Fintech M&A puts a squeeze on the ISO model
For several years, independent sales organizations have been warned by colleagues in the merchant acquiring business that they had to keep up with payments technology to remain relevant in the payments ecosystem. And judgment day is fast approaching.
The barrage of mega-mergers among payments technology providers and processors will again bring to the forefront the existential ISO question about how to adapt. Will the Fiserv-First Data, Global Payments-TSYS and FIS-Worldpay deals erode the ISO model — or will they provide the opportunity for ISOs to set themselves apart from their ever-bigger rivals?
"There are two points of view about ISOs, with one being that they are helpful and necessary for the system," said Steve Mott, principal of BetterBuyDesign, a Stamford, Conn.-based consulting firm. "The other is that they are exploitative and they goof around with interchange rates, fees and terminal leasing."
That, in part, explains why ISOs following the traditional "terminal out of the box" business model have suffered in the growing digital payments age. With so many merchants either starting out as e-commerce businesses and then considering a physical presence later, or vice versa, the independent software vendor model has found more customers than the ISOs.
"The ISV model makes a lot more sense to those merchants seeking multi channels," Mott said. "The business model calls for creating websites, and ISVs can do that far easier."
Still, there is more opportunity through the type of increased scale the mega mergers represent, and the fact that merchants increasingly seek new technologies to solve various problems from payment acceptance, to fraud security and instant merchant onboarding. And they need someone to explain all of that technology and the options that work best for their business size and customer demographics.
"The effect of mergers on ISOs means different things to different constituencies because the investment industry will see consolidation in automation and synergies for cost and revenue," Mott said. "But I see opportunity because investment in new technologies is more economical because of the scale. Two big companies don't have to spend two equal amounts to get the same thing."
Banks generally outperform fintechs and scale processors in small-business customer satisfaction with merchant services providers, a J.D. Power study found in a survey of 3,544 small business customers of merchant services provider in late 2018.
Those banks benefit from having deeper customer relationships, the study said.
That explains why ISOs have generally been left out of Apple Card marketing, because Apple considers the banks as the only help it needs to reach consumers and merchants. It's an indication that if major third-party technology providers continue to creep into the payments ecosystem, the traditional ISO-merchant account setup will further decay.
Engagement with new technologies drives higher satisfaction with business owners who rated cloud-based POS and mobile card readers higher than countertop card readers and payment gateways in the J.D. Power study.
“Whether they are selling goods online, through retail locations or in business-to-business markets, small businesses in America are being required to accept a range of card and digital payment options, and merchant services providers are a vital partner in that process,” Paul McAdam, senior director of banking intelligence at J.D. Power, said at the time of the study. “While overall satisfaction with merchant services providers is strong, there is room for improvement in the areas of helping businesses understand the pricing of merchant services and in providing consistent technology training and support.”
It also remains to be seen the extent to which the mergers will transform the overall third-party transaction processing industry, as the acquiring side of the ledger for most companies has not also included a card-issuing processor leg.
But now it could, as more companies may have the look and feel of what First Data has touted itself as for years in being able to deliver both services.
Plus, in the past five years or more, merchants have found that signing up with Square — which is essentially a super ISO — or First Data's Clover and other mobile POS providers can deliver the ability to accept card transactions in just minutes. With that kind of experience, merchants increasingly wonder why they would need to work through an ISO.
As if that isn't enough of a concern for ISOs, many are also falling behind in their own innovation by not always making good use of social media channels and other technology that would enhance and support their acquiring efforts.
As such, it will be wise for ISOs to build compelling business models to assure they are offering new digital-first value propositions, said Mark Ruddock, CEO of BFS Capital, which deals with ISOs in the lending space.
"Even smaller, niche players must create a frictionless on-line experience for their customers," Ruddock said. "Dialing for dollars is a dying art."
Because merchants have information about potential options readily available on the Web in seconds, it has generally undercut the value of the traditional intermediary, Ruddock said.
"In many cases, those merchants are more comfortable sourcing and working directly with vendors than leveraging an intermediary," he added. "The market is at risk of shrinking for traditional ISO players if they don't understand this."
Those companies that have established bank relationships and continue to advance technology to benefit ISOs are likely to find themselves in a comfortable spot.
"It's the evolution of the industry, and I'm pleased to say that we have very good working relationships with the companies in the recently announced mergers," said Richard McShirely, chief marketing officer of linked2pay.
Linked2pay has delivered various software tools for ISOs, from acceptance of Same-Day ACH and real-time payments to faster merchant onboarding.
"As a solution provider, we are not surprised by the mergers; and because we have always taken the long view through our consolidation of card, ACH, real-time payments and other services, through a single-user login, we view this as good news for us," McShirley said.
That position speaks to the reality that most business owners are not specialists in payments, financial products or services. That will not change because of mega mergers on the payments landscape.
In some ways, the mergers could create an environment in which merchants become even more confused about the numerous options and products available to them in an increasingly digital world.
ISOs can still find an important role for those merchants who don't understand or can't decide about what would work for their business, or face "serial rejection as they apply for financial products from vendors for whom they are not a fit," BFS' Ruddock said.
The changes in payments and security technology, as well as the need for merchants to secure funding access, will always open the doors for ISOs that concentrate on better costs and service capabilities. They will have to, since the major mergers point to a desire for the large companies to also step up that part of their image and brand.
"One thing our research tells us is that half of the merchants still need someone to help them," Mott said. "They are basic human beings who want another human being telling them this is what they have to do and then to act accordingly."