By Patti Murphy
To the ongoing list of threats to the ISO and agent channel, add software companies. But here's the good news: ISOs and their channel partners have an opportunity to get in front of this threat by partnering with independent software vendors (ISVs) to integrate payment processing into their software.
"We're seeing a pretty dramatic acceleration in the sense of urgency ISVs have for getting payments integrated," said Caleb Avery, founder and CEO at Tilled, a payfac-as-a-service startup based in Denver. "ISVs are increasingly interested in working with ISOs."
Some of these companies already integrate with payments company Stripe or PayPal's Braintree, Avery noted. These managed payment facilitators were easy to implement early on, and pricing was transparent. But as businesses grow and payments volume increases, the processing fees (2.9 percent plus 30 cents, and 3.4 percent plus 30 cents for manually keyed items) mount. Plus, all of the profits go to the payfac, which provides little to no customer service in return.
At the same time, a significant number of software companies are facing slower growth and looking for new revenue opportunities. Payment processing fits the bill, but building out the technology to become a payfac is costly and time-consuming. This, in turn, has opened up opportunities for ISOs and their technology partners.
"It's a competition, so [ISOs and acquirers] better get moving quickly," said Vijay Sondhi, CEO of the payment processing platform NMI.
"Software is the heart of a business," said Gary Liu, president of the ISV/VAR channel at Bold Integrated Payments. "And payments need to be integrated with that."
Liu understands first-hand the value proposition. He co-created a POS system, called HotSauce, which began rolling out to the hospitality sector in 2002. HotSauce soon began working with ISOs for payment processing services, reveling in the opportunity to collect recurring revenue from these deals. But there was a downside: a dearth of information in the monthly statements HotSauce received from these ISOs.
"They couldn't reconcile every income item and every expense down to the penny, down to the interchange level," Liu said. That's when he decided to launch his own ISO, working directly with independent software developers and value-added resellers to integrate payment processing with those company's software and platforms.
Today Bold, formerly Priority Integrated Solutions, works with 225 ISVs and VARs serving over 220,000 merchants, which combined process about $60 billion a year in card payments. "We're a preferred provider to these companies," Liu said. "ISOs and acquirers should really be thinking about these kinds of opportunities."
Sondhi agreed. "What we're seeing is the verticalization of software," he said. "There's a myriad of software solutions for every type of business. Payments companies have to follow that lead." "ISOs need to identify verticals they really understand, then find an ISV that serves that market," Avery added. Key verticals include: healthcare, nonprofit, restaurant and hospitality, gym and fitness, field services, property management, and shopping cart platforms.
Many of these also have sub-verticals. The healthcare sector, for example, includes doctors, dentists, medical device providers and hospitals, and several ISVs serve each of these sub-verticals.
The consultancy McKinsey & Co., in a recent report, reiterated how these sub-verticals create opportunities for new ISVs, and by extension, payments companies. "The same formula that allowed Square to displace incumbents is now letting newer companies penetrate underserved sub-verticals," the consultancy stated.
Bain & Co. has described the trend toward bundling software and payments as a "better together" value proposition. "The 'better together' logic can unlock an enormous profit pool, especially for ISVs serving smaller businesses, complementing SaaS revenue and raising customer lifetime value," the consultancy wrote in a recent report commissioned by Stripe. "In fact, payments revenue can outstrip the platform's core SaaS revenue."
Just ask the folks at Shopify. In 2021, the ecommerce platform company generated $3 billion, more than two-thirds of its total revenue, from merchant services, primarily card processing and currency conversion, according to Bain. Similarly, 80 percent of Toast's revenues last year came from payments and other financial services, not software and equipment leases.
The United States is home to over 10,000 ISVs, the website Statista reported. Each of these ISVs has a roster of companies that use its software to manage business. And increasingly, that includes payment processing. "I have a sales team that does nothing but call on ISVs and VARs," Liu said. In its report, McKinsey detailed just how big the shift has been to software-led payments. Nearly half of the over 800 small businesses participating in the consultancy's 2022 merchant acquiring survey now use ISVs for payment processing; 15 percent said they are in the process of making that transition.
And which ISVs are they using? "Across all industry verticals, the ISVs used most by small businesses are Square and Clover, our survey revealed," McKinsey reported. "Toast is a close second in the food and beverage industry, where overall ISV adoption stands at about 65 percent."
Credit Suisse, in a 2021 report, estimated that software-led payments accounted for 16 percent of payment processing volume in the United States and that these payments are growing at two-times industry averages. Credit Suisse expects that by 2023, software-led payments will account for 20 percent of U.S. payment processing volume.
Companies that provide both software and payment processing see lower attrition rates—generally under 10 percent, Credit Suisse estimated. This compares to an acquiring industry average of 15 percent. It's easy to see why: once businesses are tied into an underlying software environment they are not inclined to swap it out, unless service is really bad, several experts noted.
The large legacy payment companies have seen the writing on the wall. "Everyone is going after this," Sondhi said. First Data owns Clover, which morphed from a hardware company to an ISV, while other acquirers have been buying ISVs outright. Global Payments has purchased thousands of ISV; its pending acquisition of EVO is expected to add over 1,000 more to that total, according to an analysis by The Strawhecker Group.
"There are so many verticalized software companies out there to partner with. And it's a really high-margin opportunity for payments companies. We have one ISV that has boarded 200 merchants with us this month, and the referring ISO did nothing" except collect residuals, Avery said.
James Shepherd, president of the sales training firm CC Sales Pro, added, "Keep in mind that the majority of profits from payments processing will go to the software company, but don't let that discourage you, because the potential volume from these deals is huge."
Tilled works with more than 80 ISOs and agents that bring ISV referrals to the company. These ISOs take a cut of the residuals on every account boarded through ISV referrals. They can also earn referral fees for any accounts brought to the ISV. "It's like putting your portfolio on autopilot," Avery said. "That's the exciting thing about this opportunity."
Avery estimates that Tilled has a close ratio of over 50 percent on qualified ISV leads delivered by its ISO partners. Unlike traditional referral partnerships, there are no paper applications or onboarding routines in this payfac-as-a-service model—everything is pretty much digitized. Pricing is interchange-plus; ISVs can mark that up or down as they deem necessary. Recently, Tilled landed a deal with a company that sells music studio software. "Within 28 days of the first sales conversation the company was processing payments on our platform, with each of us [the ISV, Tilled and the referring ISO] generating ongoing revenues," Avery said.
End-to-end integration typically takes a company like Tilled about four days. "It's a pretty dramatic acceleration of time to market for software companies wanting to monetize payments," Avery added.
To date, most of Tilled's clients have been card-not-present merchants. In September, though, the company announced it can now process for card-present merchants through a partnership with technology company Aevi.
The rise of software-led payments does not signal the demise of the traditional ISO sales model. "I don't think it will ever go away, but it is going to be a smaller percentage of the market," Liu said. Avery concurred, noting the move to software-led payments "will be a gradual transition." Sondi suggested that working with ISVs should become a natural extension of ISO businesses.
"Software companies are niche players. They don't understand payments. They need help," Sondhi said. "That's where ISOs should play to their strengths," especially customer service.
Related services and technologies, like loyalty, invoicing, scheduling and CRM should also be part of the mix. This will often require ISOs to partner with other technology companies first. "They need to become aggregators of tech stacks," Sondhi said.
McKinsey, in its report, offered similar advice, suggesting that ISVs can grow market share by adding value-added services to their core offerings – services that ISOs and banks can deliver. In fact, a third of small businesses surveyed by McKinsey are interested in value-added financial services.
McKinsey also made a pitch for ISVs to seek out incumbent players, like ISOs, as partners. "While ISVs have achieved success through self-service or offline sales processes, 40 percent of small businesses surveyed say they purchased their services through a salesperson or payments consultant. Partnerships could leverage incumbent companies' broader reach to drive growth for ISVs," McKinsey concluded. 
Patti Murphy is senior editor at The Green Sheet and co-host of the Merchant Sales Podcast. Follow her on Twitter @GS_PayMaven.
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