The changing face of merchant acquiring not only creates new opportunities, but also challenges. In an increasingly competitive market, merchants must explore new service channels while also keeping an eye on regulatory developments. Victoria Conroy reports.
The payment industry maxim that what happens in the US will inevitably happen in Europe seems to be holding true in the case of merchant acquiring. Gradually, over time, the European acquiring marketplace has started to resemble the US, with larger players eventually dominating the space.
Over the past five years, the rate of consolidation has been rapid, much like what previously occurred ‘over the pond’, with the US landscape dominated by four or five large players.
But the fragmented nature of the European payment marketplace means there are some fundamental differences when comparing European acquiring practices to the US situation and it could be argued that there is inherent divergence in Europe, driven by a multitude of factors.
The impact of regulation
Perhaps regulation is the single most important factor to have reshaped the European acquiring industry.
Initiatives like SEPA and the Payment Services Directive (PSD) have been disrupting long-established business models and regulatory pressure on the payment networks, and by extension their bank members, forcing changes to pricing and profit margins.
The introduction of the PSD in November 2009 has left the field open to non-payment institutions to enter and bring extra competitive pressure on what is already a fierce marketplace.
According to European payment consultancy Edgar Dunn, the PSD could bring about increased pressure on larger merchant acquirers from smaller and more nimble players.
Because of their smaller size, these companies can more readily adapt to the European marketplace and the existence of national and local payment schemes and emerging payment trends.
The other regulatory issue that needs to be considered is the introduction of unbundled merchant service charges (MSCs) from January 2011, following the European Commission pressure on Visa and MasterCard over the level of MSCs.
A recent report from European payment consultancy PSE Consulting outlined the implications facing European acquirers from offering unbundled MSCs.
Until now, European acquirers have priced MSC on the combined costs of card transactions for both major card schemes to create a single rate. In some European markets credit and debit products are charged separately but again use a common rate.
This practice reflects acquirers’ limited ability to charge by card product and scheme separately so most merchants have not had the option of a more detailed break-out of acquiring fees.
Only a small number of large merchants have been able to negotiate interchange plus pricing and thus receive a full break-out of interchange, card schemes’ fees and acquirers’ charges.
However, this is about to change, and the payment schemes were mandated to agree that acquirers would introduce unbundled MSCs by the end of December 2010, with the rationale being to ensure merchants would know the exact costs of each transaction processed and could compare the cost of each international card payment type.
In essence, unbundling means acquirers must separate out the costs associated with processing each card scheme and further subdivide by card programme; for example, consumer, commercial and debit cards.
European acquirers will no longer be able to combine all credit and/or debit card products unless specifically agreed with merchants. This greater visibility into pricing for the merchant could drive even more change.
PSE Consulting predicts that European acquirers will offer interchange plus pricing to many more merchants than is currently the practice.
In addition, acquirers are expected to start charging separately for individual elements of the acquiring service, for example, automated clearing house rejects, chargebacks, refund processing and statement fees.
As interchange rates continue to decline, merchants will see a decline in headline MSC rates but will begin to pay for services previously embedded in bundled pricing.
Merchants will have greater choice as a result of unbundling and will be able to pick and chose which card product to accept.
The changing face of consumer payment preferences will also come into play, with consumers now having a wide array of payment options to chose from and also a greater choice of channels. The advent of e-commerce will have specific implications for merchant acquirers operating in this space.
Acquirers will increasingly need to be able to provide enhanced technology support and operational functions to better service their merchant customers.
As an example, US payment consultancy First Annapolis recently conducted primary research on the channel orientation of UK card-accepting merchants, finding that of the roughly 500,000 merchants in the UK accepting cards, 60% are actively processing card-not-present (CNP) volumes.
CNP now accounts for over 40% of UK Visa/MasterCard volume and according to First Annapolis estimates, virtually all of the growth expected in the UK cards market in the coming years will come from e-commerce.
For acquirers, it is crucial they can provide a fully-integrated, multi-channel offering to the market as there is an obvious and overwhelming demand for what has traditionally been a product fragmented by channel, along with a well-formulated e-commerce strategy.
The impact of loyalty evolution
Perhaps another important factor will be the continuing evolution of payment card loyalty programmes.
It is rare for credit cards in developed markets to come without some form of loyalty programme or rewards scheme attached and consumers usually expect them to be included as a standard feature nowadays.
However, the ubiquitous nature of the loyalty scheme proposition, from originating as a way of differentiating cards, has itself become increasingly competitive and saturated.
Cardholders could be forgiven for thinking that one loyalty scheme looks very much like another, giving little incentive to change their allegiances.
Over the last few years, financial institutions have sought to evolve their loyalty propositions from simple points-based schemes into a wider choice of propositions, features and benefits.
A look at the European marketplace shows just how much change has occurred as issuers seek to stand out from the crowd, with a shift towards merchant-funded rewards schemes sweeping over the market – Barclaycard’s Freedom programme is perhaps the most notable recent example of such a scheme at play.
Behind the scenes, however, there is another factor at play – that of the relationship between the merchant and its acquirer. Many in the industry argue it is the merchant that gains the most benefit from offering a loyalty scheme, with greater visibility of customer spending, analysis of transactional behaviour and improved communications with customers.
Yet the merchant acquirer also has issues to contend with in relation to loyalty schemes. Again, the US marketplace would appear to be indicating where the European marketplace may be headed.
A recent report from US payment consultancy Aite Group shines the spotlight on the challenges facing US merchant acquirers. According to the report, it has been proven by many industries how points and rewards can drive sales and usage; the card issuing industry, for example, did very well using points and rewards.
Despite this, points and rewards contribute to decreased profit margins. If merchant acquirers start giving points to the types of merchants they want to retain, the expense will have to come out of the pocket of the merchant acquirer.
The market opportunity is to bring merchants new customers or a value proposition that retains the customers that they already have.
Three types of companies have achieved or are achieving this: group coupon, mobile-based marketing, and merchant-funded rewards companies.
Group coupons are internet-based coupon companies that bring new customers or existing ones via a company’s website, and which typically split the revenues generated from coupons with the merchant.
In fact, a lot of these merchants are taking a loss once they factor in the overhead, the cost of the goods and services, and the staffing needs to fulfil the orders. Merchants are, however, counting on the repeat business in order to generate more sales in the future.
Aite contends that this model is going to come under attack from other market players because of three factors:
- Some merchants don’t see return on investment on the offers that they make and have to be very careful to prepare for their offers logistically (eg increased labour and supply costs);
- Some merchants don’t necessarily see new traffic – the same old consumers that have been shopping at their stores often take advantage of the offers; and
- Merchants find 75% of the face value of their services is a very high price to pay for acquiring new customers.
Merchant-funded rewards were the recourse of many issuers seeking to provide value to their cardholders without increasing the cost of reward fulfilment. In this case, a loyalty management company negotiates a deal with merchants and offers these deals to an issuing bank or any organisation that seeks to offer added value to their membership base.
The issuing bank has to pay for integration and for the transactions, and merchants have to pay for integration and must offer some kind of a discount or a special offer.
This model shows how banks that own the relationship with their customers, and in some cases with the merchant as well, are willing to spend money connecting them.
The third and last market opportunity is mobile-based marketing. In this case, a mobile-based marketing company recruits customers directly, but also through the help of merchants, and collects their mobile phone numbers.
The consumers specify what kinds of deals they would like to receive. Merchants decide when they want to send a deal to consumers and, if so, what kind of deal they want to offer.
The merchant enters the offer on a web dashboard and it is instantly sent to all consumers via text message to all the consumers who have signed up for the service.
Creating new opportunities
Aite states that merchant acquirers and in some cases their bank parents, are missing an opportunity to bring new clients to their merchants.
For the bank that has both an issuing and acquiring arm, the opportunity is very interesting, especially at the local level. The group coupon model, merchant-funded rewards and the mobile-based marketing demonstrate four important points:
- Merchants are willing to offer up to 75% of the face value of their merchandise and services in order to acquire new customers;
- Merchants are willing to pay a flat monthly fee in order to communicate instantly with potential customers;
- Customers are very receptive to larger discounts offered by merchants, as opposed to smaller discounts; and
- Customers show eagerness to cash in the offers provided by local merchants.
Banks in unique position
Aite’s report concludes that an opportunity becomes clear when banks can approach their own merchants and secure participation in a rebate programme that is designed to help drive traffic to the merchant and provide the bank’s credit and debit cardholders with rebates at the local merchants for which the bank processes.
Banks can actually charge for such a programme; merchants have demonstrated that they are more than willing to pay for exposure to new traffic.
Banks are also in a unique position to learn from the different models that exist today and combine the best of their offers in order to reach these customers.
Banks can develop the social networking model by adding aspects of mobile marketing technology (sending instant offers to enrolled cardholders) and charge merchants for their use of such a platform. In this way, banks are the most well-positioned party to generate revenue from interchange, acquiring fees and participation fees.