The most important development in merchant payments right now isn’t happening in Silicon Valley (though I do think PayPal is only a few chess moves away from becoming the fifth network.)  It isn’t happening in New York City (though I’m increasingly convinced that NYC can be the center of the alternative lending universe.)  It isn’t happening in Atlanta (though I do like the mojo Frank Bisignano has brought back to First Data.)  And it isn’t in cyberspace (though surely math-based currencies will have their day.)

It’s in Durango, Colorado.  And it will likely destroy much more value than it creates.

The trend I’m referring to is commonly referred to as integrated payments, or embedded payments, but I think of it as submerged payments.  The leading (and, indeed, defining) company in the space is Mercury Payments, in remote Durango.  Before Mercury, the traditional retail payments industry practice was for merchants to make two decisions regarding their point of sale (POS); first, they pick a software provider, and then separately, a payments provider.  Sometimes these two were loosely coupled through various integrations, but rarely were they tightly linked (basically never for small and medium sized merchants) and almost never sold together.  In the world of on premise software, it was difficult to merge a necessarily dynamic platform like a payment processing system, which changes frequently due to association rules, with a static POS system that could only be upgraded through CDs sent in the mail.

What Mercury realized was that the increasing adoption of SaaS-based solutions at retail meant that payments could be far more easily (and far more tightly) integrated into POS software.  They began a landgrab in the retail software developer community, offering payments wholesale to these developers, who could then offer attractive rates to their customers on an embedded basis.  Better yet, they could use the payment card data (with sensitive details tokenized) as the basis for a CRM system, so that in essence the payments platform became the identity utility for the software system.  Good luck to the ISO salesperson who walks into a salon looking to sell payments at a 5 basis point discount, when for the merchant a decision to change payment processing providers means switching software vendors, or at least losing access to your customers’ tokenized card numbers.

Merchant acquirers currently differentiate primarily on distribution (generally feet on the street), and only at the margin on technology, approval rates, customer service and uptime.  In a submerged payments world, that is entirely flipped around.  Distribution changes from sales to business development, and payment companies will be pitching POS developers on their technological sophistication, advanced features and nimbleness.  Those are not adjectives commonly thrown around about the incumbent merchant acquirers today.

This trend is not entirely lost on the industry.  Both Vantiv and Global Payments have made acquisitions in the space (see here and here), and everyone else has at least added the word “integrated” somewhere on their website.  But they are also doing some of the wrong things, in particular acquiring or investing in POS software companies themselves.  If I’m a developer, am I going to choose an embedded payments partner who has a software package in the market competing with me?

Ultimately, regardless of what they do, this is a bad trend for the sector.  Payments are becoming dial tone … expected to be there, always on but never acknowledged, and certainly not worthy of a premium price.  At its IPO, Mercury will likely be worth $2-3B, representing approximately 5% of the enterprise value of the merchant acquiring segment, by my estimates.  In five years, they will likely be worth $5B, given the likely share gains they will see as SaaS POS systems crowd out on premise software.  Sadly, by that point, I expect they will be fully 20% of the segment’s market value, as price erosion and market share losses degrade the margin structures of their over-levered, largely fixed cost competitors.

It turns out that no one wants to buy payments, they just want commerce.