ately we've been hearing catchy statements to justify what could be irrational behavior: "Give away the razor and sell the blades" or "Our industry is just like the cellular industry."

Both of these declarations have been used to rationalize the transfer of wealth from ISOs and merchant level salespeople (MLSs) to merchants. However, to equate our industry to the razor blade or cellular phone spheres is not apt.

The razor analogy

Our customer base is far more diverse than the razor blade market. Men who use razor blades consume them at about the same rate. Therefore, when giving a razor away (and incidentally razors are still sold everywhere I shop) Gillette, for example, can easily estimate how many blades per razor it will sell.

Merchants, on the other hand, are a diverse group. Some are highly profitable to sales professionals, purchasing many and varied ancillary services. Others are marginally profitable and continually contact customer service for assistance in "batching out." What percentage of Gillette's customers contact customer service regularly, do you suppose?

The cell phone analogy

Consider the ubiquitous cell phone. Have you noticed how many models in use are actually free? The free one is the largest and dorkiest cell phone on display. If my Dad knew how to use a cell phone, this is the phone he would own.

In researching the cellular phone industry, Ben Goretsky, Chief Executive Officer of USAePay, found that with one particular cellular phone provider only 40% of all new cellular contracts involve free phones. The remaining 60% of customers purchase phones (or "match up" as the company explained it), and 85% of those spend more than $100 to receive the higher end features.

Goretsky also learned that when customers evaluate cellular phone options in person, as opposed to purchasing their phones online, the percentage of customers paying for a phone is far higher than 60% because they can see first hand the benefits of the higher-end phones. Certainly, my Treo was not free ... was your cell phone free?

Onerous long-term contracts

One similarity between cellular phone service and merchant processing is that when a terminal or cell phone is given away, a long-term contract with high termination fees usually comes with it. In our industry, some of these fees are charged no matter when the merchant closes the account, even if it's done at the end of the contract's full term. Others have provisions so restrictive that the contract can only be terminated during narrowly defined periods.

These types of contracts are easy to sell against. Merchants are savvier than ever about rates and realize that terminals, like interchange, represent a hard cost. They know that if they're benefiting in one area, they're paying more in others.

It's also easy to point out that if an acquirer requires a long-term contract, its service may be suspect. Even if this is untrue, suspicion can be placed in a merchant's mind. Another negative is that discount rates can be raised during a contract's term with minimal notice to merchants. A "free" terminal pitch certainly has some merchants reading the fine print, as any of us would do.

Why give wealth away?

OK, I've established that merchant processing is not similar to the shaving products industry and that most cellular phones are not free. So, why are so many companies giving away terminals?

I can't answer this question for others, but I can explain why Humboldt Merchant Services and acquirers like us are discerning in our terminal deployment.

_ We have an extremely liberal underwriting policy and accept merchants with no certainty that they'll still be in business six months down the road. If we give away a terminal and a merchant subsequently closes shop, our options are to charge the terminal's cost back to the sales partner involved, collect from the merchant or absorb the loss.

The merchant may have had poor credit to start with, and business failure probably made matters worse. Given this, many free terminal programs have claw-backs for merchants that default and cease processing within a specified period. Permitting sales partners to deploy free terminals to merchants with questionable credit records is a bad business decision; underwriting merchants and then transferring liability to sales partners if merchants fail is even worse.

• The size and profitability of the merchant base we support does not justify the cost for a free terminal program. We serve the small merchant market; many acquirers I correspond with serve the same market. The merchants with whom we work process an average of $10,000 per month. If net revenue for a retail merchant averages 0.60% (60 basis points), that leaves $60 to split. If the acquirer keeps 50%, that leaves $30 before overhead.

  Providing free terminals to this merchant base is a poor business practice. We could offset up-front costs by paying business partners less or charging annual fees. Certainly some free terminal programs do this, and when sufficient annual fees or residual reductions are applied, this makes financial sense. I applaud some of the programs that operate in this fashion.

• Giving terminals to merchants limits MLSs' income. When terminals are given away, wealth is transferred directly to merchants, and MLSs make little on those transactions; leases can earn MLSs hefty installation bonuses. If terminals must be given away, why not give them to the MLSs for resale?

  By giving terminals to merchants, we artificially limit sales commissions. For example, when MLSs give away terminals, they make less than they would by selling or leasing them. MLSs also run the risk of making less on their residuals, while being forced to charge merchants higher fees and/or lock merchants into the unfavorable types of contracts I mentioned previously. This sends MLSs a terrible message and may perpetuate bad habits in lazy or unskilled sales professionals. And new or inexperienced MLSs won't have a chance to acquire the skills necessary to actually sell. I can hardly imagine that MLSs will be able to live off referrals from existing customers.

• If we at HMS gave away terminals, why would we need to sign and train a sales team? Heck, I could give away terminals directly.

Free terminals aren't for everyone

Given liberal underwriting and small merchant customers, a free terminal model simply does not cost justify for businesses such as mine. To survive, we would need to employ claw-backs, decline merchants with lower credit, have onerous termination penalties or charge hefty annual fees. I applaud acquirers that have found ways to justify the cost of supporting free terminal programs. I assume that they serve a merchant base that is significantly different from mine. And that's one reason why this is such a wonderful industry - there's room enough for all of us.

Ken Musante is President of Humboldt Merchant Services. E-mail him at kmusante@hbms.com