A Different Perspective on Square


We reposted some analysis by Jon at TableCrunch earlier. We then received a reply from Don Apgar and thought his perspective was one worth sharing. In a nut shell, Don thought that, while Square is quite expensive per Jon’s analysis, it provides merchants with consistency and confidence: something they strongly miss with traditional processing relationships. Don does a good job walking through the labyrinth of the payments world, and every merchant should read this.

It seems obvious that this merchant should jump on Jon’s pricing, and it makes you wonder why anybody would sign up with Square at these prices?  The numbers are clear, the answer is less so.

The answer lies in the labyrinth of the processing industry: in order to quote pricing, an ISO has to be signed up either as a sales agent or registered as an ISO with a processor/acquirer.  As such, they receive a revenue share to perform these sales functions, namely quoting a price, obtaining a signed contract, and boarding the merchant.  However, the merchant is entering into a processing contract with the processor/acquirer, NOT the ISO.  The processor/acquirer owns that relationship and as such can change its terms, including pricing, at any time.

In an ISO agreement, the processor provides a cost structure (buy rates) to the ISO, commonly referred to as the “Schedule A”, along with a revenue share (not every deal is like this but the large majority are.) The ISO goes out and quotes a rate to the merchant, and the processor boards the deal at whatever rates/prices the ISO quoted on the merchant agreement.  At the end of the month, the processor collects the fees from the merchant.  The merchant fees are the gross revenue (not including interchange and card brand fees), then the ISO’s Schedule A costs are applied to determine the net revenue, and then the ISO gets their revenue split from that.

If the processor arbitrarily raised the Schedule A buy rates (as some have done in the past), the ISO’s revenue is at risk since their split is now calculated from a lower net revenue amount.  Every ISO contract contains a clause that prohibits the processor from raising the Schedule A buy rates to the ISO.

However, the ISO is only the sales agent: they get paid to deliver a contract between the processor and the merchant.  The ISO is not party to the merchant agreement.  Every merchant agreement (there are NO exceptions) has a clause that allows the processor to raise prices to the merchant at any time with 30 days’ notice.  This is due to the unpredictability of interchange fees – they have been pretty stable lately, but not long ago they went up every 6 months.

Visa rules require that agents/ISOs disclose who the processor/acquirer is when they talk about card processing. The effect is that unless merchants read the fine print to see who the other party to the merchant agreement is, they don’t know who they are doing business with for processing.  They may be led to believe that the processing being done by their payments rep, but it’s not.

But back to the merchant.

First, interchange pass-thru pricing is the most efficient way for merchants to be billed.  However, it creates a monster of a statement since each interchange fee category is itemized on the statement. There are 500+ interchange categories, 50 or so that apply to restaurants and hospitality merchants.  Some processors have taken that opportunity to add fees such as monthly access fees, PCI non-compliance (failed to file SAQ), etc., etc.  These fees get “lost” in the long unwieldy statement.  Other processors actually mark up the interchange fees calling them simply “fees”.  They are made to look like cost pass through items but in reality have margin built in.

What’s worse is that the processor can add fees at any time and the ISO has no control over that process.  Some ISOs are not even aware of how the processor they are selling for bills out interchange to merchants, so ISOs wind up unknowingly misrepresenting the processor’s services to the merchant.

The result is that merchant has no ability to audit what they are paying: they don’t know if the interchange fees are actual fees, if cards are being billed at the right categories, or which fees on the statement are actual costs vs fees added by the processor.  It’s only a matter of time until a bankcard sales agent knocks on the merchant’s door, looks at the statement, and is “shocked and appalled” by how much the ISO is overcharging the merchant. The merchant pressures their ISO to lower its price, but it can’t since it no longer controls the price.

Right or wrong, merchants feel like they don’t have control over their costs because they can’t audit them.  Enter Square at a flat price.  Sales x rate = cost.  I can understand this.

New merchants will likely feel educated by Jon’s analysis.  Merchants who have dealt with processing before are drawn in by the simplicity of the Square model.  No question they are overpriced, but sometimes you pay more when you shop on price.

Competition at all levels in the industry has never been fiercer, and processors are competing for agents and ISOs at a furious clip.  So as the processors compete for POS company business, pricing goes down.  It’s not uncommon for a POS company to get a 90% revenue share with a very low buy rate with no production minimums.

Now Jon, acting as the ISO, goes out and signs the merchant for cost plus .10%, because they are competing furiously with the other ISOs.  Do the math: the processor is now living on 10% x 0.10% = .01%.  For this $100,000 merchant that’s $10 per month that the processor gets to keep.  Out of that $10 the processor needs to service Table Crunch as the reseller, service the merchant if there are issues, hold the risk and do periodic reviews, pay for card brand system upgrades, maintain the network, manage PCI compliance, you get the idea.  Multiply this by thousands of merchants.

3Q18 rolls around, the processor has a revenue shortfall.  They can’t increase the costs to the ISO, so they add a “compliance fee”, a rate increase, or some other fee to the merchants.  They may or may not share the new fee with the ISO.  Over time, the merchant is paying a lot more than they were when they signed.

In the terminal world, this only lasts until another agent knocks on the merchant’s door, the merchant switches processors to get a lower rate, and the cycle repeats.  This is why POS companies like Toast are so important to processors today: because the merchant can’t switch processors without switching their POS system.

Excluding the bad actors, this is the reality of the payments industry today. The “last push” will be the convergence of ISOs and ISVs (POS companies), so that processing is tied to the POS, reducing churn, reducing the acquisition costs for the processors, and allowing pricing to stabilize for the merchants.

Ultimately, the industry will look like Square….they have the right model, selling directly to merchants with no channel expense.  Their issue is that micro-merchants do no volume. Yes, they collect 2.75%, but multiplied by a low volume doesn’t generate enough dollars to cover their overhead.