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Transaction trends The Official Publication of the Electronic Transactions Association

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| July 2011

The Ties That

Bind

From traditional to high-tech, quality service compels merchant loyalty

ALSO INSIDE: The Evolution of Merchant Acquisition Facts on IRS Merchant Reporting

on. h every transacti innovation throug

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Transaction trends The Official Publication of the Electronic Transactions Association

Vol. 16 | No. 7

cov e r s tory

12 The Ties That Bind

By Bryan Ochalla Superb customer service is key to retaining professional relationships with merchants and creating a business that lasts. From traditional in-person meetings to online selfservice portals, take some cues here to strengthen your portfolio.

FEATURES 16

16 Merchant

By Julie Ritzer Ross Once upon a time, only individual banks were responsible for issuing and acquiring functions. Now, fierce competition and nontraditional players are pushing the disintermediation envelope.

By John Manasso Velocity Merchant Services, founded by a 19-year-old working in her parents’ basement, has since blossomed into a family-run company processing $200 million in transactions annually.

Acquisition— Then and Now

SPECIAL SERIES

Startup Stories: Cinderella Story

d e partm e n tS

4 6 10

President’s Message Insights from ETA’s elected leader

Industry News

23 Ad Index 24 Industry Insider

Lexcel Solutions’ specialty lies in end-to-end process testing

Trends, strategies, and news in the payments business

ISO Corner

Details on IRS merchant reporting requirements

Transaction trends | July 2011 3

Electronic Transactions Association 1101 16th Street NW, Suite 402 Washington, DC 20036 202/828.2635 www.electran.org

President’s Message

ETA Chief Executive Officer Carla Balakgie

ETA Director, Communications & PR Thomas Goldsmith Transaction Trends Publishing office: Stratton Publishing & Marketing Inc. 5285 Shawnee Road, Suite 510 Alexandria, VA 22312 703/914.9200 Publisher Debra Stratton Editor Josephine Rossi Contributing Editor Angela Hickman Brady Editorial/Production Assistant Teresa Tobat Art Director Janelle Welch Contributing Writers Douglas R. Kelly, John Manasso, Bryan Ochalla, Julie Ritzer Ross Advertising Sales Steve Schwanz or Fox Associates (800/440.0232; adinfo.eta@foxrep.com) Fox Associates Offices Chicago 312/644.3888 Atlanta 800/699.5475 Los Angeles 213/228.1250

New York 212/725.2106 Detroit 248/626.0511 Phoenix 480/538.5021

Editorial Policy: The Electronic Transactions Association, founded in 1990, is a not-for-profit organization representing entities who provide transaction services between merchants and settlement banks and others involved in the electronic transactions industry. Our purpose is to provide leadership in the industry through education, advocacy, and the exchange of information. The magazine acts as a moderator without approving, disapproving, or guaranteeing the validity or accuracy of any data, claim, or opinion appearing under a byline or obtained or quoted from an acknowledged source. The opinions expressed do not necessarily reflect the official view of the Electronic Transactions Association. Also, appearance of advertisements and new product or service information does not constitute an endorsement of products or services featured by the Association. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided and disseminated with the understanding that the publisher is not engaged in rendering legal or other professional services. If legal advice and other expert assistance are required, the services of a competent professional should be sought. Transaction Trends (ISSN 1939-1595) is the official publication, published monthly, of the Electronic Transactions Association, 1101 16th St. N.W., Suite 402, Washington, DC 20036; 800/695-5509 or 202/828-2635; 202/828-2639 fax. Postage paid at Pittsburgh, Pennsylvania, and additional mailing offices. POSTMASTER: Send address changes to the address noted above. Copyright © 2011 The Electronic Transactions Association. All Rights Reserved, including World Rights and Electronic Rights. No part of this publication may be reproduced without permission from the publisher, nor may any part of this publication be reproduced, stored in a retrieval system, or copied by mechanical photocopying, recording, or other means, now or hereafter invented, without permission of the publisher. Nonmembers, government agencies, $150 per year; single copy, $20. Subscriptions are available for 12-month periods only, at the quoted rates.

4 July 2011 | Transaction trends

We Hear You few months ago, the Transaction Trends staff conducted a survey of our readers. The results of the survey told us a lot about you, your opinions of this magazine, and what you would like to see in future issues. Often, those who take part in reader surveys do so either because they like a publication very much or because they’re unhappy. I’m pleased to say your opinions of the magazine were overwhelmingly positive. It’s clear you find Trends to be relevant and delivering useful information. In reviewing the study, I was struck by two things that extend beyond Transaction Trends to ETA itself. First, when compared to a similar survey in 2008, Transaction Trends readers have changed their minds about why they read our magazine. In 2008, the top motivation for reading the magazine was “to learn about best practices and strategies.” In this year’s survey, the most common answer was “to learn what my peers or competitors are doing.” In fact, 2008’s top reason to read Transaction Trends actually fell to fourth place. Numbers two and three were “to keep on top of policy trends” and “to learn about new technology.” In another part of the survey, we asked what topics readers wanted to see covered in future issues.The results were similar. Ninety percent of readers want to read more about new technology, and 80 percent want more coverage of legislation and regulation. Now you can be sure the Transaction Trends editors and writers will take note of these responses in shaping future content. But I also want to point out that ETA is getting much the same message, backed up by other research, such as the annual Voice of the Member survey: Y ou’re in an extremely competitive business, and in particular, knowledge about new technology and the legal and regulatory framework in which you must work is crucial to your success. As an organization that exists mainly to serve its members, ETA considers this feedback in all our activities and plans, and already, the association has taken steps to address your need for timely information on these topics.And there’s more on the way. We put a great deal of emphasis on new technology—especially mobile—at the 2011 Annual Meeting and there will be plenty more of that when we convene for the Strategic Leadership Forum in Chicago later this year.A big part of that will be to make sure that ETA and its members are on the radar of technology companies that, until now, haven’t been part of our business world. And while ETA’s advocacy efforts have grown significantly over the past few years, we’re taking steps to increase our communication to ETA members about those activities, including publication of a quarterly legislative and regulatory report for ETA members (in the MyETA section of our website) and through a newly revamped Voice of Payments website (www.voiceofpayments.org).We’re also going to increase the frequency and depth of government affairs coverage in Transaction Trends in the months ahead. On that last point, keeping you informed is just part of the equation.We’re also encouraging you to put that information, whether about federal or state-level developments, into action, through Voice of Payments or on your own. In the language of politics, it’s called grassroots action. From our perspective, it’s acting in the best interests of your business, your employees, and ultimately, those who depend on the services and products you provide. Sincerely, Rick Pylant Rick Pylant is President of ETA and President & Chairman of COCARD Marketing Group, LLC

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INDuSTRYnews Small Business Owners Experience Staggering Fraud Rates

Although fraud and identity theft declined in 2010, small business owners were clobbered by the cost of fraud— estimated at $8 billion, according to 2011 Small Business Owners (SMBO) Identity Fraud Report: How SMBO Fraud Rates Impact FI Revenues and Retention from Javelin Strategy & Research. Here are some highlights: n The average victim cost of small business owner fraud is reported to be $1.56 billion—more than double the amount of all consumer fraud. n The estimated fraud rate is more than 15 percent higher for small business owners than the general consumer population. n The mean victim costs for small business owners totaled $1,574— more than double that of the consumer cost of $631. n The mean fraud amount for small business owners was $4,851 compared to consumer at $4,607. n Small business owners are twice as likely to suffer from existing noncard fraud as the general consumer population.

Visa Debuts Digital Wallet New payment solutions from Visa include a secure cross-channel digital wallet and a range of customized mobile payments services that address the specific requirements of global geographic markets. The digital wallet will store Visa and non-Visa payments accounts, support NFC payments, and deliver a variety of transaction services to accommodate multiple commerce scenarios—including e-commerce, mobile commerce, micropayments, social networks, and person-toperson payments. Consumers will be able to set preferences for how their wallet will work— designating which account will be accessed based on factors such as merchant type or purchase amount.

Visa is working with financial institutions and mobile-network operators to provide consumers in countries like India and Russia—where card issuance and mobile subscriptions are high, but card usage is low—to link card portfolios with mobile devices to allow easier access to mobile payments. In regions like Africa and the Middle East—where mobile device usage is high and traditional electronic payments are less developed—Visa will work with mobile network operators to give consumers greater access to mobile payment services. Visa expects to launch the digital wallet in the United States and Canada in fall 2011.

Fast Fact In the past two years, 36 percent of PCI DSS-compliant merchants reported data breaches, faring slightly better than noncompliant merchants—with 38 percent of noncompliant businesses reporting breaches. Source: Imperva and The Ponemon Institute 2011 PCI DSS Compliance Trends Study

6 July 2011 | Transaction trends

Who Would Consumers Trust With Mobile Wallet Security? 100%

59% 47% 32% 8% 0%

Facebook

22%

23%

Mobile Phone

Google

12% iTunes

Source: First Data and Market Strategies

Credit Card

PayPal

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Tr a n s a c t i o n P r o c e s s i n g

Risk Mitigation

Business Analytics

ISO Corner

Crossing the T’s

For the new IRS merchant transaction reporting requirements, the devil’s in the details By Douglas R. Kelly

nyone who bought and traded baseball cards as a kid may have a leg up on the new IRS reporting requirements. For some kids, just trading a Nolan Ryan for a Reggie Jackson with a friend was enough; they didn’t care that Jackson was card number 114 or that Ryan was number 332. But if you wanted to build a complete set of that year’s cards, you tended to have a lot of blank spaces next to those numbers in your notebook, at least before the Internet. Blank, that is, until you got your hands on a checklist card, which matched up player names with numbers. Then you could get an idea of the size of the hill you were climbing, and with 600 or 700 cards in a set, it often looked like a mountain. Added to the Internal Revenue Code as part of the Housing Assistance Tax Act of 2008, the merchant transaction reporting requirements also focus on matching names with numbers. In effect since January 1, the new rules require settlement entities such as processors, ISOs, and other merchant acquirers to report to the IRS their merchants’ gross annual charge volume (gross receipts from electronic payment transactions). “The IRS has made it very clear that, for them, gross volume really is gross volume,” says Karen Markey, manager, risk and compliance, for Omaha-based TSYS Merchant Solutions.“You don’t take out returns, you don’t take out chargebacks, you don’t take out rejects. If the merchant says ‘Here’s $1,000 worth of sales,’ then you report $1,000 worth of sales, not necessarily what you deposited to their DBA.” During the comment period in 2009 and early 2010, the IRS received feedback from the payments industry that charge volume minus adjustments such as chargebacks is a more accurate gauge of sales volume.The IRS, however, stuck to its original model requiring gross sales to be reported. Reporting will be done via a new form, the 1099-K, the first of which will report on merchants’ 2011 gross volume, and 10 July 2011 | Transaction trends

which the settlement entity must file with the IRS by Jan. 31, 2012. The entity also will provide each merchant a copy of its 1099-K.

Twisting the Knife Many in the payments industry say the challenge will be not so much in gathering and reporting gross charge data; rather, the hard work will often come in matching a merchant’s taxpayer identification number (TIN) and legal name with those that are on file with the IRS. “With gross volume, that will all be systematic,” says Edgard Lequerique, vice president, merchant acquisitions, at Merchant Data Systems in Miami.“We’ve been doing that for years, collecting that volume data. [But with the TIN and legal name], basically, the first three to four words of a legal name should match exactly what’s on file in the IRS database. Meaning, when the merchant first goes to the IRS to create a

tax ID, there’s a letter, the SS-4, and exactly how it is on the SS-4 is how it should be on our legal documentation.The tax ID has to match, which is the number assigned. It doesn’t have to have the dash after the first two digits, but the nine digits should match the first four words of the legal name. Not the ‘doing business as’ name, but the legal name.” A lot of things can cause a mismatch, says Deana Rich, a consultant and the senior associate and risk management expert at the Omaha-based Strawhecker Group. “The simplest, and most innocent, is [a difference in] the corporate name. For example, my corporate name is Deana Rich Consulting, Inc. with a period. If you don’t enter it exactly like that, let’s say you wrote Deana Rich Inc. instead of Deana Rich Consulting, Inc., and then put my tax ID, that wouldn’t match.” Things can get ugly for a merchant if the TIN and legal name don’t align with IRS

records: A mismatch may trigger backup withholding of 28 percent of payment card transactions, which is a big bite for any size business. But merchants will be given a reasonable period to resolve discrepancies, says Markey. “Once we send the IRS all of the 1099-Ks, etc., they’ll run those up against their database. If there are mismatches, they will send us what’s called a Notice B.We’ll have 30 days to reach out to our merchants with a specific form and specific language that says, in effect, ‘Now we need you to fill out a W-9 because what we reported to the IRS isn’t matching.’ If we haven’t gotten a response after 30 days, then we’re obligated to start the 28 percent backup withholding. Obviously, our interest, as with any ISO, is to get those out of the picture. We don’t want to be in the business of keeping money from our merchants.”

Ensuring a Match There are ways that ISOs can help ensure their merchants’ TINs and legal names

A mismatch [between the TIN and legal name] may trigger backup withholding of 28 percent of payment card transactions. match up with the IRS database.The most important strategy is to communicate, clearly and often.“We’re going to be doing several means of communication,” says Lequerique. Communications include statement messaging, several letters in various sequences, outbound calling, and an email or fax for hard-to-reach merchants. Lack of merchant education is a potential pothole on the road to compliance.

“There needs to be a real effort to help merchants understand what’s happening and why,” says Markey. Partnering with an organization that’s equipped to gather and reconcile this kind of data also can benefit a processor or ISO. “We’re working to sign a contract with a vendor that does tax reporting, including TIN matching,” says Markey. The company will send back results “so we can then make decisions on, for example, do we send a letter with a W-9? Or do we send an email and just tell the merchant, ‘It looks like there’s a discrepancy here, we need some clarification so we can get this fixed for you.’” “A lot of people kind of think this is above their pay grade,” adds Rich, “but in fact, every level that touches that employer identification number should find a way to ensure that it’s correct.” TT Douglas R. Kelly is a contributing writer to Transaction Trends. Reach him at streamlux@yahoo.com.

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Transaction trends | July 2011 11

[ COVER STORY]

The Ties That Bind How ISOs can be better service providers, build more loyalty, and own a bigger share of the merchant By Bryan Ochalla

hile ISOs may dream of a perfect world in which terminals never break down, merchants always understand their statements, and customer service calls are nonexistent, the smart ones know merchant interaction is a must. But the even smarter ones know the ability to effectively assist and educate merchants is key to differentiating themselves from competitors and retaining steady business. Unfortunately, many of today’s ISOs have a less than stellar system of providing that level of customer service.“As an industry, our approach to customer service is pretty archaic. Some industries have become really good at leveraging new technology and new customer-service techniques; others—like ours—have remained somewhat stagnant,” says Henry Helgeson, co-CEO and president of Boston-based ISO Merchant Warehouse.“In fact, I would say our industry hasn’t evolved much in this regard in the last 10 or 12 years.” “I don’t think ISOs could be considered best in class,” agrees Todd Ablowitz, founder and president of Double Diamond Group, a Denver-based payments consultancy.“They’re very much reactive, in my experience.” Rather than focusing on the tried-and-true methods of customer service—responding to questions via phone, Internet, or face-to-face meetings—Ablowitz suggests ISOs concentrate on preventing those questions in the first place. “[Merchants] just want their payments to work,” he says.“They want them to work the first time, they want them to be easy, and they want them to not take strategic energy away from what they really want to do, which is to sell stuff to people.”

12 July 2011 | Transaction trends

KEY NOTES 8

Rather than responding to questions via phone, Internet, or face-to-face meetings, ISOs should concentrate on preventing the questions in the first place.

ISOs that do not regularly talk to their merchants about their problems and needs sacrifice innovation and miss opportunities to provide products and services that further enhance loyalty and strengthen the business relationship.

Traditional approaches to customer service have their place in the modern payments space. Face-to-face meetings make ISOs accessible to merchants and reinforce the message of reliability.

[ COVER STORY] No Need to Call For some ISOs, retaining the processing relationship and merchants’ loyalty beyond the point of sale may be the single best strategy for steady business and a positive bottom line. “I haven’t seen anybody successfully drop in another product that consistently generates as much revenue as the merchant account itself,” says Helgeson.“Other products, like check, gift, and loyalty, all of those things are great, but I don’t know how sticky they make our customers. So we focus on retaining that processing relationship and making sure everything is going right for that customer.” To accomplish this, Merchant Warehouse reps proactively engage with the merchant to ensure processes are working the way the merchant expects them to. Waiting for the merchant to come to them is ineffective, says Helgeson.“When a merchant picks up the phone and calls us, they’ve already got a problem,” he explains. “I wouldn’t say they’re already an unhappy customer, but they wouldn’t call you to tell you,‘Hey, everything’s great!’ So you’ve got to go out there and proactively try to preempt those calls.”

Help Me Help You ISOs also hear a lot about becoming “trusted advisors” to their customers in order to provide better service. That means taking an authoritative stance with merchants by having a strong understanding of their businesses and developing creative solutions to their problems. “If you don’t continue to talk to your merchants and find out what makes them tick, what their problems are, what they need, you’ll miss an awful lot of products and services that you could deliver to them that will help tie them even tighter to your organization,” explains Rick Pylant, ETA president and chairman and president of COCARD Marketing Group in Nashville, Tennessee. “Our salespeople are more or less consultants” to their merchants, he adds. “They know their businesses, and they talk with them about what’s troubling them.” ISOs that are not interested in taking on an advisory role should be prepared to offer merchants the lowest rate possible, Pylant continues.“The problem with that approach, of course, is that the guy next door 14 July 2011 | Transaction trends

The Real Difference

Keeping one step ahead of the competition is a challenge in the ISO community, so Transaction Trends talked to payments consultant Todd Ablowitz, founder and president of Denver-based Double Diamond Group, about how ISOs could truly separate themselves from the pack. TRANSACTION TRENDS: SHOULD ISOs DIFFERENTIATE THEMSELVES WITH CUSTOMER SERVICE OR COMPELLING PRODUCTS? Todd Ablowitz: What I think really differentiates one ISO from another is when they have a compelling product differentiation. What I mean by that is they have something embedded into their services that merchants need and want and that is tied to their service. That is going to be far more compelling [to current and potential clients], I think, than a subjective argument about who offers better customer service because nobody really cares [about customer service] until they don’t get it good enough, and then they get angry. TRANS TRENDS: WHAT QUESTIONS SHOULD ISOS ASK THEMSELVES? Ablowitz: What are you doing with products or services that increase business for your merchants? What are you doing with loyalty, what are you doing with gift cards, what are you doing with Check 21? TRANS TRENDS: WHAT IF ALL OF YOUR COMPETITORS ALREADY ARE DOING THOSE THINGS WELL? Ablowitz: You have to be even more creative. What kind of software is bundled into your solution, or what kinds of partnerships have you created so that when your merchants come to you they are tied closely to your services? Those are the types of things that I think differentiate ISOs from one another. Look at Apple. They make all kinds of mistakes, but they have a product that is so differentiated and so appreciated that their customers give them a lot of leeway [when it comes to those mistakes]. A lot of ISOs would benefit from following in Apple’s footsteps in that regard.

to you can do the exact same thing and take all of your merchants away from you.” Working in reactive mode also stifles innovation. “Don’t just ask your merchants what they want or need, ask them what sorts of problems they have or what’s occupying too much of their time,” says Ablowitz. “ Also [ask],‘what kind of solution should be there that isn’t or what are some of the things that have been bothering you that you wish someone would figure out a way to help you with?’” Offering portals and tools that allow customers to help themselves, however, also has its place in a top-notch customer service strategy, according to Helgeson. “I think so many people are used to selfservice portals on the Internet that a lot of

our customers—I’m not saying all, but a lot of them—would prefer to help themselves online than to talk to a person on a phone.” Merchant Warehouse has a self-service portal in place that allows customers to look at their statements and keep track of statistics such as monthly and annual transaction volumes.“I wouldn’t go so far as to say it includes all of the metrics needed to run a business, but it’s certainly featurerich,” Helgeson says. The company also eases the process for merchants who can’t help themselves by using “screen pops” that allow Merchant Warehouse customerservice representatives to identify the caller without having to ask for a merchant ID number. ISOs that adopt these kinds of self-

service tools “are going to have lower attrition and happier customers” than those who ignore them, Helgeson suggests. “Also, their bottom lines are going to look a lot healthier because these tools are such a highly efficient way of talking to customers.”

Keeping With Tradition Still, traditional approaches to customer service, particularly face-to-face meetings, have their place in the modern payments space. With 92 offices scattered across the country, COCARD is adept at communicating with merchants in-person.“One of the reasons we have that many offices is the personal contact and personal service that can be achieved as a result,” says Pylant.“It really makes a difference in terms of [customer] loyalty and retention, I think. [Such an approach] allows you to maintain that sense of community, that local presence, which is needed if you want to be considered a top-notch service provider.” It also keeps an ISO from falling victim to price wars. If ISOs want to keep their customers from being stolen by the competition, they have to be accessible to mer-

“If you don’t continue to talk to your merchants and find out what makes them tick, you’ll miss an awful lot of products and services that you could deliver to them that will help tie them even tighter to your organization.”

—Rick Pylant, COCARD

chants, Pylant says. “You have to be there in their time of need—whether that means they have a terminal that has to be fixed, or they need you to drop off some supplies.” Build that kind of trusting relationship with your merchants, he adds, and “if they ever take one of those phone calls from your competitors [in which they offer a lower rate, for example], you will get the opportunity to do something about it. If you don’t have that kind of relationship with them, though, they’re

probably going to leave.” Helgeson agrees and cautions ISOs that while self-service portals and other interactive tools are usually enough for many merchants in most situations,“when something breaks, when a high volume comes up and batches won’t balance or close out, they’re going to want to see someone’s face.” TT

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Bryan Ochalla is a contributing writer to Transaction Trends. Reach him at bochalla@yahoo.com.

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1-800-695-5509 Transaction trends | July 2011 15

[ FEATURE]

Merchant Acquisition—

Then and Now

Once the exclusive purview of banks, merchant boarding, as any ISO knows, is now increasingly sophisticated and competitive with a focus on new technological solutions KEY NOTES

By Julie Ritzer Ross

First Data Corp. and Heartland Payment Systems were among the first non-bank acquirers/processors to enter the acquiring space between 1989 and 2004.

Intense competition among merchant acquirers has led to differentiated business strategies aimed at leveraging the trend toward disintermediation.

Today, acquirers are embracing mobile technology to meet demands from merchants whose customers are increasingly demanding to use smartphones and other mobile devices not just to communicate, but to shop.

16 July 2011 | Transaction trends

ll industries see their share of evolution as they mature. The electronic payments space—in particular, the acquiring sector born of the birth of bankcards in the 1960s—is no exception. In fact, if any term describes the change undergone by the acquiring landscape since the advent of bankcard, “radical” is it. Fifty years ago, responsibility for issuing and acquiring functions alike fell squarely on the shoulders of individual banks that serviced cardholders and merchant customers in a common geographic market.The model was a straightforward one; banks that issued credit cards to customers considered the merchant payment acceptance function part of their traditional commercial depository business.

of International CyberTrans of Brentwood, Tennessee. Cook, who served two terms as ETA president in 1994 and 1995, notes that this step helped to cut non-banks a larger piece of the acquiring pie. She also points out that in the late 1990s and early 2000s, “an enormous amount of POS technology was going where banks didn’t expect it and weren’t willing to handle it. For example, in 1990 hardly anyone paid for groceries with credit cards, and most supermarkets did not even accept them.” By 2003, credit card transactions accounted for more than 60 percent of all grocery sales, according to the Food Marketing Institute in Chicago. The early 1990s also saw the first moves among banks to partner, rather than compete, with non-banks to build their acquiring bases. In 1993, Abbey says, the credit card operation of Wells Fargo Bank started shopping around for alternative merchant processing capabilities. The company formed an alliance with CESI Holdings Inc. and Card Establishment Services (CES), the latter’s merchant credit card processor subsidiary. Shortly thereafter, First Data purchased CES, establishing it as a Wells Fargo acquiring partner and kicking off First Data’s program of establishing joint-venture merchant acquiring business with banks.

Differentiated Strategies

In the 1980s, the tide began to turn. Electronic terminals at the point of sale (POS) eliminated the need to physically deposit and collect paper receipts, rendering geography a lot less critical to merchants’ choice of acquiring banks and stepping up competition for merchants’ business. Even more significantly, merchant adoption of POS terminals rendered the merchant acquiring business a high-tech, dataintensive one. Such development spurred many banks that lacked technical expertise or scale to exit the sector and, for the first time, opened doors for non-bank processors to get into the acquiring game. Between 1989 and 2004, about 50 commer-

cial banks left merchant acquiring and a wave of non-bank acquirers/processors entered the space, says Marc Abbey, managing partner with First Annapolis Consulting in Linthicum, Maryland. Atlanta-based First Data Corp. and Heartland Payment Systems in Princeton, New Jersey, rank among nonbanks that broke into the acquiring industry during this time period. Other developments in the late 1980s and early to mid-1990s also paved the way for a shift in the acquiring business, including the creation of ETA.“We hired an executive director and put together a certification program ISOs could use to sell against their competitors,” says Joyce Cook, CEO

More recently, intense competition among merchant acquirers has led to the development of differentiated business strategies aimed at leveraging the trend toward disintermediation and ensuring a strong position for non-bank acquirers going forward. But that brings challenges:Annualized attrition rates, as measured by portfolio charge volume, slipped from around 16 percent in 2005 to 20-23 percent last year in the wake of the economic downturn, says Kurt Strawhecker, co-founder and president of The Strawhecker Group. For some acquirers, like Fifth Third Bank, volume is the name of the game. These players are hanging their hats on the commodity-like nature of the business, especially when vying for large national accounts, and they promote themselves as low-cost providers or deep discounters. Other acquirers, like Heartland Payment Systems, which targets the restaurant sector, have adopted a business model whereTransaction trends | July 2011 17

[ FEATURE] in they target a specific market segment by offering specialized services (including consulting and technology) tailored to the needs of merchants in a specific group or handful of groups.

But There’s More Whereas the majority of acquirers were once reluctant to move beyond the basics in terms of products and services, an increasing need to stave off competition, especially in the wake of the recent recession, has propelled many to board the addon products train. Mobile and near-field communications (NFC) payment hardware solutions—many of which go beyond payment processing to include other capabilities and components (e.g., inventory tracking, social media, and loyalty, to name just a few)—have topped the list of introductions. Acquirers are seeing their Tier 3 and Tier 4 merchants realizing that mobile POS is not “just for the big guys,” and that they can benefit to the same degree as their larger counterparts from utilizing these solutions for line-busting and transacting sales in the aisles, says Strawhecker. Acquirers are also embracing mobile technology to meet demands from merchants whose customers are increasingly demanding to use smartphones and other mobile devices not just to communicate, but to shop. The popularity of mobile POS—and, hence, its incorporation into the acquisitions model—is also being driven by the abundance of “nontraditional” merchants, from flea market stall operators to fishermen selling out of their trunks, who seek alternatives to traditional payment vehicles like cash and checks. Whatever the driver, the spate and scope of mobile payment options being rolled out by acquirers themselves, as well as by vendors, is seemingly endless. In May 2011, First Data revealed it’s offering a service to help mobile payments operators manage customers’ credentials through a partnership with SK C&C USA. Trusted Service Manager is aimed at systems using NFC technology to enable the use of mobile phones as a credit or debit card. The service permits companies involved in mobile payments to perform over-the-air provisioning of customer accounts. “As more consumers go mobile while managing their busy lives, an increasing 18 July 2011 | Transaction trends

We’re nearing a tipping point where connected consumers with access to a range of NFC-enabled devices and mobile wallets will be able to migrate all of the accounts in their leather wallet to their mobile device.” —Dom Morea, First Data

number of smartphones equipped with NFC technology are now being deployed across a range of carriers and handsets,” says Dom Morea, senior vice president and division manager of advanced solutions and innovation at First Data. “We’re nearing a tipping point where connected consumers with access to a range of NFC-enabled devices and mobile wallets will be able to migrate all of the accounts in their leather wallet to their mobile device in order to make payments anytime or exchange value, anywhere.” Even social commerce opportunities are emerging. Zumago, from Lehi, Utah-based ProPay, combines security and mobile components with social commerce capabilities. Consumers can find merchants, contact them for information, and make payments all from the same device.Atlanta-based Elavon also announced several months ago its intention to market and support VeriFone’s PAYware Mobile secure card payment system for iPhone. The solution transforms the iPhone into a mobile payment device with a card encryption sleeve that allows merchants to capture data via card swipe. VeriFone has also launched PAYMEDIA Solutions, a turnkey portfolio of systems, infrastructure, and services ISOs, acquirers, and other resellers can use to equip merchants with a true “intelligent checkout” capability that integrates traditional payment with discounts, rewards, and coupons, explains Paul Rasori, senior vice president, marketing. A monthly subscription-based pricing model eliminates upfront hardware costs and ensures compatibility with new capabilities and services as they become available.

Meanwhile, International POS, a VAR/ ISO headquartered in Teaneck, New Jersey, has launched Handy Register, a mobile POS solution for the SMB market that enables cash and credit/debit card transactions and generates daily sales reports by item. For its part, Hypercom late last year introduced the M5000 payment terminal. Initially supporting GPRS and Bluetooth connectivity, it is geared toward the needs of mobile merchants as well as small- and medium-size hospitality players that want to enable mobile payments in-store. Elsewhere in the mobile sector, Apriva of Scottsdale, Arizona, is now touting “Freedom To Choose,” an initiative to deliver flexible and scalable mobile payment solutions to partners and merchants. As part of the “Freedom To Choose” program, the company is continuing to support an array of mobile payment endpoints, including made-for-purpose terminals and iPhone, Android, Windows Mobile, and BlackBerry smartphone devices. While not all industry players agree about the degree to which mobile payments will further alter the acquiring landscape, they concur that further change is to be expected down the road. “This isn’t a stagnant space,” Strawhecker concludes. “Never has been. Never will be.With changes wrought by legislation, the probable consolidation of smaller players as competition grows tighter, and the like, there are certain to be a lot more twists and turns in the road.” TT Julie Ritzer Ross is a contributing writer to Transaction Trends. Reach her at jritzerross@gmail.com.

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Velocity Merchant Services

Cinderella

Story

Launched by a 19-year-old with $1,000 in her pocket, Velocity Merchant Services is the stuff of dreams By John Manasso

ema Barakat says she’s a very curious person.“I like to find out about businesses and how people got started,” she says. So as a 19-year-old who had done some telemarketing for Sears and had worked for a few other companies, including a credit card processor, while she took classes at a junior college, she decided to give her own company a try. Borrowing $1,000 from her father and working in the basement of her parents’ home, she founded Velocity Merchant Services (VMS). Today, VMS has 70 employees housed in its recently purchased 30,000-square-foot office building in Oak Brook, Illinois. By the end of the calendar year, the company hopes to have 120 employees on its rolls. Its goal is to process 1,000 merchant applications per month—doubling its current number. “I think the first processor that I made a long-term commitment with looked at me and said,‘OK, she’s coming out to New York to get a good deal. Is she serious?’” says Barakat, who is now 35.“Basically, they took a chance on me and I took a chance on them.” “I think I did surprise them,” she continues.“I knew we had a good plan.And it was tough.” VMS’s modest start and rapid growth is the story of both a dynamic and somewhat old-fashioned family business, but one with big dreams. Barakat’s mother Kout does accounting, her brother Hafez is vice president, and her cousin works in human resources. Three years ago, she married the person she hired in 2003 to be CEO, Danoush Khairkhah. “If you work for a family company, you have more invested in it,” says Hafez Barakat, who left a job in the restaurant industry as a general manager in 2005 to join VMS.“If we fail, the whole family 20 July 2011 | Transaction trends

Velocity Merchant Services Oak Brook, IL Founded: 1998 Portfolio size: 6,000 merchant accounts Transaction volume: $200 million annually

fails. If you work for another company, you can move on if it fails. If this fails, your mom has a vested interest, your sister, your brotherin-law. Everyone eats off it. It’s a lot more difficult.”

Building Merchants for Life That family-oriented mentality carries over into how VMS deals with its clients as well its employees. Many of VMS’s merchants are momand-pop merchants and startups. VMS tries to cater to as many of their needs as possible—whether it’s developing websites, printing business cards and letterhead, handling gift cards for merchants like hair salons, and even offering a lending program for merchants.VMS offers a mobile application as well. “We learned throughout the years that merchants are ordinary people and they have needs,” says Khairkhah, who was the company’s 14th employee when Barakat hired him out of the MBA program at the University of Texas—Dallas to provide structure that would complement her expertise in sales. “What we try to do is

meet their demands with a solution. If you look on our site, you’ll notice that we try to accomplish this with our value-added services. We try to differentiate ourselves, create a ‘stickiness factor’ for our company.” Having started out in sales herself, Barakat understands her reps’ trials and tribulations. As a result, she has tried to create a work environment where employees want to stay and remain productive. Her lucrative incentives have kept some reps at the company for seven and eight years and put their salaries “in the six-figure range.” The company also offers a warm, hospitable physical space.“We really did top-of-the-line renovations,” Barakat says.“When you are on the phones all day, and this is your job, work becomes your home away from home.A lot of the vendors or people we do business with, the first thing they say when they come into our office is,‘There’s this energy that you get when you walk into VMS,’ and I think that energy is what really drives this company—the idea of warmth and energy.” VMS offers more than a warm-and-fuzzy environment to help retain its employees. As part of its aggressive growth strategy, the company has recruited at local colleges. Khairkhah says the company’s compensation package is “bar none” better than all of its competitors. Khairkhah says typical VMS reps can earn from $48,000 to $90,000. Growing its number of reps is integral to the company’s strategy because part of its business model is based on generating volume.“Our mentality, or what we believe in, is if we beat anyone’s prices and satisfy that merchant, we got a merchant for a life,” Khairkhah says.“Basically, we think of ourselves like Costco. Our overhead is less... We’re not interested in gaining $60 or $70 a month on that merchant. We’re happy with 25 bucks a month so we go for more volume.”

Embracing Full Disclosure Rather than give away terminals, VMS embraces the leasing model—“a dying sport in our industry,” says Khairkhah. In 2006, 90 percent of the company’s business came from leasing and, while that has diminished, it remains important to the company’s strategy.VMS wants its merchants to save the larger amount of money they would have to put down upfront buying terminals to lease them so the merchants can free up cash for marketing, advertising, to increase inventory, or for other purposes. VMS sales reps are trained to explain to merchants about the hidden fees involved in accepting free terminals. “We’re full disclosure,” Khairkhah says.“We say,‘Lease the terminals at $29. Your statement is $10 and your monthly minimum is $25, and that’s it. Those are our costs. There are no hidden fees.’ Sometimes it’s difficult to relay that message on the phone, overcoming free terminals, but if you do it the right way, it can be done.” Transaction trends | July 2011 21

Startup Stories:

Velocity Merchant Services

Of course, there are always exceptions. If a rep asks Barakat if she can help them close a huge deal by offering free terminals, she’ll do it.“Yeah, of course, I’m going to give them free terminals because they’ve been in business and they process ‘X’ amount of dollars and, hopefully, we make our money back on the residual side. But leasing has definitely been a great part of our business and we always expect to keep that aspect of it.” Another strategy to the company’s growth came in 2006 when it made the decision to stop outsourcing many of its operations. That’s when VMS brought in Hafez Barakat to oversee many of the administrative sides of the business: deployment, risk, underwriting, equipment, customer service, retention, and quality control among them. Hafez Barakat formerly worked at the restaurant chain T.G.I. Friday’s and likens his role at VMS to that of a general manager of a restaurant.“I have my hands in everything,” he says.“At Friday’s, they teach you not only as GM, but what it’s like to be the bar manager, in the kitchen, in the front of the house—they give you all the training in all different aspects of the business. That’s how I wanted to be here, so I know what

WORDSFROMTHEWISE ake each day as a learning experience. “This industry has a lot of trials T and tribulations,” says VMS CEO Danoush Khairkhah.“Find the competitive advantage and relay that message to clients. Don’t leave them [hanging] out to dry. I tell them to invest in their people. If they’re true to their company, reciprocate that feeling back to them by showing appreciation.” Try to do as much in-house as possible.“Don’t outsource too many things because you lose that accountability aspect and that’s why some companies get in trouble,” Khairkhah says.“Our motto here is,‘We deliver what others promise.’” Get good legal advice.VMS founder Dema Barakat has a two-year degree and grew the company starting in her late teens and early 20s.“In the beginning, I wish I had gotten more legal advice,” she says.“I wish I didn’t just make decisions because of trust.”

happens in each part of the deal process all the way to the merchant.” Having built such a large and successful company by such a young age, Dema Barakat is now taking more time to enjoy her life. She works three days a week and often brings her 19-month-old daughter to work. In building the business, she acknowledges she had to give up some things that normal 20-year-olds do, like going out and traveling.

But she’s very proud of her accomplishment. “I am proud of everybody,” she says.“I am proud of where we are at right now. It is a story that, sometimes when I drive to the building and I look at the building, I’m like, ‘Wow, this is an American dream.’” TT John Manasso is a contributing writer to Transaction Trends. Reach him at john_manasso@yahoo.com.

SAVE THE DATES

ETA’s Strategic Leadership Forum October 25-27, 2011 Chicago Palmer House

THE FUTURE OF PAYMENTS, TODAY! 22 July 2011 | Transaction trends

ETA 2010-2011 BOARD OF DIRECTORS OFFICERS PRESIDENT Rick Pylant Chairman & President COCARD Marketing Group LLC PRESIDENT-ELECT Eddie Myers President & COO Payment Processing Inc. TREASURER Roy Banks CEO ACCELERATED Payment Technologies Inc.

Gary Goodrich CEO ProPay Inc.

Mike Passilla President & CEO Elavon

Robert McCullen CEO Trustwave

Jeffrey Sloan President Global Payments Inc.

Diana Mehochko President TSYS Merchant Solutions

EX-OFFICIO Carla Balakgie CEO Electronic Transactions Association

Jeff Rosenblatt President EVO Merchant Services

SECRETARY Tom A. Wimsett Chairman & CEO J&T Ventures

Debra Rossi Executive Vice President Merchant Payment Solutions Wells Fargo Bank

IMMEDIATE PAST-PRESIDENT Holli Targan Partner Jaffe, Raitt, Heuer & Weiss P.C.

Kurt Strawhecker Managing Director The Strawhecker Group ADVISORY COUNCIL Tom Bell CEO Bank of America Merchant Services

DIRECTORS Todd Ablowitz President Double Diamond Group

Jan Estep President & CEO NACHA Sameer Govil Head of Acceptance Solutions Global Aceptance Visa Inc. Steve Carnevale Senior Vice President/Group Head Commerce Development MasterCard Worldwide Ron Shultz Vice President American Express Gerry Wagner Vice President Discover Financial Services

Donald Boeding President—Merchant Services Fifth Third Processing Solutions

Robert Baldwin President & CFO Heartland Payment Systems Inc.

Chuck Harris President NetSpend

Gregory Cohen President Moneris Solutions Kim Fitzsimmons Senior Vice President—First Data Services First Data Corporation

LEGAL COUNSEL Dave Goch Attorney at Law Webster, Chamberlain & Bean

Chris Hylen General Manager & Vice President Intuit

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Transaction trends | July 2011 23

Industry Insider

From Start to Finish Lexcel Solutions helps companies test payment systems from transaction generation all the way to settlement By Bryan Ochalla

or 25 years now, Lexcel Solutions in Scottsdale, Arizona, has focused on providing end-to-end testing applications to the payments community. More specifically, the company has provided financial institutions, third-party processors, and retailers with Windows-based solutions that allow them to test and exercise their payment systems from transaction generation and origination all the way through to clearing and settlement. Lexcel also has provided those tools to payment networks—such as the Star Network—which then deploy Lexcel’s simulators to their clients. Company research shows that Lexcel saves its customers substantial time in testing and stressing their systems, leading to as much as 75 percent in savings in network certification time.

“We can simulate ATM machines and POS terminals, as well as e-commerce and mobile.”

Products for Every Stage

Companies turn to Lexcel for part or all of the process.Those looking for help on the transaction generation and origination end of things are served by the Lexcel TestSystem —Lewis Kubitz ATM and POS products. With those products, “we can simulate ATM machines and POS terminals, as well as e-commerce and mobile,” says Lewis Kubitz, head of business development.“We can simulate the actual devices and terminals themselves, or we can simulate a host, so those devices and terminals can test the functionality and connectivity.” Other financial institutions, third-party processors, and retailers prefer the Lexcel TestSystem Network product, which Kubitz says is for those “who want to send transactions in to a payment network.” Lexcel “can act as a switch or a host, in pretty much any flavor or any format.” Lexcel’s CapSystem product enables companies to conduct “capacity testing, performance testing, and stress testing by stripping down our simulators and allowing our clients to do high volumes of transaction generation into a host,” says Kubitz.“They can look for reporting functions where they can see stress points within their system.” And then there’s Lexcel TestSystem Clearing and Settlement, which simulates the process of clearing and settlement engines and allows payment companies to test the functionality of their systems in those areas. Although some of Lexcel’s clients start by using just one

24 July 2011 | Transaction trends

of the company’s simulators, quite a few use more than one. All of the Lexcel TestSystem products “latch together,” Kubitz says.“They can sit on any side of a transaction.”

Out-of-the-Box Solution As to how all of this works in practice, Kubitz shares an imaginary example involving a chain of fast-food restaurants. “They might have 50,000 terminals they’re able to swipe cards on,” he says. In such a case,“we could simulate those POS terminals coming into their system while also simulating, on the back end, all the different payment networks they hook up to.” A similar situation may involve a bank or other financial institution.“They might have 50,000 ATMs and we’d simulate those coming in and then the payment networks on the other side, too.” In both scenarios, Lexcel’s clients would benefit from not having to do what they would otherwise have to do to test their systems—which typically involves having someone walk up to an actual machine, like an ATM or POS terminal, and test it manually by punching buttons. “All of this lives within the lab,” Kubitz says. “It’s all virtual.” Lexcel’s customers are “constantly updating and changing code because of industry mandates or regulations, or because they’re bringing new terminals or new merchants onto their platform.To do all of that, they have to update their systems and then test them out.They [use our products] to send in transactions to virtually exercise the functionality or to see if the new volume will affect their software.” Kubitz says Lexcel has an advantage over competitors: “Let’s say someone wants a Visa simulator.When they send transactions to Visa [using our simulator], it processes and sends back responses just like Visa would. They don’t have to build in responses; they don’t have to say, ‘ If I send Transaction A, I’m going to get Transaction B back.’ Right out of the box, it processes and sends back responses just like Visa would. “All of our competitors have to build in those responses so a lot more manual labor is needed at the beginning to set up the simulators,” he explains.“Also, in such a scenario you lose some of the outliers that, unfortunately, can take down systems. So I would say our products are more robust and have more depth.” TT Bryan Ochalla is a contributing writer to Transaction Trends. Reach him at bochalla@yahoo.com.

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