Dive Brief:

• About half of small businesses now use an integrated software vendor (ISV) as their payment processor, and another 15% are in the process of switching to that type of provider, according to a survey from global consulting firm McKinsey. About 38% currently use a legacy merchant services provider.
• New businesses have formed at record rates during the COVID-19 pandemic, and those businesses are far more likely to opt for ISVs over legacy providers, McKinsey said. The consulting firm polled about 800 small businesses as part of its annual merchant acquiring survey.
• Across different verticals, Block-owned Square and Fiserv’s Clover are the ISVs most used by small businesses. ISVs are even more widely used in the food and beverage industry — about 65% of businesses in that vertical have turned to ISVs, McKinsey said. Toast is “a close second” in that industry. 

Dive Insight:

McKinsey noted ISVs such as Square and Stripe have gained traction with small business merchants by offering easy-to-use digital payment processing that’s often lower priced than competitors. That’s threatening traditional players’ standing in the merchant acquiring space. “Incumbents should expect to face continued significant attrition to ISVs,” McKinsey analysts wrote in a Sept. 22 web post on survey findings.

That could be especially apparent as ISVs move upmarket: About 20% of midsize business respondents have also tapped ISVs, McKinsey said. 

ISVs face disruptors, too. McKinsey noted Square and Clover face competition from smaller ISVs that are concentrating on specific verticals — such as Mindbody in the salon industry — and fintechs will need to push into areas like healthcare or sell more services to continue to grow. 

“The same formula that allowed Square to displace incumbents is now letting newer companies penetrate underserved subverticals,” the analysts wrote.

Merchant service revenues exceeded $30 billion in 2021, and small businesses accounted for almost two-thirds of that, McKinsey said. More than one-third of small businesses polled called themselves “omnichannel,” highlighting the importance of seamless digital payment processing. 

The firm noted ISVs also have become popular with merchants by offering added services that help entrepreneurs run their businesses, such as payroll, accounting and access to capital.

Seventy percent of small businesses polled employ at least one added service from their ISV, McKinsey said. Of those services, the largest share of small business owners (40%) were interested in corporate cards. 

Additionally, 37% of merchants named fraud management, 33% said accounting solutions, 31% named access to borrowing and 31% said payroll were appealing. More than one-quarter (26%) identified buy now-pay later or point-of-sale lending.

In the competitive merchant acquiring space, Fidelity National Information Services (FIS) edged past rival Fiserv in 2021 to become the top non-bank acquirer, according to industry publication The Nilson Report. 

JPMorgan Chase, which was No. 1 in that ranking, said in September it is buying payments services firm Renovite Technologies to update the services it offers merchants in the acquiring space. Even when merchants use ISVs, it’s often incumbents actually processing transactions, McKinsey noted. That only affords incumbents per-transaction fees, and they miss out on the relationship with the merchant. Aiming for a larger share of revenue per transaction, Banc of California recently said it was acquiring payments firm Deepstack Technologies. 

Although big banks have trailed fintechs when it comes to cost and ease of use, a J.D. Power study released in February indicated banks such as Bank of America and JPMorgan Chase have begun matching or exceeding fintechs like Square when it comes to merchant satisfaction.