MisShaping the merchant account industry…

I often receive questions as to why merchant service providers so often are just simply trying to rip businesses off. A recent question got me to thinking of what had caused the shift in what should be a great service, into something that rarely reflects a good or honest industry. This is a quick analysis of how some past decisions in the processing industry have influenced the way the industry is often viewed, and why there are so many companies doing bad business.

(Take this article with a grain of salt, as I am not touching on positive aspects of the industry, which there are many.)

A little history:

In the US, merchant accounts were traditionally controlled by banks. Elsewhere in the world, banks still have this same unchecked control over credit card processing. At some point, banks in the US began to give up their control over processing, and a group of businesses called ISOs (Independent Service Operator’s) were born. ISOs perform the same service that banks did, but created some much needed competition in the industry. Fees and prices went down almost overnight, and the acceptance of credit cards spread much more rapidly due to the lower cost to businesses. Since ISOs were specifically devoted to providing merchant services, their levels of knowledge and customer support became superior to banks. The few ISOs at the time got really big, and started allowing smaller ISOs and sales agents to operate under them. This branching created a massive service industry in a short amount of time, empowering thousands of companies and individuals to provide merchant accounts.

Processing equipment in the beginning:
In the beginning, equipment for processing was usually giving to businesses to use for free from banks. The cost of accepting credit cards was high, and banks pretty much just gave equipment to businesses just for processing with them. With the increased competition from ISOs and the subsequent lowering of fees to accept credit cards, equipment turned from a merchant account feature to a commodity. Equipment became a way for banks and ISOs to make some upfront money on their merchant accounts. Since processing become cheaper, in theory this would not have been a problem.

Lease abuse creates the foundation for bad business:
Providers realized that one of the best ways to make money was to lease equipment to their customers. Leasing became the standard, and stayed that way for over ten years. A low cost lease (~$25 / month) fronted the provider much more money than would have been made by selling equipment or giving it away. But, higher cost leases of $79 or more were common, even for equipment costing under $200. On a 48 month lease a provider could easily make $2000 upfront for each lease they signed. For a medium size organization bringing in 500 accounts per month, this would easily equate to 1 million dollars in extra profit each month. This cash flow from leases allowed even smaller ISOs to get very large and have very high revenue and profit. ISOs that heavily abused leasing had extremely high cash-flow and made this industry look like a gold nugget for anyone looking to make a quick buck. A lot of ISOs sprung up only with the intention of capitalizing on the ability to make money from high cost leases. High cost leases also tarnished the integrity of the industry as this cash flow was entirely at the expense of businesses. I still come across businesses locked into $79 / month and higher leases, as some banks and ISOs still dupe unsuspecting business owners into these ridiculous contracts.

A shift:
Sometime between 1999 and 2002, after the .com crash, leasing began to rapidly lose it’s appeal. Several merchant service providers (Merchant Warehouse is the first I know of starting in ’98) started selling credit card equipment online for very cheap, and leasing no longer seemed practical for many business owners. During this time several leasing companies also halted new leases, and lease provider’s practices came under scrutiny. Many ISOs lost their entire cash-flow overnight with the fall of prominent leasing companies.

Free terminal programs re-emerged in 2004 when United Bankcard and later Total Merchant Services revived the practice. Although United claims that they invented the free terminal program, they only re-invented it. It has however been an effective marketing tool for them. Now, most businesses either get a free terminal or they purchase one with very little markup when they first sign up for a merchant account. Both of these practices have their advantages and disadvantages.

How competition took a wrong turn:
At some point in the development of merchant services, the actual fees associated with processing became the primary competition focus. ISOs fought, basing their marketing and sales strategy solely off of their price. Since every ISO pays almost an identical cost, the industry shifted from a service driven industry to a price driven industry. ISOs began further and further discounting their services to make themselves appear the cheapest, and eventually hit their cost or below it. In response to no longer making money, many ISOs began getting creative with their fee structures. A business would sign up for a merchant account thinking they were getting a great price, and would get hit with a ton of other padding fees, or their provider would simply raise their rate. Things like monthly, convenience, yearly, and other fees become more common as ISOs had to make money somewhere. The industry ramped onto a self-destructive path, and still has not stepped off of it or even taken the steps to change it’s path.

Effects on the provider-customer relationship:
Processing companies have rarely been regarded as honest companies and taking this route did a few things. As more and more businesses started getting ripped off, the trust that these businesses had for service providers degraded more and more. Businesses locked into leases or contracts realized that they were being taken advantage of. Customer loyalty has become almost completely non-existent. ISOs started using termination fees more to keep customers with their business, and it doesn’t look like that is going to change any time soon. This has contributed to the further separation of businesses from ISOs. ISOs also make the mistake of isolating themselves from their customers, believing that they are better than the businesses that use their services. This can be party attributed to the business practices passed down from banks into the processing industry, but mainly ISOs just believe that their knowledge empowers them (which it very often does).

What we get in the end:
After all the cards are played, we end up with a service based industry competing only on price to a bunch of businesses that don’t care who they use because they will immediately switch as soon as there is any problem, or the next lower offer comes around. There is no real trust between the business and the provider, and as a result, there is no loyalty between the provider and the business. Businesses expect ultra-low processing rates, and providers are trying to figure out how to be fair and not lose money.

The bad providers keep the entire industry in a stalemate, as they keep focus on the price of services, while continuing to rip their customers off with other fees, increasing rates, and absurd contract terms. This in turn pushes the cycle of mistrust, and entices the good providers to remain in a price competition with the bad ones.

On the bright side:
There are still good providers out there. These companies don’t exist just to rip businesses off, and they do provide a needed and honest service to their customers.

The best way to find a good provider is to initially take price out of the picture. Find a provider that your business colleagues recommend, that has a good rating with the BBB, that doesn’t use high pressure sales, that didn’t first solicit you, and that has fair fees on their application. Find 4 or 5 companies that match some or all of the above criteria, and get some info from them. You should find a provider that has fair fees, is completely upfront with you, and you feel comfortable with.

In the end, Knowledge is the most powerful tool for any business looking for a merchant account. A basic knowledge of the industry will greatly benefit any business looking for merchant services, and the industry itself.