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The Green Sheet Online Edition

September 08, 2014 • Issue 14:09:01

Managing for the long term

By Brandes Elitch
CrossCheck Inc.

Consolidation has always existed in the ISO business, but recently two payment processors sold for significant amounts – in the hundreds of millions of dollars each. I have known the principal of one of these since he started 19 years ago, and have been privileged to watch from the sidelines as he painstakingly built his company in accord with his vision. It was never easy for him.

The day the sale closed, two dozen employees became millionaires – a day they will never forget. Perhaps more importantly, the acquirer gained a platform that will serve it well in acquiring future merchants for a long time to come.

Building and managing a company to conform to a long-term vision of merchant count and revenue projections is rare. More common is the scenario of compromise, downward projections, curtailed project plans, diminishing market share and merchant attrition. In this article, I'll tell you about a company that, unlike the one my friend just sold, followed a fundamentally flawed plan. There are lessons here for us all.

A quick start

A sleepy company in a sleepy (at the time) and highly regulated industry acquired a major competitor and virtually doubled its size. It bought the other firm at a discount from market pricing and left the seller with the bad loans to boot. The company started negotiations by declaring the other party was precluded from negotiating with anyone else while their discussions went on. A foreign institution that wanted to exit the U.S. market owned the other company, so the deal was struck.

The other company had been in business for 116 years and had many talented employees and good products and IT infrastructure. But from the beginning, the acquirer made it clear the "not invented here" syndrome was firmly in place. The chief executive officer had little interest in listening to the acquired company's employees. In the first 18 months, 5,700 jobs and 120 stores were eliminated.

The success of this acquisition seemed to go to the CEO's head. He was adulated and praised in all manner of publications. He gave speeches that the firm only hired the best people and that it was the de facto training ground for industry executives, many of whom left to go to competitors. At the same time, two major competitors were on the ropes financially. One was probably technically insolvent, but squarely in the "too big to fail" category; our featured company eventually acquired the other.

The CEO's vision was to build the dominant firm in its industry. He might have succeeded, except for a few basic mistakes. First, he decided to sell off or abandon large parts of the acquired business, to the point where the company would just end up with its retail stores and little else.

One day, the firm had 400 employees in stores doing mortgage originations; the next day it was out of that market. The department that supplied correspondent services for smaller institutions in this business – providing financing, participations, cash management services, trading, etc. – was closed. Decades of relationship building were written off; clients were told their accounts were being closed and to find a new home.

The CEO wrote an infamous memo titled "Doing Business With Competitors," which was widely circulated. It stated that any action or service that helped a competitor was detrimental to the company's best interest and would not be tolerated, regardless of the lost revenue implications for the firm.

Fatal errors

The CEO's claim to fame was expense management and growing net revenues by reducing expenses. He instituted changes that proved catastrophic for the core business. Here are several examples:

  • Each Accounting Unit (AU) had to stand on its own. For example, my group, selling fee-based services, was required to bill out our time for calling and proposal writing to the AU that "owned the account." A proposal might take 10 hours to write, and this could mean a $2,000 bill to the responsible AU. If it had not budgeted for this, the account officer could be fired for exceeding the expense budget. This caused the responsible AUs to instruct employees to never call us again.
  • Clients were told they would no longer receive an earnings credit allowance on their free collected balances, nor would they get same-day credit for deposits of on-us items. When clients complained that other companies in the business did not do this, they were told to go elsewhere if they wished. Some of these clients were the largest firms in the state.
  • My group got most of our leads from the retail stores. A sharp store manager could immediately sense a large fee-based opportunity and ask us to call on the client. However, our manager decreed that the salespeople would not receive credit for a call when the merchant was owned by the store AU.
  • Certain products were discouraged or even terminated – even though they were needed by clients – because their return on expense was deemed inadequate. One of these was wholesale lockbox, which was a very sticky product; another was ACH processing. The senior manager told the salespeople, "Nobody ever made money in ACH and nobody ever will," which had a chilling effect on the customers. The group executive bragged to clients he was looking for ways to get out of the cash vault business, which was an absolute necessity for most retailers. I will never forget the day my boss called on the largest company in the state and asked its treasurer why he was kiting checks. This sort of arrogance and condescension was quickly recognized in the marketplace.
  • Employees – who were told they were the best in the business – were graded on and fitted to a bell-shaped curve. The policy was to keep all of the ones and twos, some of the threes, and none of the fours. This meant that at least half of the employees were "on the way out" at any given time. Turnover was high. Clients became accustomed to "revolving account officers." Paranoia was rampant, and the managers seemed to enjoy the climate of fear they carefully fostered.

Lessons learned

In the end, management tried a hostile takeover of a major competitor, and the competitor succumbed. As the merger time drew near, the implementation team warned management that the wire transfer department was not ready to move over. However, the Big Eight accounting firm consulting on the merger was giving presentations on why a merger should never be delayed under any circumstances.

While vacationing in Europe, the person in charge gave the order to move forward. The result? The wire transfer department of the Federal Reserve District involved was brought to a standstill. From then on, the acquisition could be termed "disastrous"; the press described the merger as "botched."

The firm had planned on generating almost a billion dollars in annual operating savings by terminating over 7,000 jobs in the first 18 months after this merger. But operational sloppiness led to bounced checks, lost deposits and long lines in the stores (when other stores were closed).

A mass exodus of employees and customers ensued, and the financial performance and subsequent stock price collapse left the firm vulnerable to a hostile takeover. Rather than be acquired by a hostile competitor, the firm arranged a "merger" with a competitor 2,000 miles away. The heady days of being the "smartest guys in the room" were over. And new management began rebuilding the institution, replacing what the previous CEO had jettisoned, an effort that will take decades.

It is obvious now that "mistakes were made," but at the time, it would have been fatal to question management's direction. It is also obvious the CEO's primary error in judgment was to believe that his own company and shareholders were much more important than the clients – or the employees for that matter. For this error, the CEO lost control of the firm.

Managers and CEOs in the payments business are often tempted to cut corners to increase revenues. But when you emphasize what is best for the customer, you can seldom go wrong. Also, it's expensive to hire good employees and even more expensive to replace them; treating them as expendable is not a good strategy, a point seldom lost on the customers either. The Green Sheet, Inc.

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.

Notice to readers: These are archived articles. Contact names or information may be out of date. We regret any inconvenience.

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