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Developing proprietary products, such as integrated point-of-sale systems or Apple Inc. iPhone applications, has the potential to increase revenue and client retention for merchant-service providers. However, simply building or purchasing a proprietary system from a third party does not guarantee immediate success for ISOs, acquirers and others, note industry insiders.
"The proprietary solution, if it has no value or opportunity for the merchant, there is no reason for them to embrace it," says Jared Isaacman, CEO of United Bank Card Inc., a Hampton, N.J.-based ISO. Merchant-service providers should give merchants proprietary systems "with a lot of value, something they don't expect," he says.
United Bank Card has a proprietary integrated point-of-sale system called Harbortouch, which includes a magnetic card swipe, software for a clock, merchandise pricing and inventory management. The ISO is among the first to independently develop and sell its own POS system.
The process of creating a successful proprietary system requires not only industry insight and value but also continual revisions and updates throughout the product's lifespan, all of which amounts to a great deal of effort and upfront cost for merchant-service providers, say observers.
Despite the uncertainty involved in creating proprietary products, more service providers likely will develop them, says Adil Moussa, an analyst with Aite Group LLC, a Boston-based consulting firm. The benefits associated with proprietary systems, such as lower client-attrition rates, will cause more companies to consider developing their own systems, he predicts.
"We are going to see a lot more of them, which is going to make the marketplace more interesting," says Moussa.
PROPRIETARY SYSTEM BENEFITS
Competitive advantages exist for those merchant-service providers that create proprietary systems, notes Henry Helgeson, president and co-CEO of Merchant Warehouse Inc., a Boston-based ISO. "If you can build something that is different than the competition, merchants will want that product if it has value and will come to your ISO versus another one," he says, noting the ISO has signed some accounts because of its technology.
Merchant Warehouse has developed multiple proprietary systems, including iPhone and Blackberry applications, a gateway, and encrypted card readers.
ISOs with proprietary software or hardware systems also typically achieve higher client- retention rates than do providers selling off-the-shelf products, observers note.
If a provider develops a system "and it doesn't work with [other systems on the market], that merchant will have to stay," says Moussa. If a merchant is using a product that is compatible with multiple systems and is widely available, the merchant more easily "can move to another provider if they aren't treated well," he says.
If a merchant can get a product at one company only, "it is a huge gain over the competitor," agrees Helgeson.
Additionally, switching away from a proprietary system can be more complicated for merchants.
Indeed, developing their own POS systems may help ISOs stem merchant-attrition rates by offering more services and making it more difficult for the merchant to switch ISOs, says George Peabody, director of the emerging technologies advisory service at Mercator Advisory Group Inc., a Maynard, Mass.-based consulting and research firm.
For instance, United Bank Card's Harbortouch integrated POS system runs exclusively on the United Bank Card network and provides the merchant with more than just payment functions, thus making it "harder to rip it out," Peabody says.
Because of this, merchants using a provider's proprietary system are less likely to switch to a competitor over concerns about transaction rates, notes Merchant Warehouse's Helgeson.
Having proprietary systems "has helped us with attrition quite a bit," he says. "Merchants don't leave over rates at this point."
Retention is "unbelievable" with United Bank Card's Harbortouch POS system, says Isaacman. "The retention benefits are pretty obvious," he says.
Besides decreased attrition rates, merchant- service providers with proprietary products have more control over product design and can create products that match the needs of their clients, note observers.
It is not uncommon to run into difficulties when using hardware or software created by a third party, says Ben Goretsky, CEO of USA ePay, a Los Angeles-based online-payment gateway. A product that does not perform as expected or is faulty can put a service provider "between a rock and a hard place, especially when selling through resellers," says Goretsky, adding that USA ePay encountered "a lot of difficulties" when it used another company's hardware for wireless products.
When USA ePay created its proprietary gateway, it was "cutting out the middle man," says Goretsky. Developing a proprietary system allowed the company to make sure "the product we sell is the one we envisioned," he says.
Having the control to quickly change small details is beneficial, agrees Isaacman. United Bank Card added to one of its cash registers the words "press here to change paper" to reduce confusion among merchants that need to change receipt paper. The move likely reduced the number of client calls to the ISO.
"If we can do one little tweak that can reduce calls, it is worth it," Isaacman says, noting a software developer likely would not think to add such a feature.
A company that creates its own products also can gain a better understanding of the security aspects associated with it, Goretsky notes. "I like the fact we make our own stuff because we know there is security in place where it needs to be," he says.
Proprietary systems also potentially could earn ISOs additional revenue, but the amount varies depending on an ISO's size, business model and the proprietary product it adds, says Helgeson. "It's not inconceivable that it will generate millions, but it's hard to predict," he says.
CHALLENGES EXIST
Though developing proprietary systems can help a merchant-service provider increase revenue and retain clients, it also can create sales and marketing challenges that threaten to stunt product distribution among merchants and revenue growth, observers say.
"When developing something new, it takes awhile for people in our industry to feel comfortable enough with the product to sell it to their merchants," says Goretsky. "Selling it is always the hard part."
Product training is necessary to increase the likelihood that agents will sell a proprietary product to merchants, says Helgeson. "Industry reps are so conditioned to talking about price. It takes sales training to get the reps comfortable enough to talk about the product," he says.
Some salespeople may have difficulty grasping new hardware or software products, agrees Goretsky. "We do our best to train them," but sometimes increasing a salesperson's comfort level with a proprietary product is a slow process, he notes. "Any time you develop something new, it will be a hard sell in this industry," he says.
New salespeople entering the industry also are helpful in selling new systems because they are not focused on existing systems or selling methods, says Goretsky.
Another challenge for creators of proprietary systems is completing projects quickly, notes Isaacman. United Bank Card began working on Harbortouch in 2006, and the system entered the market in late 2007, he says.
"Developers have a backlog of ideas," and often there are too many projects for them to work on at one time, says Isaacman.
IN-HOUSE OPTIONS
A merchant-service provider may choose to outsource development of a proprietary product to a third party or build it with an internal team, says Helgeson, noting Merchant Warehouse builds most of its products in-house.
The choice of building a proprietary system in-house or with a third-party vendor often depends on the type of product a company wants to create, the service provider's staff capabilities and the amount of funds a company is willing to put toward the new product, note industry observers.
Although developing products internally requires a significant staff, an ISO is "able to tweak the pieces" and continue to update them, Helgeson says. "It is cheaper to buy if for the first time with someone else, but the problem is when you have to update it," he says.
An ISO also will need to pay the third-party vendor each time it returns to revise the product, Helgeson says.
ISOs must be fully dedicated to their proprietary products throughout their lifespan, says Goretsky. "You can't go out there and think, 'I am going to buy or create a solution and, once it's done, it's done,'" he says. "It's got to be constantly maintained and upgraded."
Outsourcing product development is beneficial if a company wants to complete a project faster, says Goretsky, noting that 90% of USA ePay's development projects occur in-house. A third- party team also is useful if a project requires technology or systems with which an in-house team is unfamiliar, he says.
Overall, not every merchant-service provider is in a good position to successfully create and sell a proprietary system.
"When you are signing 100 merchants a month, it doesn't make much sense to invest thousands in a product," says Helgeson. "But once you start signing thousands, it's a better cost justification, and you have the resources internally to support it."
First Merchant Card Services LLC does not have its own proprietary system but sells USA ePay's proprietary products, says Jeff Beaute, CEO of the St. Charles, Ill.-based ISO.
"If we had our own, there would be an advantage to it for sales," and it could be easier to sell, Beaute says.
The cost of developing a proprietary product is the top factor in whether the ISO would consider adding its own system in the future, he says.
The costs to produce a product often include the initial development and providing staff for it, says Helgeson. A company cannot launch a product without providing support staff for it, he says.
"We have 25 to 30 people on staff that really have to deal with our proprietary products," Helgeson says. "It takes quite a bit to do this, more than I initially expected."
When anticipating the cost of developing a proprietary product, "whatever you think it will be, add a zero to the end of it, and that is what the cost will be," says Goretsky.
The first proprietary project requires the most due diligence, says Helgeson. "You probably need to put twice as much due diligence in it as you think you do, and then when you think you are done, look again," he says. The process becomes easier after the first project launch, notes Helgeson.
Creating a proprietary hardware or software project can be beneficial for many merchant- service providers and lead to increased revenue and client-retention rates. However, success is not guaranteed.
