Cards & Payments the way we see itChallenges & Opportunities forMerchant AcquirersIn the rapidly changing global payments landscape, merchant acquirers face increasingchallenges which bring new opportunities

Table of Contents1. Highlights32. The Basics of Merchant Acquiring42.1. Key Participants52.2. Key Functions53. A Look at the Global Acquiring Industry73.1. U.S. Acquiring Industry Structure84. Key Trends104.1. Increasing Regulatory Scrutiny on Debit Interchange104.2. Dilemma of Having Independent Sales Agents versus In-house Sales Force104.3. Lack of Awareness About PCI-DSS Among Small Merchants104.4. Rising Need of Training and Educating Sales Agents114.5. Expanding Usage of Mobile Payments Solutions114.6. Compelling Need for Providing Differentiated Service115. Key Challenges125.1. Debit Interchange Fee Regulation125.2. Challenge to Make Small Merchants PCI-DSS Compliant135.3. Competitive Threat from Non-Traditional Players145.4. Increasing Card Fraud in ‘Card-Not-Present’ Situations155.5. Merchant Attrition176. Areas of Focus186.1. New Pricing Strategies186.2. Technological Investment Areas206.3. Multichannel Acquiring217. The Way Forward238. Conclusion25References26The information contained in this document is proprietary. 2012 Capgemini. All rights reserved.Rightshore is a trademark belonging to Capgemini.

the way we see it1. HighlightsMerchant acquiring is an integral part of card payment transactions processing.Acquirers enable merchants to accept card payments by acting as a link betweenmerchants, issuers, and payment networks—providing authorization, clearing andsettlement, dispute management, and information services to merchants. Themerchant acquiring industry is dominated by a few large players across the globe,with the top ten acquirers in the world handling nearly 50%1 of the global cardstransaction volume in 2010.This paper identifies key challenges faced by merchant acquirers in a rapidlychanging payments landscape. These challenges are making it more difficult formerchant acquirers to sustain and grow their business. The paper also exploresthe drivers behind these challenges and proposes probable solutions which can beused to address the key challenges. Finally, we analyze these solutions to map theeffectiveness of each one.1The estimate is based on data from Top 150 Acquirers Worldwide, Nilson Report, October 20113

2. The Basics of Merchant AcquiringMerchant acquirers enable merchants to process credit and debit card paymentsand help in increasing sales by accepting the most popular cards to attractcustomers to their businesses. Typically, a card payment transaction involves twosides: the first between the cardholder and the bank that issued their card; and thesecond between the merchant and the acquiring bank. This paper focuses on thesecond: the merchant acquiring side of the industry. Cardholders only deal withmerchants and the issuing bank while performing card transactions; they are notconcerned with the merchant acquiring side of the industry. However, this secondacquiring side of the industry contains a network of highly advanced intermediarieswho handle card transactions via authorization, clearing and settlement, anddispute management.The acquiring industryconstitutes a networkof highly advancedintermediaries thathelp to complete cardpayment transactions.The role of key intermediaries in a typical card payment transaction isillustrated below.Exhibit 1: Steps in Typical Card Payment Transaction Flow1287Merchant StoreE.g. BestBuyBuyer10ProcessorE.g. FirstData9MerchantBank / AcquirerE.g. Citi65Issuing Bank / IssuerE.g. Bank of America43Card Association1Cardholder uses a card as a payment mode2Merchant sends transaction information to the Acquirer by swiping ormanually feeding card information3The acquirer or third party processor on acquirer’s behalf sends thetransaction information to the card association4The card association sends the transaction information to the Issuerfor authorization5Issuing bank pays the card association network once it validates thetransaction (after deducting its charge)6Card association pays the acquirer or processors on acquirer’sbehalf (after deducting its charge)7Merchants account is credited for the transaction amount by theprocessor (after deducting its charge)8Purchase transaction is completed9Issuer bills the Buyer for the transaction.10 Buyer settles the billSource: Capgemini Analysis, 2012; Global Trends in the Payment Card Industry: Acquirers, Capgemini, 20114Challenges & Opportunities for Merchant Acquirers

the way we see it2.1. Key ParticipantsThe merchant acquiringbusiness dynamics aredependent on smoothlinkages of all industryparticipants—merchants,acquiring and issuerbanks, independentsales organizations(ISOs), third-partyprocessors, and paymentcard associations.The acquiring side of the industry typically involves interaction among variousstakeholders including merchants, acquirers, processors, independent salesorganization (ISO), and payment networks. Each of the stakeholders has an incentiveto play its specific role in completing the payment transaction: Merchant: A merchant accepts payment from the cardholder by swiping theuser’s card at its terminal, increasing the chance of a sale by accepting popularcards used by cardholders. For example, retailers such as Walmart who acceptthese cards have higher chances of sale compared to local retailers without cardprocessing capability Acquiring Bank: The acquiring bank provides payment processing servicesto the merchant, enabling him to accept payments from cardholders. The banklevies a merchant service charge (MSC) on every transaction at the merchant’spoint of sale (POS) terminal to generate revenue. The MSC is usually 2% of thetransaction amount and contains an interchange fee, the fee paid to card networkassociations such as Visa and MasterCard, and the acquirer fee Independent Sales Organizations (ISOs): The ISOs solicit merchant accountson behalf of acquirers and charge a service-based fee from the acquirers. ISOsalso manage risky merchant accounts with a higher possibility of credit fraud, forwhich they charge a higher fee. Examples include: Cornerstone Credit ServicesLLC, and Bankcard Systems of Newport Third-Party Processors: Third-party processors provide transaction processingservices to acquirers as they possess economies of scale and advancedtechnological systems for cost effective processing. Processors charge a servicebased or fixed fee from acquiring banks based on the type of pricing contract.Examples of third-party processors include: Global Payments Inc. and First Data Payment Card Network Provider (Card Association): Card associations,such as Visa and MasterCard, act as the link between the issuer bank and theacquiring bank. The payment card network validates the availability of credit orfunds with the issuing bank and communicates the same to the acquiring bank.The payment card network provider charges a fee for each transaction processedthrough its branded card by the card issuer/acquiring bank2.2. Key FunctionsMerchant acquirers help in completing the card payment transaction cycle byensuring the flow of funds to respective parties. To ensure this flow of funds,acquirers perform four key functions.Merchant Sign-UpThe first function of acquirers is to sign-up merchants to accept card-basedpayments. Some acquirers outsource this function to ISOs and pay them a fee.After signing up the merchant, the acquirers underwrite the merchants to ensuretheir financial stability, which is important in checking the credit-worthiness of themerchant. Acquirers at times also provide point-of-sale equipment and other servicesto the merchants if specified in the merchant agreement.5

Transaction AuthorizationAcquirers help incompleting thepayment transactioncycle by ensuringthe flow of funds torespective partiesthrough authorizationof transactions andclearing & settlement.Authorizing transactions is a critical function of acquirers as it ensures that thepayment is guaranteed and that there will be no dispute in the future settlement.Operationally, when the card is swiped at the merchant’s POS terminal, the acquirerreceives an authorization request from the terminal. This request contains transactiondetails such as the cardholder’s information and amount of the transaction.The request is forwarded to the card association/network, for example Visa /MasterCard, which in turn validates the availability of funds with the issuing bank. Theissuing bank sets aside the funds from the cardholder’s account for the transactionand sends an authorization code to the network. The network forwards the code toacquirer and then to the merchant’s POS terminal.At this point, the funds are not yet transferred to the merchant’s account but theissuing bank agrees for a future settlement with the acquiring bank and, in turn,the merchant. After the authorization is complete, the merchant records the salestransaction information and sends it to the acquirer for processing at the end ofthe day.Clearing and SettlementThe merchant acquirer transmits the sales transaction data received from themerchant to the respective card-issuing bank via the payment card network. Theissuing bank charges the cardholder’s account and sends the funds to the acquirerthrough the payment network, subtracting its fee. The acquirer then credits themerchant’s account, after deducting the fees paid to the issuer and the paymentnetwork, and the fee for its own services.Dispute Management and Information ServicesAcquirers provide dispute management services including charge-backs, refunds,and claims to the merchants. Further, as a value-added service to the merchants,acquirers compile and report the merchant’s transaction data. The acquirers alsooffer analytical services to merchants to help them to manage and improve their cardprocessing functions and decrease costs.6Challenges & Opportunities for Merchant Acquirers

the way we see it3. A Look at the Global Acquiring IndustryThe global acquiring industry is dominated by a few large players, who have growninorganically through mergers and acquisitions. In 2010, the top 10 acquirers handlednearly 50%2 of the global transaction volume due to the consolidation in the industryin past ten years.The acquiring industry haswitnessed consolidationEven the top acquirers in the world have revenue sharing alliances and joint venturessince 2001, resulting in the among them. For example, First Data owns 51% in Bank of America MerchantServices (BAMS); has a revenue sharing alliance with Sovereign/Santander, Citi, anddominance of a few largeSunTrust Merchant Services, and also owns 40% equity in Wells Fargo Merchantplayers in the industry. For Services and PNC Merchant Services. The consolidation has enabled these largeacquirers to leverage economies of scale and provide more cost effective solutionsexample in 2010, the topto customers.ten acquirers in the worldhandled nearly 50% of the Exhibit 2: Top Acquirers Worldwide by Transactioncards transaction volume. Volume (million), 2010Bank of America BAMS (U.S.)9,2615,885First Data (U.S.)Chase PaymentechSolutions (U.S.)5,490Citi MerchantServices (U.S.)5,2054,600WorldPay (U.K.)Fifth Third ProcessingSolutions (U.S.)4,2384,063Cielo (Brazil)2,717Barclays (U.K.)Credit Mutuel (France)2,350Redecard (Brazil)2,32002,0004,0006,0008,00010,000Note: The data is based on only Visa and MasterCard payment transactions volume and the data doesnot take into account any partnerships, alliance or joint ventureSource: Capgemini Analysis, 2012; Top 150 Acquirers Worldwide, Nilson Report, October 2011Consolidation has resultedin acquirers having multipleinflexible IT systems whichhinder innovation.On the other hand, consolidation in the industry has also resulted in many acquirershaving multiple legacy technology systems which are built on mainframes in a layeredmanner over many years based on changing business requirements. These systemsoperate in silos and the applications running on these systems are not integrated. Asa result, the duplication and inefficiency of these unintegrated applications hindersinnovation and results in increased maintenance cost.2The estimate is based on data from Top 150 Acquirers Worldwide, Nilson Report, October 20117

3.1. U.S. Acquiring Industry StructureThe global trend ofdominance of largeplayers in the industry isalso reflected in the U.S.,as the top ten acquirersin the market handled73% of the cardstransaction volume.As shown in the previous section, the largest acquirers in the world areheadquartered in the U.S. It is therefore important to analyze the industry structurein the U.S. to understand the global acquiring industry. The U.S. acquiring industryis also dominated by a few large players, with these players showing strong growthin 2011. For example in 2011, Chase Paymentech Solutions registered a growth of21% in number of transactions handled, followed by Wells Fargo with 16% increase.Six of the top 10 acquirers in the U.S. registered double digit growth in the volume oftransactions handled in 2011 over 20103.Exhibit 3: Top U.S. Acquirers by Transaction Volume(billion), 2010–2011Growth2010-119,577Bank of America BAMS9,2616,632Chase PaymentechSolutions21%5,4906,120First Data4%5,8855,828Citi obal Payments13%1,7631,988Elavon5%1,8901,981Heartland ls FargoMerchant 010Note: The data is based on only Visa and MasterCard payment transactions volume and the data doesnot take into account any partnerships, alliance or joint venturesSource: Capgemini Analysis, 2012; Nilson Report, March 201238Nilson Report, March 2012Challenges & Opportunities for Merchant Acquirers

the way we see itAs merchant servicesare highly commoditized,price is the mostimportant competitiveelement while acquiri