Acquirer pricing strategy has converged over the past year, continuing a trend that has been prevalent in the business for half a decade. Increasingly, the acquiring industry makes use of homogeneous set of fee types that have highly similar list-pricing. Nevertheless, the incidence of pricing customized to an individual merchant remains quite high as acquiring salespeople are generally provided the flexibility to arrange a basket of fees. First Annapolis recently completed research analyzing acquirer pricing structure for merchants less than $10 million in annual Visa/MasterCard volume. This research was an update of similar research completed annually stretching back to 1999. Participants in this year’s survey represented more than 54% of all bank card dollar volume, including credit and signature-based debit transactions.
The Triumph of Gross Pricing: In the issuing business, there seems to be a dozen different ways of calculating finance charges. In the acquiring business, there are at least half a dozen discount-calculation methodologies. At the end of the 1990s, the industry was split in terms of which methods were most prevalent. However, in our 2003 survey, 83% of acquirers used gross discount pricing (charging discount against gross purchase volume) as their primary method, up from 36% in 1999. Gross-gross discount pricing (charging discount against gross purchase volume plus returns) had virtually disappeared as a standard, and net discount (gross purchase volume less returns) had fallen dramatically. Note that this conclusion does not mean that there are no merchants on gross-gross pricing; this conclusion simply means that acquirers’ current pricing strategy involves signing new merchants on a gross discount basis.
The Decline of Rental: Years ago, the industry’s equipment financing was dominated by a rental model in which acquirers would buy devices and provide them to merchants for a monthly fee. (Most non-U.S. markets continue to be dominated by this model.) Increasingly, this model has been replaced by a third party lease model or an equipment-sale model. In 2003, 76% of acquirers utilized sale or lease as their primary equipment-financing strategy. Sale and third-party lease programs are similar for acquirers in that both models front-end-load the net present value of the equipment relationship with the merchant. In the case of leases, this takes the form of an origination payment from a lessor who essentially buys the lease paper from an acquirer which originates the lease.
This lease/sale model has become dominant for several reasons. First, non-bank acquirers especially use leasing to manage cash flow and offset heavy outflows related to sales commission programs. Second, a lease/sale model is much less investment-intensive because the acquirer does not have to finance a large, deployed terminal base. Although rental programs can generate solid financial returns, a lease/sale model can generate extraordinary returns on assets when an acquirer turns its terminal inventory like a retailer would manage merchandise inventory. Generating lease/sale payments and turning inventory rapidly is a compelling financial business case. Third, as attrition has increased as a significant business issue for acquirers, lease/sale models have emerged as a tactic to mitigate the impact of attrition. For example, if small-merchant attrition is being driven by business failure (which was common in the recent business cycle) no servicing tactic will address this attrition driver, but a leasing program will allow an acquirer to recover acquisition cost on such merchants faster.
The Proliferation of Fee Types: The 1990s saw a great expansion in the number of billing elements that acquirers commonly use in pricing merchants. This phenomenon results from a merchant behavior that tends to over-value discount rate and under-value other fee types. As a result, acquirers face a lower level of price sensitivity when emphasizing other fee types rather than discount, on a relative basis. On a same-fee basis (e.g., controlling for fee types that we did not ask about in previous years’ versions of this research), the level of unbundledness continues to rise. In 2003, 17% of respondents used more than 13 fee types in their standard pricing, up from 3% in 2002.
Based on an expanded set of fee questions in this year’s survey, 16% of respondents indicated they use 15 or more different fee types, although use of a given fee among an acquirer’s merchant portfolio can vary widely.
More Exception Pricing: As price competition has increased, so too has acquirers’ willingness to make exceptions in order to win or retain a valued merchant. Based on our survey, as average of 10% of new merchants are priced as an exception to either standard pricing structures or standard pricing levels. Though the most common reason for exception pricing of a merchant is defense from competition, relationship-based marketing and bank product bundling also appear to be an increasing consideration in the marketplace. In circumstances where bank products are bundled for a merchant, acquiring service is often discounted below standard levels in order to retain or attract deposit and/or lending business.
Higher Emphasis on AmEx Pricing: Bankcard acquirers in the U.S. do not “acquire” American Express transactions, of course, but they do charge merchants for the terminal driving and transaction processing services they provide with respect to AmEx transactions. In 2003, 92% of acquirers had an AmEx transaction fee, whereas in 2002, 83% had the fee. Nearly 60% of acquirers charge between 10 cents and 15 cents per transaction. This is highly topical given the AmEx/MBNA announcement. If American Express is successful in shifting market share from bank card brands, AmEx-related fees will be a primary means for acquirers to protect themselves from the reduction in acquirer revenue such a shift would trigger.
Emphasis on Downgrade Surcharges: The practice of applying a surcharge to downgraded interchange continues to be a primary pricing strategy for most acquirers. Based on our survey, three-quarters of acquirers charge either a fee based on incremental interchange plus a surcharge or a fixed fee inclusive of both the interchange and a markup. For 17% of acquirers, this fee is in excess of 100 basis points, although the fees are often tiered based on the severity of the downgrade.
Although a surcharge is the most common way to price interchange downgrades, not all acquirers use this approach. Approximately one-third of survey participants use tiered discount pricing for at least some of their merchants. Under such a structure, downgrades are priced into the discount rate charged on a given transaction. Finally, 17% of respondents indicated that they typically charge only the incremental interchange with no markup.
Universality of Chargeback Fees: Chargeback fees are the industry’s de facto risk-based pricing strategy, and in 2003 all of the respondents utilized a chargeback fee. As recently as 1999, 19% of acquirers did not use this fee.
Rise of Termination Fees: For several years now, there has been a trend for acquirers to implement term contracts with merchants and to embed a liquidated damages provision for early termination – a termination fee. This tactic impacts the behavior of a subset of merchants, discouraging attrition, but the tactic also mitigates the impact of attrition. In 2001, 41% of the industry had not yet implemented a termination fee, but in 2003, only 17% of acquirers continued not to use the fee type.
Acquirer pricing appears to be affected by a number of factors, but from our perspective, the single greatest impact is competition. Acquirers are matching each other in the marketplace, to a large degree. We think the implication of this phenomenon, which has been playing out over several years, is that it is more difficult to achieve any sort of differentiation using pricing as a primary mechanism.
This NEWS ARTICLE
Digital Transactions
