Tired of high risk and low returns, banks began an exodus from the acquiring end of the credit card business years ago. Now some are wondering whether they should have postponed that trip.
It wasn't long ago that many banks decided that handling credit card transactions for merchants was no longer worth the trouble. Though a few big players have hung on, Citicorp, Chase Manhattan Corp., Chemical Banking Corp. and many smaller banks bailed out at roughly the speed of a credit card authorization.
At the time, it looked like a judicious move. Handling merchants' credit card transactions was a good service for banks to offer business customers, but many institutions were scraping then for capital and profits, and dumping this low-margin business unit wasn't optional in many cases.
There were eager buyers for the portfolios that went on the block, mostly in the form of non-bank processors that could leverage their scale to squeeze out the profits that eluded banks. Today, four of the nation's 10 largest merchant acquirers are non-bank processors, including the top three.
Just to prove the old adage that the only constant is change, the merchant acquiring business might have better prospects than it appears to have on the surface. Structured correctly, many banks--even small ones--are finding that it can be a profit center. More importantly, perhaps, offering this service can provide a stronger tie to business customers who need cash management services, loans and other products.
In addition, the banks that have remained merchant acquirers are competing aggressively for customers, and are looking at innovative ways to use information gathered at the point of sale.
All this adds up to renewed interest in a decidedly unglamorous field. Although the money center banks that once dominated merchant processing contend that they have no interest in re-entering the business, some banks that sold their portfolios are reportedly taking a second look now that non-compete clauses from the sales are expiring.The Biggest Merchant Acquirers 1993 Volume 1992 VolumeAcquiring Institution ($ Billions) %
change NaBanco(*) $54.3 $35.851.7% National City Processing(*) 46.1 33.6 37.2 Card Establishment Services(*) 42.7 35.8 42.3 Bank of America 18.0 12.7 41.7 First USA Merchant Services 13.4 8.0 67.5 First Bank System 10.2 4.1 148.8 NationsBank Card Services 8.6 8.4 6.2 First Nat. Bank of Omaha 8.6 6.5 32.7 National Data Corp.(*) 7.4 7.0 5.7 Banc One 6.2 4.5 37.8 * Non-bank companies.
"I don't think you'll see many players exiting the business," says Fred Gore, senior vice president of U.S. Acceptance for MasterCard International, the unit that works with acquiring banks.
For smaller banks, especially, simply having good access to a merchant base might allow the bank to make a go of this business. Though their access is to smaller merchants, those merchants are the ones that provide wider margins because they don't generate the volume that commands price breaks.
It's difficult for the non-bank giants to compete for small merchants when banks have branch systems offering merchants other services as well. While some banks use independent sales organizations (ISOs) to sign up merchants, the branch system offers a small merchant immediate contact with the bank. "We are very dependent on our branch system, because that's where the initial contacts are made," says J. D. McBrayer, vice president at Wachovia Corp., whose merchant portfolio grew 17.2% in 1993, to $2.5 billion. "But what better people can you have? They've already qualified those merchants."
In addition, dropping one's merchant acquiring portfolio, say those in the business, can cause the bank to lose other merchant relationships as well. Small merchants may also take their personal banking business elsewhere.
"If banks lose (the merchant) relationship, they're going to lose a lot more than that," says Paul Martaus, president of Martaus & Associates, a consulting firm based in Clearwater, FL. "The majority of mom-and-pop stores are consumers, and they're going to act as consumers. They're not going to have banking relationships over Hell and half of Georgia."
In 1993, the total card dollar amount going through the three largest merchant acquirers--National Bancard Corp. (NaBanco), National City Processing Co. and Card Establishment Services, all non-banks--rose 44%, to $143.1 billion. NaBanco alone grew 51.7%, from $35.8 billion in volume in 1992 to $54.3 billion last year. (CES was formed when Citicorp sold its portfolio to investors in 1992.)
The future, most say, will be more of the same. "I continue to see further consolidation," says Eric Turille, senior vice president of First of Omaha Merchant Processing, owned by First National Bank of Omaha.
It's a sentiment echoed by other bankers. Non-banks' dominance would apparently leave little room for banks. But bank merchant acquirers grew as well in 1993. BankAmerica Corp., the largest bank merchant acquirer, had growth of $5.2 billion in 1993, to $17.9 billion from $12.7 billion, an increase of 41.2%. With the acquisition of Rocky Mountain Bancard System, First Bank System's merchant volume rose 148%, to $10.2 billion. First National Bank of Omaha's merchant portfolio was $8.6 billion in 1993, up 32.7%.
This growth, partly due to increased credit and debit card usage, indicates to banks that there's a lot of life left in the merchant acquiring business. And, despite dominance by the non-banks, some say that bigger is not necessarily better. Most of the large acquirers have customers who deal in huge numbers of transactions--national retailers and airlines, for example.
Those large merchants also tend to negotiate and re-negotiate prices downward. That reduces margins despite the large scale those merchants' transactions bring. Price competition is keeping margins slimmer than ever, and many merchants will switch acquirers with just the slightest price change.
Unleashing Profit Potential
Despite small banks' efforts to secure customer relationships through acquiring, it's impossible to make money in the business without some scale. So why is the number of bank acquirers on the rise, including small banks? It's largely due to acquiring structures that enable small banks to get into the business with a minimum of risk.
Small agent banks can sign up merchants for a larger bank. That way, the large bank gets a new customer while the smaller one keeps a customer relationship without having to actually enter the business.
Small banks are also using ISOs to sign up merchants. Offering lower prices, ISOs can take business from the larger regional bank by handling the transaction through another merchant acquiring institution. Family Bank, a small suburban institution owned by $130-million Bridgeview Bank and Trust Co. in Chicago, has a portfolio of 8,500 merchants in 49 states. The bank is able to make its acquiring portfolio profitable by keeping control of costs and ISOs, says Tom Haleas, who manages the bank's ISOs.
Martaus says that some ISOs have gone so far as to hire ex-bankers with strong ties to the local community to sell merchant acquiring services. As a former banker, the ISO representative knows what the institution needs. And in small communities, the ex-banker and banker usually know each other. "If he walked the walk and talked the talk, the targeted bank will listen to what he has to say," says Martaus.
For larger banks, the issue is often much bigger than keeping customer relationships. For years, Visa International and MasterCard International have warned that banks exiting the acquiring business were making an egregious error. In giving up the merchant end, they say, the banks lose control of the attendant point-of-sale and the information-gathering capabilities.
"It's very, very scary," says Roger Peirce, a former Visa executive and now president of the Electronic Funds Services Group, a unit of First Data Corp., the largest credit card processor. When banks "agree that the bank card is used in an environment controlled by third-parties other than the card issuer, banks really don't have control over the primary purpose of their product, and that leaves them in a very vulnerable position."
In an age of target marketing, knowing what the customer buys and where he or she buys it is essential. Most merchant acquirers don't compile that kind of information in depth--at least not yet. FDR recently announced a new company that can give banks access to such information.
But while banks dawdle, American Express Co. is working on ways to mine its vast database of buying information to shape marketing campaigns towards cardholders.
"If American Express is successful in its program, it will have the effect of diminishing bank cards at the point of sale," Peirce says.
But can banks really afford that access? Martaus notes that the reason banks got out of the business was the margins--50 basis points, perhaps, compared to 250 basis points or more in the card-issuing side of credit cards.
"Most banks have failed in this business because they haven't focused on this business as being a viable revenue stream," says O. B. Rawls, senior vice president at NationsBank, which was the seventh-largest acquirer in 1993 with $8.6 billion. "It's a complicated business--it's not rocket science, but it's complicated. There are a lot of nuances and opportunities to lose money in this business."
Striking a Blow for Banks
Most of the nation's credit card transactions are handled by a few merchant acquirers, a group dominated by non-banks. That means most banks are shut out of information gathered at the point of sale, information that they could use to sell their own credit cards.
But First Data Corp. doesn't see it that way. As the nation's largest bank card processor, FDC says it processes transactions on 27% of all the nation's cards. And that, FDC says, is a huge database waiting to be mined-for banks' consumption.
In August, the Omaha, NE, processor formed USA Value Exchange, a company that will take information at the point of sale and distribute it to its customer banks. The company, which will be owned by banks but have a service contract with FDC, will channel purchasing information into databases, enabling banks to offer their cardholders discounts and other inducements for card usage.
For instance, a clothes manufacturer could offer a 20% discount to frequent buyers of the company's clothes at a specific retailer. USA Value Exchange would search its database to find consumers who had previously bought the manufacturer's clothes with their bank cards.
Those names would be passed on to banks, which in turn would give a coupon for a discount to any person that happened to be an existing cardholder. The cardholder using the card to buy manufacturer's clothes at the specified retailer would then get 20% off the next statement item from that merchant.
This is a direction that industry experts have predicted for years, and, FDC hopes, one that will avoid the privacy issues that have plagued past efforts, says Roger Peirce, president of the Electronic Funds Services Group, a unit of First Data Corp. By giving information to banks on their own cardholders and not to retailers, FDC says that it won't be disclosing private information to outside entities.
More important, Peirce says such information can help banks battle non-bank cards, which usually have a product affiliation or rebate. "This could literally change the way bank cards are perceived in the market-place," Peirce says. "It goes beyond co-branding--it eliminates co-branding to some degree, by putting the bank brand back into focus."