Executive Cases: Interviews with Senior Executives of Early-Stage Companies:
Heartland Payments Systems – USA
Prepared by George Foster
In 1997, Heartland Payment Systems opened its doors with a modest plan: provide fair, honest and fully disclosed card payments solutions to help businesses prosper. In the ensuing 16 years, Chairman and Chief Executive Officer Bob Carr transformed the fledgling credit card processing business operating out of his basement into a national payments leader. Heartland has been named a Fortune 1000 company several years running; climbed the rankings of processors from number 62 to number 5 in the nation, and number 9 in the world; grew from 25 to 3,000 employees, from serving 2,500 to more than 250,000 business locations; and from a portfolio of US$ 0.4 billion in annual bankcard volume to more than US$ 80 billion. Today, Heartland processes more than 11 million transactions a day and more than 4 billion payment transactions each year.
Building upon its foundation of credit/debit/prepaid card processing, Heartland’s portfolio now includes a full suite of merchant business solutions including mobile commerce, eCommerce, marketing solutions, security technology, payroll solutions and related business solutions. Heartland serves a diversified customer base spanning a broad range of industries including retail, restaurant, lodging and hospitality, and petroleum, as well as convenience stores, campuses, public schools, and laundry and vending businesses, among others.
Robert H. B. Baldwin Jr is Vice-Chairman of Heartland Payment Systems Inc. He joined Heartland as Chief Financial Officer in 2000 and was promoted to President in 2007. During that time, he was instrumental in helping the company raise US$ 40 million of private equity in 2001 and taking the company public on the New York Stock Exchange in 2005. Baldwin serves on the Board of the Electronic Transactions Association. Prior to joining Heartland, he served as Chief Financial Officer at COMFORCE Corporation, a publicly traded staffing company. From 1980 through 1998, he was an investment banker with Citicorp and Smith Barney, where he served as a managing director in Smith Barney’s Financial Institutions advisory business. He holds a Bachelor’s degree in history from Princeton University and an MBA from Stanford University.
Q1: What was the source of the initial idea, and how did that idea evolve into a viable, growing company? How did it change over time?
Carr: “With the late 1970s advent of microcomputers, I focused on building some of the first-ever accounting applications for small businesses using these low-cost computing devices. After two or three years developing general ledger, payroll, accounts receivable and accounts payable systems, I began focusing on the vertical market of small oil jobbers and developed the first-ever pay-at-the-pump software to integrate to a microcomputer invoicing and accounts receivable system. One of my clients asked, “If you can capture and bill these private-label trucking transactions, why can’t you handle the credit card payments at the gas pump as well?” This gave me the idea of submitting credit card transactions for settlement to the Visa and MasterCard agencies, and that idea became the genesis of building Heartland Payment Systems.
“I realized soon that this business could be very profitable. Not long after, I learned why it could be so profitable but that the industry had a crooked reputation. Many credit card sales organizations were taking advantage of merchants, realizing windfall profits from deceptive pricing schemes at the expense of unsuspecting business owners. Unwilling to go against what I knew was the right thing to do, I set out on my own, committed to building a business the honest way.
“When I founded the company with Heartland Bank, Heartland was the new kid on the block. In many ways, that worked to our advantage. Business owners were sick and tired of dealing with deceptive companies and highly receptive to a processing model that was based on fairness and transparency. We established Heartland as a merchant advocate, a true business partner. This founding principle continues to fuel Heartland’s growth today.”
Q2: What were the major growth accelerators for your company in the early years of high growth?
Carr: “We recognized early on that ‘feet on the street’ would be Heartland’s ticket to growth. We needed a team of serious sales professionals to serve as Heartland’s ambassadors and bring our unique value proposition to merchants in local communities across the country. Offering one of the most compelling compensation models in the industry with portfolio-based equity, signing bonuses and lifetime residual payments, and the satisfaction of representing an ethical company, we aggressively built a national sales force of employees that are accountable and personally invested in Heartland’s success.
“Our decision in 1999 to focus on restaurants enabled us to become vertical experts and penetrate the industry with great success. It lay the groundwork for the portfolio of more than 60,000 restaurants that we serve today and our exclusive endorsements by the National Restaurant Association and 46 state restaurant associations.
“Additionally, the 2003 class action settlement between Visa/MasterCard and Wal-Mart that called for hundreds of millions of dollars in interchange fee reductions elevated awareness of the need for transparency in payments processing and created an environment that was receptive to Heartland’s existing value proposition of fair dealings. Our new merchant installs grew dramatically when we passed through the entirety of the reductions to our merchants.”
Q3: What role did key aspects of the entrepreneurial ecosystem surrounding your company play in the growth of your company?
Carr: “The market was really ready for a different approach. For the most part, sales in the industry were based on deceptive practices and misleading pricing, leaving many merchants disgruntled and looking for a better alternative, which they found in Heartland.
“Our differentiated model was not only attractive to merchants but also to sales professionals who could be proud and feel good about the company they represent, and who had the opportunity to build significant wealth with our attractive, uncapped compensation plan.
“Funding was a bit of a roller-coaster ride. In addition to the US$ 1 million that Heartland Bank invested to co-found the company, they provided about US$ 7 million in debt financing to help fund our initial growth. In December 1999, they dropped the bomb that they had to withdraw all advances to non-banking clients before year-end, forcing us to pursue outside sources of capital, fast. We ended up selling one-third of our merchant portfolio to a third party, and repaid the debt on 31 December. Needless to say, our relationship had changed, so we then undertook a management buyout, in which I granted Heartland Bank rights to the cash flow from half of our merchant portfolio in exchange for their 50% ownership in the company. The environment was imperfect, but with complete control over the business, it did enable Heartland to access the private equity ecosystem, which ultimately allowed the company to flourish.”
Q4: What key aspects of the entrepreneurial ecosystem surrounding your company that were absent (or existed only in a weak form) created the greatest challenges for growing your company? Please describe and discuss how you met/were impacted by these gaps in the ecosystem and their resultant challenges.
Baldwin: “Funding was one of the most challenging aspects of the business in the early years of the company. Our original partner shared our vision but did not have the wherewithal to support our aggressive growth. With the unexpected withdrawal of our funding source, we found ourselves in extreme circumstances and were forced to struggle daily with short-term survival, even turning to a last-resort, high-rate lender at one point to keep the business alive. The portfolio sale and buyout created complexity in our financial reporting, which substantially delayed the introduction of adequate capital from other third parties. This could only be resolved over time as the owned portion of the portfolio became more significant.”
Q5: At what stage did you invest significant resources seeking to grow your company internationally/beyond your domestic country or region? What factors were pivotal in deciding when to seek growth internationally and where to seek that growth?
Baldwin: “A number of large organizations influenced Heartland’s predominant domestic growth, including:
“1. Banks. Co-founder Heartland Bank was integral in Heartland’s formation, yet also a source of financial distress and instability when forced to abruptly withdraw funding and loans. Sponsor banks are also important partners that enable Heartland to operate by accessing Visa and MasterCard’s networks.
“2. Competitive processors. Until we developed our proprietary processing engine, Heartland was entirely dependent on outsourcing our processing activity to large, competitive processors. While ‘co-opetition’ is regularly seen in our industry, reliance on such third parties inevitably limited the solutions we could offer to our clients, and we moved as quickly as was practical to build our own platforms.
“3. Card brands. By charging identical rates for interchange (paid to the issuing banks) and their fees and assessments, Visa and MasterCard set a level playing field for all acquirers and immediately enabled Heartland to compete with larger, more established acquirers. Beyond sponsor bank requirements, the absence of regulatory obstacles as a non-bank offered us the freedom to operate in an entrepreneurial manner and manage the company according to our own plan.
“Ironically, we have found that competing against much larger and more established companies has not represented a major barrier to success. Our major competitors are either large banks, which have powerful brands that attract customers but do not have strong sales cultures, or companies that have outsourced their sales to independent agents who they cannot control. Being vertically integrated, and in particular maintaining control over our sales force, has allowed us to thrive against all of the larger incumbents.”
Q6: What were the biggest challenges in building growth internationally? How did you meet or adapt to those challenges?
Carr: “While we have grown the business significantly over the past 16 years, Heartland still only represents approximately 3% of the total US processing market, leaving substantial opportunity for domestic growth. The opportunity to bring our everyday low-price, transparent approach to merchants will only increase as demand for electronic payments continues to grow in today’s increasingly cashless society. If and when an opportunity exists for us to garner international expertise, we will consider expanding into other countries.”
Q7: What major role, if any, did key aspects of the ecosystem in the country (or countries) you first sought international growth either promote or impede your ability to grow in those international markets?
Baldwin: “The factors that were most instrumental in fostering an environment that was so conducive to Heartland’s successful growth in the US, including an aggressive sales culture that fed our sales organization, are not frequently seen in other countries. Historically, thousands of US banks did not have the capacity or interest in taking care of merchants’ card processing needs, which created a vacuum that independent acquirers like Heartland filled. However, in most other countries, there are a handful of large banks that dominate the marketplace and leave little room for smaller, entrepreneurial companies to compete with them. With Visa and MasterCard’s requirements that acquirers partner with domestic sponsor banks in each country that they operate, these banks are the gateway to business and can easily prohibit non-bank competitors from playing the game. This very situation happened in the late 1990s when Heartland expanded into the Caribbean and experienced early success. Local banks refused to partner with us and reported us to the card brands, forcing us to cease operations in the region.
“Looking forward, we do think our status as one of the largest transaction processors in the world, with one of the most modern and secure platforms, could allow us to enter into joint ventures with international parties that have good access to the markets but lack the technology to compete effectively.”
Q8: Seeking international growth often has both high moments and dark (low) moments. Briefly describe one high moment and one dark (low) moment in seeking international growth.
Baldwin: “The successful US$ 40 million funding from two private equity firms in 2001 was clearly a high moment. Our sales model had succeeded, we were just going live with our new processing platform. But the buyout of our former partner left us in a financially weakened position, and had introduced tremendous complexity to our financial statements, which made financing discussions very challenging. Add in the bleak post-dot-com funding environment, and we faced a real risk of having to meaningfully reduce our sales and operations. By mid-2001, though, the complexity began to ease, allowing investors to appreciate the fundamental strengths of the company and model, and we secured commitments for funding in August. Even then we faced a setback: closing was scheduled for mid-September, but the 9/11 tragedy immediately shut down much economic activity and the deal was put on hold. Fortunately, we could demonstrate how business was returning day by day, and two private equity firms stuck with us (Greenhill Capital and LLR Partners). On 11 October we closed on the first significant PE funding following 9/11.”
Carr: “The year 2009 was one of the most challenging in Heartland’s history. We discovered a criminal breach of our payment system environment, and the company that we had worked so hard to build was in jeopardy. Our stock price plummeted from about US$ 16 per share to US$ 3.42. Our business was at risk. Our reputation was at risk. Our merchants and customers were at risk.
“But rather than sweep the news under the rug like other organizations that found themselves in similar situations, we went on the offensive, publicly sharing details of the breach and mobilizing the entire Heartland team to create a strategy that focused on the best interests of our customers, business partners, employees, investors and the company at large. Within three days, Heartland, myself included, contacted the majority of our merchant customers to explain first-hand what happened. Our dedication to transparency, even in the face of adversity, enabled us to emerge from the breach stronger than ever and well positioned for future growth. We also took a leadership position in advocating for increased data security in the face of ever-more-aggressive attempts to steal card data. We drove the formation of the Payments Processor Information Sharing Council to share information on potential threats, and introduced our E3™ End-to-End Encryption solution to the market that allows merchants to render this valuable data unusable by any hacker.”