Independent service organizations have come back from the fringes.
Adhering to tougher standards imposed in recent years by MasterCard and Visa, and taking other steps to burnish their images, many of the companies, known as ISOs, have taken places in the mainstream of the card processing trade.
To be sure, some of the stench still lingers from when a few fly-by- night outfits gave the whole group a bad name. In two notorious cases about five years ago, Comerica Inc. of Detroit and Colorado National Bankshares absorbed multimillion-dollar losses when their merchant processors abruptly closed shop.
But for the most part, the ISOs, which specialize in processing arrangements for the smaller and midsize merchants that bigger processors avoid, have opened lines of communication with the bank card establishment and earned its favor.
"The ISO business has come of age," said Darrell G. Rickman, vice president and general manager of bank card services at Old Kent Bank and Trust Co. in Michigan. Their reputation, he said, "started to change in late 1993, and ISOs really came on strong in 1994."
Mr. Rickman, who is on the board of the Bankcard Services Association, an ISO advisory group, acknowledged that the industry "did have a rocky start in which it was undisciplined and uncontrolled."
ISOs, which number about 500, have matured, he contended, and now perform a "valuable function in ferreting out new merchant opportunities and reaching markets that wouldn't be penetrated otherwise - that we in the past would have ignored."
Mr. Rickman added, though, that "some old-school bankers might still view them with a jaundiced eye."
ISOs came on the scene in the early to mid-1980s, said Paul Martaus, president of Martaus & Associates in Clearwater, Fla. Their advent was "relatively benign," he recalled.
They offered banks an opportunity to save money by outsourcing mundane tasks, said Mr. Martaus.
He attributed most of the ensuing problems to what he characterized as "old-line ISOs" - companies set up by former bank employees "who had to feed their families" and whose primary focus was peddling terminals.
"Many were less than scrupulous, getting $5,000 for $500 terminals," said Mr. Martaus.
Such organizations were gradually displaced as the card associations tightened their standards in the early 1990s, according to Mr. Martaus. He estimated that less than a dozen such "old-line ISOs" remain.
"MasterCard and Visa, both with their stiffer regulations and control and oversight, got some really credible players in the industry, and it became legitimate," Mr. Rickman said.
The credit card associations were motivated by concerns that irresponsible ISOs would damage their brand names and reputations.
Linda S. Perry, vice president of acquirer and processor marketing for Visa, said the merchant-acquiring business "has changed over the last five to 10 years. So have ISOs. The mix of folks there is completely different."
Ms. Perry is a member of the Bankcard Services Association advisory council, which she said "has worked hard to legitimatize the business" since its formation about five years ago.
Card associations look at ISOs as "not the greatest thing in the world," said Liam Carmody of the Carmody & Bloom consulting firm, Woodcliff Lake, N.J. "They're an unwanted offshoot of the industry. There's nothing they can do about them (except) regulate them and not let them destroy the integrity of the card business."
Whatever the case, the card associations' toughened rules led to what Mr. Martaus calls "new-wave ISOs," which currently dominate the field.
Then there are what he classifies as "institutional ISOs," such big-name merchant processors as Nabanco and First Data Corp.'s Card Establishment Services, which may meet the technical definition of ISOs but operate on huge scales and never suffered an image problem.
Including these, ISOs handle between 70% and 75% of the card transaction market, which runs at least $200 billion annually.
"Whereas the old-line ISOs were run by displaced salespeople, the new ISOs consist of the former bosses," said Mr. Martaus. The executives tend to be "dedicated to sales and service and to the care and feeding of small merchants."
The Federal Trade Commission also got into the act of cleaning up ISO merchant abuses. The FTC has concluded that ISOs ignored obvious indications of illegitimacy such as excessive chargebacks, high volumes of same-day "churning" of transactions at the same dollar amounts, and drastic increases in sales volume.
In the most recent case, settled in January 1994, the FTC forced a California-based company known as Echo, or Electronic Clearing House, to accept responsibility for handling the telemarketing accounts of a deceptive prize promotion.
The FTC also sued four Echo clients, charging that the clearing house continued to process their credit card payments even when it knew, or should have known, about their wrongdoing.
"No one ever said that the majority of what the industry does is problematic," said David Medine, the FTC's associate director for credit practices. "The industry has not been as attentive as it should be to problems when they arose.
"Lots of times, when we look at a fraudulent operation, we ask who's doing the processing," he continued, "because without processing, these frauds wouldn't be in business."
Now that ISOs appear to be here for the long haul, what new markets and avenues are they likely to pursue? Like the rest of the card industry, they are eyeing the Internet.
Cardservice International of Agoura Hills, Calif., announced an agreement last month with Netscape Communications Corp. to become a value- added reseller of Netscape's IStore programs for setting up shop - and taking payments - on the Internet.
Cardservice said it would provide Internet services to corporate "cybermalls" for its merchant clients and prospective new business relationships. The processor has marketed its Internet capabilities since early March, recently adding Sportsline USA, an Internet site for sports enthusiasts that provides interactive contests and memorabilia.
Cardservice made a symbolic proclamation of its growing ambitions at the American Bankers Association's card conference Sept. 11-13 in New York, where it announced the Netscape deal. It also made the goodwill gestures of sponsoring the opening-night reception and hiring retired baseball star Steve Garvey to sign hundreds of autographs.
Mary Gerdts, president and chief executive of Post Integrations, an ISO in Scottsdale, Ariz., said she believes that while the Internet is enticing, it carries more than the usual risk, which may make some ISOs hesitant to get involved.
"The larger players are jumping on board, while the smaller ones are taking a wait-and-see approach," she said.
Meanwhile, ISOs are grappling with another new technology - smart cards. There is widespread disagreement when, or if, chip technology will displace the stripe card in small stores. Chuck Burtzloff, Cardservice's president and chief executive officer, said this could happen as soon as mid-1997, creating a huge opening for ISOs.
"If the chip card comes, all terminals will need to be refitted," said Mr. Burtzloff. "Banks will be unable to retrofit all terminals. It will be a tremendous opportunity for merchant processors such as ourselves to grab a market share that we don't have now."
Mr. Rickman said he expects the evolution to take much longer. Though chip technology eventually will triumph, he said, "Keep in mind that we still have paper merchants" who will take time to become automated.
There will be considerable competition to "create an information value that happens to support cash management and check verification," said Nick Ferrante, a bank card issuing veteran who crossed over to become president and chief executive officer of American Heritage Bankcard in Chatsworth, Calif.
He does not see the allure of credit cards alone as enough to hook smaller merchants. "There is not going to be a speedy rush to ask for credit cards by those who are traditionally not required to do that," said Mr. Ferrante. "There will be other motivations to do it."
One such example is a pilot program American Heritage has initiated with McDonald's restaurants.
"The basis for the pilot and their interest in it has more to do with judging customer satisfaction than credit card transactions," said Mr. Ferrante. "We've developed a touch-screen device that would be in the lobby of the restaurant.
"The customer would have the option of defining the degree of good or bad service they received and can order a combination plate through their credit or debit card."
He added, "You are increasingly seeing personal computers in restaurants that track food orders, while the waiter and waitresses enter information. Restaurants have a huge problem with inventory theft, he said, "so this tells you whether somebody is stealing food from the kitchen."
Along similar lines, Mr. Ferrante predicted that municipal parking lots would provide additional ISO opportunities. He estimated they suffer 20% in theft, or "shrinkage," by employees.
"Installing a credit card system in the lot eliminates that problem - the cash is not there," said Mr. Ferrante. "The ancillary benefit is that it reduces pilferage by staff members."
ISOs are also looking at airborne processing opportunities.
"All major airlines want to put in a system that would allow consumers to use credit cards to buy entertainment in flight, from playing games to checking stock quotes to gambling," said Ms. Gerdts of Post Integrations. Anticipating this, MasterCard recently created regulations for in-flight commerce.
David Robertson, president of The Nilson Report, the Oxnard, Calif.- based newsletter, predicted ISOs "will be putting PIN pads into locations that don't have them."
He added that "you'll see regional EFT systems, like NYCE and Pulse, performing the same leasing functions that Visa and MasterCard do in the credit card world."
Mr. Martaus sees a bright future for ISOs, relatively untouched by the mergers at the high end of merchant processing, notably First Data Corp.'s pending $6.7 billion deal with First Financial Management Corp., Nabanco's parent.
"Consolidation is the name of the game," said Mr. Martaus, but, he said, "there is not a global negative ramification. Everyone is gloom-and-doom and saying it will cause the end of ISOs as we know it. But there are too many people in this business for ISOs to ever go away."
