The Green Sheet Online Edition
April 25, 2016 • Issue 16:04:02
The shifting landscape of merchant acquiring
Aggregation – long discouraged by the card brands – has become a springboard for growing card acceptance. Just don't call the companies offering these services aggregators. They are payment facilitators, sometimes called PayFacs – software and technology firms that contract directly with acquirers to support payment services for their merchant clients. And they are sanctioned by the card brands.
Shopify Inc., a commerce platform used by nearly 250,000 small merchants to manage stores across channels, is a payment facilitator, registered with MasterCard Worldwide. There are dozens of other registered payment facilitators serving North America, including U-Haul International Inc., Groupon Inc., Square Inc., Stripe Inc. and several vertical-specific billing companies, according to lists maintained by MasterCard.
Many of these companies initially worked through gateways, like Authorize.net, until they realized card acceptance wasn't that far removed from what they already were doing for their clients, and that they could trim costs by taking the process in house.
"The term payment facilitator has become synonymous with the idea of being able to simplify" merchant services, said Roy Banks, Chief Executive Officer at Network Merchants Inc., a gateway provider.
When working with a payment facilitator, merchants don't have to go through extensive applications processes, fulfill onerous underwriting requirements and pay daunting monthly fees. "There are merchants that would not be accepting electronic payments but for this model," said Theodore F. Monroe, a Los Angeles attorney specializing in payments and merchant services. "The sweet spot is some type of [software-as-a-service] company that provides some type of enterprise software that allows merchants to take credit cards."
Most experts agree that Square paved the way for this approach to merchant services. "Square gave everybody a boot in the pants," by demonstrating how easy it was to sign up micro merchants, said industry attorney Adam Atlas. "And everyone had to play catch up," he added.
Visa Inc. saw the writing on the wall, and in 2011, placed a significant investment in Square. Visa and American Express Co. each have sizeable investments in Stripe, which supports online payment for consumers and small businesses using the software-as-a-service model. Stripe has said it will rely on Visa's footprint to grow its business, globally.
"Given the explosive growth of new commerce experiences enabled by a global developer community, Visa is expanding its strategic relationships across the payments ecosystem," Visa executives said in a statement last year. Square, which originally was intended as a card reader that attached to mobile devices, has been moving online, with a new toolkit that makes it easy to support Square and store management routines.
In February 2016, Stripe launched Atlas, a toolkit that enables foreign companies to incorporate in the United States and grow online business. In March, the company began accepting applications from Cuban startups. Despite its proximity to the United States, Cuba is woefully behind in the digital revolution. According to several sources, less than 4 percent of the Cuban population has Internet access, and credit and debit cards are practically nonexistent.
The case for new card-accepting merchants
"Square and Stripe are two payment facilitators that have proven that people are willing to pay for convenience," said Chad Roll, Managing Director at Zift LLC, which specializes in payments as a service integration for business management software. It runs on UniPay, a processor-agnostic payment gateway.
Acquirers have always found it difficult and costly to pursue very small merchants as clients, since the same administrative procedures are required whether the prospect has millions of transactions or just a handful a week.
Payment facilitators are a product of the evolution of ISOs, Roll said. Payment facilitators take on underwriting, funding and other administrative procedures in exchange for cheaper access to transaction processing services. They're similar to super ISOs, which are large ISOs that sell through downstream ISOs, because "they aggregate transactions and they leverage scale economies," said Donna Embry, Senior Vice President at Payment Alliance International.
According to Adam Atlas, some ISOs have gone the payment facilitator route. "They become PayFacs with the intention of signing merchants and transitioning them to full merchant relationships down the road," he said. "It's about getting a foot in the door."
But super ISOs tend to stay clear of risks, leaving merchant underwriting to acquirers. Payment facilitators, on the other hand, handle underwriting and merchant funding, as well as general merchant support. "It's about bringing efficiencies to something that historically has been a disjointed process," NMI's Banks said, referring to merchant application completion and underwriting.
NMI recently rolled out FACe, a gateway platform designed for payment facilitators. "FACe saves payment facilitators the considerable time and capital required to engineer a payment platform from the ground up," Banks said. He noted that the platform provides solutions for merchant and sub-merchant management, including real-time onboarding, account management, know your customer (KYC) requirements, reporting, billing and accounting services, statements, and reconciliation reporting.
What once took weeks – signing, underwriting and onboarding merchants – PayFacs can now complete in just a few hours, stated Nick Starai, Vice President, Product Development at NMI.
What makes a payment facilitator?
"There are plenty of companies in this space," Roll said. Examples include firms that provide management software to specialty businesses, like fitness clubs and medical practices. "They can easily set themselves up as payment facilitators, and it gives them the ability to provide a better customer experience," Roll said.
Ideally, a payment facilitator has a unified platform that can manage the entire lifecycles of merchants and their transactions. "It significantly lessens the risks for acquirers," Roll noted.
Visa addressed the trend in a 2014 document titled The Visa Payment Facilitator Model: A framework for merchant aggregation. "The Payment Facilitator model has a positive impact on all key stakeholders in the payment processing system," the document states. Establishing a payment facilitator is not cheap, nor is it simple to establish. Acquirers must register payment facilitators with the card brands, and pay an initial registration fee of $5,000 plus $5,000 a year for each registered payment facilitator relationship.
Following are key payment facilitator responsibilities, as spelled out by Visa:
- Contracts with an acquirer to provide payment services to sponsored merchants
- Contracts with merchants to enable card acceptance
- Monitors merchant compliance with card company operating rules
- Receives transaction settlement proceeds from acquirer on behalf of sponsored merchants
MasterCard also revised its rules in 2014 to address payment facilitators. It set a $1 million cap on combined MasterCard credit and Maestro debit card transactions before requiring direct acquirer relationships with PayFac merchants. Visa requires a direct acquirer relationship when a merchant's annual Visa sales exceed $100,000.
Initially, payment facilitators were encouraged to be vertical specific. "The expectation was that these companies would know a lot more about industries they were already serving," Monroe said. "I don't know if that's as important now as deploying technology with competence, a deep understanding of the risks and underwriting skill."
Culture of change
The merchant services marketplace is continuously changing, with the emergence of new players, technologies and business models. This has had an impact on MLSs. "Their way of working is under attack," said Atlas. "We're on a trajectory where face-to-face and to a lesser extent telephone cold calling are continuously coming under attack by new cultural realities." The consultancy McKinsey & Co., for example, predicts that over the next five years the "vast majority" of revenues from merchant payment processing – more than $1.5 billion in new revenues – will be acquired through software solutions rather than traditional payment terminals.
These anticipated changes are not necessarily bad news. Indeed, new players are good for the market. "That's how you get creative, how you keep everyone on their toes," Embry said. "Shouldn't the traditional model be threatened? We're talking about a model that has been around for a long time."
Atlas offered some cautionary notes regarding payment facilitators. "PayFacs assume full liability for merchant losses and chargebacks," he said, noting that absent sufficient front-end defenses, it only takes one bad actor to bring down a payment facilitator – and payment facilitators need to invest in leading edge technologies. "This is a lot more than what the typical ISO is doing," he added.
And then there are challenges posed by KYC and anti-money laundering rules. "The risk is elevated in the PayFac environment because [acquirers] may not be getting to know merchants as well as they used to," Atlas said. "The entire industry should be reflecting on the risks posed by PayFacs." He also pointed to a potential for a "disconnect" between consumers, merchants and processors.
So what does a PayFac actually do? Here's a list adapted from a list provided by Zift:
- Contracts with acquirers, which will require proof of financial viability, necessary insurances, etc.
- Handles customer relationship management systems and expertise
- Creates mechanisms for verifying merchants, including access to credit files and background checks
- Implements payment gateway software that can integrate with chosen acquirers and/or processors
Garners necessary Payment Card Industry Data Security Standard compliance certifications
Establishes a merchant funding strategy. This can be performed either through the acquirer, or the functionality can be implemented on the payment facilitator's own server
Implements strategies and tools for identifying and preventing fraud perpetrated by merchants or consumers
"Ideally, a prospective payment facilitator needs a unified platform capable of managing the whole lifecycle of the merchant and the merchant's transaction," Zift stated.
Betting on technology
Technology has been and will continue to be a major driver of change in the merchant services as it has been in most business lines. McKinsey addressed this in a 2014 report, Innovation and disruption in U.S. merchant payments. "Over the next decade, technology will drive evolution in merchant payments that will rival the changes prompted by the introduction of the electronic terminal 30 years ago," the report stated. "New entrants, armed with the latest technologies will challenge traditional customer relationships."
Traditionally, if a business owner needed software he or she went to a retail outlet and purchased it off the shelf. Not these days. Similarly, ISOs would sell, install and train merchants to operate POS devices. "That doesn't happen much anymore; the industry is changing," Roll said. "You need to add value for the customer." Tighter integration with business solutions is one example, and Roll suggested that many legacy players aren't up to the task. Worldpay is one legacy player that seems up for the task. "We understand the face of acquiring is changing," said Steve Karp, President of the Small Business Unit at Worldpay. "We know the day will come when the standalone payment terminal is no longer central to merchants."
In 2015, Worldpay gave $1 million to the Advanced Technology Development Center, a business incubator housed at Georgia Institute of Technology in Atlanta. The funds were allocated to build a financial technology practice focused on the next generation of payment technology companies. The ATDC reported in April 2016, one year into the program, that the center is working with 20 startups, including eight that have raised more than $16.8 million in funding. Atlanta has been building a reputation as a global fintech capital. The Technology Association of Georgia said that 60 percent of financial technology companies are located in the Atlanta metropolitan area, and 70 percent of payment card transactions are processed through Transaction Alley in the metropolitan Atlanta area.
Over the past decade, investments in financial technology have been growing exponentially, increasing from $1.8 billion in 2010 to $19 billion in 2015, according to Citigroup Inc. In a recent paper titled Digital Disruption: How FinTech is Forcing Banking to a Tipping Point, Citi wrote, "The majority of this investment has also been concentrated in the payments area. Despite all of the investment and continuous speculation about banks facing extinction, only about 1 percent of North American consumer banking revenue has migrated to new digital models. Although FinTech companies have the advantage of new innovation, incumbent financial institutions still have the upper hand in terms of scale."
SIDE NOTE: Merchant services 2016: Players and more
- Acquirers: Acquirers are banks registered with the card brands that provide payment processing services to merchants. Acquirers rely on in-house staff and/or ISOs to solicit and sign merchants and assess merchant services fees, which include interchange.
- APIs: Application programming interfaces consist of tools, routines and interfaces that allow users to build software applications. With APIs users can program reconstructed interfaces rather than individually programming devices or software.
- Gateways: Payment gateways essentially are data pipelines. They connect merchants with acquiring bank processors and the card networks. In 2014, McKinsey estimated there were about 500 gateway service providers in the United Sates.
- ISOs: These are independent sales organizations that sign merchants for processing and related services. They help merchants prepare for the acquirer/processor underwriting process.
- MLSs: Merchant level salespeople are the feet on the street. As independent contractors, they sell directly to merchants on behalf of ISOs and acquirers.
- Payment facilitators: Sometimes referred to as aggregators or PayFacs, payment facilitators are technology companies. Some, like PayPal and Square, are payment pure plays. Others (for example, CRT Medical Systems) have integrated payment acceptance with business management solutions.
- Processors: These are organizations with direct links into VisaNet and BankNet, the two leading card networks. They provide authorization and/or clearing and settlement on behalf of acquirers. Sometimes an acquirer is also a processor.
- Super ISOs: Very large ISOs that support multiple downstream ISOs and MLSs. A super ISO can also be a processor. Super ISOs help merchants prepare for but do not actively participate in merchant underwriting.
- VARs: VARs are value-added resellers, or third-party resellers, that typically sell technologies developed for specific verticals (restaurants, automobile dealers, etc.) They work with processors and acquirers to facilitate payments and integrate with other business products and services.
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