Applying Data to Boost Your Merchant Services Program David Reed brings 10 years of financial management experience and a deep understanding of interchange to Security Card Services bank partners. David helps providers of merchant services programs identify opportunities for improvement by understanding the strengths and weaknesses in their portfolio. My objective is to equip you with a high-level understanding of the variables I measure every day to evaluate the health of merchant services programs. This will include data in our portfolios and the portfolios of our bank partners as well. So, you should be able to take some of these insights and apply them to your program today. I ll also cover some general terms. We ll talk about attrition; understanding attrition and some different ways to view attrition. We ll talk about applying data to evaluate the health of your program. This is where we ll discuss different variables that you can look at. Then we ll also talk about basis points and why a basis point is the most important driver to use within your portfolio. Let s cover a few general terms and calculations that I m going to reference throughout this discussion. MID, which is a Merchant Identification Number. Basis Point, which is 1% of 1%. One percent equals 100 basis points. Effective Rate. This is a measure of how much money is made per dollar in volume. This could also be applied to merchant charges. What we re looking at here is revenue divided by volume. We use billable volume here. We ll use the dollar figures that we re actually making money on, which is typically a function of Visa, MasterCard and Discover volume. When looking at effective rates, the quotient will be stated in basis points. If I process $10 million in Visa, MasterCard, Discover volume, and made $50,000, effectively, I made 50 basis points. Attrition Rate is the number of MIDs lost in a given period expressed as a percentage. Attrition is the enemy We re all used to seeing attrition rates from our providers, whether it s provided quarterly, annually or monthly. It s simply the percentage of merchants who no longer process through us. The question is, what does that really mean to you? What are you really losing with attrition? While account attrition is certainly an important number, and it s the most common metric supplied by providers, account attrition doesn t always tell you the whole story. We like to also 1
look at attrition in terms of volume and revenue. Volume attrition and residual attrition is typically calculated as a static loss - comparing the volume from 13 months ago to the volume today. The difference in those volumes divided back into the original volume is your volume attrition rate. This can also be calculated similarly for residuals. For example, imagine a portfolio that loses 15.52% of their accounts, but only 12.2% of their volume and 8% of their residuals. Those numbers can tell you the quality of the business lost. It s the difference between losing smaller accounts that process little volume or one account that processes huge volume. Understanding the difference between the accounts lost, and how the volume lost and the residual lost relates to those accounts, is certainly important. On the economy and the importance of understanding your data When the recession hit in 2008, we saw a lot of small businesses, a lot of small-volume merchants, simply couldn t sustain through the recession. The end result was high attrition in accounts, but the accounts weren t making up as much of our volume and residuals. Business closures are a primary reason for attrition, but those businesses generally yield diminishing volume and residual revenue before closing. The second piece to attrition, outside of measuring volume, residual and account-related attrition, is to understand why merchants leave. In order to develop a strategy, you have to understand their reasons for leaving. We typically see two causes. One is closure of the business. Not much you can do about that. The second largest variable is generally price. In most pricing situations, you don t lose merchants because you re not able to compete with pricing. The reason you lose merchants is because you re not given the opportunity to compete with the competitor s price. We find that a lot within our bank portfolio. Here are a few of the strategies that our bank partners are using to try to help retain some of those merchants they re losing due to price: Use secure terminals. The terminals have a secure file download and before a competitor can come in and re-download that terminal to point to their provider, the merchant is required to pick up the phone and call the bank. The bank will actually have to do a partial download to allow the new company to download that terminal. What this does is it gives you another opportunity to retain that account. Another huge benefit here is that this practice prevents slamming. If there is a secure download feature on that terminal, it prevents somebody from walking in off the street and slamming that terminal. By slamming, we mean somebody from another payment system provider reprogramming the terminal to process through them without the merchant s consent. 2
ETF. The second tool we like to use is an Early Termination Fee. Nobody likes to lose merchants but in the event the do leave, an ETF generates some revenue. With that being said, we primarily look at early termination fees as more of a retention tool than a revenue stream. Say a competitor tells your merchant, Look, I can save you $20 a month. If that merchant has, let s say, a $500 ETF to contend with, they are much more likely to pick up the phone, call you and give you the opportunity to retain that account before they decide about the other provider. Again, understanding attrition and why your merchants are leaving really gives you the ability to implement strategies to retain some of those accounts. Whenever a merchant calls to close an account, part of that process needs to include a close reason. We always require our merchants to provide a reason before we ll close the account because the information is so valuable. Regardless of which processor you use, you need to make sure that you re capturing this information. A couple of other thoughts around attrition. Ask yourself, Am I losing merchants that range from $10,000 to $20,000 in volume, and $20,000 to $40,000, $40,000 to $60,000, $60,000 to $80,000? You can implement specific strategies around those volume groups to aid retention efforts. Other variables Beyond attrition, the two most important numbers to track are, of course, how much money you made and how much volume you processed. But what else can you track to determine the health of your program? Three important variables are revenue per merchant, volume per merchant and basis points. I know these three variables are simple and they re easy to calculate. But they are very informative and offer great insight into how your portfolio is performing. Revenue per merchant. How much money are you making per account, per month, per quarter, per year? The key here is consistency, as with any measurable. As long as you are consistently tracking the same measure month over month, you will have the ability to reliably gauge performance. How is this valuable? The question here is, Am I adding or retaining more profitable accounts than I m losing? That knowledge can be critical to your sales team and their strategies. While we do trend these numbers month over month, we certainly recommend comparing these by prior periods. These prior periods help account for shifts and seasonality. Within this industry, everything is volume based. As volume shifts from season to season, it sometimes can be difficult to compare, let s say, August revenue per merchant to September revenue per merchant. 3
Whether you re comparing December 12 over December 13 or FY2012 over FY2013, comparing like periods will account for those seasonal shifts. Volume per MID. The same seasonal principles apply here. You should still compare volume to prior periods. How much volume are you processing per account, per month and how does this compare to the same timeframe from prior periods? Basis Points. Basis points normalize volume and revenue into a percentage. It accounts for your shifts in volume, your shifts in revenue and it normalizes it into one percentage that you can use to judge how much money you re making on a monthly, quarterly or annual basis. What this reveals is how much money you re making per dollar and volume. We take this just like we did volume and revenue and we compare it by the same timeframe for prior periods. Basis points: the best measureable of margin When we begin any portfolio review, we always begin with basis points. It normalizes volume. It allows you to say, Okay, my volume dropped by $300,000 and my residual dropped as well. Was there a parallel decline in basis points? If my revenue is lower but my basis points are the same, chances are it s due to a seasonal shift in volume. Where it really gets interesting is when you start combining these different variables together. It gives you the whole picture as to what s going on within your portfolio. 4
Look at the example table at the bottom of page 4. For the period ending in 2013, we processed $101 million in volume and made $487,000. Our volume per merchant was $12,749.64 with a $61 residual. We made 48 basis points. For the same period ending in 2014, we had $104 million in volume. We increased volume but revenue decreased by $16,000. Our volume per MID went up and residual per MID went down, which drives our basis points down. What does this tell us? From a high level, the accounts we added are less profitable than the accounts we lost. What s really interesting in this example is that this program actually grew in terms of MIDs and volume per account but produced less money per dollar and volume. This is really where understanding how to price merchants makes a huge difference. As an example, if the merchants added during the year generated an additional five basis points each, and generally there s always room to increase the rates by five basis points, it could have meant the difference between a year-over-year revenue loss and a year-over-year revenue gain. Understanding trends over time Calculating these monthly variables and then plotting them on a graph gives you a great visual of what s going on within your portfolio. I recommend everybody do this on a monthly basis. Anybody within your organization that has a little bit of Excel experience can generate graphs like these. In this example, volume is basically static: the top blue line is the volume trend. We re running pretty parallel with volume. The merchants we are losing - the merchants we are adding - everybody is running around that same average volume. 5
What we also see is a slight decrease in income as well as a decrease in basis points. Again, everything s pointing towards adding less profitable accounts than the ones that attrite. This might reveal a couple of things to you: First are you pricing merchants the best you can? If not, you need to increase pricing. Second - if you are pricing merchants as high as you can and you re still losing revenue, you have to go elsewhere to grow. You have to either attack higher volume accounts or add a higher number of accounts at the lower profit margin. We really take a consultative approach to selling. When I say that, interchange is our primary component; our primary cost component within this industry. So many merchants process incorrectly, paying too much and wasting money. Simple best-processing practices will many times allow you to decrease your merchant s interchange cost while increasing profit margin. Let s say that, with a previous processor, 30% of a merchant s transactions were key entered. Well, they re not entering the AVS information and they re not batching out on time. What s happening is that volume is moving from a card-not-present bucket down to EIRF (Electronic Interchange Reimbursement Fee), which is about a 50 basis point swing in interchange. On top of that, because they re not entering the AVS information, they re paying a $0.10 Visa transaction integrity fee per offline debit transaction. We would educate the merchant on the best practice ways to process those transactions, make sure their terminals are set up to prompt for the appropriate information and set their terminal up to auto settle within the appropriate time frame. By doing that, we re able to reduce their interchange costs by 50 basis points, leaving intact the margin the merchant enjoyed with the previous provider. We re actually able to board that account for the same margin as the former provider, yet reduce the overall cost to the merchant. Selling on service instead of price Understanding the value that the bank provides is key to this approach. There s not an ISO out there on the street that s going to provide the same level of value and service that you can provide for your merchant. Understanding and selling on that value helps avoid price pressure. If you go into a sales meeting and you focus on price, the issue is going to be price. If you go in and you focus on the service and the value that you can provide, like these interchange items and how to reduce your interchange costs that s a different kind of sales call. As long as pricing is competitive and you re focusing on the value, you will be able to sell at a higher margin. Seeing the big picture If you understand the measurements we ve been discussing, if you plot and track these items, you will have everything you need for forecasting, projecting and budgeting. I know all of our bank partners, at the end of the year, are budgeting for what s going to happen next year. These 6
three variables plus the added attrition data really gives you everything you need to accurately budget and forecast for the future. It can also help you understand how to grow. What if you add merchants at a higher volume? What does it do based off of your basis point trends? What if you add more accounts? It really gives you great insight into which variables you need to focus on, where you can increase revenue and how you can grow your portfolio. What can my bank do to enroll merchants at a better basis point, higher basis point margin? Consultative selling. We talked about reducing interchange for merchants not processing correctly. There are other ways to help. Let s say the merchant is processing large ticket transactions. It s possible they re not set up through a secure gateway that allows them to enter level three data. Maybe it s being able to take that merchant and reduce their interchange cost through special interchange categories. Then again, understanding the value that the bank provides, those two tools allow you to sell higher margin accounts. Can you use revenue per merchant to design incentive programs to keep merchants from leaving? Absolutely, you can. That s what we do here. The first thing I do is pull volume per merchant and revenue per merchant. How much money am I making per merchant? That allows me to estimate merchant value and design an incentive plan to add merchants over the next quarter. Here s what I can expect the value of each of those merchants to be. We generally formulate incentive plans around those dollars. I m making $150 over the course of a quarter. Here s how much I m willing to invest into that relationship to basically purchase that growth. Absolutely, you can use revenue per merchant there. What is the average volume of a community or regional bank merchant? What can we do to sign higher volume/revenue merchants? The average volume we see ranges from around 13,000 up to 18,000. Now, we have merchants that process nothing every month and others that are processing millions of dollars. It s really a good question: what can we do to realize higher volumes, higher margins and more merchants? The answer is the bank s DDA base. Generally, all of our bank partners already have hundreds of high-volume, high-revenue merchants who likely don t even know that the bank offers merchant services. I really think the key is tapping into that treasure chest that you already have. They need to find out who holds those relationships. Is it your cash management team? Your loan officers? Find out who holds those large relationships and coordinate a strategy to win them. 7