Acceptance is a key driving element of whether a particular card brand is primary or secondary in certain consumer segments. Also,
payment-card volume growth is driven heavily by acceptance development.
The Acceptance Gap And Its
Impact on Discover’s Acquiring
Strategy
Discover is reversing its historical patterns and boldly adopting a bank card model in its effort to gain acceptance among
small merchants. But its strategy is a high-stakes poker game, say Charles Marc Abbey and Nicole Schrader.
Discover Financial Services LLC has embarked on a bold new acceptance strategy in which it is comprehensively changing the nature
of its relationships with both acquirers and merchants. This change at Discover is driven fundamentally by an acceptance gap that has
persisted due to the advantages of a multiparty acquiring model, the strategy Visa USA and MasterCard Worldwide have pursued for
years.
American Express Co. and Discover have long suffered an acceptance gap relative to Visa and MasterCard. In fact, Visa and
MasterCard acceptance defined “universality” in electronic payments. This acceptance gap is concentrated in small-merchant segments.
Both AmEx and Discover have effective acceptance parity among large merchants, which control the vast majority of the volume.
The acceptance gap among small merchants is important because of the impact on consumer behavior. Most research on the topic
indicates acceptance as a key driving element of whether a particular card brand is primary or secondary in certain consumer segments.
Acceptance is also a critical primary demand generator, in the sense that payment-card volume growth is driven heavily by acceptance
development.
A Stubborn Gap
In First Annapolis’s analysis of Visa data, volume in traditional acceptance markets has been growing on average at high single-digit
rates. But emerging acceptance categories (which we defined as merchant categories with less than $1 billion in volume in 1999) were
growing well in excess of 20% a year. This factor has enormous implications for issuer interchange revenue growth, and in fact, issuer
outstandings growth.
The AmEx and Discover acceptance gap results from several factors. First, because both brands represent a much smaller
percentage of a merchant’s tender mix than Visa and MasterCard due to market share, AmEx and Discover have less relevance for
smaller merchants.
Second, AmEx and Discover have related cost disadvantages. It costs these brands about the same as it would a Visa/MasterCard
acquirer to service a merchant, but AmEx and Discover have less volume and revenue at the merchant level. Therefore, they either have
to command a higher price point (AmEx) or they have to accept lower effective acquiring profitability (Discover) relative to
Visa/MasterCard acquirers.
Third, AmEx and Discover represent exception processes for merchants because the brands are slightly different from Visa and
MasterCard—different forms, phone numbers, statements, and so on. These differences are just enough to cause a small segment of
card-accepting merchants not to accept the brand.
Fourth, AmEx and Discover are exception processes for acquirers, again creating a barrier for acquirer sales staff to sign merchants
for AmEx and Discover in a small percentage of cases.
All of the factors above result in structural acceptance gaps. And, in addition to these structural gaps, AmEx and Discover simply
invested less historically than the investment represented by the collective actions of all of the Visa/Mastercard bank card acquirers in
addition to the direct investment of Visa and MasterCard themselves.
Both AmEx and Discover have made significant efforts to build out their acceptance base over the past several years, but recently
completed First Annapolis research underscores the difficulty in bridging the gap. We measured acceptance by card brand at merchants
with annual total sales less than $10 million in four traditional acceptance categories: mail order, retail, hotels, and restaurants. We
originally completed this research in 2003 and recently repeated the research with 2007 levels.
Our findings indicate that both AmEx and Discover increased acceptance levels significantly in the U.S. over the intervening years,
but Visa/MasterCard acceptance grew as fast or faster, maintaining or expanding the acceptance gap in these markets.
Reversing Course
We view Discover’s new strategy as a direct by product of these phenomena. Discover and AmEx both worked along similar lines
historically in that bank card acquirers acted as sales agents for them. So an acquirer would source a new merchant for Discover, but
Discover would assign a price to the merchant, sign the merchant agreement, and provide servicing and processing. The bank card
acquirer earned a form of referral fee and residual, but it was far lower than the earnings the bank card acquirer enjoyed with Visa and
MasterCard transactions.
Discover is reversing its historical strategy and emulating the Visa and MasterCard models, allowing bank card acquirers to
literally acquire Discover transactions (to price, settle, and service merchants). This move, if it is successful, addresses two of the
causes of the structural acceptance gap by making Discover less of an exception process for merchants and acquirers and by providing
acquirers largely the same incentives to invest in Discover as in Visa and MasterCard.
This strategy is high-stakes poker, however, because Discover will cede margin to the bank card acquirers, and there are no
guarantees that it will result in the targeted benefits. This is clearly one of the bolder moves in payment-acceptance strategy in recent
years. But it may require years to measure the level of success in the presence or absence of a continuing acceptance gap.
Nicole Schrader is a consultant and Marc Abbey is managing partner at First Annapolis Consulting Inc., a Linthicum, Md.-based
management-consulting and merger-and-acquisition advisory firm. Reach them at marc.abbey@firstannapolis.com and
Nicole.schrader@firstannapolis.com.