By Jeff Fortney
Clearent LLC
Editor's Note: The Green Sheet is most pleased that Jeff Fortney will be penning the Street SmartsSM column for the coming year. He has been a dedicated contributing writer to our publication for some time, even submitting articles in advance if he anticipates a particularly demanding patch ahead. Since Jeff is an active member of GS Online's MLS Forum, we expect he has already stirred up an active discussion thread or two that will be featured here. Why not join the conversation at www.greensheet.com/forums? I'm sure Jeff will give you a warm welcome.
In the payments world, street wisdom is necessary for navigating difficult situations, both during and after the sales process. We can read books, ask questions and even study the parameters of interchange, but if we don't have practical industry knowledge, healthy portfolios will elude us.
As we begin a new season of Street Smarts, my goal is to share the street wisdom that so many of us have obtained throughout our careers. I hope that offering practical, relevant lessons will help reduce the amount of time you have to spend in the school of hard knocks. I'll begin with thoughts on what our industry may face in the coming year.
The Spanish philosopher George Santayana once said, "He who does not learn from history is doomed to repeat it." From history, we gain insights that help us forecast the future, often within a reasonable margin of error.
Futurists and economic forecasters use market indicators and trends to predict such events as market meltdowns, upswings and more. They forecast markets based on specific statistics in an effort to increase their clients' revenues. Such predictions are never 100 percent correct because there is always the unforeseen. However, they can be highly accurate and are used in determining investment strategies and decisions based on anticipated gain or loss.
If futurists were to study the payments world, they would concentrate on revenue sources driving the industry. They wouldn't look at the specific revenue fields, but rather at the overall opportunity for revenue growth and retention. In our world, two areas would apply: new sales and merchant retention.
Before attempting to analyze historical data, futurists first seek to fully understand their market by asking, "Who is my audience?" I believe their answer for our realm would be "small merchants."
The Small Business Administration defines a small business as one that is independently owned and operated, organized for profit and not dominant in its field. Depending on the industry, size is based on the average number of employees for the preceding 12 months or on sales volume averaged over a three-year period.
Examples of SBA general size standards include:
The majority of merchants we target fit into the categories just listed, as they are the best sources of revenue in the payments world. Knowing that, futurists would then examine the market's overall health.
Again, the SBA offers valuable information, as it provides quarterly bulletins on the current marketplace, as well as historical data. It doesn't sugarcoat facts, which others can interpret and analyze. Consider the following:
These facts speak volumes about the recent recession and its impact on the small business community. In 2009, the number of small business "births" dropped. We were in the early stages of what is now being called the Great Recession, but the fact that there was a downturn during that year is an exception to historical records. Consistently, history has shown that new business openings grow the first year of a recession.
Halfway through 2010, new merchant births began to grow again. In 2011, the number of new business openings, by quarter, ranged from 183,000 to over 225,000. Small business deaths spiked in 2008 and have declined ever since. Small business bankruptcies, which do not necessarily define closures but rather the financial situation of the merchant, rose dramatically in 2008 and 2009, but began a steady decline in 2010 that continued through 2011.
Not surprisingly, such a spike in closings and bankruptcies is common. A recession tends to be the "straw that breaks the camel's back" with many merchants who are already struggling. The recovery post-2009 is also consistent from a historical perspective. The numbers may be different, but the reaction of the market is the same. Many merchants are seeing growing sales volumes, and manufacturing and trade sales have risen every quarter since mid-2009.
Another important point not found within the SBA statistics is significant: 2012 is an election year. Typically, when a U.S. president is running for re-election, the economy is actually growing. There are exceptions to this rule, but they are few. Elections occurring during an economic downturn typically have not coincided with a sitting president running for re-election.
All things being equal, these statistics show there is a growing market for merchant services as we progress further into 2012.
When it comes to examining merchant retention, a futurist will first want to know what drives attrition. The answer can be found by examining the health of the market and how it affects merchant decisions about their payment processors.
During a recession, merchants become increasingly cost conscious. They understand that to survive, they must be frugal. They must control their costs because their sales volume will likely be down. Even the small overall cost of payment processing comes under scrutiny. Because of this, merchants become more susceptible to sales pitches centered solely on cost containment and control. Loyalty may have value, but in tough financial times, saving money trumps loyalty.
Merchant level salespeople (MLSs) also become more aggressive in pricing accounts. They, too, fear a downturn in new merchant sales and feel the impact of bankruptcies and closures. As a result, sales practices developed to help merchants "ease their pain" wane in favor of more aggressive pricing and, of course, smaller profits.
During recessions, ISOs and MLSs frequently trade new merchants for diminished profit. Meanwhile, as the feet on the street are selling to new merchants at a lower return, their existing merchants are being wooed and won by competitors. Effectively, although the merchant count is effectively treading water, margins are sinking, and the battle to stay afloat could be lost.
As the marketplace improves, merchant concerns over cost control become less pivotal. However, many ISOs and MLSs, having developed poor sales habits, inadvertently delay taking steps toward margin recovery, which results in continued attrition. Other key factors related to retention are changes in price and process caused by external forces. In an ideal world, pricing changes would not exist. Merchants would rarely notice their processing costs, and as long as their service needs were being met or exceeded, they would not consider moving to new service providers.
However, we live in a world in which the card brands make frequent changes to their costs and structures. For example, Visa Inc. rolled out changes, effective April 2012, that will have an impact no matter how they are measured. This is not a prediction or a forecast - it's a fact. Historical references show that when the card companies change their pricing enough to create merchant pain, attrition grows. Although the changes affect every processor, they nevertheless lead to portfolio retention pressure.
Futurists would also look for current situations in the industry that, if not corrected, could amplify attrition over the coming year. One glaring area creating attrition today is the way processors and ISOs are addressing the reduction in debit card processing costs mandated by the Durbin Amendment to the Wall Street Reform and Consumer Protection Act of 2010.
Many ISOs and MLSs offer different options for new merchant customers, but few have addressed their existing portfolios. The Durbin Amendment has already exacerbated attrition, and unless it is addressed, attrition will surely continue to grow.
I do not claim to be a futurist or someone who has mastered the art of predicting what is around the next corner. What I can say is that if one analyzes data from the SBA and examines similar historical references, there are some things we can all agree on:
It is easy to see the importance of gaining street wisdom, as opportunities will be greater this year. I look forward to the next 12 months and sharing how we can all become more streetwise. It's going to be an exciting ride.
Jeff Fortney is Vice President, ISO Channel Management with Clearent LLC. He has more than 17 years' experience in the payments industry. Contact him at jeff@clearent.com or 972-618-7340. To learn about how Clearent can help you grow faster and go further, visit www.clearent.com.
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