Open Systems Model Cassone Ran

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Running head: Effectiveness in an Open Systems Model

Effectiveness in an Open Systems Model Solutions That Make Cents Marco Cassone Gil Ran

Dr. Ann Feyerherm MSOD 613 Pepperdine University December 7, 2012

Running head: Effectiveness in an Open Systems Model

U.S. consumers hold 609.8 million credit cards, nearly double the US population. 1 Roughly 80% of U.S. families use credit cards, average more than 3 per consumer. 2 98% of the total U.S. revolving debt is made up of credit card debt.3

Based in Torrance, CA, Merchant Solutions IQ, Inc. (MSIQ) is a privately held and

registered ISO (Independent Sales Organization) in the electronic payments industry, reselling processing services that allow merchant clients to process all forms of customer payment transactions. As an attractive, medium-growth industry, the environment is highly competitive and well-populated, arguably serving more merchants entering the market than ever before.
In the electronic payments transaction world, margins are small and accounts pay on a

monthly basis. Here the predominant ISO business strategy is to achieve protability through economies of scale, customer time on the books, and the up-sell of ancillary value added products. MSIQ forms and retains longterm client relationships in the role of expert consultant; sales agents analyze individual merchant needs in order to offer customized solutions that bundle small business services, like payroll management and POS (point of service) systems.
The combination of competitor price wars, emerging technologies, the rise of identity theft,

government regulation, complicated security measures, and the promise of developing markets all contribute to the highly complex and evolving landscape of risk management. An outside-in analysis using The Five Competitive Forces That Shape Strategy (Porter, 2008)4 shows how MSIQ strategic positioning is inuenced by the industrys external environment, general attractiveness, and overall protability. Later, an abbreviated inside-out analysis using the Open Systems Model (Cummings & Worley, 2009)5 shows how MSIQ strategic effectiveness is driven by the organizations internal design and subsystem alignment within the environmental context.
Porters rst competitive force, threat of new entrants, reveals several barriers to entry

that diminish industry appeal by giving advantages to incumbents relative to new entrants:

Running head: Effectiveness in an Open Systems Model

1. Supply-side economies of scale AND Unequal distribution access (Strong) -- Established ISOs meeting monthly sales quotas qualify for lower cost service from major processors (suppliers). 2. Demand-side benets of scale (Strong) -- Merchants trust/favor known resellers over unknown. 3. Customer switching costs (Medium) -- Cancellation fees are common, yet often covered by resellers as a cost of customer acquisition, requiring operational cash new entrants often lack. 4. Capital requirements (Medium) -- While the setup costs for independent agents are minimal, a signicant capital investment [estimate of $2M6] is required to launch an ISO like MSIQ.
According to Porter, these advantages for incumbents at the level of MSIQ should increase

potential protability and decrease industry appeal to prospective entrants at a similar level. At the individual level, however, new independent agents face few barriers and minimal startup costs, which explains the higher perceived appeal and subsequent proliferation of single resellers, who collectively congest the market and diminish potential prot.
Looking through Porters lens, bargaining power of suppliers describes the advantages

and strengths suppliers have as a competitive force affecting protability and ISO strategy: 1. Supplier switching charges (Weak) -- Suppliers are non-exclusive and charge no switching fees. 2. Product differentiation (Weak) AND Supplier substitutes (Medium) -- Government regulation limits new product/platform development; existing products and services are functionally similar. 3. Supplier entry into industry (Strong) -- Some suppliers (FirstData, for example) have integrated forward to create their own independent sales force competing directly with their ISO clients.
Though predominantly weak in overall supplier power, the desire to gain market share by

new independent entrants and large supplier sales efforts does put industry-wide pressure on prices, ultimately decreasing margins and protability for everyone.
A tough challenge resellers face is a unique form of Porters third competitive force, the

bargaining power of buyers. Merchants (buyers) see card processing as a necessary evil -confusing, deceptive, and costly -- a bias making them virtually unapproachable by sales agents.

Running head: Effectiveness in an Open Systems Model

1. Buyer price sensitivity (Strong) AND Standardized, undifferentiated products & services (Strong) -Merchants predominantly focus on cost, which undermines any affects of product differentiation. 2. Buyer switching costs (Strong) -- Switching costs are often covered in order to acquire clients. 3. Affects on buyer costs AND buyer output quality (Weak) -- Few affects on merchant business.
A dominant factor in risk mitigation is the rise of fraud and identity theft, resulting in

government regulation, costly protective safeguards, and complicated fee structures riddled with hidden fees. MSIQ strategy accounts for general industry mistrust by establishing trusted clientconsultant relationships. Their open-book disclosure of all costs and prot shows merchants what theyre actually paying for, enabling longterm savings via smarter products and services.
Porters fourth competitive force, threat of substitute products or services, is low.

1. Price-performance trade-off (Weak) -- Customers prefer multiple, cash-free payment options. 2. Buyer cost of switching (Strong) -- Cash-only sales can signicantly decrease merchant revenue.
With so many different kinds of transactions (swipe, online, mobile wallet, etc.) on different

technology systems (Square, card terminals, virtual gateways, etc.) serving diverse businesses in many industries (from retail to restaurants), government regulation impedes development of new substitutes as a security measure -- a favorable inuence on potential protability.
Industry rivalry among existing competitors shows a highly competitive environment:

1. Number and size (Strong) -- Relative to MSIQ, competitors are numerous and similar in size. 2. Industry growth (Medium) -- Protability is predominantly compromised by price wars. 3. Exit barriers (Weak) -- Exit barriers are very low, especially for individuals and smaller ISOs.
Apart from xed costs (payroll, rent, etc.), marginal costs for the industry are generally low;

more companies are passing costs through to clients using Cost-Plus pricing (i.e., Cost+0.50%). In todays economic environment, however, merchants must capture revenue any way they can, and younger consumers like payment options. Competitor price wars aside, consumer behavior and demand by new businesses continue to foster moderate growth in the industry.

Running head: Effectiveness in an Open Systems Model

To summarize using Porters framework, electronic transactions is a highly complex, yet

attractive industry. Despite ISO saturation, however, emerging technologies, developing markets, and steady industry growth all suggest there is still money to be made. As crime sophistication increases, risk analysis must consider many kinds of transactions, consumers, merchants, and technologies, all requiring specic (and costly) security protection. The resulting price schemes are so convoluted, merchants often cannot read their billing statements. Aggressive sales tactics, hidden fees, and bait-and-switch deals further portray the industrys dark, opportunistic side.
Here is the clearest example of the inuence of environment on strategic position. Against

this unscrupulous backdrop, MSIQ brands itself as a solutions provider. Acting as consultants, sales agents try to reduce costs by educating merchants on their true card processing needs. MSIQ differentiates itself by squarely confronting industry mistrust; the company guarantees against hidden fees or rate changes and uses transparent pricing to remove information advantage. Beyond addressing pain points, merchants learn about new revenue streams available through add-on products and services (core to MSIQs strategy), such as POS solutions, gift cards, loyalty programs, and their capital funding program, which provides upfront cash leveraged against future sales. The combination of cost-savings, transparent pricing, trusted relationships, and new, potential revenue gives MSIQ a very strong strategic position in the industry.

All organizations are perfectly designed to get the results they get.7 As a framework, Porters Five Forces presents detailed analysis of environmental forces that

shape MSIQ strategy and position. Effective business output, however, is not solely a matter of strategy; it is tied to organization design and the alignment of inner design components to each other and to the outer environment. Switching frameworks, Open Systems gives an overview of MSIQs process-oriented design, its strategic alignment, and its overall effectiveness.
Following the framework presented by Cummings and Worley (2008)8, strategic orientation

considers ve major design components, the rst of which is strategy. Building on positioning

Running head: Effectiveness in an Open Systems Model

framed using Porter, a systems lens helps identify alignment within an organization. MSIQs mission, goals, and functional policies, for example, collectively target integrity, loyalty, and competitive prices; transparent negotiations and prot ceilings are examples here of aligned functional policies. With narrow margins, economies of scale are achieved cumulatively over time, suggesting client trust as a possible driver (or at least motivator) of effectiveness. A direct output of MSIQ strategy is their unusually high retention rate -- over 97%, as compared to the industry average of 77%-80%. 9 Organizational effectiveness can be perceived in strategic alignment and measured in performance: MSIQs annual growth rate last two years is 30%. 10
The second design component, technology, is the core transformational function in open

systems. This is especially clear with technology-based products and services. When a customer presents a credit card for payment, an immense amount of activity occurs in under a second to authorize the purchase and ensure merchant payment. Additionally effective design components are MSIQs proprietary CRM software (customer relations management) and fully integrated technology systems that seamlessly coordinate sales and marketing teams, merchant and consumer needs, and massive information processing (including a call center in the Philippines).
Effectiveness in the third design component, structure, requires close alignment with the

organization technology systems that support business objectives and day-to-day operations. MSIQ is at in shape, allowing enough decentralization to give agents tactical independence to work directly with clients on customized order packages. The highly regulated and scrutinized steps in qualifying an order, however, do require more centralized cross-functional coordination. Effectiveness in structural integration for MSIQ is most evident in the seamless user experience across products, processes, and platforms. Differentiation in the formal structure is partly based on process (verication vs underwriting) and on function (sales vs operations). This hybrid design can be viewed in the MSIQ organization chart at the end of this document.
The fourth design component is measuring systems, which are directly related to system

feedback that enables adaptation (learning). In compliance with heavy industry regulation, it is

Running head: Effectiveness in an Open Systems Model

vital for MSIQ to monitor vast company accounts and residual streams originating from different processors. As the lifeline of the business, residuals also require precise, complicated calculations involving individual overrides, nancial bonuses, and performance benchmarks. Unlike a majority of competitors, MSIQ practices an open book policy to give managers access to internal reports and incentive calculation methods, and to encourage trust in the family business. Transparency and directness are integrated into the company mission, leadership style, culture, functional policy, and measuring systems, as well as the fth design subsystem: human resources.
In the processing world, it is common for individual agents to build client portfolios of their

residual streams. MSIQs compensation plan is extremely competitive compared to the industry, utilizing a transparent 60%-40% prot share between agent and MSIQ respectively. Unlike most competitors pushing sales by any means, MSIQ human resources promotes agent training and development, as well as a learning culture built on family values and ethical behavior. The organization comprises dozens of independent agents across the country, but there are only seven full time managing MSIQ employees, three of which currently pursue graduate study in organization development and management. Academic inuence streamlines company best practices and creates an atmosphere fertile for innovation and change. The primary inuence on MSIQ culture is the strong set of values of its president, who supports and encourages trying new ideas that make cents. He continuously mitigates shareholder demands to protect the steady growth of the organization.
Effectiveness in an open system model takes a panoramic view of alignment across all

subsystems of organization design in relation to each other and to the environment. MSIQs mission, values, culture, leadership, structure, functional policy, and practices are congruent. The company has demonstrated 30% sustainable growth and is effectively poised to expand into front-end processing. To an industry of risk, competition, price wars, small margins, mistrust, and opportunistic rivals, MSIQ brings the design, strategy, values, and alignment capable of turning environmental complexity into solutions that make cents.

End Notes

Federal Reserve Bank of Boston. (2010). The Survey of Consumer Payment Choice. Retrieved from: http://www.creditcards.com/credit-card-news/credit-card-industry-facts-personal-debtstatistics-1276.php#ixzz2E8GkGJZR
1

Braintree Payment Solutions. Merchant Account Basics. Retrieved from: https:// www.braintreepayments.com/assets-12f1dabfb6/assets/307/Merchant-Account.pdf
2 3 The

Federal Reserve. (2012). G.19 Report On Consumer Credit. Retrieved from: http:// www.creditcards.com/credit-card-news/credit-card-industry-facts-personal-debtstatistics-1276.php#ixzz2E8GsrZhs Porter, M. (2008). "The Five Competitive Forces That Shape Strategy," Harvard Business Review, Vol. 86, Issue 1: 78-93
4

Cummings, T. and C. Worley. (2009). Organization Development and Change (9th edition). Southwestern: Engage Learning, pp. 89-91
5
6

Interview with G. Ran, MSIQ Director of Business Development. December 2, 2012. Hanna, D. Self quote on The RBL Group website. Retrieved from: http://dave-hanna.net/

7 8

Cummings, T. and C. Worley. (2009). Organization Development and Change (9th edition). Southwestern: Engage Learning
9 Adler, J.

The War on Attrition. Digital Transactions blogpost February 2011. Retrieved from: http://www.digitaltransactions.net/news/story/2906
10

Interview with G. Ran, MSIQ Director of Business Development. December 2, 2012.

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