As ISVs disrupt payments, can merchant acquirers stay relevant?

The US merchant acquiring business is facing unprecedented challenges, especially in the key small-business segment. Of the industry’s estimated revenues—more than $30 billion—nearly two-thirds comes from small businesses,1 but in recent years, this revenue source has come under threat. Integrated software vendors (ISVs) have been grabbing market share with software-driven, digitally savvy, point-of-sale solutions that help small-business merchants not only accept payments but also manage their business more effectively.

To determine how widely small businesses (those earning less than $10 million in annual revenues) have adopted ISVs and to discover the source of their appeal, McKinsey surveyed over 800 businesses in its annual Merchant Acquiring Survey. The survey revealed that ISVs are rapidly encroaching on incumbent acquirers’ market share. In addition to providing business management capabilities, ISV solutions are driving up adoption by offering ease of use, relatively low transaction costs, and value-added financial services, such as accounting and payroll.

As the acquiring industry becomes increasingly digital, the movement of small businesses toward ISVs will likely continue. But incumbent acquirers and other players can still act on several opportunities for growth—if they move quickly.

The ISV challenge

ISVs compete with legacy point-of-sale solutions by offering a fundamentally different value proposition: Rather than just processing payments, they aim to help small businesses manage their operations easily and digitally. With this value proposition, ISVs have captured significant market share relatively quickly.2Merchant acquiring and the $100 billion opportunity in small business,” McKinsey, October 11, 2021. Our survey found that about 50 percent of small businesses now use ISVs as payment providers, and 15 percent are in the process of transitioning to an ISV provider (Exhibit 1). The survey also found that ISVs are the overwhelming choice for new businesses, which are forming at a record-breaking pace in the current economy.3 Together, this evidence supports the expectation that ISVs will continue to gain share.

Many small businesses have already begun using integrated software vendors (ISVs).

According to survey respondents, ISV solutions are appealing not only because they help merchants manage their business better. They satisfy additional small-business needs: they are easy to set up and use, and payment acceptance costs are both lower and more transparent than those offered by incumbents.

Across all industry verticals, the ISVs most used by small businesses are Square and Clover, our survey revealed. Toast is a close second in the food and beverage industry, where overall ISV adoption stands at about 65 percent.

What merchants want

Small businesses are increasingly drawn to ISVs by their growing lists of value-added services, which enable them to consolidate their business with a narrower set of providers—which in turn creates new revenue streams for ISVs. Seventy percent of the small businesses we surveyed use at least one value-added service from their payments provider, and respondents express interest in purchasing additional services in the future. Among such services, small businesses are most attracted to business credit cards (which appeal to 40 percent), fraud management (37 percent), and accounting solutions (33 percent) (Exhibit 2). Respondents at small businesses indicate that they are willing to spend a total of $10,000 annually on such services.

Value-added financial services are seeing significant demand among small-business merchants.

At present, nearly two-thirds of small-business merchants already use value-added ISV services at the point of sale (Exhibit 3). Of these merchants, about 10 percent use five services or more.

Among the two-thirds of small-business merchants using value-added services at point of sale, about 10 percent use five or more services.

Small businesses that currently use non-ISV payment providers are almost three times more likely to switch to ISV providers in the coming year than those who are already using ISVs are to switch to a new ISV. In short: incumbents should expect to face continued significant attrition to ISVs.

The future is omnichannel

As more customers seek to transact digitally, small businesses are adapting practices to enable seamless digital transactions. Their payment solution providers must do the same. Among the small businesses we surveyed, 35 percent described themselves as “omnichannel,” with more than a third of their sales volume coming from e-commerce. Typically, merchants report using three or four channels, across products and sectors served (Exhibit 4). Small businesses selling online say that about 40 percent of their sales come from transactions outside their own website—for example, from customers who buy online and then pick up their purchases in the store or customers who buy online from third-party resellers.

Across verticals, most small merchants use three or four payments channels.

This channel proliferation requires that acquirers also operate in omnichannel mode. Doing so would include offering certain value-added services, such as inventory management and order management, that are particularly relevant for omnichannel merchants.

Challenges and opportunities for acquirers and others

While incumbents are under pressure from ISVs, the current trends present challenges and opportunities for all types of players in the payments market.

Incumbent acquirers

For incumbent acquirers, the potential disintermediation of relationships by ISVs is a significant threat. Almost 50 percent of smaller merchants are already using ISVs as their primary payments provider, and even more are considering moving to ISVs. In most cases, even when small businesses use ISVs, incumbents do the actual processing of transactions—a function that generates only nominal per-transaction fees, as it can be provided by most large-scale processors, and has become commoditized. In other words, incumbents keep small merchants’ volume but lose most of the revenue opportunity to the ISVs that own the merchant relationship.

Moreover, many ISVs are starting to move upmarket. While small businesses dominate ISVs’ customer base, approximately 20 percent of the emerging, survey respondents at midsize businesses (those with annual revenues of $10 million to $50 million) also have adopted ISVs. As ISVs continue to expand their offerings, they will meet the needs of larger, more complex businesses and disrupt incumbent relationships.

To defend their position, some incumbents, including Elavon and Global Payments, have acquired ISVs. Fiserv took a different approach and built its own ISV, called Clover. Incumbents can also consider improving their existing solutions to offer more functionality, easier implementation and use, and more fee transparency. These strategies can help incumbent merchant acquirers reestablish direct relationships with small merchants, thereby enabling the incumbents to upsell value-added services. But competing with ISVs as a group can be difficult, as they tend to specialize in verticals. It is hard for any provider—incumbent or insurgent—to be best in class in every vertical.

Acquirers can consider a third opportunity: partnering with ISVs. This approach usually is mutually beneficial: The ISV brings business functionality to the table, while the incumbent brings distribution and processing scale. Many incumbents already process transactions for ISVs and thus deliver services including submerchant risk checks, onboarding, and reporting. But without a formal partnership, those back-office functions see price compression, and the incumbents do not receive a share in the revenues from value-added services.

Banks that serve small businesses

ISVs also pose challenges to banks that serve small businesses. They are becoming lenders by embedding financial services into their offerings and integrating them with adjacent software, such as accounting or expense management applications. For example, Square offers lending products and demand-deposit accounts (DDAs). This strategy provides merchants with “business in a box” tools to help them manage their operations.

Even if banks modernize their offerings, they may struggle to win back their share of the acquiring business from ISVs. Some 70 percent of ISV users from our survey say they are unlikely to switch providers. Once a merchant has adopted an ISV’s software and value-added services, converting that business to another provider is typically difficult without a compelling value proposition that outweighs the onerous task of switching.

All is not lost for banks, however. They can leverage their “gateway” position as providers of DDAs for small merchants to offer additional products, such as cash-related services. DDAs remain a core product for any business, and although cash use is declining overall, it remains essential for merchants who operate in certain verticals, such as the food and beverage business. By offering cash-related services that ISVs cannot provide, banks could potentially cross-sell acquiring services to smaller merchants at a relatively low cost.

About 20 percent of the small businesses we surveyed say familiarity or prior experience with their provider was an important key buying factor in choosing a solution. An additional 12 percent of small businesses say they want the same provider for both banking and payments services. If banks can deliver digital experiences on par with ISVs, they have an opening to beat the ISV competition.

Integrated software vendors

Although ISVs are steadily winning market share, they also face challenges in today’s market—namely, increasing competition and diminishing paths for growth. ISVs have penetrated about 50 percent of the small-business market and 65 percent of the food and beverage industry, but if they want to keep growing, they must penetrate other verticals, such as consumer health and healthcare, or sell more value-added services.

New entrants will likely struggle as leading ISVs continue to invest, but even these leading companies are not safe: Emerging ISVs will likely focus on narrower subverticals. For example, Square and Clover are being challenged by Toast and Mindbody for share in the restaurant and salon spaces, respectively. Some ISVs are concentrating on even smaller categories, like pizza restaurants, car washes, dry cleaners, or flower shops. The same formula that allowed Square to displace incumbents is now letting newer companies penetrate underserved subverticals.

ISVs may gain further share by taking advantage of several opportunities. First, they can capture more wallet share by continuing to embed value-added services into their offerings. As evidence, a third of small businesses surveyed say they appreciate value-added financial services, such as accounting solutions and business credit cards. Offering more of these services will allow ISVs to capture more of their customers’ non-payment-related spending, which averages about $11,000 annually for each small merchant.4 Value-added services may be developed internally, sourced from a partner, or acquired through M&A; various companies have successfully pursued each of these strategies.

ISVs may also target underpenetrated verticals and move upmarket. For example, the consumer health and healthcare space is still underpenetrated; only about 30 percent of these businesses have adopted ISV services. ISVs may grow their share among midsize businesses as well. Toast, for instance, is embarking on an initiative to serve hotel restaurants, which have specialized needs, such as providing room service. Moving upmarket will allow ISVs to build scale. Additionally, ISVs may choose to focus on subverticals where targeted customization can make them a category leader.

In yet another opportunity, ISVs may partner with incumbent providers to leverage their distribution networks. While ISVs have achieved success through self-service or offline sales processes, 40 percent of the small businesses surveyed say they purchased their services through a salesperson or payments consultant. Partnerships could leverage incumbent companies’ broader reach to drive growth for ISVs.


Investors have a new set of decisions to make. They must refine their strategies as competition for a small set of ISV “winners” intensifies. Most of these companies are already public and are themselves buying smaller ISVs. This situation puts pressure on valuations in the next tier down, where many ISVs may focus on narrower subverticals with smaller total addressable markets. Among ISVs that are already public, valuations are under pressure from a decline in the general market—which could open the door to leveraged buyouts.

In this shifting landscape, investor profit may be found in identifying attractive niches that may be ripe for consolidation. Strategies to identify these may include looking at verticals or subverticals that are rapidly adopting ISV services, such as consumer health and healthcare. Investors may also choose to pursue a consolidation strategy that aggregates ISVs across verticals to achieve greater scale, especially in areas like value-added services. Lightspeed and Global Payments, for instance, have successfully pursued such M&A strategies, while Square has achieved the same ends organically.

Time is of the essence

The merchant acquiring space is clearly undergoing profound change as ISVs gain market share. Up to 50 percent of small businesses have adopted ISVs’ software-driven solutions, so the acquiring market may have reached the steepest point on the adoption curve. When adoption begins to plateau, the window of opportunity will start to close, and incumbents and other players will be left to fight over market share and/or late adopters.

Nevertheless, industry players still have opportunities to compete and win. While the movement toward ISVs creates significant challenges across the entire acquiring ecosystem, providers, banks, and investors that act quickly can seize opportunities for growth—and avoid being left behind.

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