# Software as the Future of Payments Distribution Notes

By [jelca thinks](https://paragraph.com/@jess) · 2022-02-08

payments

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[Bain Capital - Software as the Future of Payments Distribution](https://medium.com/ideas-from-bain-capital-ventures/fintech-2-0-software-as-the-future-of-payments-distribution-57e8b5b8e643)

### **Early Days**

1.  Legacy merchant acquirers e.g. Chase, BoA, Wells, Elavon / US Bank sold directly to large merchants like Best Buy
    
2.  These merchant acquirers needed better distribution channels
    
3.  The rise of ISOs and ISVs
    
    1.  ISOs do not integrate with software but are more SME facing and on the streets selling
        
        1.  For example they'd sell a merchant a POS system then intro them to a payment processor like Worldpay to set up the back end
            
        2.  Merchants have little software overlaying it like data analytics, only can accept payments
            
        3.  Merchants need to be underwritten by a bank acquirer. Took a long ass time and often was difficult due to documentation requirements
            

### **First Wave of Integrated Payments**

1.  Maybe ISOs aren't the best. Let's look at software company-led sales channels instead
    
    1.  Payments embedded in software sold to merchants. Essentially pre-packaged.
        
    2.  Merchants get a POS system with a bunch of integrations such as CRM, analytics, etc.
        
    3.  The tech company would refer the merchant back to Worldpay and then an acquirer to be underwritten
        
2.  A lot of consolidation occurred - Global Payments acquired Accelerated Payment Technologies in 2012 and Vantiv/Worldpay acquired Mercury Payments in 2016 for $1.65bn. Over $10bn was spent on acquisitions for companies in this space to boost integrated payments abilities.
    
3.  Integrated payments is important because you can own the payments experience at a lower CAC and increase customer stickiness as you cross and up sell. Onboarding is sleeker and implementation is easier.
    

### **Vertically Driven Payments Software**

1.  Rise of Shopify, Mindbody, Lightspeed
    
2.  These softwares becoming commoditized? Becoming a price war? Need to keep layering on more value added services such as analytics, campaign marketing, etc. Greater focus on value way beyond just payments. This is why Square is so expensive and can charge an MDR (merchant discount rate) that is more expensive than industry average
    
    1.  MDRs cover interchange to issuer, network fees to the network, and merchant acquirer spread
        
3.  New revenue models such as Lightspeed monetizing through referrals (company refers merchants to third party payment processors to get a share of payment processing economics). Merchants can choose to use a Lightspeed partner basically and Lightspeed gets % based referral fees
    
4.  Huge benefits when merchants scale - EBITDA margins on average of 70% (adj net rev)
    

### **Value Driven Offerings**

*   Integrations suck. There are a lot of them. Offer a fully baked end to end solution in a vertical specific manner.
    
*   Examples: MindBody for fitness, spa and salon. They also have dynamic pricing to price classes. Lightspeed offers ingredient and order management, menu and floor management
    

### **Seamless Merchant Onboarding**

*   Before, software providers set up an offering for the merchant then referred the merchant to a payments provider to set up acceptance. The process sucked - it is easier to just purchase payments as part of a software package with integrations in it already. Software providers become the one stop shop.
    
*   This also makes it easier for merchants to get underwritten. Onboarding became instant. Square was a pioneer in the space. They popularized the payfac model to underwrite small merchants
    
*   This is also great for software companies because they will have visibility into merchant payment activity, inventory fluctuations, marketing campaigns, etc. Basically data is king. Vertical players know their market very deeply and can help underwrite them better too.
    

### **Ease of Implementation and Use**

*   There are so many vertical specific payments companies now, it is easy to find one that can serve you!
    

### **3 Options for Software Companies to Get Into this Space**

### **ISO Model**

1.  Company refers merchant customers to payments processor
    
    1.  MindBody is an ISV that refers salons and spas to Total System Services
        
    2.  MindBody is NOT involved in underwriting and compliance aka funds flows BUT this means they can't fully monetize their transactions hence they take a referral fee instead of % of tx volume
        
2.  ISVs do not have end to end control of the payments experience
    

### **Partner with a Payfac**

1.  Stripe, Adyen, Braintree, Square
    
2.  Software company can capture more payment economics and own the payment experience more.
    
3.  Merchants can accept payments instantly.
    
4.  Because you are foregoing building a payfac, you better pay up! If you scale up in GMV a lot, end users will bear the fees.
    
5.  You are limited and reliant on the payfac you partner with
    

### **Become a Payfac**

1.  Software company opens a merchant bank account and gets a merchant ID (MID) to acquire and aggregate payments for their submerchants. Submerchants do not need to register their own MIDs because they get aggregated
    
2.  The software company is thus responsible for underwriting and acquiring all these submerchants. The software company better reduce the complexity of setting up payments!
    
3.  Good for those who have access to a broader pool of merchants e.g. low sales volume merchants
    
4.  This allows software companies to monetize their submerchants' transactions and create differentiated services aka stickiness.
    
5.  They also get the biggest chunk of payments economics
    
6.  Cons: Must control who they admit (onboarding), meet KYC/AML standards, monitor high risk activity and fraud, PCI compliance
    
7.  This is not easy! Huge time and monetary investment.
    
8.  Companies like Finix, Payrix, Infinicept provide middleware to help software companies capture more payfac upside without all the time investment.

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*Originally published on [jelca thinks](https://paragraph.com/@jess/software-future-payments)*
