By Adam Atlas
Attorney at Law
It seems the super ISOs are getting bigger, regular ISOs are being squeezed on pricing and small ISOs are having trouble getting started. What's going on in our industry? It could be consolidation. The purpose of this article is to highlight for ISOs a few legal considerations that are relevant to consolidation in the payments industry.
An ISO whose portfolio submits a certain number of transactions enjoys a bump up in pricing for making it into a new tier in its processor's pricing grid. Similarly, the processor strengthens its bargaining position vis-à-vis its bank when its volume increases to a new tier. And when a publicly traded processor, bank or payment network boasts of additional billions of dollars in recurring processing activity, the market reacts favorably.
This cascading set of overlapping interests sometimes leaves smaller ISOs out of the market because they do not have the transaction count or volume to negotiate for lower pricing. There isn't much to glean from this observation beyond the fact that volume counts at all levels of our industry.
Payment networks, banks, processors and ISOs all add value to the processing their merchants do. That said, the reality of contemporary technology and business is that, theoretically at least, the price of merchant services should be steadily – and perhaps even rapidly – declining.
Except for the odd state park campground that might still have a knuckle-buster, all payment transactions are electronic. Volume brings economies of scale to bear on payment processing and, logically, pricing should decline over time as volume increases. Advances in technology could have a multiplier effect in the decrease in pricing.
From one perspective, this is bad news for ISOs, because conventional sources of revenue could be declining. On the other hand, the decrease in revenue from core processing activity is an opportunity for ISOs to offer better value elsewhere to earn their living. Hardware, apps, business integrations and data portability are all examples of value ISOs can bring to merchants to make their offerings better than those of their competitors.
As pricing is compressed in the acquiring industry, those with the largest volume are generally able to decrease sale prices and still survive. This reality favors super ISOs and processors at the expense of ordinary ISOs.
For example, some processors have in-house sales divisions that sell below the cost charged to their external ISOs. Apart from being immoral, this practice puts into question the good faith of the processor that negotiated the ISO agreements in the first place.
There could be anti-trust issues with a processor selling directly to merchants at prices below the buy-rates of their ISOs. Setting aside how maddening that reality is for ISOs, it's still hard to see how a processor can do that in good faith. The result is that regular ISOs have to work harder to earn less money, and sometimes lose accounts to their own suppliers – the processors – because keeping the accounts would mean negative residuals.
Once upon a time large processors expressed unwavering appreciation for their ISOs. Now some have stopped taking on new ISOs or are driving them away with pricing that is ever harder for ISOs to live with.
With consolidation comes less competition. Where there are two or three mega ISOs competing for a typical account versus 100 ISOs, the competition is reduced, and merchants have less choice as to products, service and pricing. Ironically, if the market becomes highly concentrated, the opportunity and temptation for collusion, price fixing and monopolistic behavior increases – with bad outcomes for everyone.
Greater consolidation also increases risk to the payment system's stability. With a few mega ISOs, loss of just one could be catastrophic to the ability of large swaths of merchants to operate.
The ISO business is a veritable entrepreneur factory. I have seen countless examples of people reinventing themselves thanks to the ISO business: folks who have gone from ordinary salaried jobs or ordinary sales positions to build successful ISOs. With less opportunity at our industry's entry point, there will be fewer success stories like the hundreds that our industry has generated previously.
The closer a merchant is to the person who sold him or her the account, the better service the merchant will get. Compare the super ISO sale through a call center where no individual champions the merchant's account to the small or midsize ISO that has an agent dedicated to soliciting the account – an agent who, critically, depends on the residuals of the account for his or her livelihood.
Hunger is a great motivator. The hunger (in the best sense) of the merchant level salespeople in our industry often translates into better customer service for merchants. The counter-argument to this, of course, is that new millennial merchants might prefer impersonal email or chat-only support and don't like dealing with real people.
Virtual currency, faster payments, phone-based gateways and other rivals to conventional acquiring are all strengthened by consolidation within the acquiring market. This is so because a concentration of supply within the acquiring market will likely be less supple and adaptable than a market comprising a variety of competitors. Ironically, the titans of acquiring may be combining portfolios and businesses only to see them all be supplanted in one shot by a rival technology.
For years now, hundreds of millions of dollars have poured into acquiring, which has allowed super ISOs and processors to gobble up smaller players. The money that financed these acquisitions was cheap due to low interest rates. When rates go up, pressure will increase on these super ISOs to pay back their creditors or see their portfolios auctioned off.
Being optimistic to a fault, I think ISOs should see consolidation as an opportunity, perhaps to sell at a good price before money becomes expensive again, or maybe to distinguish their businesses in a market that is increasingly homogenized.
In publishing The Green Sheet, neither the author nor the publisher is engaged in rendering legal, accounting or other professional services. If you require legal advice or other expert assistance, seek the services of a competent professional. For further information on this article, email Adam Atlas, Attorney at Law, at atlas@adamatlas.com or call him at 514-842-0886.
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