Once upon a time, a merchant was a merchant was a merchant. The putative strategy in merchant acquiring was simple: board as many accounts as possible – big merchants, small merchants, low risk merchants, high risk merchants, and even new LLCs – basically any merchant with a checking account and an “open for business” sign. The rationale for this was straightforward: payments processing – transaction processing – produced real, actualizable revenue that made merchant acquiring a lucrative endeavor.


Fast forward to the year 2017, and much has changed, not the least of which is margin compression on basic transactional processing. In fact I submit that the “merchant is a merchant is a merchant” strategy is no longer viable. The fact that so many leading acquirers today have transitioned their revenue models away from a dependency on transactional processing, and towards the delivery of technology based, value added products and services, is a defining attribute of today’s new merchant acquiring paradigm, and one that will surely be a lasting one.


Beyond the evolution of the product offering, a second, and perhaps even more consequential change in the merchant acquiring paradigm comes by way of the increased sophistication of merchant acquirers themselves. Today’s owner / operators are just as likely to have a background in finance as they are in sales. As such, the industry is bearing witness to a surge in operational expertise and business acumen among its leading management teams. Furthermore, this surge in operational competencies has precipitated the implementation of new standards for best practices in building quality portfolio assets. In particular, one of these new best practices caught my eye not too long ago during an auction, and I feel there’s tremendous value in bringing it to the forefront of the collective consciousness of the merchant acquiring industry: portfolio rationalization.


If you haven’t heard the term “portfolio rationalization” in your discussions with merchant acquiring owner / operators, you will. Though the concept isn’t new, the terminology is, and its relevance continues to gain import in the industry as its usage becomes more ubiquitous. As a stickler for proper attribution, my first exposure to this term came by way of a sophisticated operator in the space, former investment banker John Wu, Managing Partner at ANARAQ Holdings, LLC. While working with John on an M&A transaction, I found myself having to explain the concept of portfolio rationalization to many of the prospective buyers.


Though the concept of portfolio rationalization isn’t new, its increasing adoption as an effective way of increasing a firm’s profitability is.


The basic premise behind portfolio rationalization is performing a cost benefit analysis on the new merchants a merchant acquirer boards, as well as those MIDs that already exist within an acquirer’s portfolio. The objective of the owner / operator is the identification of low to no-revenue (or even negative revenue) accounts: accounts that may require costly, high-touch customer service from the acquirer and / or set-up and equipment costs commensurate with those required for high revenue, highly profitable accounts. The portfolio rationalization process essentially purges these costly accounts from an acquirer’s existing book, and establishes minimum processing thresholds for new boards so that the resultant portfolio is primarily comprised of quality, high revenue, and high margin accounts.


Preston Todd Advisor’s data analytics show that over the past 30 months, net static pool attrition runs on merchant portfolios consistently produce outputs for account / MID attrition which are 10% – 20% higher than the outputs for net processing volume attrition on the same merchant portfolios.


The takeaway from this data point is that for a majority of merchant acquirers, there has occurred a natural sloughing off of low to no-margin accounts from their portfolios. I would argue that much of those losses have been to the likes of Square, whose payfac (payment facilitator) model is better suited to accommodate low revenue merchants. Accordingly, it stands to reason that by implementing a portfolio rationalization initiative, whereby a merchant acquirer proactively removes these types of merchants from its book of business and creates guidance that will prevent it from boarding new ones in the future, the merchant acquirer has much to gain by way of profitability.


One caveat…


Now, it ought to be noted that one drawback, albeit a temporary one, to implementing a portfolio rationalization process is when an acquirer is preparing its book of business for sale. A necessary consequence of purging accounts from an existing merchant portfolio is that the process artificially increases the rate of attrition on the book – a primary driver of merchant portfolio valuation. So it behooves all merchant acquirers to be mindful of their future objectives regarding an exit or financing event, and the timelines thereof. If an acquirer intends to go to market in the offing, the acquirer would be well served by documenting the merchant accounts that were intentionally purged so that this information can be verified by prospective buyers. This in turn would allow buyers to adjust or “normalize” the portfolio’s attrition numbers. The other option, particularly if an acquirer is working on a longer time frame for an exit or financing event, would be to effectuate the portfolio rationalization process at least 18 months before going to market, which would allow for normalized year-over-year comps when running attrition analyses, and flush out the purged accounts long before they would artificially, negatively affect the attrition numbers, and ultimately the merchant portfolio valuation.


Article originally published in The Greensheet on August 28th, 2017


Adam T. Hark is Managing Director of Preston Todd Advisors. With over a decade of consulting in the payments and financial technology sectors, Adam advises clients on M&A, growth strategy, exits, and business and portfolio valuations. Adam T. Hark can be reached at adam.hark@prestontoddadvisors.com or 617-340-8779.