Integrated payments: why the future of payments is inside software applications

Software is becoming more pervasive and integral to organizational success. This phenomenon isn't exclusive to the enterprise. From point of sale (POS) to reservation management to bookkeeping, software solutions are permeating the SMB market at an increasing rate. For payments providers, this presents a lucrative and fast-growing new distribution opportunity. By embedding payments services into partners' software applications, payments providers stand to achieve greater scale and customer retention than selling through their traditional ISO and agent reseller networks. In this report, we introduce the integrated payments opportunity and explore the benefits and challenges for both payments and software providers.

The 451 Take

The past several years have seen the intersection of payments and software come to life at scale. Most large processors have completed large integrated payments acquisitions to make inroads into the opportunity and are now working to organically build out developer platforms and API access to further expand their reach into the ISV, VAR and software developer ecosystems. The growing emphasis on integrated strategies underscores a realization that payment processing on its own is a commodity service, but when integrated with software like bookkeeping and POS it can drive new value and efficiencies for customers. This approach helps to increase customer retention, reduce margin pressure and ultimately expand distribution – all of which are top priorities in the c-suite of any payments organization.

The software-driven SMB
SMBs are using a wide range of software to complete business tasks, with many of those applications playing an essential role in supporting day-to-day operations. In fact, according to a survey conducted in 2016 by 451 Research and Verifone, 70% of SMBs use software that they consider 'mission critical' to running their business (see Figure 1 below).

Figure 1: Most SMBs run mission-critical software Source: 451 Research, 2016

It's no stretch to say that software has permeated virtually all aspects of an SMB's operation. As shown in Figure 2 below, mission-critical software runs the gamut from back-office to customer-facing applications, crosses channels and plays a role in practically every phase of the sales cycle. In many respects, software has become the 'oil' of the SMB that keeps operations running smoothly.

Figure 2: SMBs run many different types of mission-critical software Source: 451 Research, 2016

Software providers of all types have shown a growing appetite for aligning with the payments ecosystem in recent years. The momentum is driven by a growing realization among software vendors that integrating payments within their products can:

  • Add an additional revenue stream. Depending on the nature of the agreement and partnership model with the payment processor, software providers earn a referral fee and/or cut of each transaction. For large software providers, this can result in millions of fast-growing net new revenue. Shopify, for instance, launched Shopify Payments in August 2013 and is on track to see the service exceed $200m in revenue this year.
  • Drive greater customer value. Integrating payments can help software providers enhance the value of their own offerings by providing customers with access to better data and eliminating manual reconciliation processes. Under certain arrangements, software providers can also offer their merchants a single contract and relationship that encompasses payment services, eliminating the need for contracting with a third party.
  • Underpin new services. Payments can serve as a platform for software companies to launch new, highly complementary products and services. Specifically, the data gleaned from transactions can be used to build custom anti-fraud tools, CRM solutions or even lending products, as Square has done with Square Capital.

Today, the variety of software companies with integrated payments strategies is expansive and includes non-profit solution providers like Blackbaud, account and billing systems like Sage (Sage Group), POS providers like ShopKeep, marketplaces like Etsy, invoicing specialists like Billtrust, scheduling and reservation management companies like MINDBODY, event management software providers like RunSignUp, property-management systems like YapStone, and e-commerce platforms like Shopify.

The interest in integrated payments is not one-sided. Over the past half-decade, more payments providers have made moves to address the growing role of software within SMB operations. Software approaches like POS, bookkeeping and reservation management have emerged as highly attractive distribution conduits for payments services and as a result, we are seeing more players develop strategies to embrace the ISV, VAR and developer channels. The reasons driving these integrated payments strategies include:

  • Stickiness. By embedding payment acceptance and processing within a software application, payment processors get to ride the coattails of the relationship SMBs have with their software provider, helping to alleviate the churn payment processors have long struggled with in their SMB portfolios.
  • Distribution. Software vendors offer payments providers reach into an existing customer base, lessening the reliance on agents and 'feet on the street' sales teams. This model can also open up payments providers to new customers that may have been unwilling (or unable) to attain a merchant account previously.
  • Price. Payment services that are integrated within software applications like accounting can drive operational efficiencies and time savings for SMBs. This helps to move the conversation away from price and toward value, justifying more robust processing margins.

Tackling the integrated channel
A variety of strategies are being implemented by payments providers to tackle the integrated channel. Inorganic growth has been among the most favored approaches by large payment processors, with more than $10bn in integrated payments-related deal volume occurring in the US alone over the past five years (see Figure 3 below). Among the most attractive targets have been midsized processors and super-ISOs that have built out extensive integration networks with ISVs and VARs over the years. Vantiv's $1.65bn reach for Mercury Payment Systems in 2014, which fetched a multiple of 8.1x TTM revenue, underscores the value being placed on integrated payments specialists. While many of the more prominent players are now off the market, a few strong candidates like Cayan remain.

Some processors have also made acquisitions in adjacent software areas like POS, subsequently integrating their processing services into the target and selling as a bundled offering. This approach can run the risk of channel conflict but if properly executed provides the greatest level of control over the customer relationship. First Data has been among the more successful with this approach, via its 2013 acquisition of table POS provider Clover Network. Heartland Payment Systems, now part of Global Payments, has taken a somewhat similar path through its 2015 acquisitions of restaurant POS solutions pcAmerica and Dinerware.

Figure 3: Integrated payments strategies are driving M&A activity

DateAcquirerTargetDeal value
6/2/2017GTCRSage Payment Solutions$260m
5/29/2017First DataCardConnect$750m
4/6/2016Global PaymentseWay$50m
1/26/2016TSYSTransFirst $2.35bn
12/15/2015Global PaymentsHeartland Payment Systems$4.3bn
9/15/2014Global PaymentsEzidebit$279.8m
5/12/2014VantivMercury Payment Systems$1.65bn
1/24/2014Global PaymentsPayPros$420m
7/25/2013VantivElement Payment Services$162.5m
8/15/2012Global PaymentsAccelerated Payment Technologies$413m

Source: 451 Research's M&A KnowledgeBase

We are slowly beginning to see payment processors do more in the way of organically developing their integrated payments strategies. This is no small task and often requires considerable change from a technology, go-to-market and even cultural standpoint. Two of the more prominent tactics gaining traction include:

  • Developer platforms. Challenged by developer-centric players like Stripe and Braintree, large processors have made moves to improve API access and support via developer portals and platforms. Vantiv, for instance, launched its developer network called Vantiv O.N.E. in Q3 2016 and First Data followed suit in Q4 2016 with the unveiling of its Integrated Solutions Group. Both initiatives are oriented around increasing ease of use and integration for software providers.
  • Payment facilitator programs. The payment facilitator model has taken off in recent years, with many ISVs and VARs actually choosing to own and manage the payment-processing relationship with their merchant customers. In response, players like Vantiv have developed payment facilitator programs, allowing software providers to essentially white-label their underlying processing infrastructure and take ownership of the customer onboarding and relationship. Examples of software players using the payment facilitator model include Shopify, Toast and MINDBODY.

Considering the challenges
For payments and software providers, integrated strategies aren't an automatic solution. There are several challenges with the integrated model than must be considered before a strategy is executed. The more pertinent obstacles include the following:

  • Customer ownership. Integrated payments strategies fall apart when merchants are unclear whom their payment relationship is with. This becomes problematic when merchants have support and billing issues and are unsure whom to contact. Customer ownership can also be a concern for payments providers when it comes to upselling and cross-selling. Payments providers may have little to no access to merchants who have signed up through a software vendor or payment facilitator.
  • New skills and competencies. Payment providers accustomed to selling directly to merchants will find that selling to software vendors is often a more challenging and technical sale that requires a different set of negotiation tactics. Building out API access and developer strategies will also require payments providers to operate more like technology companies and increase their software engineering headcount. For software providers, payments is often not an area of core competency and requires new skillsets in complex areas like risk management, PCI compliance and EMV certification.
  • Scalable partnership models. Among the greatest challenges dogging integrated payments strategies is moving the partnership from paper to activation. A strong commitment to execution is required from both the software provider and payments provider to ensure the partnership results in tangible business benefits for both parties. If one side of the partnership lags, revenues may never meaningfully materialize, or worse, the customer might be subject to support and service issues.

451 Research believes the outlook for integrated payments is highly favorable, supported by strong, tangible business benefits for both payment and software providers as well as merchant end users. We anticipate continued M&A activity over the next several years among large payment processors and merchant acquirers as they look to build out their integrated strategies by purchasing specialists that offer reach into ISVs, VARs and software developers.

We also expect to see a continued evolution among these players from a product standpoint as they work to position themselves as more developer-friendly companies. Looking at the opportunity through a software lens, we anticipate the payment facilitator model to continue to gain traction as players look to diversify revenues and deepen customer relationships. Software providers will seek out payment processors that offer ease of integration and have processes in place to support and expound upon relationships with their software partners.

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