Another week, another suit alleging nefarious practices by a payments provider. This time it’s CardConnect, a processor (but mostly payments portal) First Data acquired last year for $750M.
The suit alleges that CardConnect had two agreements: one that the merchant signed which promised all sorts of low rates, and another which stipulated the actual rates. In the fine print of the first agreement was the reference to the second agreement the merchant never saw, giving CardConnect the rights to ratchet rates and impose penalties for early termination.
Where do we sign up?!
If you’re wondering why these practices take place, it’s actually a fairly simple explanation.
This is a chart of US GDP, or gross domestic product.
GDP is an economist’s measure of a nation’s growth. If the GDP were up 10% in a year, it would mean the economy grew 10%. Our GDP has been growing at an average clip of 3% annually per the chart below. This takes into account down years like 2008 when the economy contracted.
GDP isn’t equally applied. You’re probably wondering why your business grew 25% last year yet the US GDP is only a fraction of that. Well, that’s because there are plenty of industries or businesses that are shrinking. On the aggregate, the these businesses grow at around 3% annually, hence the 3% growth in GDP.
US public companies, on the other hand, have averaged ~10% long-term annualized growth. That’s roughly 3x US GDP growth. If you were an investor you would be wise to invest your money in public companies as opposed to companies that make up the overall US GDP.
Many merchant acquirers (or payments processors) are pubic companies. As we’ve shown, investors demand relatively higher returns for public companies than they do for the average company included in the US GDP. Thus to remain investible or “competitive” with other public companies, these public merchant acquirers need to meet the ~10% long-term annualized growth numbers we discussed.
Unfortunately for many merchant acquirers their customers/merchants are not growing at 10% every year. If they were, the merchant acquirers wouldn’t much worry about it and would instead think like this:
My customers are growing by 10% every year. So as long as I keep them as customers I will keep hitting the growth numbers public market investors expect of me.
Of course we all know that many merchants are not growing anywhere near these amounts. Physical retail is shrinking at the expense of ecommerce (i.e. Amazon) and is barely meeting GDP growth metrics per the below graphics.
Restaurants have been even worse, far underperforming US GDP after accounting for inflation:
The $799 billion increased 4.3 percent over last year’s estimated sales of $766 billion, and 1.7 percent when adjusted for inflation. That rate of growth is slightly better than the 1.5 percent increase estimated in 2016.
National Restaurant Association, https://www.nrn.com/sales-trends/nra-restaurant-sales-hit-799b-2017
Much of the payments growth in online retail is being captured by technology companies that happen to process payments, like Stripe. We’ve even written about how the growing trend of online ordering/delivery will start taking material share out of existing payment processor approaches: as more orders emanate from online consumers, there’s no card swiping happening on-premises.
When confronted with these realities it should become clear that the most expeditious way for public merchant acquirers with large brick and mortar merchant exposure to reach their 10% annual growth targets is to increase rates on merchants who, on the aggregate, are not growing at 10% annually. As should now be obvious, many of these brick and mortar merchants are struggling to reach even 3% annual growth.
Is that to say that these public merchant acquirers with such merchant exposure can’t find other ways to achieve growth? Of course not. But it’s far easier to increase rates on existing accounts than it is to innovate, sell, and support something new, isn’t it?
Here’s a list of public merchant acquirers for those interested in extra scrutiny. We don’t know how much brick and mortar exposure each one has, with the exception of NCR which is highly concentrated in brick and mortar. Also note that some banks have acquiring arms, like JP Morgan and Chase Paymentech, though we are not including them below:
For the record, private merchant acquirers also need to demonstrate similar – if not higher – growth rates to attract investment or buy out capital.
Now that you’re aware of the financial realities of payments processors we hope you better understand why they do what they do. Not that their behavior is excusable, of course: they should learn to innovate like everyone else.
