One of the industry’s best kept secrets: Integrated Payments
Why (and how) SaaS companies have become payments businesses
Earlier this week, GoDaddy announced its agreement to acquire a payment service provider, Poynt. And private equity software specialist, Thoma Bravo, announced its plans to acquire Realpage in a take-private transaction. What is the common thread? These deals point to the fast-emerging trend of Integrated Payments.
Not too long ago, another private equity firm, Providence Equity Partners, invested in a company called Ministry Brands, one of the pioneers of the Integrated Payments model. Ministry Brands sells software to churches and other faith-based organizations, and facilitates the payment transactions that the churches receive from their members (e.g., donations). Remarkably, Providence Equity Partners invested in Ministry Brands in 2015, then sold it in 2017 for 12x its original price — a hugely profitable buy-and-flip that took just 21 months!
So what are Integrated Payments?
Integrated Payments is a relatively simple, but powerful concept — at a high level, Integrated Payments combines two revenue models, software plus payments. In most cases, there is a B2B software company that already sells a software subscription to its customer. Let’s imagine that the customer is a merchant (e.g., a retailer), which builds its online storefront using a software platform (e.g., Wix, Shopify) — this is revenue model #1.
Staying with the same example, the online retailer generates its own sales, which are often accepted via credit card with the help of a payment gateway and merchant acquirer. In most cases, the payment gateway and merchant acquirer are some third party (e.g., Braintree). But in the case of Integrated Payments, the software company assumes the role of the Merchant Acquirer in order to earn the Acquiring Mark-up (if helpful, see my last post on how payments companies make money), which is typically a percentage (e.g., 1%) of the payment volume — this is revenue model #2.
Notable examples of Integrated Payments companies
Integrated payments companies are rarely advertised as such, but if you look hard enough, you’ll find that a handful (of very notable) examples exist in the public markets. Companies such as Square and Shopify already generate sizable payment revenue streams, while others such as Wix, Lightspeed, and Realpage have a lot of room left to grow with their payments businesses.
If you’re like me, maybe you did not realize that Shopify now generates most of its revenue from payments. Payments has been a growing share of the company’s business and is really driving the company’s overall growth.
Why Integrated Payments matters
If Shopify is any example, Integrated Payments has the potential to supercharge growth.
- New revenue stream (on top of the software subscription).
- Higher ARPU (or average revenue per user).
- Higher customer retention (i.e., lower churn).
Higher ARPU
At its core, the Integrated Payments model enables the B2B software company to leverage the sales of its customers (i.e., the merchant) into revenue for itself. For example, let’s think about how this applies to Shopify. With over 1 million merchants on the Shopify platform, paying an average monthly subscription that ranges from $29 to $299, Shopify generated $642 million of revenue (in 2019) just from its software subscription business.
$642 million, not a small sum — but, relatively small when compared to the $61 billion of revenue that Shopify’s customers (i.e., the merchants) generated from sales to their end customers. By adopting an Integrated Payments model, Shopify is able to benefit from the success and scale of its customers — for each $100 of sales that its customers (i.e., the merchants) generate, Shopify could generate $1 of payments revenue. In effect, Shopify is able to generate a higher ARPU (or average revenue per user) from its larger customers that generate more sales, far above and beyond the sticker price of the SaaS subscription .
Higher Customer Retention
Another key benefit of the Integrated Payments model is that it ties the software and payments service together, ultimately making it harder for customers to switch providers. As Shopify explains in its annual report, Shopify Payments was a key platform addition in 2013, which:
“eliminates the need for merchants to set up and maintain a direct relationship with a third-party payment gateway, gives merchants access to low credit card processing rates, and allows [Shopify] to cross-sell additional solutions to our merchant base.”
Bundling Shopify Payments with the core Shopify e-Commerce platform is really a cross-sell model, which (according to old school business school theory) should help to raise the switching costs and therefore improve customer retention.
Higher ARPU + higher retention = faster growth
Increasing ARPU and improving customer retention collectively improve net dollar retention, which is exactly the message Shopify illustrates (without explicitly saying it) with this cohort revenue chart from the company’s annual report.
Expect to see more Integrated Payments companies
Until recently, the only way a software company could adopt the Integrated Payment model was by building its own, entirely new payments company. Unfortunately, building your own payments company is not easy. The upfront costs of starting a payments business are high, and the ongoing operations can be a burden.
- There is significant upfront time, resources, and R&D required to build the payments tech platform (as if building a software company wasn’t challenging enough).
- There are regulatory hurdles to get through, which can be different on a state-by-state basis.
- Then there are the ongoing efforts dedicated to KYC, AML, fraud prevention, and chargebacks, among several other everyday complications.
Not to mention, all of this probably takes at least 1 year to fully build-out, not to mention being a drain on your engineering talent and a possible distraction from the core business of delivering great software!
Introducing: PayFac-as-a-Service
In the same way that Wix helps small businesses to quickly build an online presence, there are now fintech companies that can help software companies like Wix to quickly build a payments business. If you take a closer look at some of the public Integrated Payments companies — companies like Shopify, Wix, and Mindbody — you will notice that their payments businesses are powered by Stripe. According to Shopify, from its annual report:
“We currently rely on a single supplier to provide the technology we offer through Shopify Payments. At present, we have payment service provider agreements with Stripe, Inc.”
So how is Stripe involved? Stripe has done the heavy lifting of building a payments company so that others (namely B2B software companies) don’t have to.
- Stripe has built an entire tech stack, undergone the regulatory rigmarole, and acquired the necessary licenses to become a payments company.
- Stripe offers its tech stack (and its PayFac license) to the likes of Wix and Shopify, so that they can, in turn, facilitate payments on their software platforms.
Conclusion: It is now possible to adopt the Integrated Payments model without having to build your own payments company. Let that sink in — rather than have to reinvent the wheel, software companies can now plug-and-play with “Stripe’s wheel,” which achieves in just a few days what previously would have taken an entire year (probably more) to build in-house.
Pause: If this sounds similar to the story about how Amazon AWS made it simpler, cheaper, and faster to build a cloud infrastructure — you’re right, and this is the beauty of embedded fintech! (more on this in a later post)
For B2B software companies, the story just keeps getting better. Start-ups such as Finix, Payrix, and Infinicept, which each raised new venture rounds in the last 3 months, are also coming to market with their own PayFac-as-a-Service solutions to quickly stand-up payments capabilities for any aspiring Integrated Payments platform. Stripe may (soon) be the $100 billion gorilla, but it is not the only one in this race and the B2B software companies stand to benefit from the supply of alternatives.
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Disclaimer: The views expressed here do not necessarily reflect those of my employer.
