If you’re a new business owner, you’re probably new to the world of credit card processing. Many business owners we encounter have little to no idea what interchange fees are and how many different entities are involved for businesses to have the ability to accept credit and debit cards. In this article, we’re going to help explain the basic ‘stuff’ you need to know: what interchange fees are, what a typical transaction looks like and the pricing options you have for your business.
What are Interchange Fees?
Interchange fees are transaction fees that the merchant’s bank account must pay whenever a customer uses a credit/debit card to make a purchase from their business. The fees are paid to the card-issuing bank to cover handling costs, fraud and bad debt costs and the risk involved in approving the payment.
How Many Entities are Involved in a Single Transaction?
Most don’t know that as many as seven entities are involved in a single transaction, and it all happens in seconds or less. Here is a quick example of the process for a typical transaction:
Once a card is swiped, the business’ point-of-sale device triggers the merchant processor. The merchant processor triggers the customer’s card issuer to confirm the customer has credit available to complete the purchase via the network the customer’s card issuing bank utilizes (such as Visa or MasterCard). The issuing bank then sends back an approval, or denial, through the credit card network to the merchant processor. The merchant processor then notifies the business electronically, via their POS device, if the purchase has been approved or declined.
From the perspective of a business owner, you don’t need to become an expert on the payment processing ecosystem – that’s why you hire the experts. What is important to understand is what rates, fees and charges are hard costs you have to pay…and which are extras that companies tact on. Unfortunately, a lot of companies tack on a large amount of unnecessary costs. Fortunately, this is actually very simple to negotiate when you understand the basics of the system.
The Unnegotiable Stuff
Interchange is the universal cost any business must pay in order to accept card payments. Interchange is set by the card networks, and interchange rates are always made public and can be found online. The good news is virtually every business pays the same interchange. There’s also association dues. In order to issue credit cards banks work with associations, like Visa for example, charges an assessment of 0.13%. The assessments are made public by the associations, and you can easily run a Google search for the current rates.
So, if every merchant pays the same fees for interchange and association dues, why are merchant processing fees so different?
The Negotiable Stuff
The wide variability in merchant processing fees come from the other bank in the mix: the processing bank. Rates charged by processing banks and ISOs vary substantially. Banks, in general, are very good at assessing small fees for their many services, and processing banks charge for everything. Not only do they have many different fees, they assess these fees in many different ways. These are the things you can not completely eliminate – but can negotiate based on what is best for you and your company.
Here’s to put your options simply. There are three main ways merchants are typically billed for processing:
2. Flat Rate
3. Interchange/Cost Plus
With tiered pricing, merchants usually pay three different rates for their processing. They pay the lowest rate for Qualified cards, a higher rate for Mid-Qualified cards and the highest rate for Non-Qualified cards. This sounds good, because rather than many different rates, the merchant knows they will only pay three different rates, and they hope most of their customers will use their debit cards, keeping their costs to a minimum.
The problem with this method is merchant processing companies widely advertises the lowest rate, and many merchants skip the fine print disclosure showing the higher Mid and Non-Qualified rates. They mistakenly believe they will pay the low Qualified rate on all their transactions and receive a big sticker shock when they see their first bill. “Teaser rates” are still widely advertised, so buyer beware. Who decides which cards fall into which tier? You got it — the processing bank. We don’t usually recommend this type of processing to anyone because it can easily be misleading and confusing.
Flat-rate pricing was created to combat the confusion and provide a simple and easy to understand fees structure. Because of the widespread confusion in the industry, coupled with merchants tired of being hit with hidden fees, this pricing style has been wildly successful as of late. Companies like Square and Paypal have built their entire business models around flat-rate pricing.
So, what’s the catch? With flat-rate pricing, it’s simple, but simple is not cheap. In fact, it’s pretty expensive. For small businesses or startups not processing very much in card volume (around less than $10,000/month), flat-rate pricing is a great solution. However, for most businesses, you’re leaving a lot of money on the table by going with a processor that offers flat-rate pricing.
Big retailers figured out tiered pricing was not a good option for them a long time ago and thus interchange plus pricing was born. With this pricing model, the merchant agrees to pay a small percentage (known as discount) and a small per-transaction fee over interchange on each swipe. This way, the merchant does not pay a larger than fair markup on some cards over others. This pricing model used to be referred to as “wholesale” pricing. We now use the terms Interchange Plus, Cost Plus or IC+ for this pricing model. Interchange plus can be a little more time consuming to fully-understand, but the end result is a fair pricing model that allows businesses to scale quite seamlessly. Interchange plus is usually the optimal pricing structure for businesses doing a larger amount in volume (around greater than $10,000/mo).
Is there technically a lot more that goes into interchange fees and credit card processing? Yes. But as a business owner, you don’t necessarily need to know the complex in’s and out’s to make the best decision for your business. If you want to check whether you are paying tiered, flat rate or IC+ pricing, take a look at your statement or have an expert take a look for you. We recommend that you get a few different opinions in order to compare and contrast what’s available to you. Everyone is different on their needs and wants! The industry is confusing to say the least – but empowering yourself with the basic ‘stuff’ can make it less of a pain-point.