Despite sweeping organizational changes in First Data Corp.'s merchant services unit, the processor is staying its strategic course.

The strategy revolves around what it calls merchant bank alliances. For the last three years, First Data offered banks the opportunity to retain their relationships with card-accepting merchants, while leaving the back- office grunt work to First Data.

Observers say these joint-venture arrangements-an idea First Data inherited from a company it acquired, Card Establishment Services Inc.-have yet to prove their financial merit. But they have refocused many bankers' attention on a lucrative piece of the credit card business that slipped away to specialists like CES and First Data over the last decade.

First Data Corp.'s performance has lagged in recent quarters, and the company pins some blame on its Omaha-based merchant unit. Recent announcements about management and organizational changes led the industry to question First Data's faith in the alliances.

Charles T. Fote, an executive vice president recently put in charge of First Data Merchant Services, defended the alliance approach.

"We are more committed to it today than we were yesterday," he said in a conference call last week with reporters.

Mr. Fote (pronounced "Fotey") said First Data has "about 12" bank alliances, and predicted there would be 14 or 15 in a year.

Analysts began wondering about the alliances after Henry C. "Ric" Duques, First Data's chairman and chief executive officer, said at a shareholders meeting in late January that the company would fold its "owned" accounts-merchant relationships that First Data handles directly- into the bank alliances.

First Data had previously stated it would hold on to such accounts, which were gained through corporate acquisitions. They were seen as the "yeast" that fermented the alliances. First Data typically offered to pool some of its merchant accounts with those of a partner bank, and to put cash into the deal as well.

Might First Data's decision to divest its owned accounts have signaled that it might not seek new alliances?

No, said Mr. Fote. From now on, he said, the company will compensate for the absence of owned accounts by putting more cash into alliance deals.

"Just because we won't have any owned merchants doesn't mean we won't form more alliances," he said.

Mr. Fote would not quantify the number of owned accounts, but said they represent "tens of millions of sales volume."

"The alliances bring us a branch network of 7,500 locations," the biggest referral network in the industry, he said. "We have over 1,000 people selling directly into the market, so we have people knocking on doors en masse. When we get the consolidations done, we should see some cost-per-unit improvements also."

Last year, for the first time, First Data lost an alliance partner. The old U.S. Bancorp of Portland, Ore., severed its relationship when it merged into First Bank System Inc. of Minneapolis (which renamed itself U.S. Bancorp). Though that development was viewed more as a consolidation effort by the banks than as a slight to First Data, the loss did draw attention to problems in the merchant services unit.

"Our principal disappointment in 1997 was the slowing rate of growth in merchant processing revenues over the last half of the year," Mr. Duques told shareholders. "We have reexamined every facet of this business in recent months. We are convinced that our bank alliance strategy is a winning one for this market."

While growth slowed in 1997, domestic merchant credit card volume processed was up 20%, to $259 billion, Mr. Duques said. Total domestic card accounts on file were up 20%, to 161 million at yearend.

First Data made numerous executive changes, moving Roger Peirce, who had overseen the alliances as president of electronic funds services, to a transitional role. Scott Loftesness, a deputy whom Mr. Peirce recruited from his former company, Visa, was also reassigned, and three other executives quit.

Mr. Fote called 1997 "the beginning of a transition year" for Merchant Services, which has been suffering growing pains since 1995. That was the year it began an acquisition spree and embarked on the alliance strategy.

Among the acquisitions were Envoy Corp., Telemoney, and the one-time Citicorp operation Card Establishment Services Inc., which processed accounts for merchants through a facility in Hagerstown, Md.

Next, First Data merged with First Financial Management Corp., in the process picking up Nabanco-formerly National Bancard Corp.-the largest of all merchant processors. Nabanco, which had been CES' top rival, had a processing operation in Sunrise, Fla.

Consolidating all those operations-including the "owned" part of its portfolio-in 1996, First Data became by far the biggest transaction processor on the merchant side of the credit card business.

By March 31, all the owned accounts are to be taken in by the merchant bank alliances.

Mr. Fote's merchant division is working on many fronts: to sign up more banks as partners, to complete a year-2000 conversion (estimated to cost $146 million to $171 million over three years), and to combine three processing systems into one (a task Mr. Fote said would probably be done by mid-1999).

"CES has absolutely state-of-the-art systems," he said. "Nabanco is not that far from being state-of-the-art, but Nabanco had a chargeback system that wasn't as far ahead as CES'."

Mr. Fote said the payment systems group-which includes the money-wire giant Western Union-handles $600 billion in transaction volume annually, of which merchant sales represent $200 billion. "We have the systems and the scale to handle that type of volume," he said.

"We needed focus in Hagerstown, we need focus in Sunrise," Mr. Fote said. "We've taken the best-of-the-best day-to-day operations people and asked them to take on the business applications" in those locations and Nashville, the home of Envoy.

The sales force has also been restructured in a way that Mr. Fote said "has everybody enthusiastic."

The strategic moves have buoyed analysts' confidence.

Mr. Fote and Mr. Duques "have said a lot of great things," said Joseph Donaldson, an equity analyst at Lehman Brothers. "I think you have a kind of 'show me' type of situation now."

Mr. Donaldson said he believes in the alliance strategy. It was "just a matter of time before these things actually mature and start producing at the levels that were originally anticipated," he said.

As for the management, he added, "It seems as though they have implemented a new compensation structure for the banks, which should 'incent' the branches to grow the merchant business. That is definitely a step in the right direction, and now it is just a matter of executing that strategy."

Merchant processing consultant Paul Martaus of Clearwater, Fla., said Mr. Fote has "a long history of fixing things at First Data."

"They certainly have the economic wherewithal to weather this kind of a storm," Mr. Martaus said. "They have a whole different magnitude of problems because they play on a different level. They have redefined scale in this business, they need to consolidate, and they're doing that."

Mr. Fote conceded that 1997 saw "some miscues, some lack of focus on the marketing effort in the alliances, some lost opportunities on the First Data level."

In 1998, he said, the company has "identified the lost opportunities, but more important, the future opportunities in the merchant business."

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