et any two acquiring industry people together, and at some point the discussion will turn to pricing, with much lamenting about today's slim margins and the good old days when margins were substantial and fortunes quickly made. This article will discuss briefly the history and current status of merchant pricing but will focus primarily on the trends in pricing and possible future changes.

The good old days

In its early days, the acquiring industry commanded hefty margins on processing and equipment as merchants saved big money on interchange and reduced chargebacks by converting to electronic bankcard processing. Since the marketplace was in its infancy, there was enough new business for everyone. Merchants were saving money; the bankcard industry was making money; everybody was happy.

As the bankcard industry matured, it became more competitive. Since nearly every merchant in the country now accepts bankcards, most sales today are "take aways" rather than new business. Less savvy agents have resorted to selling strictly on low rates to entice merchants to switch.

In doing so, the industry has trained merchants to focus on lowering their rates. The result has been an ever downward spiraling of merchant rates, and consequently, margins. While merchant rates have fallen, card Associations have been raising interchange fees. This puts even more pressure on acquirers' margins in a two-way squeeze.

Looking to the future

Margins will continue to shrink as merchant turnover worsens. But, as this occurs, it will be increasingly difficult to offer merchants a rate that is low enough to generate savings that are sufficient enough to justify switching.

This is especially true if a merchant is content with an existing acquiring relationship or at least not too unsatisfied. (The devil you know versus the devil you don't.)

Also, as margins shrink, acquirers must become more cost efficient to survive. To do this, some acquirers will cut back on customer service. Many ISOs and member service providers (MSPs) will resort to long distance direct sales strategies, such as telesales and e-commerce, to acquire merchants more cost effectively and retain a greater share of the shrinking margin. Both trends will drive down margins and lead to degradations in customer service.

Shrewd merchant level salespeople (MLSs), finding it more difficult to compete on price, will differentiate themselves based on customer service, with a personal touch that is impossible to achieve with long distance sales.

The second effect on MLSs will be a shift in pricing formats. Today, downgrades and check cards are the last bastions of acquirer profitability. More and more acquirers will find it necessary, however, to break check cards out into a separate pricing bucket to create a savings that will entice a merchant to switch.

As bankcard issuers reissue cards as higher-interchange rewards cards, downgrades will become a bigger merchant issue. This will force acquirers to cut margins on downgrades and/or break out rewards cards into a separate bucket to be able to undercut the incumbent acquirer.

With three pricing buckets increasing to four, five and more buckets, acquirers will begin offering more "interchange plus" pricing that breaks out every interchange category separately. Merchants will now know exactly what they are paying the acquirer for each card type. With all the cards on the table, margins will shrink to a point where it will be extremely difficult to switch merchants on price.

Industry consolidations

Thinner margins will also drive industry consolidation in an effort to become more cost efficient. First, there will be horizontal integration as ISOs and MSPs merge, sell out or go out of business.

Second, there will be vertical integration. Today there are several layers between the merchant and the card Associations. For example, there can be the acquiring bank, payment processor, super ISO, sub-ISO or MSP, MLS organization, and individual MLSs. As margins shrink, the market will no longer be able to support all these layers, so acquirers will strive to eliminate layers and sell more directly.

The vertical and horizontal consolidations will significantly affect MLSs as their suppliers change. There will be more fluidity and less loyalty by agents and some (unfortunately) will get the short end of the stick.

Most will hedge their bets by using more than one ISO. ISOs and MSPs will be competing not only with each other, but also with processors and banks that emphasize signing more agents directly.

Will margins continue to shrink?

What could stave off this ever-increasing focus on merchant rates and the resulting downward spiral in acquirer margins? I really don't see anything on the horizon. It will take a major paradigm shift to turn the tide on shrinking margins.

There is growing discussion about the federal government regulating the industry, especially interchange rates. Although this could alter our industry dramatically, I doubt that legislation or regulation is likely or that it would improve acquirer margins anyway.

One wild thought is that acquirers could someday share in interchange. As acquiring margins shrink to near nothing, they might need some interchange to survive. This is not without precedent: ATM acquirers share in ATM interchange. Unfortunately, I don't see acquiring margins rebounding anytime soon.

What can MLSs do?

As an MLS, prepare to compete on thinner margins. Instead of focusing on rates, learn to sell on service and lead with add-on products/services like check services, gift/loyalty cards and merchant capital advances. Selection of an ISO, processor or bank to represent also will have great influence on your profitability and market success.

Don't get so focused on the split percentage that you end up paying a high buy rate. A larger split of a smaller margin yields less money than a reasonable split on "pass through" pricing.

A free terminal program is another way to generate higher margins. Merchants who are getting free terminals don't focus as much on the rates they pay. In the end, it's all about selling smarter rather than selling on price.

Ken Boekhaus is Vice President, Marketing and Business Development for Electronic Exchange Systems (EXS), a national provider of merchant processing solutions. Founded in 1991, EXS offers ISO partner programs, innovative pricing, a complete product line, monthly phone/Web-based training, quarterly seminars and, most of all, credibility. For more information, please visit EXS' Web site at www.exsprocessing.com or e-mail Boekhaus at kenb@exsprocessing.com . EXS is a registered ISO/MSP for HSBC Bank USA, National Association.