By Brandes Elitch
CrossCheck Inc.
In banking, and most other industries, a concentration is not a healthy thing. Generally, you do not want to have more than 10 percent of your capital and surplus loaned out to one borrower or group of related borrowers.
Merchants estimate that 20 percent of their customers generate 80 percent of their revenues, which is another form of concentration. And then, there is the other side of the coin: monopoly, or more likely, monopolistic practices, that can dominate an industry. These factors affect both the wine and payments industries.
The Santa Rosa Press Democrat published an article by Cathy Bussewitz on Dec. 8, 2012, indicating there are about 1,500 grape growers and 500 wineries in Sonoma County. The annual crop is worth about $400 million. Yet the top five vineyard owners control about 20 percent of the harvest, and they control the price wineries pay for grapes.
The two largest players, the Gallo family and the Jess Jackson family (also known as Kendall-Jackson), own about 3,200 acres apiece. They began to buy land in quantity about 20 years ago. Over this time vineyard acreage in the county more than doubled, from 28,000 to 63,000 acres. It should be no surprise that today the cost of raw land is at least twice what it was then. Recent prices have ranged between $60,000 and $125,000 per acre.
The remaining land is not so desirable; it might lack enough water or the right soil or climate, and the county has adopted a more intensive environmental review of hillside planting, wetlands and, of course, endangered species.
Jackson and Gallo took different approaches. Jackson contacted every vineyard owner that had over 100 acres and asked if they would sell their property. Gallo bought land and reshaped it with huge earth-moving equipment like that used to build the Alaska pipeline. Gallo was less focused on premium wines and more on supplying bulk wine to its Modesto, Calif., factory.
Two - thirds of our vineyards are still owned by independent growers. Conversely, in Napa County, only one-third of the vineyards are owned by independent growers. The big wineries want to control their supply, and of course the quality, but increasingly it is becoming a capital intensive business.
Today, roughly 35 to 40 percent of the grapes are harvested by machine, which is expensive. So it is a reasonable prediction that the larger wineries will continue to pay the highest prices and get the more desirable vineyards as they come up for sale. But the 1,500 growers are still powerful and important, and contribute much of the vitality and innovation to the industry.
Now, what about concentrations in the payments industry? Do a small number of players dominate the business? Well, Visa Inc. and Mastercard Worldwide are monopolies, so that would qualify them on the face of things. It would be virtually impossible to start a new payment network like these two – not impossible, but it would take a new or different model.
VeriFone Inc. seems to dominate the POS device market, but there are a few other players with healthy market share, including MagTek Inc., RDM Corp., Panini, and Ingenico. The issue there is compatibility. ISOs and developers want to certify to one or two vendors but not many more.
The lines between acquirer and processor are blurred. But generally, the processor does the transaction authorization, capture, clearing and settlement from the POS to the network for front-end processing. Then, it handles the back-end processing: sending the money to the merchant.
Some acquirers do their own processing, and some resell for a third-party processor. To make it more complicated, an acquirer might use one processor for front-end processing and another for back-end processing, and there might even be different merchant accounting systems. Because of the processors' complexity, there have been large barriers to entry for at least the last 15 years, and it is unlikely there will be any new entrants anytime soon, at least in the traditional sense.
The list of top ten processors hasn't changed much in the last few years. Data I have from mid- 2010 shows the following:
Preliminary data collected by The Green Sheet indicates the following companies were the top 10 acquirers in 2013:
The top 10 processors in the world handle fully half of global transaction volume. Of course you would expect money center banks like Wells Fargo and Bank of America (who would have guessed that North Carolina would become a global money center?) would be on this list because they have a lot of business-loan clients. It isn't legal for a bank lender to "tie" the loan to other contingencies, such as moving all their depository and investment business to the lender, but it does happen. In my years of banking, I have seen it happen many times.
When the First Data, BofA alliance was formed, BofA was able to bring 240,000 merchants to the books, and First Data brought 140,000. This is critical mass. I imagine the same is true for the Wells Fargo alliance, too. Estimates I have seen indicate First Data processes fully 40 percent of all transactions. Now, that is a concentration.
But what does it really mean to have a concentration in the card processing business? To answer this, you have to look at First Data in more detail. After KKR bought the company in 2007, the debt rose from $2.5 billion to $22.5 billion, more than twice the company's annual revenue. I am not making this up. Annual profit fell from $1.5 billion to a negative $500 million.
Last year, First Data had to renegotiate some of its debt out to 2017. First Data lost $3.8 billion in 2008, lost $1.1 billion in 2009, and lost $1 billion in 2010. For the first nine months of 2013, the consolidated net loss was $746 million. I will refrain from commenting on these figures, because they speak for themselves.
Of course, you might argue that this is benign, because First Data is subsidizing merchants and ISOs via these massive losses, but I am not so sure that is a viable long-term strategy. In fact, as a car collector, this reminds me of the notorious Cerberus Capital Management's 2007 acquisition of DaimlerChrysler AG, which ended badly for the boy wonders at Cerberus.
Now let's circle back to the wine business. It seems that the top 10 big wineries control about 20 percent of the land, and there are 1,500 healthy small growers. I wouldn't call that a concentration. There is still healthy competition, and it is an incestuous industry, with people moving around all the time. Knowledge and information is being shared, to a large degree through the University of California at Davis. The acid test is, would you and could you start a small winery today? The answer is yes.
But on the payments side, could you start a new network, processor or even large ISO today from scratch? I can't imagine that many people would agree this is possible. This is good news for the existing players, but not so good news for the traditional small ISO, the reason that The Green Sheet was started in the first place.
This doesn't, however, mean the demise of smaller players. If you aren't working with a top 10 payment company, think about how to add value to your merchants to make you an integral part of their businesses, not a commodity. Fortunately, the many new ideas and innovative products coming out now make this a realistic option. 
Brandes Elitch, Director of Partner Acquisition for CrossCheck Inc., has been a cash management practitioner for several Fortune 500 companies, sold cash management services for major banks and served as a consultant to bankcard acquirers. A Certified Cash Manager and Accredited ACH Professional, Brandes has a Master's in Business Administration from New York University and a Juris Doctor from Santa Clara University. He can be reached at brandese@cross-check.com.
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