells and whistles that create a wow factor for the merchant. Instead, processors compete almost solely on price.
The need for a value-add component as a point of differentiation is where VARs come into play. Since VARs create the software to run a merchant’s front and back office, they have tremendous influence with merchants when it comes to recommending add-ons, such as payment processing, and in turn can help processors open new markets.
With VARs so numerous that it is almost impossible to count them, processors can expect to find a VAR hawking applications in every merchant category. “We have a VAR in every industry we service,” says Bruce Dragt, senior vice president for payment acceptance at Atlanta-based First Data Corp., the massive payments processor. “VARs will go to merchants of any size, even Mom-and-Pop merchants, in any industry as long as they have an application the merchant wants.”
In many cases, a VAR’s application helped processors crack new vertical markets, since it makes more sense for the merchant to bundle it with payment processing. Some of the merchant segments VARs have helped processors open up over the past decade include taxis, quick-service restaurants, Laundromats, and health care.
Health care is a market where VARs played a significant role for processors because of the complexity of the applications used by health-care providers. These apps typically combine such functionality as patient management, insurance-claim processing, and acceptance of patient deductibles at the point of sale. Including payments processing is a natural fit for VARs.
In addition to opening new markets, VARs help processors retain price- sensitive merchants, such as restaurants. VAR applications enable restaurateurs to integrate, with payments at the point of sale, such functionality as employee time and attendance, table-turnover rates to project wait times, and the profit yield per table. This combined functionality enhances the value of the processor’s services, making it harder to displace.
“VARs tend to be on the cutting edge of technology and having the technical capability to plug their applications into our solutions creates a stickiness that not only grows our business, but results in lower attrition than if one of our sales representatives signed the merchant,” says Jeff Sloan, president of Global Payments Inc.
The extent of a VAR’s influence over the merchant account, and consequently its cut of the transaction fee, is determined by the size of its customer base, sales force, and service center. The largest VARs, such as IBM Corp., Intuit Inc., and Radiant POS Systems, not only serve as the feet on the street for the processor, but in some cases provide the first line of service for them.
The ability of these VARs to deliver a full turnkey business solution to merchants that includes processing and service enables them to command the lion’s share of the transaction fee because the processor only provides its core service.
“When we just provide processing, then we’ll give up a bigger cut of the transaction fee because the VAR becomes our distributor,” says Greg Cohen, president of the USA Group for Schaumburg, Ill.-based processor Moneris Solutions. “It makes sense for processors to leverage a VAR’s merchant relationships where possible to increase distribution of their products and services and vice versa.”
The percentage of the transaction fee earned by the VAR depends on a variety of factors, such as the size of its merchant base, how easily payments can be integrated into its application, and the size of its support and sales staff.
“There are VARs that can have huge client bases and tight relationships with their clients, but if their application does not enhance payments or is not a good fit technically, there’s no real benefit to the processor,” says Ken Musante, president of Eureka Payments, a Eureka, Calif.-based provider of payments processing and gateways. “What a VAR earns from a processor comes down to how critical their application is to selling the processor’s services.”
On average, VARs earn 10% to 20% of the transaction fee, according to payments experts. Aite’s Moussa places the figure at 16%, which earned them an estimated $2.3 billion from merchant transaction fees in 2011, up from $1.7 billion in 2009. Ultimately, Moussa predicts VARs’ cut will rise to between 25% and 30% of transaction fees.
“The competition for VAR relationships is creating a bidding process for their services, which is escalating their cut,” says Moussa.
VARs whose percentage of the transaction fee is at the lower end of the pay scale are usually niche-oriented and capable of only delivering a few hundred merchants or less or are so new they are unknown in the merchant community.
Conflict of Interest
Some small VARs will also look to processors to help provide basic customer support for their application if they have approached the processor about writing a payment module specific to their platform or if they want to write a module specific to the processor’s platform. In these instances, there is enough crossover between the products that some processors feel comfortable providing initial support on behalf of the VAR.
“There are times it may require us to collaborate with a VAR on providing basic service for their application, but we typically look to them to service their application as they know it better and we service our end,” says First Data’s Dragt.
For processors, a key criterion for selecting a VAR partner is the cultural fit between the two companies. “Partnering with a VAR that is a leader in their industry is important, but it’s just as important to have good chemistry and similar business goals to avoid conflicts,” says Jeff Alderman, director of marketing for North American Bancard, Troy, Mich. “Some VARs come to us because our products and services are a way for them to generate incremental sales or break into new markets.”
Indeed, Radiant and Intuit are two VARs moving into payments processing. Radiant reportedly offers processing through an ISO and Intuit, which owns an ISO, offers gateways.
While processors do not insist on exclusive arrangements with their VAR partners so the VARs can service a merchant that uses a competing processor, VARs morphing into processors represents a conflict of interest.
Rectifying that conflict depends on the processor’s business objectives. Some processors say they are willing to work with VARs that offer processing gateways as long as they have a chance to pitch their processing services to the merchant.
It’s when there is a clear conflict of business interests that processors say they will end a VAR relationship. “We can work with VARs that offer gateways, but we don’t work with VARs offering their own processing services,” says Jim McCole, executive director for affiliates at Heartland Payment Systems Inc., Princeton, N.J. “Our goal is to embed our services into the VAR’s solution to help them offset the margin compression they are experiencing as the price of the hardware they sell comes down.”
There is another downside to partnering with VARs: They can be the weakest link in a processor’s security chain. The vulnerability stems from smaller merchants running older versions of VARs’ software that are not compliant with the Payment Card Industry data-security standard (PCI). When these older versions are integrated into payments processing, the move can inadvertently poke a hole in the processor’s firewall.
To combat the problem, processors typically insist that VARs be PCI-compliant. Some processors, such as Heartland, go further, offering merchants signed through VARs additional data encryption on all transactions. Other processors, such as Global Payments, subject VARs to a certification program to evaluate the risk of doing business with them.
“If the underwriting process raises any red flags about the security of the VAR’s application, they are not certified until those concerns are addressed,” says Sloan. “VARs, however, do understand the importance of data security.”
As the role VARs play in signing merchants increases and more VARs look to expand into offering processing services, payment experts ultimately see processors creating more of their own value-added applications to increase their value to the VAR and protect their margins.
“There is a lot of payment technology processors can provide around mobile payments and e-commerce, for example, that are unique tools VARs can leverage to attract new business,” says North American Bancard’s Alderman.
Opportunities also exist for processors to strike partnerships with VARs outside the United States and Canada. “There has not been a lot of internationalization of VAR relationships because VAR technology can vary dramatically region to region globally, but that is a potential next step for processors with an international presence,” says Global Payments’ Sloan.
With VARs firmly entrenched as strong allies of processors, expectations are that processors will strive to expand and strengthen their VAR relationships.
“Partnering with VARs is another hook that increases the value of a processor’s services to the merchant and helps solidify merchant relationships,” says Alderman. “There are a lot of mutual benefits to be gained from processors and VARs partnering with each other.”