COVID, Contactless and a shifting market

The payments industry agrees that COVID-19 will accelerate the adoption of contactless payments but it will also add fuel to shifts occurring at the merchant level.  Private investment in payments has been driven by many things like great cash flow based on a reoccurring revenue model and defensible technology. Several factors will drive a change in payments that were already shifting in the marketplace. Processor change at the merchant level is generally driven by three key events: Change of ownership, price difference or a shift in technology. Processors, Acquirers and ISO’s have historically focused on the first two. Technology has emerged over the last decade as the king catalyst for merchant change. Merchants have moved to integrated payments whether it be through an updated online experience or converting to a modern point-of-sale(POS) system like Clover, EPOSnow or Square. COVID- 19 and its enormous reach will add to ongoing shifts from cash to card, from in store to online and from dip to wave. The very nature of contactless as a solution for commerce in the age of Coronavirus presents an opportunity to shift technology and therefore merchant service providers. Traditional ISO's and legacy processors long dependent on price over value will see a increased attrition and churn in their portfolios.


Payfac growth

How PayFacs Drive Revenue

Integrated Software Vendors (ISV) that choose a PayFac path for their payments strategy, over the long term, can have the capacity to earn more revenue than traditional payment models or referral programs.  They accomplish this through varying methods but the three core tenants for driving maximum revenue are adoption, functionality and commercial terms.

First adoption rates, driving a high adoption rate is a key component to maximizing the volume and therefore revenue across your platform. Two high profile examples of successful adoption strategies would be Shopify and Toast. They drive extremely high payments usage by automatically enrolling customers to use their payments offering or create penalties for customers that want to choose a different path. This carrot  and stick approach makes almost every SaaS client also become a payments client.

The second lever is determined by the functionality. An ISV’s customer that boards to the platform and uses the “preferred payments path” are often given sight line to activities like funding, chargebacks, batch reporting etc. which are not available with third party providers. Settlement data is the most common and significant data included or omitted, a result of both design and practicality. ISVs do not want to have to code and support endpoints into every processor that their clients desire, especially where the commercials terms are not favorable.

The last lever and often the most impactful are the commercial terms.  ISV's that choose to become a Registered Payment Facilitator enjoy high multiples that are only available to payment providers that carry their own liability called full-liability Independent Sales Organization(ISO’s), Acquirers or leading edge Fintechs. Referral models are a great introductory go-to-market but don’t allow for the ISV's to account for the top line revenue created by payment processing. Carrying ownership of the merchant contract, Payment Facilitators are often vertically focused limiting the liability exposure often associated with this higher liability, higher reward model.

There is no one right answer when it comes to ISV's and their payment strategy. Coronavirus has shown us that even low risk verticals, like retail and restaurants can carry substantial exposure during these uncertain times. Even with Payment-as-a-Service (PaaS) companies like Finix, Payix and Infinicept that have all shortened the road to becoming a Payment Facilitator, it is still a significant strategic decision for every software company.


PCI Compliance for Payfacs and Traditional Acquirers

There are many double standards that exist in the payments industry. The landscape is littered with conflictions laid out from Security Standards Council(PCI), Card brands(Visa, MasterCard, American Express) and the sponsor banks. Companies like Square that have received investment directly from Visa benefit from bias rules created to manage an industry they are often competing against.

PCI compliance has a double standard for Payment Facilitators or PayFacs compared to traditional acquirers. A sub-merchant processing with a Payfac often removes themselves from the cost and obligations of having to complete quarterly Self-Assessment Questionnaires (SAQ) or involve a 3rd party auditor like Trustwave, CoalFire or Security Metrics. According to Stripe, larger organizations shift from thousands of hours of compliance work to 2-5 days of effort; smaller organizations save hundreds of hours of work.

Our belief is that the logic behind these double standards is that a merchant-of-record carries the liability and compliance responsibility in an ecosystem that is all the same. The reality is that merchants, even processing with a Payfac may not have the same application and payments footprint. PCI compliance has legitimately become a more important issue for merchants, issuers and acquirers with high profile breaches including Target, Home Depot and Wawa. However,  acquirers charging monthly PCI compliance or a monthly PCI non-compliance fees of $20-$40 per month are exactly the underhanded pricing strategies that have driven so many clients to PayFacs with a true flat rate pricing model. Compliance is vital to every merchant and provider, making sure they are following proper procedure and protocols. Whether you are an ISV, registered PayFac or Merchant it is important to understand your options and the implications of those choices.


5 Predictions for Payments in 2020

January is such an exciting time for any business, filled with endless possibilities and potential for the coming year. HONOR decided to bust out our Ouija board and make a few predictions for the coming year in payments. Here are our top 5 in no particular order:

A different flavor of Payment Facilitation- With PaaS (Payments as a service) newcomers Infinicept, Payrix and Finix making the path to Payfac easier, ISVs of size will be converting in droves to become registered Payfac’s. The path to becoming a Payfac has now been reduced from 15 months to 3-4, the cost has been reduced from more than $1.5M to $250-$400.  I believe this will greatly impact the Payfac platforms like Stripe and WePay(Chase).

Strategy Expansion- We would look for companies that have already moved away from a partner focused go-to-market to double down on their ISV-owned strategy. Global(GPN) and Square will continue to grow their business through acquisitions. The scale and competition of this strategy has changed since Heartland(a Global subsidiary) bought companies like Digital Dining or LiquorPOS. With the immersion of large players like EverCommerce and Constellation Software,  the large market cap acquirers can buy their way to a broader distribution model through ISV holding companies. With a growing market share, these software holding companies are ripe for processors already looking to expand their reach through wholly owned ISVs.

More Acquisitions- I believe the big three(FIS, FISERV and GPN) will turn their attention abroad for growth. They still have an enormous amount to do domestically to realize the advantages of these massive mergers; as costs are reduced, pricing is adjusted and business units are consolidated. They will need to continue to make smart acquisitions, justifying their aggressive P/E ratios.

Cash Discounting and Surcharging- Several years ago some airlines shifted to “basic economy” and the large airlines all claimed it was ridiculous. Now they all offer it. 46 States have now passed legislation allowing surcharging, once this occurs nationally large retailers will force a change in consumer behavior and increase debit usage. Cash Discounting is protected by the Durbin Amendment but remains convoluted in its practice. Ultimately, as retailers and processors hone in messaging that wont create friction at the point of sale, the dominos will begin to fall.

Mobile Ecommerce- All signs point to continued growth of ecommerce and mobile. ApplePay and Gpay have made significant headway in reducing consumer pain points during the mobile check out process. We will look for continued innovation in mobile commerce following consumer trends.


Top 4 Reasons Payments Aren't Commoditized

HONOR payment solutions works with a wide range of ISVs supporting all kinds of business management software.  On more than one occasion I have heard “you guys are all the same”. Essentially, some ISVs like merchants have been solicited so many times they have a jaded experience with their payment processing partner. Some ISVs and even legacy payment companies believe that the partner experience is universal, with all integrated partners created equally. Whether you are choosing a referral partner, Payfac platform or registering your software as a payment facilitator, all payment companies are not ubiquitous. While some believe payments have become commoditized, here are the top 4 items to validate with any partner you choose:

  1. Seeing is believing- Don’t just take the Business Developers word for their functionality, request live demos and understanding production capabilities will only help to better inform your decision.
  2. Technical resources- Make sure the partner you choose has a dedicated ISV team, execution is the key reason so many traditional ISOs struggle with a successful integrated channel. A successful program often includes dedicated Business Developers, Sales Engineers, Technical Integration Engineers, Account Management, Merchant Sales all with Integrated payments experience.
  3. Channel adoption- This carries through as a critical component of program execution. An experienced integrated partner will work with the ISV to drive adoption through a collaborative approach drawing from experience with successful implementations. Traditional ISOs that have created integrated channels often approach these partnerships through the same lens they view traditional merchant acquisition, utilizing intensive, high pressure sales that often results in blow-back for the ISVs.
  4. Residual transparency- Residual splits are important but always come back to the same question in any payments ecosystem, “X% of what”?  PayFacs or payment facilitators have streamline or normalized merchant pricing, commonly set at 2.90% and $0.30 per transaction. Having a clear understanding of the interchange costs is your only true way to validate the payments. Are you paid on all transactions or just qualified transactions?
  5. Residual terms- Are residual streams paid in perpetuity or do they drop off after a certain period(you would be surprised how often this is actually offered!).

HONOR works with an number of processor relationships and various integration paths. The process of authorizing and settling credit, debit and ACH transactions is almost completely universal. The layers of technology, customer support, operational know-how and execution remain critical differentiators. They keep integrated payments from becoming truly commoditized.


Future Proof Payments

ISVs have adopted payment strategies varying from referral models to registered PayFac(Payment facilitators) and everything in-between. Independent Software Vendors(ISVs) generally aim to address a couple of common issues when exploring a new partnership: monetize an additional revenue stream, control the users experience including through the payments process, satisfy customer requests for payment processor support and optimize their development efforts. Given these variables, we are going to look at how ISVs are effectively implementing a payment strategy in order to solve for as many of these issues as possible.

 

Plan for growth. ISVs are often vertically focused, making them a great fit for a payment facilitator solution. A Payfac implementation can often solve for many key areas of the payment flow. It effectively allows ISVs to control virtually every aspect of the payment flow, from onboarding to settlement. This can often be an intimidating endeavor. Given the right guidance and platform, an ISV can go through the complete lifecycle of using a PayFac platform to taking liability and becoming a registered Payment Facilitator. The key to taking a phased approach is that it will also allow you to tackle each step individually without a massive disruption to the ISVs development roadmap.

 

Driving adoption. The Carrot and Stick is often the most effective strategy for driving adoption of integrated payments. Shopify is a great example of  a successful implementation of this strategy. They send their customers to their registered PayFac but also support a gateway only option. This allows them to drive adoption on the preferred, most profitable path. At the same time they are also able to support customers that require their own processor. Adoption rates of 80% or more can easily be achieved with the proper structure. However, most ISV’s have found that 100% payments adoption or a closed loop system can often be detrimental to the growth of the software. Customers often require processor exceptions when working with: enterprise accounts, high risk accounts, entangled banking or associated loans. Servicing these accounts requires a one-to-many connection accomplished through a gateway function.

 

ISVs looking to check off these strategies and features can work with a new breed of PayFac. Some payment facilitators have recently come to market that are able to act as a platform but also as a gateway. This eliminates the need for multiple integrations and reduces maintenance costs. It will be interesting to see if Stripe, WePay and ProPay ultimately follow suit.


Ask these 5 questions when evaluating the next platform for your business

HONOR has been evaluating platform partners for a couple of operational functions. We have had many conversations with Business Developers and Sales Representatives that have ranged from helpful and professional to pushy and less than forth coming. Typically we focus on ISVs looking to evaluate a payment solution partner but here are the top 5 things to assist when going through the buying process that can be universally applied.

  1. Seeing is believing. Ask to see the platform. Yes, demos can be a pain. Yes, asking for time from multiple people can be difficult. Gather input from all of the operational functions that will work with the technology. Product may have a different set of requirements or views than Finance or Accounting.  Seeing a platform in action is the best way to evaluate any solution. Sales people are great and helpful guides but don’t just take their word for it.
  2. Customization. We all think, “I want this to work for my specific industry”. The truth is that most functionality, whether it is for customer service, sales or operations is fairly universal. Before you spend a bunch of time/money and resources looking for customized features, understand what functions come stock. CRMs are a great example of this spectrum; Salesforce is endlessly customizable but difficult to implement for smaller businesses  while Insightly is ready to go out of the box but may lack integrations required by large enterprises.
  3. Data is king. You cant make smart business decisions without the right input and data. Make sure the platform can offer you the KPIs you are looking for plus the ability to customize. It is vital to have the ability to easily create and view a dashboard relevant for your business. Being able to deep dive into a specific problem or opportunity area with tangible, accurate data is critical.
  4. One size does not fit all. Platforms are generally designed to fit a certain market size and segment. Make sure that what you are evaluating is appropriate for your size and use case. Buying a license to a massive enterprise platform that requires a dedicated headcount if you are small company doesn’t make a lot of sense. It will always be a balance as you also want to plan for growth. In payments, Stripe is easy to implement but does not share much or any of the revenue with their partners. Payment platforms( PaaS) like Infinicept maximize revenue but require a greater payment volume(>$50M) and a larger investment.
  5. Don’t break the bank. What does it really cost? What is the pricing and how long is that price good for? What is included? Implementation? Support?  And most importantly, does it fit my budget?

Payment Sharks in the ISV's Pond

Community Brands, Evercommerce and Constellation Software have been on a terror acquiring as many vertically focused ISVs as they can. They seem to have a simple formula: buy and ISV, streamline supporting functions, increase monetization and offer in-house payments. As the payments community has long figured out, a successfully integrated payment strategy can sometimes drive more revenue than the actual SaaS fees.

These growing companies generally target ISVs that are vertically focused. They standardize or replace the service department and reduce overhead in areas like HR, accounting, marketing and operations. Their key to a healthy ROI of the their acquisition model is their ability to not only reduce expenses but increase revenue. Software companies or ISVs with nescient or underdeveloped payments revenue present an opportunity for acquisition, that is not necessarily in the ISVs best interest.

For example, if  “XYZ Holding company” purchased a software company charging $80 in monthly SaaS fees, with an additional $20 a month in reoccurring payments, totaling $100 per customer. Lets assume a total annual revenue of $1.2M and XYZ Holding are able to purchase that same company on a multiple of 10X. We could reasonably assume that with some investment, they could increase their reoccurring payments revenue to $60 per month, increasing their MRR by 40%. The payback now becomes ~7 years. If they are able to reduce expense by a reasonable 20%, the pay back could be estimated at 5.5 years.

While the acquiring entities may be the right fit for certain software companies, it is vital the ISVs have a clear path to a healthy payments strategy that may include Paas(Payments as a Service), PayFac(Payment Facilitator), ISO registration or a lucrative referral model. A poor payments strategy can cost the ISVs founders, owners or shareholders millions on their valuation multiple during an acquisition event. There is never one correct path but it is important for ISVs to have a clear understanding of their payment partners and implications of their payment residuals.


Becoming a Payment Facilitator

Stripe and WePay(now Chase) have made a significant impact on the eCommerce world through their cutting edge UI and easy to integrate API’s. These Payment Facilitators or PayFacs, along with Square have changed customers expectations of payment processors. These companies help set new expectations for boarding, funding controls and ease of integration.

The industry has since caught up and much of the technology they provide has become ubiquitous.  As early adopters, they enjoyed a brief runway, servicing many direct merchants and software providers with relatively high pricing and little to no, residual share for integrated partners. We are going to focus on the relationship between ISVs and PayFacs.

Integrated software providers continue to target ISVs, guiding them through a roadmap from integration to channel adoption. Many ISVs start with a referral relationship which requires the least amount of time, resources and commitment. From there they often progress to a fully automated experience or un-registered PayFac structure, and can eventually move to a fully registered Payment Facilitator. Some providers offer one or two paths for partnership; Stripe and WePay limited by the fact that they are Payment Facilitators themselves and not actual processors. Each step generally requires a more robust integration and stronger commitment which mirrors a scaling compensation structure when using more traditional payment processors. Most processors understand that larger companies with a clear, significant interest in payments want to work towards ownership of their portfolio.

ISVs can always recognize the revenue from a payments partner, however becoming a full Payment Facilitator gives larger ISVs ownership of the merchant contract and an increase in their valuation multiple as a result. Growing into a true payments facilitator can seem like a daunting task. It creates challenges, has strict requirements and generally a time frame extending out to longer than a year.

A new group of payment servicers have emerged. These companies recognize that although painful, becoming a PayFac is the right strategic decision for larger technology platform with $50-$100M or more in volume. These companies offer tools and APIs to handle some of the most painful parts of becoming a PF and bridging the connection that must be created between the ISV and Processor/Sponsor Bank. Ultimately, for large fast growing ISV, a processor, not an another PayFac is the best path for strategic growth.