Networking is vital to grow small businesses. Typically, small business owners rely on their existing networks for initial customers. In addition, small business owners will try to quickly expand their networks in hopes of generating new customers.  While this push to increase business contacts is understandable, small business owners should be careful to not alienate contacts.

For example, let’s take a look at small business brokers or advisors. These small business professionals help represent businesses for sale. Basically, they run the process to attract potential buyers and ultimately sell a given business for the current owners. Small business brokers spend a lot of time networking and cultivating relationships with various professional associations, business owners and entrepreneurs with the hope of being considered to represent the business if it is ever sold.  The most successful advisors generally adhere to the following simple guidelines for professional networking:

1. Do Not Misrepresent Yourself - You should never misrepresent yourself or your company - eventually it will come back to haunt you.

2. Genuine / Sincere Interest - You always want to come off as genuine or sincere in your interest regarding people and their businesses. For example, let’s assume you are at a networking event. If you simply ask for peoples’ cards and then quickly move on, you likely will give the wrong impression - you are only interested in yourself / your own business. This brings us to the next rule.

3. Rule of Reciprocity - Any website that has keys to networking articles will mention the “rule of reciprocity.” This rule is a foundation for successful networking. It is important to consider how you may help those people in your network. Networking is not just about gaining new contacts or new opportunities for yourself - it’s about trying to help each other. Think of it this way - are you more likely to help someone who just is interested in you being a customer or someone who is willing to make some introductions for you and interested in you being a customer?

4. Do Not Reach Out Only When You Need the Help - Unless you have a clear understanding with someone, you should not only reach out to people in your network when you need them. Again, this shows you aren’t really thinking about how you are able to help them - only how they are able to help you. Think of it this way - did you ever have a friend that you only heard from when s/he had nothing else going on? It probably bothered you, right?

We found another interesting document, courtesy of the New York Federal Reserve Bank - a research paper that was presented at a conference entitled Antitrust Activity in Card-Based Payment Systems:
Causes and Consequences in 2005 by industry researchers Alan Frankel and Allan Shampine.

Here is a link to the powerpoint presentation, called House Of Cards: The Economics of Interchange Fees.  Below I will summarize the main points for those who don’t want to bother downloading a .ppt.

* Average Visa credit card interchange rate grew at 2.2% / year from 1990 to 2004, resulting in 35.6% higher rates

* Issuing Banks’ income from credit card fees has increased 349% since 1992, from about $4B to about $15B.  This excludes debit cards, which have grown even faster.

* A credit card purchase for a grocery store costs about twice as much as a check purchase and about 7x as much as a cash purchase.

* Interchange fees increase consumer prices somewhere in the neighborhood of 0.6%.

* Merchants are in a prisoner’s dilemma - credit cards cost them more, without increasing aggregate consumption, but if they stop accepting credit cards they will lose business to other merchants.

* Interchange rates may have helped fund an explosion in junk mail credit card offers, from 1.1B pieces of mail in 1990 to 5.8B pieces in 2005.

Another good article from The Consumerist called 10 Credit Card Company Tricks To Avoid.  It is an overview of 10 things that credit card companies do to charge consumers extra fees and interest, and well worth a read by anyone who spends money.

We at TransFS are on a mission to help consumers get a fair deal on their financial services consumption.  Our efforts right now are focused mainly on business financial services, but we will tackle more consumer-focused products soon.

The biggest component (about 80%) of the credit card processing fees that every merchant must pay is “Interchange”.  Interchange is a fee collected by Visa and Mastercard and passed along to the bank which *issued* the credit card that was used for the transaction.

A 2006 report by Diamond Consultants had some facts and figures that we found quite interesting.  The report is worth checking out.  It is no longer available on Diamond Consulting’s Website but it is available at the Internet Archive - A New Business Model For Card Payments.  Highlights:

* “Credit and debit cards have been a major profit engine for issuing banks, but legal and possible regulatory challenges to the interchange model spell trouble for both issuing banks and the card associations that support them”

* “Card issuing banks and the card networks can’t be blamed for trying to maintain, or at least prolong, the current interchange fee model.  It accounts, after all, for over $22 billion in annual fee income for Mastercard and Visa issuers and the associations”

* “Paying for issuer rewards programs consumes about 44% of interchange costs, but merchants get nothing out of these programs; they are competitive tools for issuers.  Merchants likewise pay about 3% of their interchange dollars for association branding costs.  Meanwhile, processing - the original reason for interchange - comprises only 13% of interchange costs.”

* “Merchants have little idea where their interchange dollars go.  In addition to the 44% of interchange cost that goes toward rewards programs, our analysis shows that network branding takes 3% of the cost, and 35% goes to cover things such as cost of funds and profit margins.”

* “Merchants are especially irked because market forces as they understand them should be driving fees lower, not higher, and this is especially true for interchange.  Their objections to this situation include: - card acceptance has reached a critical mass that no longer requires the same degree of brand building; - transaction volume has grown enormously and resulting economies of scale have driven down transaction processing costs; - fraud has decreased as a percentage of volume.”

* “Once transparency comes to credit card pricing models - as it ultimately does to virtually every industry and now may be beginning here with the recent decision by Mastercard to publish interchange tables - merchants will use the information to force an unbundling of interchange fee structures.  The interchange structure as we know it will dissapear.”

As small business owners who have, in our previous businesses, felt significant pain from the cost of credit card processing, we at TransFS hope the above predictions occur.  Our goal is to enhance tranparency in financial services by providing tools to help the consumers of financial products make better decisions and get better deals - for example, our credit card processing calculator and more detailed credit card processing report.

Financial services companies sent out more than 4.2 Billion pieces of mail, according to Mintel Comperemedia. Thats 40 pieces of financial-services related junk-mail each year for each credit-worthy person (there are about 100 million).

Speaking for ourselves, we get a *LOT* more than that, at least a few pieces each day. That’s a lot of wasted trees, postage and a waste of our time.

One of the fundamental premises behind Transparent Financial Services (TransFS) is that kind of in-your-face marketing is a waste of time and money, that people (and business owners in particular) are immune to it and simply tune it out.  We have one friend who even disconnected the phone in his coffee shop because so many salespeople were calling him.

People are more comfortable when they can do research on their own, compare all the options, and then make a decision, which is how we have built TransFS.  So far, we have built the capability for business owners to proactively shop for credit card processing, using tools such as our credit card processing calculator to make better decisions.  Our customers really like it, which makes us happy.

The financial services providers love it too - it turns out that connecting with potential customers directly through TransFS is a lot cheaper than sending out all that junk mail.

We recently ran across a document from the Philadelphia Federal Reserve, entitled “The Merchant-Acquiring Side of the Payment Card Industry: Structure, Operations and Challenges“.  One of the biggest problems that business owners have in negotiating and understanding thier credit card processing contracts is that they don’t understand the economics of the credit card processor (also known as the merchant acquirer).  This is a 29 page document that is relatively easy to read.  If you really want to understand how payment processing works, we highly recommend it.  For those who don’t want to invest the time to read the whole thing, here is a short summary of the most important points:

* For bank-centered networks such as Visa and Mastercard, the Merchant Acquirer is defined as the member financial institution responsible for its merchant-customers’ transactions with the network.

* The work conducted by the merchant acquirer includes: 1. Signing up merchants to accept the cards, 2. providing the means to authorize valid card transactions at the client merchant locations, 3. Facilitating the clearing and settlement of the transactions through the payment network, and 4. Providing other services such as sending out statements to the merchant.

* In practice, the member banks typically outsource big portions of that work to third-party (non-banks).  Often those third parties (companies like First Data, TSYS, North America Bankcard, and Heartland Payment Systems) do so much of the work that they are referred to as the Merchant Acquirer, even though they don’t meet the technical definition.

* Of the above tasks, #2, #3 and #4 are all highly automated tasks best carried out by very large companies with massive scale.  #1, signing up and helping merchants accept cards is the most labor-intensive and and least scale-dependent.  That’s why, while there are only a few companies that maintain processing networks, there are thousands of small companies that sign other small companies up to accept credit cards.  Such companies are called ISOs (Independent Sales Organizations).

* When credit cards first came into existence in the 1960s the market was made up of local banks who conducted both the issuing and acquiring functions.  They issued cards to their personal banking customers and helped their business banking customers accept cards. Since then, the industry has consolidated, with most local banks getting out of the business.  Issuing credit cards has become dominated by a few large banks including Bank of America, Chase, Capital One and Washington Mutual.  Dealing with merchants who accept credit cards has become dominated by another group of large banks including 5th/3rd, USBancorp and Chase, as well as a few large non-banks such as First Data and Heartland Payment Systems.

* Merchant Acquirers have few ways to differentiate their services to their merchant customers and therefore rely mainly on price to attract new customers.

* Chargebacks (transactions that are disputed by the cardowner - usually because of fraud) are a very small percentage of total transaction volume.  Only about 0.015%- 0.025% of total credit and debit transaction volume is charged back.

* In 2006 there were 6.1 million merchants that accepted credit and debit cards.

* In every credit or debit card transaction there are three parties that get paid: 1. The network (Visa and Mastercard) gets to keep about 0.10%.  2. The card-issuing bank (like Capital One) gets about 2% passed on to them, depending on the kind of transaction.  The exact amount passed on to them depends on a complicated set of rules called Interchange. 3. The merchant acquirer gets to keep the rest (about 1.8% from the smallest businesses and about 0.06% from the largest businesses).

* Small and Medium merchants (those processing <$1M in credit card volume / year) make up only 20% of

credit and debit card transaction volume but contribute 67% of merchant acquirer revenue.  In other words, merchant acquirers make most of their money off small business owners because they have a much smaller markup on the transaction volume of large businesses since the large businesses are more powerful negotiators.

* The card-issuing banks, however, get to keep approximately the same percentage of a transaction occurring at a large merchant as they do from a transaction occurring at a small merchant.

Mitch Goldstone, the man behind the website waytoohigh.com, as well as the lead plaintiff in a class action lawsuit against visa, mastercard and their member banks over the setting of interchange rates, recently organized a protest in California around the high cost of credit card processing.  The particular cause for the protest was the amount of credit card processing fees charged for gas now that gas prices have grown so large.

It is not surprising that merchants are protesting interchange fees.  They are confusing and quite expensive.

Our company, TransFS, is doing our small part to reduce merchants’ frustration over interchange fees by helping them better understand and negotiate their credit card processing contracts.

Here’s a video of the protest.

Video of News Coverage

Here’s an interesting post that we ran across at Consumerist.com, called 10 Things You might Not Know About Your Credit Card.  The post is basically a short primer for consumers about Visa and Mastercard acceptance rules.

Topics covered include: “Do I need to sign the back of my credit card?”, “What is my maximum liability if my credit or debit card is stolen”, “Can merchants require a minimum amount for a credit card purchase?”.

Some of the points are quite general and miss some of the nuances of the Visa and Mastercard rules, but it’s an interesting read and a good refresher on the rules for anyone whose business accepts credit cards.

Customers often ask us how we get paid.  We are a free service to our customers, small and medium sized businesses.

When we connect a business with a service provider and they begin a relationship, we collect a commission from the service provider.   The commissions that we collect (for a credit card processing deal) are:

1. Unbiased - we make the same amount of money from all of the service providers, we have no incentive to steer our customers to one service provider over another.
2. Small - for a typical customer we collect between $50-$300 over the course of several years.  This fee is less than the service providers are used to paying their brokers and salespeople.  Since we are a low-cost method of distribution, the service providers pass along the savings to our customers

Paul Graham, one of our favorite authors about technology and business (and a successful entrepreneur himself) just wrote an essay which fits well into the way that we think about things at TransFS, entitled Be Good.

Basically his point is that small companies need to start with a serious mission to help their customers and be so committed to solving their customers’ problems that they would continue to do it even if they wouldn’t make any money.

Check it out, I think that many business owners will find this resonant. We certainly see the applicability to our business, which has consumed significant resources and won’t generate real income for some time.  We, the founders of TransFS, are lucky that the success of our previous businesses have put us in a position to invest in this business solely because we are passionate about solving the problem.  We are on a mission help small business owners shop for financial services more efficiently because its a problem that’s important to us. Hopefully, in the future we can generate some income from this mission.