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The Truth About Credit Card Processing Services, Interchange Rates and Fees
Introduction: Interchange, Discount Rates and Tiered Structure
As a professional in the field, having worked for three separate processing companies of varied reputation, I have encountered numerous opinions and many misconceptions about the credit card processing industry as a whole and the legitimacy of card rates and fees in particular. I've spent countless hours researching processing companies on the Internet (the ones I have represented as well as the competition) to get a broad sense of their reputations, complaints against them and what they ultimately offer to merchants. The official name of the industry is, after all, "Merchant Services," so one would assume that they must offer something of value to businesses. So why is the industry apparently shrouded in mystery? It is often needlessly confusing and neither Visa nor MasterCard has made it any clearer with hundreds of different "interchange" fees that they pass along to the card processing companies that handle the transactions.
"Interchange" refers to the cost of moving money from one bank to another and is the basis for the oddly named "discount rate" that processing companies typically charge merchants. Without understanding interchange rates and why they differ from card to card, it is impossible to understand whether a pricing structure is actually appropriate for any particular merchant. This is what makes my job interesting and challenging, but also what makes many business owners not want to deal with changing their service — even when their deal is not particularly good. The confusion caused by the many interchange fees and the varied approaches of different processing companies, coupled with sales practices that are often either intentionally dishonest or simply under-informed, has given rise to a pervading sense of distrust toward card processing companies. Occasionally this distrust is deserved, often it is not. Even the best companies may have representatives in the field who lie or cheat to gain higher commissions than they deserve. It is a cut-throat job, selling credit processing service, because the market is over saturated; less ethical or less experienced salespeople often misrepresent their company's contracts, services and rates in order to make their sale. But the truth is, there is no "one size fits all" pricing schedule that fits every merchant.
An experienced representative of a card processing company can look at your statement and decipher the actual types of cards that a business typically takes, look over the average ticket costs and monthly volume and then figure out whether a tiered pricing structure or an interchange plus pricing structure would be the best place to start. If the representative has to call in to get rates and wants to pressure you into an immediate decision, chances are that you are dealing with an amateur. I have been that amateur, so I am fairly confident in saying this: once an ethical representative knows what he or she is doing and really understands the way the business works, there is no reason to pressure a merchant into an immediate decision and certainly no reason to call in for available rates. Yes, assigning a proper set of rates and fees to a merchant is based upon these various parameters, but if the company is operating above board their representative will already know what the best available rates are and will have the option to offer them.
Sales Tactics, Banks and Reputation
Sales representatives in the merchant services industry work on commission. This means that they have a built-in incentive to up-sell their products. Most of the companies they work for offer some combination of conversion bonus and residual income for every merchant that the salesperson sets up. Many of the companies also put a lot of effort into selling leases on terminals because this is a way for both the company and the salesperson to make a lot of extra money at the expense of a merchant who is just trying to have the tools to do business. I have sold a couple of these leases, and though they are occasionally the right choice for a business (leases are a tax deduction and can help get a business into a terminal they might otherwise not have been able to afford, as well as potentially looking good on a credit report for businesses suffering with low credit scores), leases tend to be a huge waste of money when not absolutely necessary. A business can still deduct the cost of a purchased terminal, though with depreciation, but the untold truth is that most salespeople grossly markup the sale cost of these terminals, too. Top of the line terminals generally cost under $600, under $1000 for wireless terminals, so any salesperson trying to get more than that needs to be questioned. In fact, the most popular terminals are under $300 and handle the most advanced card options on the market. Full blown POS systems are another matter and are generally supplied only by the companies that make them, and of course are much more expensive just as they are often very specific to different industries. Merchants must be aware of how sales representatives make their money just as they need to understand the nature of interchange fees as the costs of accepting credit cards are formulated.
Banks do not process credit cards, regardless of who's name appears on the top of the processing statement. Banks must outsource their processing to a third party and sometimes will change this third party without the consent (or even knowledge) of the merchants for whom the bank processes. Sometimes there appear to be good incentives for processing with a bank, but in general it is less about cost savings and more about simply being easier for the merchant to have gotten "everything" in one place. Banks do tend to be more expensive and perhaps have slightly less flexibility in their pricing options.
Every processing company has a "bad reputation" from some disgruntled merchant. The processing company I work with has an A+ rating with the Better Business Bureau, but that does not mean it hasn't had any complaints. In fact, the complaints tend to be similar to those from many of the less reputable companies out there and are often based in two areas: 1) unethical salespeople or sales practices and 2) a poor understanding of the either the agreement or the nature of the rates and fees. It is rare that the actual ability of a company to process cards is called into serious question. Unfortunately, it is also rare that a merchant takes the time to actually read their entire processing agreement and ask pertinent questions.
- Adventures in Merchant Services
After you finish this article, visit my blog to gain more insight into the industry. You can also contact me there with your questions or if you are seeking additional guidance.
Contracts, Rate Increases and Payment Structure
In this industry, it is typical that merchants are put under three year agreements. This is actually a good thing, if the rates are appropriate to the merchant. Those under month to month contracts are often subject to frequent rate increases or other costs to offset the processor's expenses. The upside to a longer agreement is that the rates and terms are in writing and therefore the merchant has protection against increased fees that are not directly attributable to new charges assessed by the card issuing companies.
Occasionally Visa, MasterCard or Discover will issue increases in their interchange fees or create something entirely new like the PCI (Processing Card Industry) security requirements that cause merchants to be charged for something that the processing companies do not control. The PCI standards must be enforced and compliance is mandatory, so no one escapes this cost, even though it now appears that merchants have an additional monthly or yearly fee.
Merchants are presented with many different offers and payment structures designed to make them feel that they are getting the best deal on the market. Often, however, a plan is presented that sounds appealing because it involves what appears to be cheaper even when it is more expensive. In order to know, it is important for a merchant to understand the reality of where or how much they are actually being charged for the processing service. In truth, processing companies make their profit based more on volume than rates — the profit margin for processing is extremely small. Sometimes, in fact, it makes sense for a processing company to offer the interchange fees with no markup at all, strictly passed through, because they are charging an inflated transaction fee that essentially jacks up their profit margin to the point where a merchant that believes it is processing for "free" is actually paying considerably more than the same merchant might have been paying under an alternative plan.
To illustrate this, I will discuss a restaurant I evaluated recently. This restaurant had a credit card revenue in excess of $40,000 per month, with many check cards being used as well as having many "rewards" or "business" cards in the mix. The merchant was being charged for the interchange fees and assessments at pass through (with no markup) plus $0.08 per transaction. This looked great on paper: "we won't charge you anything additional except a small eight cent fee per transaction." And it would be a good deal if it was the proper business for this plan, but in this case the average ticket was under $10 — meaning that the merchant was paying too much because of the inflated transaction fee. My immediate advice was to accept a small charge of 25 basis points, or 0.25%, on the interchange fees along with a lower $0.03 transaction fee. This is how the cost comparison would break down:
An $8 transaction charged $0.08 translates to a total of 1%. On the other hand, that same $8 transaction at 25 basis points, or one quarter of a percent, is a mere $0.02 plus the transaction fee of $0.03 for a total of $0.05, or 0.625%. Were the average tickets in this example of a higher dollar amount, it would have posed a progressively better deal, but one less likely to have been offered by any processing company because of the diminishing profits. There is some debate about where it is fair or appropriate for a processing company to take their profit from a percentage of the transaction or from the simple act of the transactions that they facilitate, but generally costs are balanced between the two. The fact is that transaction costs remain fairly static for processing companies, based on whether the transactions are processed over phone lines, an Internet connection or wirelessly and will range between just under $0.03 for an IP based transaction to $0.08 for one over a phone line and upward of $0.12 or $0.15 for a wireless connection. On top of this, of course, the card issuing companies have their own fees that are passed through, which usually are in the neighborhood of a dime or so. Because of this, it is safe to assume that in tiered retail plans, there is a hard cost of approximately $0.18 for every transaction, though the hard costs involved in the "discount rates" may be much more difficult to discern.
The actual hard costs passed along by Visa and MasterCard can be found here:
- Visa U.S.A. Inc. Interchange Reimbursement Fees | Merchants | Visa USA
View the interchange reimbursement fees applied on Visa financial transactions completed within the 50 United States and the District of Columbia.
- Rates| Support | MasterCard for Merchants | MasterCard Worldwide
MasterCard interchange rates are established by MasterCard, and are generally paid by acquirers to card issuers on purchase transactions conducted on MasterCard cards.
It takes some time to decipher the "transparent" information provided by these companies and even then a processing statement may prove nothing short of confusing to look at.
A bit of background on myself and the company I use to provide the card processing service:
I have a 20 year history in producing for the commercial and film industries, with a deep background in budgets and actualization, and expanded over recent years into providing consulting services to independent businesses and small companies. My interest in assisting local businesses that were hurt by the loss of so much film and video production to other countries led me to find small ways in which essential costs could be reduced; finding that many of my retail associates were being charged unusually high processing fees by their banks or processing companies, I began to explore associations with different processing companies. I have since worked with three different processing companies in order to learn the workings of the industry as well as find a solid company to partner with in order to fulfill my mission. North American Bancard has an A+ rating with the Better Business Bureau and offers the best range of service options and support that I have encountered — in addition to giving me an autonomous approach to setting up accounts with my clients.