Chris Uriarte and Justin Pituch put their heads together to sift through the August news in search of a broader storyline. Looking back at headlines surrounding merchant surcharging, fee backlash, and Adyen’s lackluster H1 performance, we noted an underlying theme of broad downward pressure on the cost of merchant processing. Companies like Toast and Adyen have enjoyed considerable success in the past by offering premium products and premium prices, but it seems that their model is challenged by an uncertain economic environment and a focus on efficiency across the business community.

The question then is whether we think that these downward pressures will lead to the commoditization of merchant processing. This is important; Adyen, Stripe, and other “modern” merchant processors have succeeded by convincing merchant customers (and investors) that merchant processing is not commoditized. Our belief is that acquirers still have room to compete on factors beyond price, but they will have to adapt to a challenging landscape in order to do so. Let’s get into it.

We observe downward pressure on card acceptance across merchants of all sizes. This is particularly visible at the low end of the market in card present environments. We’ve anecdotally observed greater use of surcharging and cash discounting at places like coffee shops and restaurants. We’ve also seen attempts at this in the ecommerce domain – Toast’s 99 cent convenience fee is an example. This behavior is attracting attention from consumers, card networks, and lawmakers:

• Consumers: Consumer willingness to pay surcharges and convenience fees is not well understood but we may start to see more consumer push back. Toast in particular was criticized for its plan to roll out a 99 cent fee on top of $10 or more transactions earlier this summer. The backlash was enough for Toast to reverse course on the fee, which was meant to fund improvements to Toast’s software.
• Card Networks: Visa’s CEO has responded to visible increases in surcharging in the U.S., noting the network is working to “make sure that when consumers do get surcharged, it’s something that’s fair and equitable”, related to the new ‘3% or cost of processing’ surcharge cap on credit cards (Note: our understanding is that the decrease in cap likely reduces the arbitrage margin an Acquirer or ISO could earn on a surcharge program).
• Lawmakers: In August, New Jersey enacted a law that “prohibits sellers from charging more than what they pay to process credit card transactions” and “requires sellers to disclose and post notices of the surcharge prior to the consumer incurring the charge.” Other states have enacted similar laws and/or laws that set a statewide surcharge cap, often lower than the network cap.

These efforts reflect how widespread the practice is today, the increasing perceived magnitude of fees, and the poor consumer experience produced by surcharging tactics that customers may not even be aware of. In any case, your local cafe owner probably believes that they’re paying too much to take your credit card and may not understand what they pay for debit.

Beyond this, we also noted fee backlash directed towards card networks. In August, network fee hikes were met with merchant outrage and criticism from Senators Dick Durbin (D-IL) and Roger Marshall (R-KS), the duo behind the proposed Credit Card Competition Act of 2022. The proposed fee increases are minor in scope, particularly compared to the scale implied by media coverage, and did not include increases to interchange. Mastercard issued a press release criticizing the Wall Street Journal’s reporting as patently “wrong” and clarifying the scope of changes. Still, merchants are clearly not keen to pay anything more for processing than what they do today.

We can see some more evidence for this in Adyen’s disappointing H1 results, which indicated stalling North American growth. Up until now, we’ve been making what admittedly might be a fairly obvious point: that merchants don’t like paying very much for card processing. The Adyen story indicates something a bit more nuanced: that merchants are less willing to pay a premium for technology than they have been in the past. Put another way, you could think of this as economic headwinds eroding the value proposition of modern acquirers. So does that mean that merchant processing is becoming (or has already become) commoditized? Our early view is no. The player that will perhaps benefit the most from Adyen’s challenges is PayPal; their Braintree product offers many compelling features beyond core merchant processing. So there is still room for modern players to survive and grow, but they will have to do so on likely tighter margins and likely with a bit more creativity. Our big question now is how PayPal will use its new stablecoin to more effectively serve its Braintree merchant customers. But that’s probably a story for another month.

We look forward to bringing you a fresh set of news items and insights in October. Until then, enjoy the last days of summer and reach out if you’d like to chat payments.