t's seductive to consider that attrition issues in merchant acquiring are a result of pricing and increasing competition; many in the industry do believe that pricing is the essential attrition driver.

However, recent research by First Annapolis Consulting Inc. suggests that this widely held view is only partially correct and that attrition is much more of a multivariate problem.

In recent research, First Annapolis used regression analysis to estimate the relationship between pricing and attrition. In essence, we plotted a line statistically through a series of data points relating pricing and attrition rates.

The y-intercept (the value at which this plotted line crosses the y-axis) is attrition in a given segment even if the price was zero. In other words, it's price-independent attrition.

By comparing this price-independent attrition rate to total attrition for a given segment, we can estimate the percent of total attrition that pricing and non-pricing factors generate. This relationship is illustrated in the graph on page 75.

For example, pricing drives 25% - 35% of attrition from merchants with annual processing volumes in the $100,000 to $1 million range, whereas pricing drives more than 90% of merchant attrition among merchants with volumes of $20 million or more.

Smaller merchants have much higher gross attrition rates than larger ones; however, the reasons behind small merchant attrition vary, and pricing appears to be the driver in a significant minority of cases.

An inflexion point exists in merchant behavior at approximately $2 - $3 million in annual volume; pricing issues increasingly affect merchants above this threshold in their selection of an acquirer.

For merchants in the mid-market and higher, pricing is the overwhelming reason for attrition. However, that is not to imply that an acquirer's investment in personalized service for larger merchants through relationship management is foolhardy.

Rather, these investments are table stakes in a market segment where the players perceive service to be undifferentiated and the cost of conversion is relatively high. Making the "switch versus stay" analysis at the end of each contract term is often a purely financial one.

With respect to the smaller merchant segment, these observations mean good and bad news for the average acquirer. The good news is that small merchants do not appear overly price sensitive, which underscores the industry's universal assumption that acquirers enjoy their best profit margins in these segments.

The bad news is that acquirers have difficulty managing small merchant attrition given the following multi-faceted reasons:

• Service Disruptions
  Negative service events, whether in the ordinary course of business (a poorly handled chargeback) or an extraordinary event (a systems conversion), are key causes of attrition. Acquirers' merchants are theirs to lose in many respects. Service events create a reason for them shop around for a different service provider.

• External Factors
  Merchants might attribute any poor service to their acquirer simply because they are unhappy with events in the payments industry. Recently we completed an analysis in which we evaluated the correlation between an acquirer's customer satisfaction tracking, its absolute operational and service performance, and its relative performance (that is, relative to industry competitors).
  We concluded that there was a weak correlation between customer satisfaction and actual performance and that external issues such as interchange increases better explained changes in customer satisfaction.

• Life Cycle Issues
  Acquirers might do everything right and still suffer from attrition simply because events have changed for their customers. Merchants open additional outlets, someone new takes over the business, they hire a professional accountant, etc.
  The larger the acquirer, the more difficult it is to maintain a close relationship with customers and to know about and react to these changes.

• Banking Disruptions
  Whether or not an acquirer is part of a bank, a disruption at merchants' banks can trigger attrition. Disruptions can range from re-pricing a commercial demand deposit account (DDA) to a servicing event. If a merchant changes banks, the new bank (or its non-bank partners) will have a nice "at-bat" or opportunity to sell to that merchant.

• Technology/Product Offerings
  As acquirers' service offerings become more complex including check services, gift cards, PIN debit and other services (in addition to credit acquiring), we have noted an increase in attrition caused by inadequate service offerings.

Managing attrition in acquiring is more a game of infield singles rather than home runs. Effective management begins with a strong understanding of merchant behavior and ends with targeted tactics to address the factors that affect acquirers' customers. This is much more easily said than done.

David Woynerowski is a Senior Consultant and Marc Abbey is a Partner at Baltimore-based First Annapolis Consulting, a consulting and merger and acquisition advisory firm. E-mail David at david.woynerowski@firstannapolis.com; e-mail Marc at marc.abbey@firstannapolis.com .