ramatic changes in the payments industry have turned POS equipment leasing on its head, threatening what has previously been a reliable source of income for ISOs and merchant level salespeople (MLSs) alike. Is the practice of leasing going to die off like a dinosaur or emerge triumphant like a phoenix? Right now, the pros don't agree on an answer.

The way it was

It used to be simple: Merchants could either rent or buy equipment; most, particularly smaller or newer businesses, tended to lease. For merchants, the benefits of leasing were (and still are) improved cash flow; tax savings - leasing costs are considered an operating expense and are thus deductible in a more favorable way than depreciation; and the ability to stay on top of technological changes rather than invest in equipment that may become obsolete before it's paid off.

For ISOs and MLSs, leasing had (and still has) benefits as well: It provides an immediate lump-sum payment, which brings ISOs and agents income while they wait for residuals to accumulate. This cash flow makes it feasible to sell to mom-and-pop or start-up merchants - accounts that may take years, if ever, to build up to substantial residuals. And merchants who lease are much more likely to upgrade to newer or more expensive equipment than merchants who own.

The way it is

The advent of free terminal programs, saturation of the existing merchant market and increased industry consolidation have substantially shifted industry dynamics. Proponents of free terminal programs say the changes were inevitable.

There are few established merchants who don't accept bankcards. In order to sell to merchants with POS systems already in place, first you need to find merchants who are seriously unhappy with their current processors. Then you need to offer substantially better prices or offer vastly improved technology, at a cost that makes switching processors appealing. This is a tall order in an industry where the prices don't vary by more than a few points from processor to processor. Hence the free terminals.

"The industry is changing," said Ed Freedman, President and Chief Executive Officer of Total Merchant Services. "It's not changing for the worse; it's simply changing. Relying on the sale or leasing of equipment for your income no longer works. But in the long term, building a portfolio has much greater potential. You may not get rich fast, but you can get rich."

Critics, however, say free terminal programs force the industry to focus on residuals and thereby:

• Undermine the health of leasing companies and increase the pace of industry consolidation
• Make it harder than ever for new blood to enter the industry and drive the best salespeople into industries that provide more immediate income from sales
• Hurt smaller merchants or agents with many small merchants in their portfolios.

Some industry insiders say free terminal programs portend a bleak future for POS equipment leasing. Bobby Joseph, a Founder of Allied Leasing Group Inc., even predicts that POS leasing will be merely a memory in five years. POS leasing "is going downhill," he said. "All the leasing companies seem to be liquidating their portfolios."

Living down a bad name

Free terminals and intense competition aren't the only factors hampering the POS leasing industry. It's also struggling under the weight of a bad name.

Kathy Harper, Director of the Merchants' TPS Georgia office, thinks the industry's sullied reputation is insurmountable. "Honestly, I just don't know how it can recover," she said.

In a typical leasing agreement, the ISO/MLS purchases the equipment, leases it to the merchant and then resells the equipment and the lease to a leasing company. Setting prices is largely up to the ISO/MLS, a situation that has given MLSs the flexibility to charge whatever the market will bear and made it easy to overcharge.

Problems arise, Joseph said, when reps "oversell the equipment at exorbitant prices and ... make promises and misrepresentation regarding the terms."

Certain merchants who are irate because they've been hit with massive monthly payments for minimal equipment have contributed vociferously to leasing's bum rap.

But Charles Salyer, President and CEO of GlobalTech Leasing Inc., pointed out, "It is, however, the ISOs that set the payment amounts, the term, fill out the agreements and have the customers sign, not the leasing company."

Salyer maintained that leasing companies have been trying for years to reduce the maximum lease payments allowed. "The high end of the spectrum continues due to competition among leasers; however, the ability for an ISO to supply free equipment is starting to bring those payments down to a more reasonable level," he said.

Holding the line

Instances of regulatory scrutiny illustrate why leasing companies try to hold down payment amounts. Several years ago, the Federal Trade Commission and law enforcement agencies from eight states went after Leasecomm Corp. (a POS-leasing market leader at the time) alleging that the company was financing get-rich-quick schemes, and either knew or should have known that its vendors used deceptive practices to make sales.

Leasecomm denied any wrongdoing but, in 2003, paid a $1 million fine and canceled $24 million in judgments allegedly obtained through deception. Leasecomm subsequently went out of business. (See "Leasecomm settles with FTC, cancels $24 million in customer debt," The Green Sheet, June 23, 2003, issue 03:06:02.) Since Leasecomm's demise, the industry has undergone extensive consolidation. Salyer noted that of the companies doing business following Leasecomm's exit, only one remains independent.

"But as is normal with any business situation, with consolidation comes an offspring of new small businesses," Salyer said. "Just a stroll through the vendor booths at the ETA [Electronic Transactions Association Annual Meeting & Expo] reveals multiple new small leasing companies searching for a niche in the business. Consolidation spurs entrepreneurs to take action and fulfill the needs of any industry."

Salyer also thinks leasing acts as the POS industry's mirror. "Occasionally the reflection is less than flattering, but the industry, through trade organizations like the ETA and regional acquirer organizations, continues to bring the bad eggs into check."

Honesty is what counts

Going against the grain, The Phoenix Group, an independent distributor of POS equipment, has recently begun equipment leasing. According to Scott Rutledge, the company's President and CEO, the stigma is no longer deserved.

"Leasing has cleaned up quite a bit since the early days," he said. "It's a legitimate tool now rather than a get-rich-quick scheme. It provides a revenue stream for agents, and it gives merchants a way to get into a better piece of equipment than they might otherwise be able to afford."

Rutledge also noted that MLSs who leaned toward equipment slamming (the practice of leasing equipment at highly inflated prices, hiding additional fees in contracts and then leaving the industry after cashing in) or who sold fraudulent leases to leasing companies have probably contributed to increased scrutiny by the FTC. But he thinks the bad practices of a few agents haven't really caused many problems with merchants overall.

"[W]e forget sometimes that even though we focus all day on the card industry, our merchants don't," Rutledge said. "Processing is just one small part of their business. If they haven't had a bad experience, they probably don't think much about our reputation one way or another."

Claude Godfrey, an MLS, agreed. "My customers care if I'm honest," he said. "If other people in my industry have been dishonest, well, what do they [my customers] care?

"I think if you take the time to explain the terms, they know they can trust you. They know there are costs involved. Hiding them doesn't help."

To lease or not to lease ...

Some experts think if leasing is taken off the table many entrepreneurs, who tend to be innovators and industry builders, will spurn payment processing altogether.

"Without leasing, the industry is left only to a small group that has the substantial seed capital to organize, start and support an ISO until the residual income grows large enough for them to turn cash positive," Salyer said.

"The POS industry was built by and continues to grow with risk takers that use leasing revenues to support the growth of extremely valuable merchant portfolios."

Joseph agreed, saying free terminal programs suit only the reps who already have a good vested residual income. "Reps need their bread and butter, and no matter how attractive the residual packages are, they have to think about today."

Freedman, on the other hand, insists not only can you make a living without leasing terminals, but it's also the only way to go. "You can close four times as many deals with free equipment programs as you can without them," he said. "It supercharges the growth of your residual income. The idea that you can't make money without leasing income is insane."

Harper acknowledged that she hasn't sold a piece of equipment in a year and a half because in most cases free equipment gives merchants the best deal, especially for high-volume merchants or those who don't want to be stuck with obsolete equipment in the rapidly changing wireless environment.

"There may be cases where leasing or buying the equipment is better for the merchant, but those cases don't come around very often," she said.

Harper said she has tripled her income, at the very least, since she's started giving away terminals. "I think even most of the old school MLSs carry a free equipment offer in their pocket even though their emphasis is on equipment leasing," she said. "But if you're a good salesman you can sell the equipment even when competitors are giving it away."

Some MLSs, like Godfrey, steer clear of free equipment, considering it to be a gimmick. Godfrey said he closes at least 20 deals per month. "If you tell a merchant there's no such thing as a free lunch, they get it," he said. "[Y]ou can't give away a piece of equipment, especially to some of these smaller merchants where you're only going to earn $10 a month; so there are really high termination fees or monthly minimums or higher processing fees.

"A good businessman recognizes that equipment is just one of the costs of doing business. The price of the equipment is a consideration, but not a priority. And it's the good businesspeople you want as your customers."

Can we all get along here?

Harper thinks free equipment programs are here to stay but isn't certain how many "players will still be in the game" in five years. "Of course, there's really no such thing as 'free' in this business," she said. "Everyone just moves the money around. Our industry is a shell game."

Godfrey thinks free equipment programs are more passing fad than sustainable practice. "I don't think you can do it [provide free equipment] for very long and stay profitable," he said. "[I]n the long run business is business, and you have to stay profitable. I'm going to sell equipment until I'm the very last one in the industry selling equipment."

So, is it time to sound the death knell for POS leasing, or will it remain a viable option for meeting merchants' needs? The outcome could be up to you.