et out your calculator because you will need to follow the money trail, and it isn't intuitive to the casual observer. In this article we are going to look at "the big picture" - the macro financial dynamics of the acquiring business in the U.S.

Let's make the following assumptions about the acquiring marketplace based upon the best available facts to me. These are not precise figures in some cases, but they are close enough to make the arguments that follow.

• Gross Visa and MasterCard Sales = $1.1 trillion annually
• Average Ticket = $64.44
• Average Fees Collected from All Merchants = 2.06%
• Average Interchange = 1.50% + 10 cents discount fee per transaction
• Visa Assessments = .0084%
• MasterCard Dues = .009%
• Visa/MasterCard split of bankcard market = 64.8%/35.2%

Simple math tells us the following:

• # of Visa/MC tickets settled = 17.1 billion
• Interchange discount per-transaction fees = $1.7 billion
• Interchange of 1.50% = $16.5 billion
• Dues and Assessments = $947.232 million

Interchange of $16.5 billion plus $1.7 billion for discount per-transaction fees goes to the issuing banks. The dues and assessments go to Visa and MasterCard to run their not-for-profit association businesses.

Conclusion: The issuing banks receive $18.2 billion and the associations receive about $1 billion of the money collected from merchant processing for Visa and MasterCard transactions.

According to Marc Abbey's article "National Merchants Revisited" in the January 2003 issue of Card Management magazine, 60% of the industry's transactions are processed by the largest 230 merchants, with an average net revenue of 13 basis points. Abbey defines a large merchant to be one that processes more than 2 million transactions annually from all locations.

Net revenue is defined to be the fees collected by the acquirer in excess of interchange, dues and assessments. He also writes that the remaining 40% of the transactions generate 55-65 basis points of net revenue.

(All of these numbers are his best estimates, but I know of no one better to make these estimates than Marc Abbey. His company, First Annapolis, has the best merchant database in the industry.)

With the help of that calculator, this means that $858 million of net revenue is earned by the acquirers who process the nation's largest merchants, and $2.64 billion of net revenue is going to the rest of us for a total net revenue of about $3.5 billion. This represents the total cash generated by all acquirers to operate all facets of the merchant acquiring business (excluding non-bankcard revenues).

In summary, here is the breakdown of where the discount fees paid by merchants for Visa and MasterCard processing are going:

• Issuing banks $18.2 billion = 80.4%
• Associations $0.95 billion = 4.2%
• Acquirers $3.5 billion = 15.4%
• Total discount fees $22.65 billion = 100%

Now let's check out where the $3.5 billion is going. If you were following the bouncing ball from my last three articles, you can understand why I can estimate that:

• Processor Fees - Average for top 230 merchants = 2.5 cents per transaction
• Processor Fees - Average for all other merchants = 11 cents per transaction

This means that a total of $256 million is going to the processing companies for the top 230 merchants and another $751 million is going to the processing companies for the rest of the nation's 4 million merchants.

This totals about $1 billion for the processing activities of authorization, draft capture, settlement, bank sponsorship and related services of the major processing companies and sponsor banks.

According to Abbey, four processors control 85% of the large-merchant segment - the First Data/Chase Alliance, National Processing, Fifth Third Payment Systems and Paymentech. Each of these entities is also a major merchant acquirer.

The large companies with platforms available to ISOs are:

• First Data Corp.
• First Data's Alliances
• First Data's Paymentech (venture with Bank One)
• Vital
• Concord EFS
• Global Payments
• National Processing
• U.S. Bank (NOVA)

Except for Vital, each of these entities also is a large-merchant acquirer in addition to being a major transaction processor. This means that Vital is the only company listed above that does not compete with its own clients for acquiring business!

Vital, of course, is a 50-50 venture between Visa and Total Systems. Vital is the Switzerland of the transaction-processing world, and Visa apparently intends to keep it that way. In my opinion, our industry desperately needs a healthy and vibrant processing entity such as Vital to be a home to those who do not want to be forced to compete with their outsource business partners, such as First Data, Concord, NPC, U.S. Bank/NOVA and Global.

Other large acquirers (those with annual bankcard transactions in excess of 250 million transactions) operate processing platforms that are available primarily (or exclusively) for their own merchant portfolios. These are:

• Bank of America
• Fifth Third Payment Systems
• First National Bank of Omaha
• Heartland Payment Systems

These bankcard transaction processors split the bulk of the $1 billion. Of course, First Data dominates this list with more than 40% of the market.

Very few ISOs not named above have their own processing capabilities, and I can't think of anyone else that processes more than a quarter-billion bankcard transactions per year in this country.

Most of the acquiring net revenues from the nation's top 230 merchants are shared by First Data, National Processing and Fifth Third. The net revenue after processing fees for these merchants is about $528 million ($858 million minus $330 million).

To summarize, of the $3.5 billion of acquiring net revenues available, about $1 billion goes to the processors and about a half-billion goes for acquiring the top 230 merchants, leaving $2 billion for those of us who compete for the bulk of the business.

To What Extent Is Merchant Acquiring a Scale Business?

Now we have laid out enough facts to get to the nub of an important question: What is the role of scale (size) in the acquiring industry for small to medium-size merchants? Clearly, the facts are in. Scale clearly drives the ability to compete for the top 230 merchants but is not the driving factor in competing for the vast majority of the rest of the nation's 4 million merchants.

Acquiring has been described as a commodity business, but let's look at this "commodity" in the eyes of a small to medium-size business owner. If 40% of the transactions are processed by the 4 million merchants in this segment, then the average merchant processes $110,000 per year of bankcard transactions.

The January 2003 issue of GSQ reported the 2002 processing results of merchant acquirers. Look carefully at the processing volume of each acquirer and the number of merchants they claim to process. Divide these two figures to get the average volume per merchant for each acquirer. You quickly will find this to be an interesting experience.

With 60 basis points of net revenue per small-medium merchant processing an average of $110,000 annually, the average merchant generates $660 of annual net revenue. Again, using the averages defined in this article, this means the average merchant processes 1,707 transactions per year at a cost of $188 for transaction processing. This leaves a net revenue after processing fees of $472.

The marketplace of small to medium-size merchants has most decidedly spoken over the past few years with a consistent answer. These merchants have demonstrated a willingness to pay about $55 per month for merchant processing above and beyond what goes to the issuers and associations. Every dime is important to every size business, but $55 per month is not the primary decision point for a businessperson who must be paid reliably for his $110,000 of bankcard transactions to keep the business going without getting jerked around!

What drives the decision to go with Acquirer A vs. Acquirer B? Is the decision really driven by a commodity called transaction processing?

Let's suppose Acquirer A is one of the national acquirers with a processing cost of 2.5 cents per transaction vs. Acquirer B, who has a transaction-processing cost of 11 cents, for example. Acquirer A's cost to process the 1,707 transactions at 2.5 cents is $43 while Acquirer B's cost to process the same transactions at 11 cents is $188. In other words, the difference is $145 per year.

Does this difference in "scale" of $145 cause a merchant processing $110,000 of Visa and MasterCard to select Acquirer A? The answer is NO.

It is true that First Data is the big-scale player in our industry, but First Data does not have 40% of the business because of its scale. It has 40% of the business because merchants like the safety of dealing with their bank partners - Chase, Bank One, Wells Fargo, etc. Their customers like the superior products and services of Paymentech and PayPoint. Their merchants like whatever benefits the First Data ISOs are offering.

Its "scale" is not what causes merchants to select First Data as their transaction processor. ISOs and acquirers are turning themselves inside out to get their piece of the $2 billion pie. ISOs can afford to (and do) pay 11 cents if they provide value to offset the commodity guy with a 2.5-cent cost. That isn't very tough to do in this era of willful statement obfuscation, arbitrary price increases and financial engineering. Of course, transaction-processing costs are important, especially to the largest of the medium-size merchants. But the vast majority of the 4 million merchants in America do not make their decision to process with one ISO or processor or acquirer because of the scale/size of the ISO or processor. They make it based upon trust and service and reducing their pain.

Finally, a short update on the First Data countersuit against Visa: The court has set a trial date of April 4, 2005, and a new judge has been assigned to the case. If the calendar holds, the Motion to Dismiss will be heard on March 12, 2003.

Bob Carr is the Founder, CEO and Chairman of Heartland Payment Systems, the nation's largest privately owned merchant acquirer and ninth largest overall, with annual revenues exceeding $300,000,000. Heartland was recognized by INC Magazine as the 57th fastest-growing private company in America and is one of the 10 largest INC 500 companies. Bob was a Founder and Vice President from 1988 to '90 of the Bankcard Services Association, which has since become the ETA.

Before entering the bankcard industry in 1986, he developed computer software systems for unattended fuel pumps and created the first integrated accounting applications for PCs. He also started the computer department at the Bank of Illinois and served as the Director of the Computer Center and as a mathematics instructor for Parkland College. He earned degrees in mathematics and computer science from the University of Illinois in 1966 and 1967.

To learn more about Heartland, visit www.hpsteammates.com or www.heartlandpaymentsystems.com, or e-mail Bob at Bob.Carr@e-hps.com.