By Ross Federgreen
CSRSI, The Payment Advisors
The Holy Grail in the payments industry is to have a merchant who processes more than $25 million per year. Many merchants at that level place their processing through a competitive process called a bid. And bidding success is contingent upon understanding certain constants.
First, at these levels and greater, merchants always receive interchange pass-though pricing, so pricing issues revolve around transaction fees, incentives and costs of ancillary services. Issues in addition to pricing include contracts, convergence and integration.
Bid specifications can be prepared by merchants or by outside consultants. Having managed this process for many merchant clients, I have found the larger entities depend upon industry experts. Specifications are written to allow the processor to understand the merchant's business and to give enough detail to allow the processor to maximize the bid.
Typically included in the bid information document are a description of the business; types of processing; average ticket amount; number of merchant identification numbers (MIDs), locations and transactions by brand; special needs and requirements; and a request for incentives.
Questions normally asked of bidding entities include market-specific experience, corporate history, financial soundness, banking relationships, interrelationships with middleware, domestic and foreign processing capacity, alternative payment experience, references, capacity and a host of bid-specific questions.
Before a bid specification can be effectively written and released, the merchant must complete a detailed analysis of multiple issues, including performance, customer support, chargebacks, reporting, potential fraud, architecture, previous contract history, among others.
Incentives are a critical issue; large merchants expect to receive them. These take the form of cash or cash equivalents such as marketing dollars, which pass from the acquirer to the merchant during the contract period, including at the time of closing.
How are incentives calculated? Normally, they are calculated as a percentage of the value of the merchant's total processing. They can vary from a fraction of a basis point on up. Some processors do not, as a policy, offer incentives to merchants; this group is shrinking in the large-deal marketplace.
The concept of a sub-interchange relationship comes from this practice. If one calculates the incentive as a discount to the interchange pass-through, one derives the sub-interchange nature of the relationship and, at the same time, allows the system to maintain interchange as the floor.
Well-written specifications always leave room for bidders to be creative and propose novel solutions. Sometimes the "better mousetrap" is the difference between the successful bidder and the runner up.
Payments industry transaction fees have trended down over the years. It is common for transaction fees in larger deals to be less than five cents per transaction. In relationships that have multiple millions of transactions per year, substantial reduction below five-cent pricing is not uncommon.
In addition, tiered transaction pricing based upon merchant performance is common. An example of this might be a reduction of transaction fee pricing in steps of five million transactions per year, starting at some threshold. It is not unusual to see transaction pricing of all card brands included in this fee structure.
As an aside, the decision of large merchants to work directly with processors associated with card brands other than Visa Inc. and MasterCard Worldwide is complex. Some issues to resolve are price differential, convenience, efficiency, reporting and reconciliation.
Large merchants may fall into a classification of Payment Card Industry (PCI) Data Security Standard (DSS) compliance that requires on-site evaluation and validation. It is imperative that the merchant becomes PCI validated at the appropriate level, preferably before the bid process or be far down the pathway during the process.
A formal gap analysis (which evaluates how effectively a company is meeting a predetermined set of standards) should be completed and a specific remediation schedule put in place before releasing a bid to the marketplace.
Determination of PCI level is not always straightforward. This is especially true if a merchant has multiple MIDs distributed throughout the enterprise. The key question is if the acquirer will roll up the total transaction count or allow the separation of transaction counts into various architectural separations.
There are strong reasons for and against an independent middleware. Acquiring institutions have recently bought a number of the major middleware providers. In such instances, there is usually a statement of intent to remain neutral on the issue of middleware (open to multiple bank platforms), but there are good reasons why it is beneficial to utilize the middleware products provided by the acquirer, even though it may restrict processing relationships.
Among the benefits of using the acquiring bank's middleware are seamless connectivity, greater reporting and one ultimate point of contact for issue resolution, which makes the relationship more manageable for both parties.
From the perspective of pricing, middleware can be folded into the underlying contract or may be billed directly to the merchant from the middleware provider.
The structure of contracts in large relationships is critical; many items in a "standard" merchant services contract are negotiable and may not fit the needs of a larger relationship.
Additionally, all terms must be defined, and the definitions must be agreed upon and understood by all parties to the agreement.
Some important areas of consideration are the contract's term, both initial and subsequent; cancellation and termination clauses; security requirements and related indemnification; trigger events; and items that impact reserve requirements. Bidders must realize the bid will be reviewed thoroughly by experts, and mistakes or perceived hidden costs will not be taken lightly.
Is the merchant capable of bringing to the processor the volume the merchant proposes? This is not a simple issue. For example, is the entity in need of transaction processing a holding company, a franchisor, a foreign entity or some other type of business? What actual control does this entity have over independents? Clearly a company that is a sole entity is easier to deal with for many reasons.
There is a certain belief among large merchants that their names carry a level of prestige that should bring them a better deal. In some measure, they are correct; a successful relationship will hinge on finding the prestige-to-price ratio that works for both parties.
Ross Federgreen is founder of CSRSI, The Payment Advisors, a leading electronic payment consultancy specifically focused on the merchant. He can be reached at 866-462-7774, ext. 1, or firstname.lastname@example.org.
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