Wells Fargo's cave to Square drags small banks into the fee fight

The simplified pricing of fintechs like Square and Stripe has finally caught up with banks' more complex fees, prompting Wells Fargo to restructure its billing for small businesses. Other banks will also face consequences—particularly community banks that depend heavily on local merchants for income.

For years, Square, Stripe, Braintree and other startups that process payments for small businesses have worn their fees on their sleeve, almost like a marketing pitch by FAQ, or at least a branding strategy based on simplicity and transparency.

Wells Fargo this week changed its fee structure for small businesses, or those that process less than $100,000 per year, to 2.6% plus 15 cents for a tap, dip or swipe card payment; or 3.45% plus 15 cents for a keyed-in transaction. For a large bank like Wells Fargo, it's a relatively minor adjustment—and most large banks don't get a huge chunk of their business from providing payment processing to small business clients. But most small banks rely on small businesses for their survival, and any pressure on their fee income is a threat.

Patrick T. Fallon/Bloomberg

"The banks that are the most vulnerable are community banks that get more than half of their income from the smaller merchants, and most of these banks don't have an acquiring solution," said Richard Crone, a payments consultant.

Wells Fargo's "percentage plus cents" fee more closely matches those from fintech merchant acquirers, deviating from the banks' typical table-based fee structure that can vary from one merchant to another.

"Square, PayPal, Braintree and Stripe are redefining the market," Crone said. The fintechs use algorithms to bundle costs, a system that improves over time as more data gets fed into the model, he added. "They're using a more simplified approach, hiding all of the complexity behind a bundled pricing model."

Wells Fargo, which processed more than $400 billion in merchant payments in 2017, is one of the five largest bank business payment processors in the U.S. It changed its fee structure to improve the user experience, the bank says.

"Specific to the Community Bank segment of Merchant Services, we have recently rolled out new, simplified standard pricing to make opening and managing a merchant services account easier for small business customers," Danny Peltz, head of treasury and merchant payment solutions for Wells Fargo, said in an email. "By offering standard pricing in addition to custom pricing, our small-business customers can find the right solution for their specific needs. Additionally, our small-business deposit customers can apply to accept card payments and purchase processing equipment through one convenient online application."

Traditional acquirers use rate tables with "penny pricing" structures that are used to maximize profits by charging for a number of different things, Crone said.

"Complicated rate-table pricing requires a people-intensive servicing structure with ISO salespeople, customer service representatives and a whole lot of hand holding," Crone said. "Not so with mobile point of sale and alternative providers such as Square, PayPal, Braintree and Stripe."

As these technology companies expand into more traditional merchant services, lending and other financial services, banks will come under added pressure since they may lose the advantage of being a broader service provider.

Square and PayPal have long offered lending products based on a merchant's ability to use its own payments to pay down the loan, but Square has also applied for a broader banking license, a move that's drawn attention from community banks since it could enable Square to encroach deeper on their turf.

The fintechs' fee structure isn't new, and the new pressure is partly banks' simply overlooking the threat from Square, Stripe and similar companies.

Banks are in a good position to compete, since one of the first things small businesses do is set up a bank account, said Rick Oglesby, founder and president of AZ Payments.

"Historically, however, banks have been among the most risk-averse and paper-driven acquiring organizations," Oglesby said. "Additionally, many have spent the last near-decade since Square's launch thinking that Square’s primary market was a bottom-feeder market made up of merchants that are too small to be profitable."

Square's lending has focused on merchants that banks have traditionally avoided, but Square is also adding more tools to allow businesses to track sales, accounting, project management and human resources—which make larger merchants look into Square's other products. Stripe has also expanded its tool set, partnering with Microsoft to add services to compete with traditional acquirers.

Many banks have been feeling more pressure recently as they are learning that winning the larger merchants that have made up their traditional strength now means trying to win those merchants away from Square because Square signed them up at the beginning of their life cycles, Oglesby said.

"Beating Square will involve much more than simplifying pricing and having a mobile offering. Square now has big leads in product, brand recognition and awareness, distribution, customer loyalty, scale, and risk management capabilities," Oglesby said. "While many banks have traditionally acquired their way out of competitive problems, Square is now so big and valuable that those options are limited too. Square and PayPal have been transforming acquiring since their inceptions, and there is no end in sight."