An Emerging Solution?

  Bit by bit, terminal makers, software developers and processors are rolling out services that might persuade reluctant merchants to trade in their old, but functioning, POS terminals.
  The U.S. payments-processing sector has long been a model of efficiency. And that is turning out to be both a blessing and a curse, depending on one's role in the market.
  Merchants are perhaps the biggest winners. By leveraging highly sophisticated telecommunications networks, retailers are performing fast and low-cost online credit and debit card authorizations that minimize transaction fraud and speed customers through checkouts.
  And unlike in Western Europe, where tens of thousands of retailers are replacing basic magnetic-stripe terminals with smart card-reading devices to meet Visa's and MasterCard's Europay/MasterCard/Visa (EMV) guidelines for enhanced security, U.S. merchants have no such mandate ("Europe Boils Over Smart Card Terminals," April).
  Thus, there is little urgency for them to spend hundreds of dollars for new-generation hardware when the millions of durable point-of-sale devices that were situated 10 or more years are doing just fine.
  While that is good news for retailers, it is less so for the device manufacturers. "The United States is a very saturated POS terminal market and vendors need to offer something new to get merchants to rip out their old devices," says Shalini Chowdhary, a payments industry analyst for San Jose, Calif.-based consulting firm Frost & Sullivan. "Terminals have a long life. Devices deployed in the 1980s still are working."
  But a solution to this dilemma might already be emerging. A move to payment devices that support a host of additional applications, such as the sale of gift cards, prepaid long distance, cellular-telephone minutes and business licenses, and the processing of loyalty points, is starting to ripple through the merchant sector.
  And it has terminal manufacturers, application developers and transaction acquirers taking steps to support what they project will be an increasingly stronger demand for devices with added functionality.
  "More merchants want applications that the old terminals can't handle," says Peter Quadagno, president of Quadagno & Associates, a West Chester, Pa.-based consultant.
  By selling prepaid and other products through their hardware, retailers are hoping to transform the POS terminal from a cost center that supports just credit and debit transactions, which carry interchange and transaction fees, into a profit generator.
  "Processing such items as gift certificates and loyalty coupons through the terminal is making it much more cost-effective for retailers," says Barbara Span, vice president of Memphis, Tenn.-based payments processor Concord EFS Inc. "Turning the acceptance of paper into an electronic transaction, for instance, makes the transaction less prone to fraud."
  But an even bigger financial benefit may be the commissions that merchants and application vendors could receive for each transaction. Prepaid transaction software provider PRESolutions Inc., for instance, has a business model in which both the merchant and the developer receive fees for each purchase.
  Atlanta-based PRESolutions might buy $21 worth of cellular minutes and then sell the time for $30 through a merchant's POS device. Retailers receive $7 of the extra $9, with $2 going to PRESolutions, says Tom Knoz, PRESolutions senior vice president of marketing and operations. The terminal produces printouts with personal identification numbers and other data that let users access the calling minutes.
  PRESolutions also is supporting the sale of a prepaid MasterCard through devices in a program with Monrovia, Calif.-based card distributor Next Estate Communications Inc. Accounts are issued by Columbus, Ga.-based Columbus Bank and Trust Co.
  Aimed at the unbanked and consumers with limited or no access to credit cards because of poor credit histories yet who want the convenience of card payments, the program carries some hefty fees. The initial fee is $9.95 for the card and first load of value. Reloads cost $4.95 each and must be made in values of $20, $50, $100, $200 or $400.
  Thus, a new consumer pays $109.95 to purchase a prepaid MasterCard with $100 worth of value. The merchant's POS terminal then prints a PIN, and the customer receives a card embossed with his or her name within 10 days.
  Cardholders can initiate PIN-based transactions at MasterCard merchants, and also can reload value at payment devices.
  Additional PRESolutions applications include long-distance, home-telephone and Internet services. All the applications are supported through VeriFone Inc. and Ingenico terminals that PRESolutions distributes free to merchants. Devices are in more than 15,000 locations, including Circuit City.
  Among the smaller merchants using PRESolutions applications is Russell's Quik Stop, an independent convenience store and gas station in Wilmington, N.C. Russell's has been selling cell-phone and long-distance minutes through a VeriFone POS device for about two years.
  Owner Robert Russell says there are 20 to 25 transactions a day for the products. He launched the service because of customer requests, and calls the arrangement a "good fit."
  In addition to generating a 20% sales commission on the prepaid product, the system also reduces store inventory, he notes. "You just print the transaction number and the PIN for cellular-phone minutes, and activate the long-distance cards at the device," Russell says. "There are no stacks of cards with value sitting around, and employee theft is eliminated."
  More Profitable
  Chris Gravatte, a Radio Shack franchisee in Sunset Beach, N.C., agrees that it is lucrative selling phone minutes through the devices. "I just generate the time through the terminal when it is needed and print a piece of paper with the calling information," he says. "It is more profitable than selling phone cards with value."
  Prepaid applications not only are generating fees for retailers and cutting their operating expenses, but the products also create healthy revenue streams for developers. Nashville, Tenn.-based Valuetec Card Solutions, for instance, which provides a stored-value package to small and mid-size retailers that includes terminal software, a database to store records, merchant training and card design, charges merchants about 30 cents a transaction, and a monthly system-access fee of $10 to $20. A flat monthly fee, which includes all transactions and system access, is offered for about $30.
  The vendor also provides reporting tools and settlement services. For retailers with multiple locations, for instance, Valuetec tracks such details as the sites that sold specific prepaid cards, and the stores in which those cards' transactions were initiated.
  Valuetec has about 3,000 merchant customers and is growing 125% annually, says Tony Holcombe, chief executive officer. More than 200 merchants also use Valuetec's electronic loyalty application, which tracks such data as the points earned by customers on each transaction. About 150 independent sales organizations are selling the Valuetec products.
  Indeed, terminals preprogrammed with multiapplications are expected to give more ammunition to ISOs working to sign new merchants. By offering terminals with the added functionality, ISOs are better positioned to get deployers to swap out their hardware, and perhaps switch acquirers in the process. Lowering discount rates as an incentive can be done only for so long before it becomes unprofitable for the ISO, analysts say.
  "Acquirers and processors are realizing that they will eventually go out of business if they keep selling terminals and services based on price," says Stuart Taylor, vice president of marketing for Santa Clara, Calif.-based VeriFone. "The concept of value-added applications has come to the fore over the last 12 months."
  Terminals that support the applications typically range from less than $200 to more than $800, depending on such factors as the amount of memory, modem speed, screen size and security levels. And the potential market for such devices is vast.
  Sixty percent of the approximately 6 million stand-alone POS terminals situated in the U.S. were deployed before 1993, and they lack the memory or processing power to support much more than credit or debit payments, Taylor says.
  Another 30% of the installed base was shipped in the mid-to-late 1990s. While many of those devices are able to process multiple applications, most lack the firewalls that help prevent the corruption of applications when new software is introduced, Taylor notes.
  Without such safeguards, all applications must be recertified each time functionality is added to a device. Because it can take up to six months for a processor to test the message fields of transactions being sent back and forth from a multiapplication device to the host system, many retailers have been reluctant to add functions.
  Newer terminals, however, are able to compartmentalize applications. As a result, only the new applications being added to those devices require certification, which analysts say can help reduce certification time from months to weeks.
  "Terminals are getting a lot smarter and capable," says Cathy Corby Parker, senior vice president, product management, for Tempe, Ariz.-based merchant processor Vital Processing Services. "A few years back the terminal was a dumb device with not very powerful processors. Now it is like a small personal computer with much faster modems."
  And with such hardware, smaller terminal vendors that focus on the multiapplication market are better prepared to compete with the largest manufacturers, analysts say. Among these players is Santa Ana, Calif.-based ExaDigm Inc., which began operations in 2000 but only this year started a strong marketing push, says Mike Mulcahy, vice president of sales and marketing. ExaDigm's hook: applications that run on the Linux open-source operating system.
  Unlike proprietary operating systems, open-source codes are freely available to the community of software developers. The whole basis of open-source is to provide a network through which developers can constantly tweak and improve codes.
  With Linux, it takes just a few days for ExaDigm to write code to customize terminals with specific applications. It might take two or three months to get a proprietary system translated, according to Mulcahy.
  "The features of today's terminals make it easier for us as a small player to carve out a niche in the marketplace," Mulcahy says. "It is easier for us to adapt the different applications."
  ExaDigm has about 3,000 terminals deployed, most outside of the United States even though the U.S. is the firm's primary market. To increase its penetration, ExaDigm has contracted with about a dozen ISOs, processors and banks to market its devices, Mulcahy says.
  To be sure, there still are obstacles that are keeping some merchants from embracing multiapplications. Downloading some programs from the Internet to the terminals, for instance, remains complex, Vital's Corby Parker says. Many retailers also are hesitant to invest in new terminals and applications without a guaranteed payback.
  "A lot depends on the acquirer's ability to sell the value and make the business case to the merchant," Corby Parker says. "Retailers are very price sensitive."
  But the prospect of greater revenues, lower operating expenses and a competitive edge are becoming powerful motivators for retailers to move beyond traditional payment applications.
  "All merchants are trying to differentiate themselves," Frost & Sullivan's Chowdhary says. "When an application such as the gift card becomes standard, merchants will look to add other applications to their terminals. The addition of these new apps will be dependent on how fast the terminals evolve."
  But with device vendors, application developers, acquirers and other parties consistently working to upgrade their offerings, the multiapplication momentum should keep on building.