SMB Merchant Services Disruptors

Introduction

US SMBs represent 99.9% of businesses with employees. This category sees approximately $16.501 trillion in sales annually, according to Insider Intelligence estimates based on the most recent US Census Bureau data.

This landscape is evolving at a breakneck pace, thanks to the combination of two factors:

• New SMBs. About 3 in 5 SMBs announced plans to digitize operations in 2020, according to a June 2020 survey conducted by Wakefield Research on behalf of Visa. And that growth hasn’t slowed, especially among micromerchants, which comprise the majority of US SMBs when including nonemployer businesses, per Insider Intelligence estimates based on US Census Bureau data. FIS estimates the US SMB total addressable market is growing between 7% and 9% annually, giving merchants an opportunity to expand their reach with new solutions.

• Increasing technology investment. SMBs are investing in new products, channels, and payment methods, per a December 2021 Visa survey conducted by Wakefield Research. This is creating a massive opportunity: SMBs will spend over $100 billion on payment services by 2025, according to McKinsey & Company.

Banks, merchant acquirers, and fintechs have reason to rapidly invest in bringing SMBs on board at the moment of maximum opportunity. Doing so can drive short-term growth while creating long-term opportunities—thanks to the lifetime value businesses can provide as they scale.

The Shifting Opportunity in Small Business

SMBs have historically struggled with merchant services, but the recent improvement in customer satisfaction has changed the space’s competitive dynamics.

• SMBs long felt underserved by their primary banks, according to February 2020 11:FS data. This drove them toward fintechs and other software-focused players with simpler, cheaper offerings—a trend exacerbated by the pandemic. Fintechs led J.D. Power’s 2021 US Merchant Services Satisfaction Study.

• Overall SMB satisfaction with merchant services providers improved in 2021, however, thanks to SMBs’ shifting perception of banks—a key category of providers. SMBs’ satisfaction with their primary bank is growing, according to a November 2021 Protocol and Morning Consult survey, and that sentiment may be carrying over to merchant services. The top two performers in J.D. Power’s 2022 US Merchant Services Satisfaction Study—and three of the top five—were banks. Banks were also the largest gainers on an annual basis, likely because of simpler fee structures and customer support.

This shift in merchant services means providers may need to out-innovate the competition. Creating simple, affordable solutions chock-full of next-generation offerings could give providers an edge as they compete in the fast-changing industry.

The Competitive Landscape

Merchant Acquirers and Processors

Acquirers’ and processors’ approach lets them reach and effectively serve a wide variety of SMBs. They often achieve this through a mix of direct sales and partnerships with independent service organizations (ISOs) and other vendors. Acquirers’ business model offers an advantage: Because many serve both issuers and merchants, they have access to a wide pool of data that can be used to build more efficient, customizable, and effective offerings.

The size of these providers is a core determinant of their success, though it’s also a double-edged sword. The top 10 US acquirers processed 93.2% of all transactions across the market’s top 63 players in 2020, per Insider Intelligence estimates based on Nilson Report data. Scale can provide reach and brand power that lets them cast a wide merchant net and offer robust support. But such a wide scope can also make it hard to meet the needs of individual sellers through the design or personalization of specific tools.

Banks

Banks’ layered relationship with merchants creates a cross-sell advantage. Banks often partner with acquirers to reach merchants through joint ventures, though they do a considerable direct sales business as well. Banks’ largest advantage is their existing account relationships with SMBs: More than 90% of Bank of America’s (BofA) merchant clients are also banking customers, according to the bank’s enterprise payments head Mark Monaco.

Not all banks that serve SMBs are acquiring banks. However, the larger banks that are, such as BofA, have a competitive advantage. Their established trust and existing relationships open the door to cross-sell opportunities. Banks can use insight into businesses’ financials and operations to customize offerings and build services into platforms that SMBs already use.

Banks’ large balance sheet lets them pour cash into product development, but their size might also make them slower moving than the competition, says Brian Dammeir, president of Adyen North America. Furthermore, banks aren’t always as invested in technology as other providers, which may limit feature parity. Since they tend to pursue merchants in verticals most strategically important to their overall business, banks can also be limited in scope rather than casting the widest net possible.

Fintechs

Fintechs’ nimbleness and tech focus can help them adapt quickly to trends. Fintechs typically sell directly to merchants. Many are also certified as payment facilitators, making them attractive partners for acquirers since they can onboard several SMB merchants at once.

This fosters adaptability because they can develop and test new products based on market needs faster than competitors—in turn bringing offerings to market quickly. It can also help them rapidly form partnerships, which are critical to their strategy. While these partnerships can drive scale, they may also force fintechs to cede revenues and relationships to middlemen.

Fintechs’ positioning may also limit who they can serve. Fintechs tend to focus on the smallest end of the market. This class of SMBs presents a considerable growth opportunity, as they’re historically last to adopt digital payments. But lower sales and less sophisticated needs make them less lucrative for fintechs. Fintechs’ positioning can also handicap their ability to serve businesses as the latter scale, as Global Payments president and COO Cameron Bready pointed out recently. Moving upmarket has been an ongoing goal for some providers in this group, like Square.

How Providers Can Best Serve Small Businesses in the Current Climate

SMBs have historically found merchant services too complex. Most want to simplify payments tech and relationships, likely because of the resources and time required to manage payment products, per an October 2021 Paysafe survey. For providers, that complexity represents a pain point and can create an attrition risk—especially in a competitive environment where SMBs can choose from a host of options.

Developing all-in-one solutions can help resolve this pain point. Letting SMBs access all the services they need through one simple integration can reduce complexity and satisfy owners: Around 7 in 10 SMB owners cite interoperability as “extremely” or “very” important, per an October 2021 Bill.com survey.

This can build relationships that last. Fiserv, for example, describes its Clover integrated commerce ecosystem as “accelerating growth beyond payments, increasing merchant ARPU, and reducing churn,” per a March 2022 Investor Update. All-in-one solutions can also help providers widen their net by offering merchants a tailored experience where they can choose specific services based on their size, type, or other demands, and update those choices as they grow.

New technology has enabled innovation that lets providers embrace ecosystems with greater ease. Large providers are moving to create these ecosystems for their clients to avoid losing customers to competitors. Smaller PSPs can develop software- or hardware-based tools that can be integrated into these ecosystems through APIs or software development kits (SDKs). In the year ahead, three areas with varying degrees of maturity and impact will dominate innovation as providers embrace all-in-one ecosystems:

• Payment products: Enable transactions across channels and locations
• Value-added services: Aid SMBs in running their businesses on the front and back ends
• Outreach: Helps payment providers attract SMB owners in a crowded ecosystem

Payment Products

A need to accept payments is often what drives small businesses to merchant services. Offering payment services comes with the primary benefit of core processing and transaction revenues. This is the bread and butter of merchant services: Square’s transaction-based segment, for example, is its largest non-Bitcoin revenues generator.

To offer next-generation payment services, PSPs may focus on supporting new payment methods, bolstering omnichannel support, and innovating at the POS.

Payment Method Diversification

Why it matters: Ensuring SMBs can accept their customers’ preferred payment methods is critical in driving volume and satisfaction. Widespread acceptance ensures that SMBs can accommodate any customer, regardless of how they want to pay. This reduces the risk of cart abandonment by customers who can’t use their preferred method, according to Global Payments CEO Jeffrey Sloan. It’s also key to retention: Being able to accept more payment methods through a single partner is the second-largest reason SMBs would switch PSPs, per Paysafe.

What’s next: Providers will turn their focus toward emerging payment types. Accepting cards, which we expect to account for over 80% of US retail and food purchases this year, remains most important, though they’re approaching ubiquity, per Paysafe.

The next frontier of payment acceptance innovation for PSPs will focus on three types:

Buy now, pay later (BNPL). Over a third of US digital buyers will use BNPL by 2025, with use highest among millennials and Gen Zers, who are gaining spending power, according to our forecasts. PSPs can accommodate these shoppers by enabling BNPL acceptance through proprietary services, such as Square’s Afterpay offering that brings BNPL to all its sellers, or via partnerships like the deal between Synchrony Financial and Fiserv-owned Clover.

Cryptocurrency. Twenty-one percent of US cryptocurrency owners want to use it for purchases, per the 2021 McKinsey Digital Payments Survey. To meet owners’ demands, 38% of online SMBs plan to accept crypto this year, per Paysafe. This makes an obvious case for PSPs to support crypto through an effort like PayPal’s Checkout with Crypto, which lets users pay with digital currency at any of its millions of merchants.

Multicurrency support. Increased globalization and travel boosted cross-border buying and pushed SMBs to increase operations abroad, per Wise. Adding new currencies and localized payment methods, as Barclaycard has done, can help SMBs court these consumers. This is especially the case among shoppers in Asia-Pacific and Latin America, who make up the majority of cross-border buyers, says Adyen’s Dammeir. Pursuing these shoppers might grow services such as Shopify Markets, which helps merchants optimize international sales and launch in new markets.

Platform Unification and Marketplace Support

Why it matters: Ongoing ecommerce growth has magnified the channel’s importance to SMBs’ overall business. We expect US ecommerce sales to exceed $1 trillion for the first time this year as consumers maintain the online and multichannel shopping habits they forged during the pandemic, when merchants rushed to adapt.

That makes ecommerce support invaluable to SMBs as more transition online: One-third of small businesses identified “new online channels” as a top area for growth in 2022, per Visa’s December 2021 data, and those selling online reported that just over half of their revenues came from the channel, on average.

Selling through digital channels, however, represents an ongoing pain point for SMBs because it requires them to make big back-end changes, says Afshin Yazdian, CEO of US acquiring at Paysafe. They might, for example, be forced to cobble together systems from multiple providers to support cross-channel sales, pushing them to devote time and financial resources they don’t have. Solving these problems can therefore help PSPs attract clients.

“We need to live in a new normal where customers are going to buy online and pick up in-store, buy offline and print a return label or process a refund online, and return by mail [in addition to online and in-store shopping]. Your ecosystem has to support that.”
— Saumil Mehta, Head of Point-of-Sale, Square

What’s next: PSPs will continue simplifying channel unification while pursuing the next generation of digital commerce. Developing streamlined offerings that support all channels on the back end is an ongoing effort, says Saumil Mehta, head of point-of-sale at Square. Doing so will lead to more products that support sales across in-person, ecommerce, and hybrid offerings like click-and-collect; Stripe Terminal, Square’s multichannel inventory management, and Lightspeed’s unified commerce suite are existing products of this ilk.

It will also become increasingly important to support selling on marketplaces. Between 50% and 70% of digital commerce will take place on these platforms by 2025, according to McKinsey. Offering SMBs functionality that can help them launch and manage sales on these platforms in the same place they manage their other sales channels will be the next omnichannel differentiator for PSPs; Checkout.com is developing such solutions, for example.

New POS Technology

Why it matters: New forms of POS hardware give PSPs access to small sellers. The smallest firms, especially nonemployer businesses, are largely unable or unwilling to pay for terminal infrastructure. Enabling in-person payment acceptance for these players as they increasingly begin selling in person can bring millions of previously unreachable sellers into PSPs’ purview. It also creates an opportunity for lasting relationships and upselling down the road.

What’s next: PSPs will invest in developing low-cost, easily accessible payment hardware or partnering to bring it to sellers. Providers will continue to embrace mobile point-of-sale (mPOS) as the market grows. But according to Dammeir, the role of the terminal will fundamentally change in the next five to 10 years. Companies will focus less on standalone hardware and more on two types of digital offerings that can help cement relationships with sellers:

• SoftPOS turns SMB owners’ smartphones into payment terminals so they can accept contactless payments without any additional hardware. Apple’s recent entry into this previously Android-exclusive market will accelerate innovation and drive partnerships by bringing this tech to the 57.9% of US adults with iPhones. Stripe and Shopify are already working with the device-maker, for example.

• QR codes’ ability to facilitate payment acceptance without hardware is also driving their popularity: Adoption grew 233% in the year leading up to January 2022, per Square. As peer-to-peer (P2P) providers such as PayPal’s Venmo and Square’s Cash App formalize business accounts, the market will continue to expand: GoDaddy debuted mobile-based QR codes targeting this class of vendors in February 2022, for example.

Connectivity will also remain a priority. SMBs rated reliability as the top factor they consider when selecting a payments partner, according to Paysafe, so ensuring limited downtime is key to PSPs’ success. Increasingly invisible terminals might drive more partnerships akin to Verizon’s deals with Clover and Mastercard, says Aparna Khurjekar, president of Verizon Business Markets. For context, the Clover deal brings mobile internet to portable terminals, while the Mastercard partnership facilitates 5G use at scale.

Value-Added Offerings

Supplemental nonpayment offerings, such as business management, inventory services, or employee support, are what define ecosystems. SMBs’ digital transformation stretches beyond payments, says Adyen’s Dammeir. Tethering other software offerings to payment tools further ensures SMBs can access all services from one provider.

And there’s rising demand: In 2020, Fiserv reported that nearly half of new sellers bought a software plan at the time of activation, and it posted a 20% increase in existing Clover merchants buying value-added services.

Taking this approach delivers two benefits:

• Profits. A move to the software as a service (SaaS) model lets providers supplement transaction income with subscription- or usage-based fee models that often drive profits. Square’s subscription and services-based revenues became its most profitable segment in 2021, for example.

• Relationships. Building their presence into more offerings lets PSPs connect merchants closer to products. This boosts satisfaction and lowers attrition by raising the stakes of leaving. It can also ensure that providers can serve merchants as they scale and their needs change, allowing PSPs to pursue larger, more lucrative clients.

“For the SMB, it’s convenience at the end of the day. If you can simply click a box, a terminal appears in the mail, you plug it in, and everything is simply working, it’s golden. Having one relationship is beneficial because there can be economic benefits of folding all your services—payments, hosting, scheduling all with one provider—into one.”
— Brian Dammeir, President, North America, Adyen

As value-added services move past simple business management tools, providers can invest in vertical-specific tools, cash-flow-focused financial services, and risk management technology.

Vertical-Specific Tools

Why it matters: Adding vertical-specific services can help PSPs broaden their total addressable market. Providers are increasingly moving from a generalist approach to “getting deep within particular verticals,” Amrita Ahuja, CFO of Square, said last year. Providing turnkey access to services that meet very specific needs can attract new types of merchants that were struggling with one-size-fits-all products and had to resort to third-party tools.

“We have to remove barriers through industry-specific applications, not generic offerings. Why should three businesses—say a hair salon, a medical spa, and a veterinarian practice—all use the same services? They shouldn’t. The same software that makes a cappuccino isn’t going to do a cut and color or run tests on your dog. But that is what the industry asks them to do.”
— Jeff Dickerson, Head of Clover Solutions, Fiserv

What’s next: PSPs will rely on partnerships and in-house development to quickly scale into new verticals. Ongoing focus on retail and restaurants won’t disappear due to the revenue potential, says Jeff Dickerson, head of Clover solutions at Fiserv. But PSPs’ focus will likely intensify on new segments with considerable runway for growth in both volume and digitization. These include health and veterinary care, wellness, hospitality, petroleum, appointment-based businesses, and trades.

We expect providers moving into these areas to take a two-pronged approach:

• Independent software vendor (ISV) partnerships. Working with vertically specialized ISVs lets PSPs capitalize on their expertise. PSPs like Clover use these partnerships to quickly scale tailored solutions for specific niches, such as pizzerias or hair salons, though it’s important that experiences remain “identical and cohesive across ISV-sold and proprietary products,” says Dickerson.

• In-house solutions. PSPs can also dedicate resources to developing proprietary tools for a narrower set of industries they’ve identified as top strategic priorities. One way they’ll do this is through research and development; Square recently launched Square Photo Studio, which it built to help apparel retailers more easily take high-quality photos to showcase their inventory. They may also make acquisitions, like Clover, which plans to use recently acquired BentoBox as a springboard for other restaurant-specific services.

Integrated Financial Services

Why it matters: Improving access to financial services can help PSPs fill a gap for SMBs while diversifying revenues. Small businesses have long struggled with access to a wide variety of capital, cash flow, and credit availability, per the US Federal Reserve’s 2021 Report on Employer Firms. Resolving these pain points remains necessary, per Paysafe, presenting an opportunity for PSPs to improve interoperability by tethering financial services tools to existing merchant service offerings. Providing these tools can also boost fee income.

Bank-based providers have a notable advantage in this regard because they already offer banking products to many of their SMB merchant clients. Moving into this space gives acquirers and fintechs an opportunity to improve parity.

What’s next: PSPs will focus on improving cash flow and capital access to resolve key pain points. Two types of offerings may help providers close gaps and meet SMBs’ needs.

Financing will be the primary focus. About one-third of employer SMBs cite credit availability as a financial challenge, per the Fed. This offers ample opportunity for PSPs, especially since they can leverage other business data, like transaction history, in their decision-making.

• Though credit cards will remain important—Amex and BofA recently tailored or launched new SMB-focused products, and Mastercard is working with fintechs on SMB-focused cards—more innovative offerings will be the next frontier.

• We’ll likely see an uptick in solutions akin to Kabbage Funding, which offers revolving credit based on merchants’ existing history and sales and can be useful in areas such as hiring, says Kabbage co-founder Kathryn Petralia. There will also likely be an increase in the availability and uptake of B2B BNPL offerings from providers like Veem.

Faster payments will also be a priority. Giving SMBs quicker—or in some cases, instant—access to their earnings, rather than waiting several days for funds to transfer, lets businesses make immediate use of funds for payroll, inventory, and other expenses, Dammeir said. Speedy access was a major driver of satisfaction in 2021, according to J.D. Power. That demand could spawn more solutions like BofA’s Business Advantage 360, which offers clients transparency into their activity and same-day fund receipt at no charge.

“There’s a growing trend of integrated financial services. I’ve had sales for half a day; can I instantly have a settlement put on a debit card that I have in my wallet? Next to that, can I have capital extended to me? Can providers see my business and lend? There are trend lines toward not just processing, but other financial services. Everyone is at a different journey in building those out. But at the end of the day, reducing fragmentation and reducing paperwork [is beneficial].”
— Brian Dammeir, President, North America, Adyen

Risk Management

Why it matters: Helping SMBs confront growing fraud can improve customer satisfaction. US card payment fraud losses grew 10.6% to reach $12.56 billion last year, according to our forecast. This is causing concern among SMBs, which must mitigate fraud and cut down on false declines without eroding the customer experience. But they often don’t have the time or human capital to do so. As they seek solutions, fraud prevention can also offer a new revenue stream: Risk management is the top area SMBs would be willing to pay a premium for, per Paysafe.

What’s next: PSPs will use data in more sophisticated ways to improve fraud outcomes. Bolstering existing AI and machine learning technology can help PSPs avoid the pitfalls of overly sensitive systems without reducing protection. Some providers—especially the banks or acquirers that operate two-sided ecosystems—will use proprietary data to improve decisioning. Growth in open banking, which can offer nonbank providers a better window into financial information, could accelerate these efforts.

Others will collect data independently, as Stripe Identity does, by letting a business ask for biometric details to improve verification. And others still will embrace third parties to leverage services like Justt’s Optimus tool, which increases visibility into dispute data over time to better inform approval decisions.

Outreach

Effectively marketing payment and value-added services is the key to new business acquisition for PSPs. Rapid SMB digitization has accelerated both opportunities and competition for PSPs—forcing them to address the challenge of capturing prospects’ attention. Outreach and marketing enable client acquisition, in turn driving growth by scale and expanding PSPs’ base of users. Improving outreach will require investment in simple onboarding and improved analytics functionality.

Simple Onboarding

Why it matters: Onboarding is a PSP’s first interaction with a small business that has the potential to become a long-term client. A simple onboarding and integration process could sway merchants to choose one provider over another, especially since ease of integration is a top priority for US SMBs, per Paysafe. A smooth and seamless process can also make busy SMB owners happy and set the tone for the rest of the relationship, according to Dammeir. At the same time, it lets PSPs capture revenues as fast as possible.

What’s next: PSPs will focus on streamlining and accelerating the onboarding process to get merchants running as quickly and easily as possible. Third parties can eliminate onboarding friction and drive simplicity through partnerships that are either dual-branded or white-labeled.

• Dual-branded. Providers can enlist third parties to eliminate steps and streamline processes. For example, Stripe is working with execution management company Celonis to accelerate onboarding.

• White-labeled. Banks have already started using solutions from companies like MANTL, nCino, Numerated, and Q2 to address weaknesses in demand deposit account (DDA) opening—which they could extend to other merchant services. Nonbank providers might leverage similar offerings to catch up.

Analytics and Data

Why it matters: Increased access to data can ensure that SMBs are receiving the most relevant offers possible. Among other use cases, analytics and data can help with targeting SMBs both at the beginning of their customer journey and once the relationship is established. They’re particularly useful when selling into specific verticals since PSPs can leverage what they know from existing seller relationships to offer similar prospects the right package of solutions or communication cadence, per Square’s Mehta.

“How are we going to take our horizontal offerings, like Square Marketing—a marketing automation product that helps businesses retain consumers—and create value for restaurants, for example? They might want to send an automated email trigger to remind customers to come back. But [the cadence] varies by vertical: in coffee shops, it might be three times a week, whereas beauty salons, it might be eight weeks.”
—Saumil Mehta, Head of Point-of-Sale, Square

What’s next: Providers will leverage data to improve the ways they’re presenting options to merchants. This tactic will come at two points in the customer journey:

Client acquisition. Providers can look at what specific categories of merchants, including verticals or sizes, have needed in the past, and use those insights to inform their marketing and sales strategies for those verticals.

Cross-selling. PSPs can use analytics to inform what additional services they show merchants and to offer customized recommendations. After Clover moved one of its partner’s apps directly onto the home screen of the POS devices used by merchants, downloads of that app increased tenfold in a day, says Dickerson. This opens the door to further initiatives like this. It also showcases how using data to increase targeting could grow adoption of value-added solutions and, in turn, the value providers can reap from offering them.

Sources

Insider Intelligence, eMarketer

11:FS

Adyen

Afterpay

American Express

Apple

Bank of America

Barclaycard

Bill.com

Block

Checkout.com

FedEx

FIS

Fiserv

Global Payments

GoDaddy

J.D. Power

Justt

Kabbage

Lightspeed

MANTL

Mastercard

McKinsey & Company

PayPal

Paysafe

Protocol

PYMNTS.com

Shopify

StatCounter

Stripe

Synchrony Financial

The Nilson Report

US Census Bureau

US Federal Reserve Small Business

Veem

Venmo

Visa

Wells Fargo

WePay

Wise