The Pitfalls of Short-term Metrics
When evaluating metrics to track, what should a merchant services provider focus on? Should it be to maximize short-term profits? How about total processing volume? Or maybe portfolio growth?
At Arcum, we think that none of these measures separately work. For example, maximizing short-term profits will lead to artificially high prices for merchants, which will cause higher attrition and bleed the portfolio to death. The goal of maximizing total volume processed or focusing on portfolio growth will lead to artificially low prices and low margins. Everyone remembers how the race to maximize sales led to General Motors’ bankruptcy with its famous cash rebates before 2008.
The King of ALL Metrics: Merchant and Portfolio Lifetime Value
If none of the conventional metrics work, what should be the goal then? We asked data scientists and an economics professor from Florida State University to join our team and help us answer this question, and they figured it out. In short, merchant acquirers should maximize the lifetime value of their portfolios. The lifetime value of the individual merchant depends on four components: size, margins, expected volume growth and the probability of retention. The lifetime value of the portfolio is then the total sum of individual lifetime values.
This answer does not make life easier for a merchant acquirer or does it? While it is easy to track portfolio margins and volume, finding out the probability of retaining a merchant and the expected volume growth requires the knowledge of market data and trends, which none of the individual acquirers actually have access to. At Arcum, we estimate both, retention probability and the expected merchant volume growth using artificial intelligence algorithms. Additionally, we understanding market trends (talk about the benefits of having an economics professor on your team), which allows us to compute the lifetime value of an individual merchant. Summing up these probabilities allows for the estimation of the total lifetime value of the portfolio.
How can Arcum Help?
If you are in the merchant services business you might be wondering, what can you do with this information about merchant lifetime value? Quite a lot! We will build for you a set of recommendations at the merchant level and determine whether raising or lowering prices will hurt lifetime value. Next, we will estimate for you whether the acquisition of a set of merchants makes sense or whether improving customer service can improve retention. In the end, you will manage your merchants better using actionable strategies that maximize the lifetime value of your merchants and portfolio.
At Arcum, we have an internal joke that if a merchant acquirer does not become our client, it’s okay, because our clients will get his merchants anyway as they will manage their portfolios better.
Co-author: Mikhail Dmitriev