Processing Your Payments Directly with A Processor? Expect The Abuse to Get Worse

When the card networks brought credit cards to the masses in the 1960’s they needed henchman to convince merchants to take plastic.

Enter the acquiring bank.

These banks would end up partners with separate entities – payments processors – to get the job done, mostly because payments processing became a grimy line of work.

In its most basic sense, payments processors offered distribution. The high brow people at the networks didn’t like dealing with main street merchants, and the types of people that did found they could reap more money than would ever be justified in ripping the skin off the merchant’s back vis a vis payment fees.

A happy marriage.

Then in 2011 the card network did something to upset the apple cart.

They sanctioned this entity called a payfac.

You can read a lot more about payfacs at that link, but for the purposes of this article all you need to know is that payfacs drastically sped up the time it took to offer payments to a merchant. This became a secret weapon for software companies that were willing to take a bit of risk to programmatically onboard payments for merchant at scale.

The payfacs write directly to the processors, but they’re protected from any changes the processor might impose by A) a contract, and B) portability, meaning the payfac can move their book of merchants to another processor whenever they want (we’re ignoring some technical hurdles but let’s roll with it for this article).

As payfacs represent a growing number of merchants, it’s becoming a legitimate concern for processors.

Let us explain why.

Here’s a list of US processor transaction counts from Nilson. We surprisingly couldn’t find a similar graphic for total processing volume by acquirer. In 2020 Chase processed 27B transactions for a total of $1.4T in volume, averaging $52 per transaction.

Margins from the acquirers are a bit tricky to pin down since some of them are part of larger banks (Chase) and others have software lines of business.

Analysts we spoke with estimate margins between 20 and 50 basis points. Acquirers with smaller merchants, like Global Payments, are on the higher end of that range.

On a $52 average ticket that margin equates to between 10 and 25 cents.

Payfacs writing to the processors are getting buy rates (i.e. what the processor makes in effective margin on each transaction from a payfac) much, much lower than the margins the processors currently enjoy.

Toast is at 0.7 cents from our last check.

Lightspeed is at 7 basis points – on a $40 average check that’s 3.6 cents.

We’ve seen payfacs down below half a cent with the average probably around 3-4 cents depending on volume and merchant code (MCC).

As you can see, payfacs can represent a literal logarithmic decline in processor margin: from 25 cents per transaction to less than a penny is a massive leap.

Payment volume flowing through payfacs is only expected to increase; some estimates put $4T of global volume through payfacs by 2025 out of an estimated $50T in global card spend.

Bottoms up math in the US, where there over $7T of card spend in 2020, starts to make these numbers hit home.

Paypal: $936B of volume.

Stripe: $350B of volume.

Square: $112B of volume.

Shopify: $120B of volume (this might be double counted in Stripe’s numbers).

Toast: $25B of volume.

Some of this is global, sure, but suffice it to say payfacs represent between 5-10% of US volume already.

And the list of payfacs is growing rapidly.

By and large, public payment processors have historically met quarterly revenue targets through a slew of fake fees. We have infinite evidence of this behavior, and why class action attorneys haven’t picked it up is still mind boggling.

There’s no organic growth in payments processing.

The problem with payfacs for acquirers? They can’t abuse the merchants represented by payfac partners because a contract and merchant portability prevents the passing of their bullshit fees.

Payfac is like Social Services, coming to your house unannounced and removing you from the clutches of your lecherous uncles.

But their car was too small so they had to leave some of your siblings behind.

Too bad for their orifices.

Here’s a handy graphic we made.

The merchants with the direct processor relationship, in the red box, are going to see more and more abuse from their lecherous uncles, the payments processors, as the processors cede market share to the payfacs. That’s why those merchants are both crying and leaking blood from, yea…

Payfacs prevent their merchants, in the green box, from suffering the wrath of Uncle Payment Processor.

We’re not in any way implying that the payfacs won’t abuse merchants, and we’ve caught Paypal and others increasing rates. But at least the payfacs can move directly to the card networks and improve features and functionality over time.

This is what we expect PFaaS companies like Infinicept to start doing with their payfacs in short order.

Conversely, it would take processors billions of dollars and literal decades to do the same.

Legacy processors are just a hot mess.

We’ve seen all sorts of malfeasance from the processors over the years, and it’s only going to get worse

Processors served their purpose (distribution) but will become a very expensive business proposition over the next 1-2 decades. Their expiration date is slowly approaching.