Article by John Jakobe
The proliferation of cloud-based software and technology has led to the digitization of our global economy, making software central to the progress and advancements of today’s enterprises. This trend is expected not only to continue but to grow rapidly over the next few years as continued advancements in cloud-based technology allows for greater accessibility, scalability, and consolidation of siloed systems. The growth of cloud-based deployment means that new entrants do not have to invest in server infrastructure, lowering the barriers to entry, and resulting in many more solutions in the market. According to Cisco’s Global Cloud Index, over 75% of U.S. companies will be running almost entirely on SaaS by 2021. More and more, software is becoming the central mode of operation for most companies, but where does this fit within the U.S. payments market? Well, payment companies of the future will be software/tech companies that evolve alongside consumer habits, behaviors, and preferences. The amalgamation of these distinct industries will eventually pave the way for a world of unified or connected commerce.
As more and more companies today run entirely on software-based solutions, it is only logical that payment processing and other integrated functionality are brought into the fold. Business owners today are seeking integrated software solutions that bring together ancillary functions of business management all within a centralized hub. It is this trend that has become the genesis behind the merging of software and payments. This has created opportunities for payments companies to buy, develop, and partner with software solutions in order to provide the cohesive solutions that business owners require, and vice versa as some software companies look to become meaningful players within the payment’s ecosystem. As this trend progressed over the past few years, software companies or ISVs (Integrated Software Vendors, as they are known in the payments industry), began to work closely within the payments industry, taking on sales responsibility, managing support functions for payments, but most importantly monetizing the payment volume they enable through their platforms.
At an increasing rate, ISVs are transforming their payment volume into meaningful revenue figures, resulting in higher profitability and higher valuations. Though getting into payment processing and the monetization of payment volume is not as simple as it sounds. Contrary to what many “experts” preach, there are many ways to monetize payments. It is essential for management at ISVs to understand their options in assessing which payment monetization model works best for their business. In the market today, there is a plethora of misinformation being spread about payments monetization, with “experts” claiming one model is vastly superior to the others, but this is simply not the case. At a high level, this article will seek to highlight the differing models along with abbreviated commentary on each model and the benefits and hurdles an ISV’s management team may face when undertaking such an initiative.
The prime example of misinformation in the market generally surrounds the term “payment facilitator”. Any company, advisor, or sales individual selling a singular model of monetization, generally payment facilitation, should be highly scrutinized. Payment facilitation is one of multiple levels of payment monetization, and may be highly profitable in certain scenarios, but suggesting that any single monetization model is suitable for every ISV is simply irresponsible and wrong. Traditionally, ISVs have accomplished payment monetization through four generalized models (Referral Model, Retail ISO, Payment Facilitator, and Wholesale ISO). Each model varies in complexity and typically takes a stance on risk versus reward. As ISVs take on more risk and operational control, they command higher revenue splits with the processor/acquirer, thus increasing fiscal upside. In most instances, acquirers/processors pay ISVs residual payments or revenue splits variably tied to the net revenue earned by processors from the payment volume generated by the ISV’s client/user. The vast majority of ISVs receive some form of economic commission split as a form of compensation from its payment processing partners. The varying levels of risk and operational support and resources an ISV is willing to dedicate to such a partnership generally dictates the split an ISV will receive.
To help illustrate the following, TSG has prepared a shareable infographic covering the four models of monetization and how they vary in complexity and level of risk vs reward. Click here to download.
Referral Model – The referral model is perhaps the most commonly executed model as it is the simplest to implement, but it is also the least lucrative. Under this model, an ISV will partner with an established merchant acquirer. Then, when a client of the software company wishes to accept payments through the platform, the ISV then refers them to the selected payment partner(s). If the referral is completed successfully, the ISV may receive a small flat success fee for referring business to their designated acquiring partner or a small percentage of the recurring revenue. Under this model there are very few regulatory requirements, liabilities, and close to no resource requirements on the side of the ISV. In some arrangements, the payment partner will have a designated representative or sales team dedicated to managing the referrals from the ISV.
Retail ISO – For ISVs looking for a bit more control of their client’s experience, becoming a registered retail ISO is a more attractive option, from a financial perspective. Similar to the previous model, the ISV will need to establish a relationship with an established merchant acquirer and sponsor bank. Under this model, the ISV may support some operational aspects of managing the merchant/client relationship, such as customer service, sales, boarding, and more. In taking on these additional responsibilities, the merchant acquiring partner will typically share a percentage of the processing revenue generated from volume flowing through the ISV’s platform. This model has drastically higher upside from the referral model, but also comes with increased responsibilities, resources, and infrastructure required.
Payment Facilitator – As expected, the payment facilitation model takes on a more complexity than the previous two options. This model requires ISVs to establish an operational posture reviewed and approved by their sponsor bank, processing partner, and technology partner(s) to facilitate the transaction processing service. It also requires registration with governing entities, substantial operational/technological resources, along with payment processing competency. Software players looking to become payment facilitators typically assume full financial liability, comply to higher PCI security standards, and assume responsibility for sales, support, risk management, credit risk, and full management of the payment processing services offered through their business. Full financial liability means that a payment facilitator will take on all credit losses, fraud losses, and responsibility for daily funding of sub-merchants. With these increased responsibilities, the ISV is able to earn a larger percentage of the payment revenue for the volume they are facilitating and maintain greater control of the customer experience. This model also requires in-depth understanding of the payment’s ecosystem and chain of risk. ISVs attempting to successfully implement this model should be prepared to make substantial investments into technology and talent to support such a significant undertaking.
Wholesale ISO – The wholesale ISO model is very similar to the payment facilitator model, with a few distinct differences. Like the previous model, it requires the establishment of an operational payments business, a sponsor bank and high-volume processor, registration with the card brands, and a hefty support structure to sustain such an operation. This model requires a substantial amount of resources, as it brings full fiscal liability, compliance with data security standards, and full support of sales, underwriting, fraud, and more. This model allows the ISV to have complete control of the merchant experience. While this model does come with a financial barrier due to the amount of resources it takes to support, it is among the most lucrative models in terms of the percentage of payment volume the software company is able to monetize.
As you may have surmised, implementing a payments monetization model is a decision that should be carefully planned and evaluated. ISVs must first determine their risk tolerance and the amount of resources they are willing to dedicate to such a pivotal undertaking before ever considering a single model. Within each partnership or model the ISV and the payment provider must jointly decide who is going to manage the various aspects of the payments strategy such as sales, risk/underwriting, onboarding, technology/delivery, support, and development.
At the end of the day, there is no one model fits all in payments monetization, in fact, many ISVs may maintain more than one model at the same time. The point is that each ISV and each scenario are different. ISVs have different customer demographics, which drive risk and pricing flexibility, and each ISV must look internally to evaluate their risk appetite and PCI exposure. Advertisers push ISVs to prescribed solutions that generate revenue for them without weighing the available options that may account for an ISV’s capabilities, market, or operational readiness. ISVs need to understand their options by exploring the models described above and seeking impartial advisors who can assist and guide them throughout the process.
Related: Case Study – The ISV Mindset
The Strawhecker Group Can Help
The payment experts at TSG have guided hundreds of software companies during this planning period. Our firm specializes in assisting organizations throughout the supplier selection process, RPF process, and complete implementation of the desired model. Learn more.
Leveraging proprietary data tools and benchmark analysis, the experts at TSG will assure that your software firm is maximizing their payment volume regardless of the model. There are several choices ISVs have when monetizing payments, as each model is nuanced and comes with its own set of benefits and hurdles, having an expert to assist your organization throughout the decision-making process is essential for a successful implementation.
Get started today by emailing Info@TheStrawGroup.com.