Trends & Tactics

Vantiv-Mercury: Bad News for ISOs?

Mercury Payment Systems LLC made its reputation as the leader in a rising niche of independent sales organizations that offer payment processing as part of business-management applications sold to merchants by software developers, dealers, and value-added resellers.

In contrast, many ISOs still peddle straight payments differentiated by little more than price.

Now Vantiv Inc., the nation’s third-largest merchant acquirer, is buying Mercury in a $1.65 billion deal that could be completed by month’s end. And with that close may sound the opening notes of the funeral dirge for traditional ISOs, according to payments-industry researcher Rick Oglesby, senior analyst at Centennial, Colo.-based Double Diamond Payments Research.

The reason: Apart from interchange, which they can’t control, ISOs’ merchant pricing is now low enough that it can’t go much lower, and their expenses are rising because they’re paying more in commissions to attract and retain good sales people. But ISOs in the so-called integrated space have not been stabbed by that pitchfork.

“Beginning in the mid-to-late 1990s, a small group of acquiring firms decided to get involved in a different race altogether. Their race was the technology race, where software was transforming the way that merchants ran their businesses,” Oglesby wrote in a May 14 commentary for Digital Transactions News.

“By providing software-centric payment solutions to independent software vendors (ISVs), these firms became the payment processors within a series of highly differentiated business-management software products that were sold on value, not on cost. Recent advancements in cloud and mobile technology have dramatically lowered the cost of software product delivery and therefore created a booming ISV marketplace. Therefore, ISV-focused payments firms achieved growth that far exceeded that of traditional acquirers.”

Merchants using such software packages proved to be less inclined to switch their business to the next ISO that offered a lower discount rate, which resulted in reduced attrition for the integrated ISOs and enabled them to pay below-average sales commissions.

“Naturally, they rapidly climbed the acquiring ladder from tiny startups to highly relevant, competitive, and valuable firms,” Oglesby says. “Not only that, but the software race is far from over.”

Those market features are what Charles Drucker, Vantiv’s president and chief executive, trumpeted in a conference call after he and Mercury chief executive Matt Taylor announced the deal. Mercury works with 600 software developers and more than 2,400 value-added resellers/dealers.

“We estimate it is equivalent to 13,000 feet on the street,” Drucker said. “Vantiv and Mercury will create a winning combination of technology, distribution, and scale that we believe is unparalleled in the industry.”

Mercury’s transactions have been growing at a 44% compounded annual rate since 2005. Drucker said the firm has penetrated only about 10% of the merchants in its network.

Symmes Township, Ohio-based Vantiv isn’t the only big acquirer eyeing the integrated-payments space. For the past two years, Vantiv and Atlanta-based Global Payments Inc. “have been taking turns acquiring the largest of the ISV-centric payments firms,” says Oglesby.

Global’s acquisitions include Accelerated Payment Technologies, which it bought for $413 million, and PayPros for $420 million. Vantiv acquired Element Payment Services Inc. for $163 million. Now comes Vantiv’s bid for Mercury, which is 62% owned by private-equity firm Silver Lake and had been planning an initial public offering of stock.

Others in the ISV space include Braintree Payments Solutions LLC, now owned by PayPal Inc. parent company eBay Inc.; Stripe Inc.; MerchantWarehouse.com LLC with its Genius platform, and EVO Payments International. “And even Visa [has] jumped into the ISV race as well,” Oglesby adds.

“So if you haven’t yet gotten the message, it’s now ISVs—not ISOs—that have the superior payments-distribution model. If you want to make money in payments, the lesson is clear: You must either sell through the ISV, or you must be an ISV. Both require a new product strategy. Neither requires an ISO.”

Taylor said Vantiv will bring scale to Mercury and enable it to reach merchants and market sectors that would be difficult on its own. “There are features on Vantiv’s platform that we don’t have today,” he said.

Taylor and his management team will remain with the company, which will stay in its headquarters town of Durango, Colo.

The Mercury acquisition is not without risks for Vantiv. The company is funding the deal entirely with debt, although chief financial officer Mark Heimbouch said the average cost of the financing will be only a shade over 3%.

Some analysts questioned Drucker about possible conflicts with Vantiv’s existing ISOs. Drucker said Vantiv has been able to “manage through” conflicts in the past and could handle any issues.

Another asked about the lawsuit that merchant acquirer Heartland Payment Systems Inc. filed in January against Mercury, accusing the processor of deceptive sales practices. Drucker said Vantiv considered the suit as part of its due diligence.

“We intend to continue to defend this vigorously,” he added.

—Jim Daly

Welcome to the EMV Doldrums

With a crucial deadline looming in 2015, the U.S. payments industry will have only partially converted to the Europay-MasterCard-Visa (EMV) chip card standard by the end of that year. Indeed, it will likely take years to equip small merchants especially to accept EMV. That glum assessment comes courtesy of a report released last month by Javelin Strategy & Research, Pleasanton, Calif.

Card issuers will lag significantly as well, according to Javelin. They will have issued 166 million EMV credit cards and 105 million EMV debit and prepaid cards by the end of 2015, but this will account for just 29% and 17% of the total cards in circulation by then, according to the Javelin forecast.

Not until the end of 2018, fully three years later, will issuers achieve anything like full issuance, at 96% penetration for credit and 98% for debit and prepaid.

Both issuers and merchants face an October 2015 deadline from the major card networks to be prepared for EMV, a 20-year-old chip card standard already well established in the rest of the developed world. By that date, liability for counterfeit card fraud will shift to the party not equipped for EMV. Gas stations have until October 2017.

But those expecting that the U.S. payments infrastructure will have largely adopted EMV by the end of next year will be sorely disappointed, according to the Javelin report. While more than half of merchant locations will be EMV-ready by the liability-shift date, no more than a quarter of stores with fewer than 20 employees will be, the report forecasts.

Part of the problem with small merchants is that many aren’t even aware of the deadline, let alone the time and cost involved in installing new point-of-sale gear and training staff, says Nick Holland, a senior analyst at Javelin and author of the report.

“There’s going to be a long tail of smaller merchants,” he says. “There’s going to be a great deal of unreadiness. There’s a liability shift happening and they just don’t know about it.”

Consumers, too, aren’t ready, Holland says. Cardholder behavior with chip cards is radically different from the swipe-and-go experience consumers are accustomed to with mag-stripe transactions. Chip cards require cardholders to insert, or “dip,” the card in a POS reader for a period of time. Consumer confusion is likely to slow down checkout lines, Holland warns.

Contactless technology would help, but Holland projects that most U.S. EMV cards issued over the first few years will not include wave-and-pay capability, primarily because of cost. Each chip card will cost issuers $3.50 on average, or a cumulative total of more than $4.2 billion by the end of 2018. Adding contactless capability would swell that per-card cost by $1, Holland estimates.

“It’s already a sizable cost for issuers to put out EMV cards at all,” he notes. “The delta between contact and contactless is significant.”

And while more than 50% of merchant terminals are forecast to be contactless-capable by year-end 2015, that doesn’t mean they’ll be performing contactless transactions. “It’s almost not an option,” Holland says, referring to new POS devices that are shipping with both EMV and contactless capability built in. “But that doesn’t mean [contactless capability] will be turned on.”

The hardware tab for merchants will total almost $2.6 billion by the end of 2018, Holland forecasts. This cost doesn’t include the toll for training, software, or maintenance.

Given the current state of unreadiness, the Javelin report recommends networks immediately launch programs to educate consumers and merchants about EMV. Merchants and issuers, meanwhile, should form EMV project teams to devise rollout strategies and budgets, including testing and deployment plans, Javelin advises.

—John Stewart

Apple Adopts NFC—for POS Via a VeriFone Sled

There may be many laggards among merchants when it comes to EMV readiness, but apparently Apple Inc. will not be one of them. The computing giant is not waiting for a key date in the U.S. migration to the Europay-Visa-MasterCard smart card payment standard to equip its 254 U.S. stores with compatible mobile point-of-sale hardware.

In an exclusive deal, Apple has begun using mobile POS devices produced by VeriFone Systems Inc., the San Jose, Calif.-based payment-terminal maker says.

Apple outfits its employees with mobile devices to expedite checkout inside its stores. Clerks use iPod touches as part of Apple’s EasyPay payment system, which allows iPhone users to walk into an Apple store, take an item off the rack, scan its barcode, enter an Apple ID and three-digit card-verification value to make payment, and walk out.

Now Apple will use the VeriFone PayWare Mobile e315, an iPhone 5- and iPod touch 5-compatible case that includes both magnetic-stripe and chip card readers and a near-field communication chip for contactless payments. The case also has a built-in PIN pad and a 2D laser barcode imager.

While the payments world has long expected Apple to incorporate NFC in its phones, to date, no Apple devices are equipped with NFC chips. Apple did not respond to a Digital Transactions inquiry about the VeriFone case and its use in Apple stores.

Apple could be preparing for the October 2015 liability shift associated with the U.S. migration to chip cards using the Europay-Visa-MasterCard payment standard.

“The key important factor here is that Apple is upgrading to EMV readiness in the United States,” says Rick Oglesby, senior analyst at Double Diamond Payments Research, a Centennial, Colo.-based payments consulting firm. “They are obviously a pretty large merchant so we can add them to the list of large merchants that are going EMV-ready in advance of the deadline.”

The move also is important to VeriFone, Oglesby notes. “Any movement towards EMV migration is important for VeriFone, which is in a position to make a lot of money during the transition,” he says. “Having Apple on its books as a customer will be an additional boost for VeriFone since Apple is perceived to be a trendsetter in the market and other companies are likely to follow Apple’s lead.”

Apple is keenly watched for any movement within payments, with Tim Cook, its chief executive, earlier this year calling mobile payments “a big opportunity on the platform.”

Though the adoption of EMV-capable mPOS hardware is notable, what it does not portend is anything specific about Apple’s potential long-term digital-wallet strategy or the inclusion of NFC on future iPhone models, Oglesby says.

“NFC is already included in the VeriFone off-the-shelf sleds, and the [card] networks incentivize merchants to adopt NFC/contactless technology within the EMV migration roadmap,” he says. “It therefore wouldn’t make sense to purchase non-NFC sleds, which would need to be custom-made, would cost more, and would delay the implementation schedule. Therefore, we can’t draw any conclusions regarding the future of Apple and NFC based on this change.”

—Kevin Woodward

Visa Puts Its Rulebook on a Crash Diet

One of Visa Inc. chief executive Charles W. Scharf’s major themes since taking the helm last year has been to make the biggest payment card network seem less imperial and easier for merchant acquirers, merchants, and card issuers to do business with.

His latest task is to put Visa’s manual of operating rules, which currently exceeds 1,500 pages, on a diet.

“On Oct. 1, we will be eliminating close to half of our operating rules,” Scharf told analysts April 24 at Visa’s earnings conference call for fiscal 2014’s second quarter ended March 31. “This includes reducing the complexity of our dispute-resolution processes.”

Scharf disclosed the rules cut after reminding analysts that Visa had talked earlier about simplifying its regulations. The company also recently announced pending changes in its Fixed Acquirer Network Fee (FANF) to make Visa acceptance more attractive to small merchants with less than $15,000 in annual Visa volume (“Get Ready for Son of FANF, Due in a Year,” May.)

Asked by an analyst for more details, Scharf said the rules reduction is the result of feedback Visa solicited from issuers, merchants, and acquirers. He said Visa’s reputation among those groups historically was that “we were probably pretty difficult to deal with.”

The increasingly competitive payments market, however, apparently forced Visa to consider ways to become more user-friendly. “We want people to enjoy doing business with us, and that we treat them openly, fairly, and clearly,” said Scharf.

Scharf said he’s got a copy of the rules on his desk and “they’re actually 1,538 pages … imagine you’re an issuer, acquirer, and you’ve got to live by those.”

Visa asked its customers what they didn’t like and what should change in the rules, according to Scharf.

“A big part of the feedback that we received was on chargebacks and the processes that we had put in place, the reporting requirements, documentation, and things like that,” he said. More changes could be in the offing after Visa gets feedback about the October changes, according to Scharf.

How much of a differentiating factor a slimmed-down rulebook will be for Visa is hard to ascertain. Asked by an analyst at MasterCard Inc.’s latest earnings call to comment on the issue, president and chief executive Ajay Banga would not talk specifically about what Visa’s doing. But he downplayed the importance of rules in getting issuers to put MasterCard’s brand on their cards and merchants to encourage customers use their MasterCards.

“We have already worked our operating rules down, actually quite some time ago,” Banga said, in this case meaning a few months back. “I’m pretty confident that we aren’t winning our business based on operating rules only.”

Instead, MasterCard is emphasizing its business analytics, marketing, acceptance locations, and pricing, according to Banga.

“All these things put together are helping us win business,” he said, adding that while MasterCard doesn’t win every proposal it bids on, it is hitting “singles and doubles.”

MasterCard is about to lose an undisclosed number of MasterCard-branded cards issued by bank giant JPMorgan Chase & Co., which is converting more of its already majority-Visa portfolio to Visa. Chase agreed to the conversion as part of its deal with Visa to license a version of the VisaNet network to create an in-house payment system using Chase-issued cards and merchants signed by its acquiring subsidiary, Chase Paymentech.

But in the win column, MasterCard is getting a significant new chunk of business from Target Corp., which in the wake of its massive data breach is reissuing its private-label credit and debit cards and Visa cobranded cards as Europay-Visa-MasterCard (EMV) chip cards. Target in April said all of its cards will use MasterCard’s technology and the Visa cobranded file will be converted to the MasterCard brand.

Meanwhile, both MasterCard and Visa reported healthy growth in key credit and debit card usage metrics for the quarter ended March 31. Visa posted total U.S. payment volume of $575 billion, up 8.5% from $530 billion a year earlier. At MasterCard, U.S. purchase volume came in at $268 billion, an increase of 8.8% from $246 billion in 2013’s first quarter.

—Jim Daly