By Brandes Elitch
CrossCheck Inc.
This article is titled after a book written by motorcycle designer Bert Hopwood and published in 1981. At the time, people were wondering how the Brits could have dominated an entire industry and then lost it all. In the 1950s, British motorcycles were so popular in the United States that American firms fought, unsuccessfully, to have them banned or heavily taxed.
The book identifies several factors that contributed to the industry's decline in Britain:
Thus, the British industry was transformed - out of existence. Ironically, classic and vintage British bikes are in great demand today, and collectors pay big money for them.
The ISO business is about to go through a similar experience, except that this changeover will take about five years; the transition took the Brits about 20 years.
Recently, a highly respected observer in the card space told me, "The traditional definition of 'processor' still contemplates the swipe function, which is going by the wayside, with mobile, digital and remote processing. I don't know if you still need 'processors' or ISOs if all transactions get authorized in the cloud."
So, how will ISOs add value in this new landscape? When electronic ticket capture came along, ISOs were transformed from pure salespeople to gatekeepers. Merchants could only buy POS terminals from ISOs, not directly from manufacturers. Most acquiring banks used ISOs to sell for them because it was too difficult for banks to hire, train and manage bankcard sales reps. While working for a large acquiring bank in the 1980s, I was stunned when the sales manager fired the salespeople and turned the selling over to the bank's "Alliance Partner," First Data Corp. This is not a viable long-term business strategy.
The card brands were focused on issuing, not acquiring, which they viewed as a necessary, if cumbersome, component of creating a revenue stream for the major issuing banks. These banks dictated what information they would require to underwrite merchants. Smaller, card-not-present, MO/TO and new merchants were usually handled by smaller niche banks. In some cases, the ISO indemnified acquiring banks for losses, which made the banks much more comfortable with the business - if the ISOs were deemed financially sound.
Today, the top 200 retailers can negotiate directly with Visa Inc. and MasterCard Worldwide or with the largest acquiring banks. They don't need ISOs to do this for them. Meanwhile, margins have shrunk so much that it may not make sense for ISOs to handle some relationships. For example, about 10 years ago, an ISO told me that when he fired one of his largest accounts, The Gap Inc., he said, "The only 'gap' here is the difference between what you are willing to pay to me to process your transactions and what I have to pay my salesperson to handle your account."
ISOs must transition again, and the next logical category is "trusted security partner." As such, ISOs can truly add value to acquiring banks and merchants because of the rapidly emerging risks in the retail payments world. The risk is not just that of fraudulent transactions. A broader risk looms that consumers won't trust the security of entities processing their transactions. Indeed, surveys now show bankers are even less liked than attorneys. Old ways of fighting fraud will not work well in an environment transformed by new technologies. More transactions will be processed remotely by nontraditional institutions, and changing risk attributes are not well understood. ISOs must stay abreast of developments between banks, regulators, mobile carriers, application providers, device manufacturers and vendors regarding security, liability and standards issues.
In the mobile payments sphere, challenges include lack of technology standards for interoperability, regulatory gaps, unresolved liability issues, and concerns about security, privacy, authentication and fraud. Banks, saddled with a fragmented approach, are dealing with over 1,000 legal and regulatory standards.
James Van Dyke, President of Javelin Strategy & Research, noted that the very nature of fraud is changing rapidly. A black market exists for stolen card data, which has a long shelf life. Buyers and sellers negotiate on forums where hackers sell data to wholesalers, who then sell it to fraudsters.
These criminals use mules to fence the stolen data for cash. They also share information on web forums, and organized crime has long-term business plans, sophisticated communication and sufficient capital to fund their efforts. The Financial Fraud Resource Center estimated that the direct cost of financial fraud to Americans was $40 to $50 billion in 2011.
The challenges of fighting payment system fraud are beyond the scope of all but the very largest merchants. The banks will not provide much guidance to their merchants beyond their service agreements. Educating merchants and managing fraud is a role ISOs are well positioned to perform. Remember, the acquiring bank normally requires the ISO to perform some degree of due diligence on the merchant, up to and including indemnifying the bank for losses, particularly ISOs that are true third-party processors, not just resellers.
So, ISOs already have expertise in this space. Some might argue that a natural tension exists between the ISO's fundamental role of getting a signed contract and the role of providing a complete, accurate financial picture of the merchant. With the new regulatory environment, however, this dichotomy will have to disappear, particularly if the ISO principal is held personally liable for sloppy underwriting.
Here are some ways ISOs can add value:
For more information about how ContractPal does this, visit www.contractpal.com. The company also holds a patent regarding e-signature that would be valuable in conjunction with an e-brochure or merchant self-enrollment capability in the ISO's product suite.
It is unlikely merchants can do all of this in-house. So, while the traditional role of the ISO is going away, unlike professionals in the British motorcycle industry, ISOs will get another chance to create and maintain a profitable, long-term business model.
Previously, ISOs functioned as gatekeepers for the card companies, furnishing an acquiring bank for the merchant and new clients for the bank, and providing a source of hardware and software to process card transactions. Now, ISOs can help by providing risk exposure management tools for both merchants and banks.
I'll end with an anecdote. Many years ago, I purchased a 1953 Velocette 350 single. Local expert Fred Twigg, restored it for me over the course of about 10 years. When he finished, it was "as new," maybe even "better than new." Fred rode it up my driveway, and we pushed it up the stairs and into my den, where it sat, virtually a new bike. It proceeded to leak oil on my hardwood floor, reminding me of the old saying, "Every part that falls off this bike is of the very highest British quality."
Brandes Elitch, Director of Partner Acquisition for CrossCheck Inc., has been a cash management practitioner for several Fortune 500 companies, sold cash management services for major banks and served as a consultant to bankcard acquirers. A Certified Cash Manager and Accredited ACH Professional, Brandes has a Master's in Business Administration from New York University and a Juris Doctor from Santa Clara University. He can be reached at brandese@cross-check.com.
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