US Payments: A Primer on Merchant Acquiring

nicklipinski

Merchant acquiring – the business of providing merchants with authorization for card payments and settling and clearing transactions, often but not always through the branded (including EFT) networks, so that funds are moved from the merchant account to the cardholder account – will be transformed by the use of mobile phones by shoppers and cloud-serviced, often mobile, point-of-sale (POS) devices by merchants (rather than traditional POS computer systems with associated on-site maintenance and upgrade costs).

Winners will have: a processing scale advantage from serving large merchants; access to distribution channels, such as value-added resellers (VARs) including merchant banks and independent software vendors[1] (ISVs), where the sale is based more on system reliability and service than price alone[2]; and issuer-relationships generating the potential to (a) save network fees through direct bank-identification-number or “BIN” routing which by-passes the branded networks particularly for PIN-authenticated transactions (where lower fraud content reduces the need for network-level fraud risk management); and (b) add value through access to cardholder PII (personally-identifying information) which can support merchant-clients in the design of digital marketing campaigns.

Beyond Chase Merchant Services (which, with the cost-advantage of ChaseNet, will likely gain meaningful share of the acquiring volume on Chase-issued cards), our favorite name is VNTV which will gain share through leveraging its relationships with issuers (particularly in PIN debit where it is the leading acquirer) and by increasing diversification: geographically (from its Midwest roots as a wholly-owned subsidiary of FITB until June 2009); into e-commerce (with the acquisition in October 2012 of Litle); and into the SMB category through the merchant bank channel, with the 2010 acquisition of NPC, and with the acquisition of Element in July 2013 (improving access to ISVs).

  • In 2013, VNTV grew US purchase volumes at 9% which was exceeded among large acquirers only by bank-owned Chase at 15% and Elavon at 11%; WFC grew at 18% but off a small base with less than 5% share versus over 12% at VNTV (see Exhibit below).
  • Chase’s volumes growth is driven in part by its dominance of the e-commerce channel (with an estimated 25% share) where retail sales have grown at an annual rate of 16-18% since 2010 versus just under 5% for all total retail sales (excluding auto).

We are cautious on business models limited to the SMB segment, as at HPY and MPS[3], although these firms are acquisition candidates as the industry consolidates for processing scale and vertical integration with issuers; there is a particular concern around allegations that MPS is using confusing sales practices and misrepresenting costs to clients.

We do not see Square (with annualized volumes of ~$15bn versus over $500bn at VNTV) as a threat to large acquirers, and do not believe it (or anyone else) is generating adequate acquirer returns on the basic payments function in the micro-merchant segment given high churn and fraud rates. Square announced in November 2013 that it would seek to move up to SMB merchants but these typically operate on an interchange-plus pricing model where Square’s scale disadvantage will count more against it than with micro-merchants operating on a merchant discount rate (MDR) pricing model.

  • The edge from Square’s mobile POS is eroding as players with processing scale and distribution advantages offer me-too/better product. For example, the “Clover” mobile POS system (developed by First Data and distributed by it and Bank of America) has an open-API that will leverage third-party developers to compete with the proprietary reporting, analytics, and other applications available on the Square product.

PayPal faces increasing competition online as pay-with-iTunes/Amazon/Google expand from in-app and native-market purchases to e-commerce more generally, and as pay-with-Chase (announced this February). More generally, bank and network implementation of tokenization[4] eliminates the original case for PayPal (avoiding the need to enter card credentials into a merchant web-site) so that volumes will increasingly depend on consumer inertia and a value proposition to consumers that is independent of perceived security advantage. A spin-out from eBay would accelerate PayPal share declines by depriving it of its own native market.

  • Notwithstanding the acceptance partnership with DFS, PayPal will not gain meaningful share of mobile volumes because it does not have the economics to compete with issuer- and merchant-funded rewards; the experiment at HD indicates that convenience offerings (e.g. skip-the-line and order-ahead) are not enough.
Please see our published research for the full note and tables.


[1] ISVs bundle payments services in an SaaS format with other business management applications including customer-relationship and inventory management)

[2] In 2011, VARs and ISVs generated 15% of new merchant accounts up from 11% in 2009 and versus 32% from direct sales forces and 21% from independent sales organizations (ISOs); they were projected to account for 24% in 2013.

[3] MPS is the prospective ticker for Mercury Payment Systems which, last month, filed an S-1 registration; technically, MPS is an ISO for GPN which has responsibility for clearance with financial underwriting from WFC. MPS has announced that it will begin to take some processing in-house and so will become a processor in its own right.

[4] In a tokenized payment system, the card account information is replaced by substitute information (i.e. a “token”) with limited life and application (and so less value if stolen than the account information itself).

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