By Brandes Elitch
CrossCheck Inc.
H.L. Mencken said, "When someone says, 'It's not about the money,' it's about the money." Here in Sonoma County Wine Country (where CrossCheck Inc. is located), spring is here, and we are experiencing "bud break," the start of the 2014 growing season.
The buds will slowly shoot into leaves and vines, and eventually, grape clusters. This year is complicated by the fact that we've had very little rainfall. When early morning temperatures fall below freezing, vineyard managers typically spray the buds with water, which freezes around the bud and protects it with an ice shield. The frost season can run until the middle of May. Some growers have already pruned their vines differently, to reduce fruit or canopy, and lower the need for irrigation.
In the past, a grower might purchase water from our local water agency, but in February the agency said that will be offline this year because of the drought. Some growers get their water from the Russian River, which is fed by the reservoir at Lake Mendocino.
However, the lake is at 50 percent of capacity and projected to run dry in November. This has never happened before. Some growers use fans for frost protection, but it can cost as much as $100 an hour to operate a fan. This is just another example of the old mantra that, when it comes to farming, "Nature bats last."
By coincidence, we are also experiencing "bud break" in the financial services industry, but here it's not about the grapes, it's about the money. In the credit card industry, there has been no new product since electronic ticket capture. Now the buds are breaking on a host of new products. Just as with grapes, the new financial innovations and related developments need to be carefully nurtured and managed, or they risk dying on the vine.
In March, I attended the annual Jack Henry-ProfitStars Educational Conference, and learned about the state of the banking industry. ISOs should pay attention to this space. This is because all payments begin and end in a demand deposit account. All payment systems require a financial institution (FI) to carry them, whether as a check, ACH, Fedwire, cash, or settling to and from a card network processor.
The sine qua non of payment processing is having a reliable and knowledgeable banker as your financial partner. Banks and ISOs have a symbiotic relationship: 99 percent of banks are not acquirers, but they have the local merchants in their footprint, and they have loans to those merchants. When you loan the money, you own the relationship, period.
These banks need someone to process card transactions for their merchants, as well as sell, train, deploy equipment, and handle customer service for card processing. There are 6,812 banks, plus thousands of credit unions. About 41 percent of the assets in the banking system are held by just four banks, and the 108 biggest banks (those with over $10 billion in assets) hold fully 81 percent of the assets. Banks with less than $10 billion in assets are not subject to the Durbin Amendment to the Dodd-Frank Act and are not subject to inspection by the Consumer Financial Protection Bureau.
Moreover, a number of the top 10 banks have large merchant processing departments, generally staffed by their own employees, who are not ISOs. The opportunity for ISOs is to work with regional and community banks.
Getting to know the local bankers and understanding their needs is one of the smartest things you can do as an ISO. I will share a secret I learned from working at a community bank for five years, starting an acquiring business: bankers don't know how to sell, and more specifically, they don't know how to sell fee-based payment products. They have customers that need these products, but they don't know that they might have a solution lurking nearby.
This is where the ISO and value-added reseller (VAR) come into play. Banks want fee income and more: non-interest income, client retention, deposit growth, e-commerce and small business loans. Only 35 percent of FIs process transactions; their merchants use a big bank for that. But the smaller bank can partner with third-party processors to compete and give their merchants what they want.
The ProfitStars conference offered up 150 sessions and lasted three-and-a-half days. To give you a sense of the ferment and scope of change bankers are dealing with, I offer up what bankers hope to say to merchants: "Here is a bundled package with everything you need. It's on your iPad and it's ready to go, and you don't need another (nonbank) partner!" Banks have the financial data on all their customers and they have their trust too – think about this when you read these discussion topics.
Managing infrastructure: Banks choose whether to license or to outsource processing. In the past, most banks chose to license, but that is changing. The trend is toward hosted-outsourced services, versus doing this in-house. This is called "infrastructure as a service." Companies like Jack Henry manage the bank's networks, servers, application software, hardware and software upgrades, patches, disaster recovery, intrusion monitoring, etc.
Now, the bank can use any core processing software and use the products of competitors. I see this as the future, because the business of banking has changed and the focus is on managing risk and increasing profitability, not running an in-house data center. Of course, ISOs and VARs can also sell these services to their clients, and do not have to worry about licensing them or trying to do part of it themselves. Security: Banks are overwhelmed dealing with the double punch of increasingly complex financial crimes and an increasingly demanding regulatory burden. Fraud can be counterfeiting, outright theft, or impersonation. It occurs in monetary/payments instruments, bank products and services, the five channels that banks sell through, and transactions. To complicate things, fraud and money laundering are linked together. The first thing regulators look for is proper anti-money laundering procedures.
Fraud: Half of all card fraud globally is card-not-present fraud. Data compromises are growing, including data theft, skimming and phishing. The third type of fraud is an outcome of evolving third-party dynamics and the increasing risk from bad actors. There is a growing regulatory interest in electronic payments, which may alter growth in this space. New players and services bring new risks with them, and clients need to be able to navigate the new risk challenges and withstand regulatory scrutiny. The future is probably some kind of dynamic authentication. Mobile solutions: The average consumer has 34 apps on their mobile devices. Some consumers are asking for a mobile wallet, that houses receipts, coupons and payment credentials. They use their phones for showrooming, preordering, location-based offers, virtual storefront, buying in aisle, mobile POS, location-based apps, and omni-channel shopping (phew!).
The wallet can be staged (run as the merchant of record, such as PayPal Inc.) or pass-through (for example, MasterCard Worldwide – takes information in a container and passes it to the merchant, who runs it as they normally would). Consider this: there are 1.3 billion active credit and debit card accounts worldwide, and there are 6.8 billion mobile accounts worldwide. Bankers want to know: will phones replace cards and cash? Or, in the future, will there be no POS, and will the payment be invisible?
Europay/MasterCard/Visa (EMV): The October 2015 liability shift is still in place; if the merchant doesn't use a chip card for card-present technology, he will be responsible for any fraud loss (even though there is no mandate for the issuer to issue an EMV card). The Durbin Amendment requires the issuer to have two unaffiliated networks, so that the merchant can choose the routing, but today, EMV is proprietary to the card brand and routing is controlled by the app that sits on the chip.
Payment options (bill pay, automated clearing house (ACH), check and remittance capture): Jack Henry owns two companies in this space: iPay, a bill pay platform used by 4,000 banks, and Banno, a mobile banking solution. One presentation at the ProfitStars convention was on new regulations in the health care market. Did you know that a hospital could run seven to 10 different billing systems (the result of acquiring other companies)? The Jack Henry product can convert paper to image, reconcile the check/EFT to the accounts receivable (A/R), auto-populate the A/R data to the patient management system, run a transaction research portal, and manage short pays, underpayments, denials, as well as providing analytics.
Another product uses mobile remote deposit capture (RDC) to run a remittance plus lockbox. The consumer can pay via a portal. Reporting is available in multiple export types, including Excel, CSV, TSV, and QuickBooks. Many ISOs and VARs have clients that need these services, but can't find exactly what the client wants.
Cash: Cash is not going away: it's anonymous, cannot be tracked, it's ubiquitous and you don't need to open an account or divulge personal data to use it. The United States accounts for 60 percent of the world's money supply held by central banks. Total U.S. currency is growing at 7 percent a year, and cash is still used for one-third of all payments.
Big data: Big data comes from the proliferation of smartphones and tablets, cloud-based computing, integrated software, hardware, and networking tools, and the ability to leverage data to capture customer preferences and profiles.
The most compelling presentation I attended at the ProfitStars event featured a small-business owner who talked about how he started his company and what he needed from his bank to do that. He discussed how hard it was to get started, and what a gamble it was to put your life savings on the line at age 57 and start a company at the start of the Great Recession, when bankers weren't loaning money. A growing business just eats cash. You can't have your cash tied up in A/R, because even with a full order book you will have to shut down.
A great story well told – and one that we should keep in mind when we, as ISOs, are calling on merchants. We need to focus on how we can help the merchant, not just what we have to sell. Thanks to Jack Henry for putting this in perspective.
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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