In thinking about any product or service, demand for that product and the supply of it balance each other at a point that is the market clearing price. At that price, suppliers are willing to make enough goods to satisfy demand but not more than that. Likewise, buyers are willing to purchase that amount but not more. Lower the price, there's more demand. Raise the price there's less demand. Here it is graphically:
The slope of the Demand line shows how sensitive the buyer is to price. A steep downward line to the right shows lower price sensitivity while a shallow line shows more.
This is the kind of thing that any sales person knows instinctively - if you charge less, more people will buy your product. This kind of graph becomes more useful when you're thinking about how to maximize the profitability of your company and set prices according to that goal. You want to make the most amount of money you can with the least amount of work. For example, it may not be worthwhile to satisfy all the demand out there. If the goods you are selling are expensive to make, and the profit on each item is large, then make fewer and you'll make more money. Think fine art. Likewise, if the product is cheap to make and there's not much profit in each one, then make lots of them to maximize profits. Think chewing gum.
How does this relationship work in the acquiring business? What's the mathematical relationship between price and demand in our industry? How can you maximize profits by moving price up or down and drawing in more or fewer merchants as a result? Is a lower price and more merchants better than a higher price and fewer merchants?
I did some basic work on the relationship between price and demand in our business. I want to say at the outset that any analysis like this is imperfect. The purpose of this article is to provide a way of thinking about this relationship rather than a definitive statement about the precise nature of the tradeoff between demand and supply in our business.
There are factors at work in the acquiring business that make supply basically infinite - it's not hard to add more transactions to a network for example. Furthermore, in today's world, merchants basically must have processing capability. You simply can't function without it. But that doesn't mean merchants are immune to price changes. Quite the opposite. Sales experience would suggest that merchants are sensitive to price changes over time, especially given two new factors at work in the business: the transparency of information (online availability of interchange tables for example) and the growing sense of commodity status of processing. I think the basic calculation about price sensitivity is simple, if merchants think the price benefit is worth the switching costs and hassle, they will switch.
Merchants react to higher prices not by dropping the service, but by switching vendors. The questions we're left with are: how sensitive are they to price changes and how do we manage a customer base to maximize profitability. Does that relationship change over time?
Rather than try to figure out what the actual price sensitivity of merchants is in the market, which is something that would take millions of data points to really pin down, I looked at the trade off between merchant count and price increase in a theoretical sense. For example, let's say you have 1,000 merchants in your base and each one produces $50 per month in gross revenues for a total of $50,000 per month. Our goal is to maximize profits - basically, making the most money with the least cost. So you need to know what the merchant reaction will be to various price increases you might make. Unfortunately, the only real way to find out is to make the change and see what happens.
Lacking that kind of real world data leads to speculation about what merchants will do and the trade offs inherent in price changes. The place to start is with the combinations of price increases and merchant attrition that balance one another. In other words, if you lose some merchants because of a price increase, but the rest stay and accept the increase, you may come out with the same revenues as before. Is that good or bad? You have to decide for yourself, but if the merchants who left were in some way troublesome or expensive to keep up and you can shed that cost, then this might be the kind of move that increases profits overall.
The minimum goal should be to keep revenue flat while increasing prices. So, I looked at the combination of variables that yield a flat price and came up with this relationship:
Price Increase(%) = - Cancellation(%)
This relationship says that for every one percent increase in overall price will generate a one percent loss of customers (negative one percent, that is). To state this a different way, in order for revenues to hold steady, merchant cancellations need to be in the same proportion as the price increase. The difficulty is that while you can know the amount of the price increase, you can't necessarily
predict the amount of merchant cancellations. This is a one-time loss of customers related to the price increase only, not in addition to ongoing attrition month to month. So, for
the theoretical 1,000 merchants, if price went up 1%, and 1% of the customers cancel, then after the increase, there are 990 customers generating $50.50 each, or $49,995 in revenues - about flat.
(The relationship is not absolutely linear, and because merchants are whole units, this is about as close as I can get.) I call this the equilibrium amount.
Here's the point: if you raise prices and cancellations are LESS than the equilibrium amount, then you are going to generate more revenue than before the increase. Raise prices and cancellations turn out to be MORE than the equilibrium amount, then you're going to have less revenues.
Represented graphically, the relationship looks like this:
Above the blue line, you're a winner, below, you're a loser. It all depends on how the merchants react. 
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