Cover Story:The Rise of Merchant Aggregators

Often regarded as operating in a gray area, merchant aggregators let small businesses piggyback on their merchant accounts. But aggregators are moving to the forefront of payments innovation and winning new supporters.

By Peter Lucas

Complex, confounding, risky, upstart. These are some of the adjectives used to describe merchant aggregators since their inception.

And why not? Merchant aggregators are cut from different cloth than traditional processors and therefore defy conventional wisdom. Not only do they focus on so-called micro merchants in underserved vertical markets, they also come in a variety of shapes and sizes and offer merchants distinct services to help them grow, differentiate and better manage their businesses.

Merchant aggregators essentially permit small businesses to accept credit and debit card transactions without having a merchant account. Instead, the merchants “ride” on the aggregator by using its account to submit transactions into the card networks.

Some of the largest aggregators began as payment technology plays and have since evolved into brand names such as PayPal. The eBay Inc. subsidiary was born as a low-cost payment option for mom-and-pop e-commerce merchants that would otherwise have difficulty qualifying for a merchant account through a merchant-acquiring bank. Since then, PayPal, which declined to comment for this story, has blossomed into the No. 1 alternative e-commerce network and also has become the mobile-payments leader, with $14 billion in volume last year.

At the other end of the spectrum lies Amazon.com Inc.’s Checkout by Amazon. Essentially a digital wallet, Checkout by Amazon is designed to simplify and expedite payment to online merchants. The wallet contains a consumer’s payment, billing and shipping information, which can be quickly downloaded to a merchant’s Web site during checkout.

Other aggregators such as Square Inc. took advantage of changes in Visa Inc. and MasterCard Inc. rules to expand merchant aggregation beyond the card-not-present arena. Subsequently, Square has enabled the likes of plumbers, hot dog stands and arts-and-crafts fair exhibitors to accept card payments through their smart phone via its now-famous cube-shaped dongle that sits atop a mobile phone. Square’s success has given rise to a host of imitators.

Fearful their businesses would be steamrolled by large aggregators, many small independent sales organizations have moved into merchant aggregation in an attempt to level the playing field. Like their larger brethren, ISOs that act as merchant aggregators process transactions for merchants on their own merchant account, rather than establishing an account for each seller. This allows the sub-merchant to get set up through a streamlined underwriting process and begin accepting transactions sooner than if they applied for a full-fledged merchant account.

Stigma Fades

Despite the potent technology behind some of the best known merchant aggregators, traditional processors have tended to view them as one-trick ponies, i.e. alternative, low-cost payment options that offer little in the way of value-added services. And until the last few years, Visa and MasterCard rules made it hard for aggregators to get up and running outside of e-commerce.

Today, the stigma around merchant aggregators is fading fast. The new breeds of merchant aggregators are seen as conduits for the networks to expand card acceptance downstream to merchants that previously could not afford a merchant account or generate enough volume to qualify for one.

“There are a lot of small merchants in niche markets that are underserved when it comes to card acceptance and as technology companies, merchant aggregators are able to provide their merchants tools and services that processors serving traditional merchant channels cannot,” says Deirdre Paone Cohen, vice president of Channel Management and Business Development for Wells Fargo Merchant Services.

The list of new-breed aggregators includes such companies as Uber, a San Francisco-based startup whose mobile application connects consumers with operators of limousine or so-called luxury black car services, taxis and non-taxi ride sharing. Airbnb, another San Francisco aggregator, connects consumers with owners of rental properties around the world online. Chicago-based WyzAnt.com connects tutors with students seeking their services, and Brooklyn, N.Y.-based Etsy provides sellers of handmade and vintage goods a marketplace to sell their products, a la eBay.

In each case, the sub-merchants within these aggregated communities are not only able to accept card payments and have those transactions processed through their respective aggregator, they also gain access to analytical and marketing tools to help them grow their businesses.

The convergence of marketing and payment acceptance is arguably one of the most powerful draws for micro merchants to merchant aggregators. LevelUp, the mobile-payments unit of Boston-based SCVNGR Inc., recently demonstrated the power of this concept with the launch of a Facebook integration application that enables LevelUp users to receive offers and coupons sent via the huge social network.

Using their Facebook accounts, LevelUp users can forward an offer to Facebook friends. Recipients can download it to their LevelUp wallet on their mobile phone by clicking on the “Claim This Offer” button in the message.

‘A Viral Hot Spot’

So far, offers made available through Facebook are averaging 1,000 views, and are downloaded by an average of five LevelUp users. Of those five users, up to two redeem the offer 14 to 30 days after downloading it.

“This feature has made social media a viral hot spot for us,” says SCVNGR chief executive Seth Priebatsch.

Consumer redemption of Level­Up coupons and offers is central to the provider’s business model because LevelUp doesn’t charge interchange, even though consumers fund their LevelUp wallets with a credit or debit card. Instead, LevelUp’s 5,000 merchants pay fees of 35 cents per dollar on incremental sales generated by the redemption of rewards earned by their customers. To complete a purchase, LevelUp users launch the barcode within their wallet that accesses their account and scan it at the point of sale.

“Connecting marketing and payments is certainly one place where merchant aggregators can play,” says Wells Fargo’s Cohen.

Organizing merchants into communities and providing them with the tools to better manage and grow their businesses is another reason aggregators appeal to micro merchants. An aggregator can consolidate a fragmented market and make it easier for consumers to find merchants within that market.

Market unification is central to WyzAnt.com’s business plan. The idea for the business came to co-founder and chief executive Andrew Geant as he was looking for ways to promote his tutoring services online. Geant quickly discovered that there were no quick ways to connect tutors and students. Then he hit upon the idea for WyzAnt.com.

“As an aggregator, one of the things we do is help bring together a fragmented marketplace that helps students find tutors and vice-versa,” says Geant. “That in itself is a value-add, because it is the consumer that actually hires the tutor.”

WyzAnt.com performs all back-end administrative and marketing functions for its tutors, including payment processing. In exchange, tutors pay a commission of between 5% and 40% of their hourly fee to WyzAnt.com, based on the number of hourly sessions booked through the site. Tutors typically charge $40 to $60 per hour. WyzAnt.com currently has more than 65,000 tutors on its site.

“A lot of tutors can’t accept credit cards and many parents prefer the idea of being able to prepay for tutoring sessions with a credit card,” Geant says. Consumers pre-purchasing tutoring services in bulk through WyzAnt.com can receive discounts, such as 15% off for $1,000 of tutoring services, he adds.

Like many aggregators, WyzAnt.com offers its sub-merchants more than just payment processing. Tutors are provided the tools to create a marketing flier and embed a QR code in it that when scanned, takes the consumers to their profile on WyzAnt.com. Consumers arriving at the Web site through this manner are tracked and when they purchase sessions from the tutor, the tutor pays a preferred commission rate on that purchase, which in some cases can be zero.

Other value-added tools in the works include the ability for tutors to administer online quizzes to their students and the sharing of assignments and completed homework between tutor and student through the site. WyzAnt.com performs all marketing for its tutors online using such channels as search engines and affiliate marketing.

“Online marketing is complex and competitive and for most tutors, marketing themselves online is tough. Most prefer to focus on the teaching end of their business,” says Geant.

Giving micro-merchants tools to manage and expand their business is becoming a bigger focus for merchant aggregators. For several aggregators, this means making their application programming interface (API) codes available to merchants to create mobile or online-payment applications. In taking that approach San Francisco-based Stripe is looking to simplify the application-development process for online and mobile merchants.

After signing up for a Stripe account, merchants integrate a few lines of JavaScript from the Stripe API into their Web site’s source code to connect to Stripe’s servers. Online merchants using Stripe can build their own branded checkout application. At checkout, consumers are prompted to enter their card information. The data are then transmitted to Stripe, which screens the transaction in the background for potential fraud before processing it. Stripe also stores the customer’s card data, thereby relieving the merchant of needing to comply with all of the provisions of the Payment Card Industry data-security standard (PCI).

Merchants are charged 2.9% of each transaction plus 30 cents. Receipts are deposited in the merchant’s bank account in about seven days. Stripe does not charge setup or monthly fees, as well as no validation, card storage or failed payments fees. Nor are merchants required to meet a monthly transaction minimum. Merchants are charged $15 per chargeback.

“As an aggregator, Stripe is helping simplify adoption of payments acceptance and by doing that they are bringing more small merchants into the payments ecosystem that might otherwise might not be able to join it,” says Todd Ablowitz, president of Centennial, Colo.-based Double Diamond Consulting LLC, which specializes in helping ISOs become aggregators.

Last Month, Stripe began testing its technology platform in the United Kingdom. The company plans to gradually release its APIs to merchants throughout Europe. Among the features to be included is currency conversion. Stripe did not respond to interview requests.

‘It’s the Little Things’

Like Stripe, LevelUp makes its APIs available to merchants wanting to create their own branded mobile-payments application, and it also provides a migration tool so merchants can link their existing loyalty programs to the LevelUp wallet. LevelUp’s merchants can access real-time analytics on individual loyalty-program members to track their shopping behavior, what stores they frequent and demographic data, as well as track cross-merchant behavior at the batch level for enrolled customers.

“Our loyalty-migration tool is a way for merchants to streamline how they interact with consumers through their loyalty program, because the consumer no longer has to remove the loyalty card from their wallet and swipe it at the point of sale,” says Priebatsch. “The capabilities we are offering are not possible with older loyalty programs.”

Regardless of how sophisticated the technological tools are that merchant aggregators offer, if merchants don’t embrace them, the aggregator will fail. The key to success then is for the aggregator to understand all the needs of the merchant segment it is targeting.

“It’s the little things like talking to a live service agent that is knowledgeable and responsive that can make the difference in attracting and retaining merchants,” says Rick Noble, chief executive of North Kansas City, Mo.-based BCC Merchant Solutions, parent company of BankCard Central, an ISO that aggregates merchants outside the United States.

Indeed, Nelson Novak, a Deerfield, Ill.-based jewelry designer, says he moved his online business from eBay to Etsy.com out of frustration with PayPal’s customer service.

“With Etsy, I am not calling into an automated phone bank when I have a question or issue with a payment, I can speak to a live agent,” says Novak. “For a small-business owner such as myself, that’s very reassuring.”

Among the other features that attracted Novak to Etsy is its ability to network with other sellers of jewelry and gems and form communities through which they can cross-market themselves on one another’s site. Etsy provides analytical data notifying its merchants about which search engines customers use to arrive at their store, such as Google Australia. Such information can be used to help merchants hone their search-engine marketing strategies.

Etsy merchants receive statistical data summarizing their transactions for the past seven days, the total amount of those transactions and what the merchant has paid in taxes and fees to Etsy. The company declined to be interviewed for this story.

“There is just a lot more information and marketing help available that can help me grow my business compared to PayPal,” says Novak. “With the tools it provides, I feel like Etsy is taking a genuine interest in helping grow my business.”

Despite all their new bells and whistles, merchant aggregators are not without their critics. A big concern is profitability and slack risk management as aggregators compete for business from small, unproven merchants.

“There are a lot of aggregator business models popping up that are not viable,” says Henry Helgeson, chief executive of Merchant Warehouse, a Boston-based ISO. “Transaction processing is a hyper-competitive business and aggregators that do not add value around processing have to compete by selling their service below cost, and that’s a slippery slope.”

Granted, micro merchants by themselves may not generate enough transaction volume to offset a processor’s fixed costs, which include PCI compliance. Processors then face the choice of either passing such costs along to the merchants, which could make their service too expensive, or eat them for a while and hope the merchant quickly generates enough volume to become profitable.

A FANF Siren Song?

“The key for the aggregator is to have solid risk-management tools to prevent losses due to bad merchants and provide services that add value around processing, otherwise it will be tough for them to make money,” says BankCard Central’s Noble.

Still, some industry executives such as Helgeson wonder if Visa’s Fixed Acquirer Network Fee (FANF), which is capped for aggregators at $40,000 monthly, regardless of additional volume, will be incorrectly viewed by potential aggregators as an incentive to actually become one simply to lower their costs, even if they don’t have the other elements needed to succeed in the aggregator market (“What’s This FANF Thing All About?” September, 2012).

Payment experts agree that while FANF’s cap can be attractive to some ISOs, the decision to become an aggregator should be based on other factors, such as using technology to consolidate merchants in a fragmented market and deliver added tools that can increase sub-merchants’ card volume.

“By itself, FANF is not a reason to become an aggregator, because there is so much more to the business case for merchant aggregation,” says Deana Rich, president of Los Angeles-based Rich Consulting, which advises aggregators.

Other industry executives reinforce the point that aggregation success requires much more than correct pricing.

“There is always a risk that processing will be treated as a commodity, but the aggregators that only offer commodity pricing won’t be able to compete long-term,” says Jason Pavona, executive vice president for Lowell, Mass.-based Litle & Co., an acquirer for e-commerce merchants. “Market leaders are innovators, and many aggregators are providing products and technology that were not thought possible. Aggregators have not only proven they can co-exist with traditional processors, they’ve shown they are here to stay.”

Some Aggregators That Are Making Names for Themselves

Uber: The San Francisco startup serves more than 25 major domestic and international markets, including New York, Chicago, Los Angeles, Berlin, Milan and Singapore. Consumers launching Uber’s mobile app are shown available licensed car services for hire in their area. Cars are reserved through Uber’s mobile app, which can also track a car’s proximity to the consumer. Uber keeps the consumer’s credit card on file for each booking and pays the service provider.

Airbnb: Founded in 2008, Airbnb connects consumers looking for rental properties across a variety of price points in more than 33,000 cities and 192 countries. Accommodations can range from an apartment or condo to a castle or villa. In 2012, the aggregator launched Neighborhoods, a series of online travel guides to help tourists identify places to see and things to do while at their destination. The site has more than 300,000 listings worldwide and consumers have booked more than 10 million nights since its launch.

Etsy: Co-founder Rob Kalin conceived of the online marketplace in 2005 as an alternative to marketplaces he felt had become cluttered with overstock electronics and secondhand appliances. Etsy has 25 million members, attracts 42 million unique visitors a month and has more than 850,000 active shops listing more than 18 million items. In 2012 merchandise sales totaled $895.1 million, up from $525.6 million in 2011.

WyzAnt.com: This tutoring marketplace has boot-strapped its business from inception, eschewing venture capital. The company serves all metropolitan markets in the United States and represents tutors across more than 250  subjects. WyzAnt is testing an online application tutors can use to supplement their regular practice. Since WyzAnt.com’s inception in 2005 more than 1 million hours of tutoring have been booked through the site.

Due Diligence Is Key for Merchant Aggregators

Individually, micro merchants may not generate much payment card charge volume, but aggregators still need to properly underwrite them in order to avoid chargebacks and fraud.

“Merchant aggregators need solid risk-management tools in place just as much as traditional processors, and it all starts with asking whether the sub-merchant’s business is viable and its business plan makes sense,” says Rick Noble, chief executive of BCC Merchant Solutions, parent company of BankCard Central, an independent sales organization that does merchant aggregation outside the U.S.

Paying close attention to a sub-merchant’s monthly goal for card volume is critical, as it can indicate whether the merchant is fronting for a fraud ring. Noble recalls one small merchant being vetted by his firm that said it expected to generate $5,000 a month in credit card sales. Given that the merchant said it was selling guns for export to South America, that figure immediately raised a red flag.

“We have worked with merchants that sell guns internationally and the figure for monthly card sales was too low based on our experiences in that merchant segment,” says Noble. “We turned the merchant down. Merchants that are in collusion with a criminal ring are always looking for different ways to exploit the system.”

On a related note, best practices for underwriting a sub-merchant include ascertaining whether the business will hit its monthly sales target consistently.

“The concern is not just that they will fall below their target, but that they exceed their monthly target on a regular basis,” says Noble. “That’s an indication of possible merchant collusion. You also want to make certain the merchant is selling what they claim to be selling.”

Validating a micro merchant is not always easy when it is an individual selling a service, such as tutoring. Chicago-based WyzAnt.com provides consumers access to a background-check service on all of its tutors and verifies their subject-matter knowledge before accepting them. WyzAnt also monitors consumer feedback about tutors.

“We guarantee payment to the tutor and if there is a dispute, we will issue a refund to the student, but our goal is to prevent customer dissatisfaction through validation of the tutors on the front-end,” says chief executive Andrew Geant. “We play a big role in the customer-service aspect of tutoring.”

Acquiring experts also admonish merchant aggregators to understand all regulations that could affect them. In January, Square Inc. got hit with a cease-and-desist order from the state of Illinois for being an unlicensed money transmitter. Illinois also issued similar orders to seven other payments companies, including prepaid card program manager NetSpend Holdings Inc. Both Square and NetSpend said in March that they were still processing transactions from Illinois customers and indicated they were working with authorities to resolve their issues.

“What happened to Square is an example of why aggregators need to know regulatory compliance in all 50 states,” says Todd Ablowitz, president of Double Diamond Consulting LLC.