Credit Card Processing Blog

From the standpoint of credit card acceptance, store-front merchants have the advantage of accepting customer payments in a face-to-face environment. Face-to-face transactions (also called card-present transactions) occur when both the card and the cardholder are present throughout the processing of the payment, which substantially reduces the risk of fraud. A face-to-face processing setting allows the merchant to examine the card’s security features and verify that they haven’t been tampered with. The merchant is also required to compare the signature on the sales receipt with the one on the back of the card. When in doubt, the merchant may request that the customer provides a government-issued ID to validate the customer’s identity.

The Credit Card Associations of Visa and MasterCard recognize the lower processing risk, associated with face-to-face transactions, and reward store-front merchants with lower interchange fees. Interchange fees are the fees that card issuing banks collect from each transaction that involves one of their cards. For card-present transactions, interchange fees can be lower by anywhere from a quarter to a half percent, compared to card-not-present transactions. The transaction fee that a merchant is assessed is the sum of the applicable interchange fee charged by the card issuing bank, and the processing fee charged by the acquiring bank.

In addition to transaction processing fees, merchants are typically charged fixed monthly fees for using their payment processing accounts (merchant accounts). Following is a breakdown of card-present merchant account processing rates and fees and our suggestions as per what they should be:

• Transaction processing fees.
  • Interchange-plus pricing structure. With this pricing model, your processor will add a surcharge to all transactions. The surcharge will be the same for all transactions, but your overall processing fees will vary, based on the applicable interchange fee. A reasonable interchange-plus surcharge would be 0.35% + $0.15 per transaction.
  • Tiered pricing structure. With this pricing model, your processor will set two or three rates (qualified, non-qualified and sometimes mid-qualified). Each transaction will be processed at one of these rates, based on a pre-defined set of criteria. The tiered processing fees are comprised of two components:
    • Discount rate. Discount rate is a percentage of the transaction amount. You should pay no more than 1.69% for credit cards and 1.40% for debit cards. These are the rates for consumer cards which are the most widely used. Various business-to-businesses, commercial, rewards and other types of cards get processed at higher interchange rates.
    • Transaction fee. Transaction fee is a fixed dollar amount that you pay for each transaction. You should not accept anything higher than $0.25 (it will most likely be the same for debit and credit cards).
• Set-up fee. Charged for setting up your merchant account. You should not be paying any set-up or application fees, even if your prospective processor attempts to convince you otherwise!
• Monthly maintenance fee / monthly statement fee. Most processors will charge you such a monthly fee, although they may have different names for it. You should not be paying more than $10.
• Customer service fee. This is another monthly fee that you should not agree to be paying.
• Monthly minimum fee. Most processors will set a minimum amount of processing fees that they would want to be collecting from you each month. So if your monthly minimum fee is $30.00 and your monthly transactions generate $15.00 in processing fees, your processor will charge you additional $15.00. Be advised that neither the interchange fees, nor the other fixed monthly fees count towards your monthly minimum fee.

In order to accept card payments, you will need a credit card terminal and your processor may provide you one and configure it to work with their system. You should also be allowed to purchase the terminal from a third-party vendor. Make sure that you carefully review the merchant processing agreement in its entirety for fees that may make card payment acceptance more expensive than it seems. All agreements will include provisions for chargebacks, bounced checks, representations, etc.

It is always amusing and often instructive to look at the credit card processing industry through the eyes of an outsider. Inc.com’s Christine Lagorio is the latest one to give it a shot in a recent article. She directs her attention to the online payment processing segment of the industry.

The author begins with an advice on how to select a payment processing service provider and mentions several names. She then goes on to review the part payment gateways play in the process and here is where it gets confusing. The article doesn’t explain what a gateway does, while it seems to be suggesting that it is all you need to accept payments online. This is a common misconception and we’ve had to separate the facts from the fiction in many conversations with our clients.

Payment gateway is a service that connects an e-commerce website’s shopping cart with the merchant’s processing bank and transmits transaction information between them. Once a customer places an order, the gateway encrypts the information, routes it to the processing bank and then relays the authorization response (approved, declined, etc.) back to the customer. It serves, for e-commerce stores, the same purpose that a physical point of sale (POS) terminal does for brick-and-mortar businesses.

The payment gateway, however, is just a component (although a vital one) of each e-commerce merchant account, just as the POS terminal is a part of a retail merchant account. Both services facilitate the capture and transmission of transaction information from the merchant to its payment processor. The secure transmission of transaction data is the principal use of a payment gateway. Once the information is sent to the processing bank, the transaction has to be authorized, cleared and settled, in order to be completed. This whole process, from the capturing of information, to the settlement and funding is what a merchant account service provides.

Lagorio also provides pricing information for several major gateways and correctly notes that payment processors use gateways as portals. What she has not mentioned is that processors also typically offer much lower gateway set-up and per-transaction costs than the gateway provider. For example, while Authorize.Net would set up an account for $99 and would charge $0.10 per transaction, a processor may set up an Authorize.Net account for $50 (or less) and charge less than $0.10 per transaction.

The biggest gap in Lagorio’s review, however, is perhaps the failure to explain what gateway authorization fees are and how they differ from the other per-transaction fees that merchants are charged. The $0.10 per transaction fee mentioned above is a gateway authorization fee. Authorization fees are charged solely for the use of a gateway or a POS terminal. For each bank card transaction, you will be charged an additional fixed fee, which is totally separate from the authorization fee. In her report Lagorio cites several examples, ranging from $0.21 – $0.25. It is important to add that you would be paying these fees, regardless of whether your provider is Authorize.Net, First Data or UniBul Merchant Services. These additional per-transaction fees are a component of the “discount fee” that processors charge for processing the merchant’s transactions. The other component of the discount fee is represented as a percentage of the transaction amount. So a typical e-commerce discount rate would be 2.19% + $0.25 per transaction. Discount fees are divided among three participants: the processing bank, the card issuing bank and the card association (Visa or MasterCard). The lion’s share of the discount fees, estimated at about 75% of the total processing fees U.S. merchants paid in 2008, is called interchange fee. It is published bi-annually by Visa and MasterCard and is collected by the card issuer. The association gets a fraction of one percent (about 0.1%), and the rest is collected by the processor.

The service that enables businesses and non-profit organizations to accept credit and debit cards (bank cards) for payment is called a merchant account. Merchant accounts cannot be set up for individuals. Sole proprietorships are acceptable, provided they first register a “Doing Business As” (DBA) name with their local municipality. The providers of this service connect the merchant’s point of sale payment acceptance device with the bank that acquires the merchant’s transactions (called an acquiring or processing bank) and funds the merchant’s account. Whether the point of sale is at a physical store or online, the process is the same, just the tools are different.

The transaction process goes through the following stages:

1. A customer presents a card for payment.
2. The transaction information is securely transmitted to the acquiring bank.
3. The acquirer sends the information on to Visa or MasterCard.
4. Visa or MasterCard send the information on to the card issuing bank for verification.
5. The issuer then verifies the information and sends back an authorization response (a decline or approval) through the same channel.
6. The merchant accepts the payment and settles the transaction with its acquirer.
7. The acquirer funds the merchant’s account for the transaction amount, after subtracting the card issuer’s fee (the interchange), the Association fee (Visa’s or MasterCard’s fee) and its own service fee. The acquirer then submits a payment request to the card issuer.
8. The card issuer funds the acquirer’s account, after subtracting the interchange fee and bills its cardholder’s account for the full transaction amount.
9. The cardholder receives his or her monthly statement and makes a payment to complete the cycle.

Merchant accounts can be provided by banks that are members of Visa and MasterCard, but more often they contract with third parties to provide the service while the banks do exclusively the acquiring of card transactions and settlement of the funds.

Before offering merchant account services, third party organizations must first be sponsored by a member bank and licensed and registered with Visa and MasterCard. The registration process includes a thorough examination of the credit histories of both the business and its principals, a review of the applicant’s business and marketing plans and the payment of registration fees which amount to $5,000 for each Association.

Third-party merchant account providers are known as Independent Sales Organizations (ISOs) when they are registered with Visa and as Member Service Providers (MSPs) when they are registered with MasterCard. Businesses apply for both registrations at the same time, through their sponsoring bank. When an ISO / MSP begins to sign up merchants, the card transactions generated by the merchant are acquired by the sponsoring bank, which at this time becomes an acquirer for the merchant. What this means is that the bank acquires the sales receipts for the merchant’s transactions and it is then responsible for funding the merchant’s account. ISOs and MSPs are obligated to display the name of their acquiring bank on every page of their website and other promotional materials. Usually this sign is placed in the footer of the website. Every year the ISO / MSP registration is reviewed and, upon renewal, a registration renewal fee is charged, in the amount of $2,500 per Association.

Registered ISOs and MSPs can sign up sales agents to source merchants for them. The sales agents, however, cannot advertise themselves as merchant account providers. They are only authorized to represent the ISO / MSP and must identify themselves as agents to these organizations. Visa and MasterCard are very strict in enforcing this requirement and violators can be fined a very substantial fee.

A lot of attention is being paid to interchange fees as of late. Various retail groups are pushing Congress to reduce them, while Visa and MasterCard, and their member banks, are lobbying heavily in the opposite direction. It is likely that a new legislation will be passed sometime this year, although it is everyone’s guess exactly how it will regulate the interchange fees. A previous article in this blog shows how the interchange plus pricing compares to the tiered pricing model but perhaps a closer look at the interchange fees is needed.

The interchange represents by far the largest share of the total processing costs that merchants pay for accepting card payments. Various sources put its share at anywhere between 70% – 90%, but it is estimated that interchange fees made up about 75% of the total processing fees U.S. merchants paid in 2008. Both Visa and MasterCard publish their interchange rates annually and they are available for everyone to see. Discover and American Express do not use interchange, as they act as both an Issuer and Acquirer for transactions involving their cards.

Interchange is the fee that a processing bank (also known as an acquiring bank, an acquirer, or a processor) pays to a card issuing bank (the issuer) when a payment card (issued by the issuer) is used by a consumer to pay for a product or a service, provided by a merchant who has established a card payment processing relationship (merchant account) with the processing bank. The issuer pays the processing bank the transaction amount minus the interchange fee. The processor then pays the merchant the transaction amount, after subtracting both the interchange fee and its own card processing cost, thus bringing the transaction cycle to an end. It is important to understand that the interchange fee is established by the Card Associations (Visa and MasterCard) and collected solely by the issuer. The fees charged by the processing bank are established and collected by the processing bank, not by Visa and MasterCard. Even if interchange fees are regulated in one way or another, this will have no effect on what the processor charges.

Both Visa and MasterCard publish dozens of different interchange fees, varying by card type (regular consumer, rewards, commercial, purchasing, etc.) and transaction environment (card-present or card-not-present). All interchange fees, however, are comprised of a percentage of the transaction amount (for example 1.90%) plus a fixed fee (for example $0.10). Neither Visa nor MasterCard disclose the exact mechanisms of establishing these rates and we do not know many details. Typically, payments that are taken in a card-not-present environment (e-commerce and MO / TO) are processed at a higher interchange than payments taken in a card-present environment. That is the reason why internet and direct marketing merchants pay higher payment processing fees than brick-and-mortar merchants like grocery stores or donut shops.

Whether interchange fees are regulated or not, merchants are not likely to gain any leverage over them. Still, it is in your best interest to know which interchange fees are applicable to your payment processing environment, so that, when reviewing a pricing proposal from a prospective processor, you will be in a much better position to make an informed decision. There are several card processing pricing structures and you can review how they compare in our Interchange Plus Pricing vs. Tiered Pricing post.

Learn how to lower your card acceptance cost

Learn how to accept credit and debit cards at the lowest processing costs. The Payment Card Acceptance kit contains a video and an e-book:

• Video – Card Acceptance Best Practices for Lowest Processing Costs (18 min).
• E-Book – Payment Card Acceptance Guide (19 pages).

What is Interchange? Interchange is a fee that the Credit Card Associations of Visa and MasterCard assess for every payment card transaction processed by participating merchants. The interchange fee is then passed on to the financial institution that had issued the card (card issuer) used in the transaction. The card issuer then credits the merchant’s account with the merchant’s payment processor (or just processor). The credited amount is equal to the transaction amount minus the interchange fee. The interchange is paid during the settlement of the transaction and typically is represented as a percentage rate plus a flat fee.

For example Visa’s CPS / e-Commerce Basic interchange is 1.80% + $0.10 + 0.11%. CPS / e-Commerce Basic is Visa’s interchange fee program classification which determines the interchange fee to be applied to each transaction. Currently there are more than 40 different Visa classifications and more than 50 MasterCard classifications.

In the above example 1.80% + $0.10 is the interchange fee that Visa passes directly on to the card issuer. This fee varies according to the fee program classification used for each transaction. It is important to understand that the interchange fee program is affected by several factors. Most important among them are the type of card (debit, credit, rewards, business-to-business, etc.) and completeness of provided transaction information.

The 0.11% portion of the above interchange example is the Dues & Assessment Fee charged by both Credit Card Associations for each transaction processed through their networks. MasterCard’s Dues & Assessment Fee is currently at $0.11%. The Dues & Assessment Fee is the same for each transaction and is not affected by the interchange fee program classification.

The interchange fees are updated twice a year, in April and October and are available on Visa’s and MasterCard’s websites.

Optimizing interchange in a card-not-present environment. Organizations operating in a card-not-present environment should always apply the following best practices to ensure securing the most advantageous interchange fee:

1. Use the Address Verification Service (AVS) for each transaction. AVS enables merchants that accept card-not-present transactions to compare the billing address (the address to which the card issuer sends its monthly statement for that account) provided by a customer with the billing address on the card issuer’s file before processing a transaction.
2. Provide service or ship product within seven days of the authorization.
3. Include the original transaction ID from your authorization in your settlement or refund transaction.

Interchange plus pricing vs. tiered pricing. Interchange plus is the pricing structure where processors add a surcharge to the interchange fee charged for each card transaction. This surcharge is the fee the processor charges for providing processing services to the merchant. The processor does not share in the interchange rate which is collected exclusively by the card issuer. The surcharge remains the same for all interchange fee program classifications, thus ensuring that the processor charges the same fee for each transaction. For example, a Visa card transaction that received a CPS / e-Commerce Basic is interchange fee program classification will be processed at 1.80% + $0.10 plus the processor’s surcharge. If the surcharge is 0.45% + $0.15, the merchant will be charged a total of 2.25% + $0.25 for the transaction. If the card was a Visa rewards card and received a CPS / Rewards 2 classification, the interchange fee will be 1.95% + $0.10. The processor’s surcharge will still be 0.45% + $0.15 and the total – 2.40% + $0.25.

Processors that use the much more prevalent tiered pricing charge one fee for “Qualified Transactions” and another for “Non-Qualified Transactions.” Sometimes processors use another qualification tier called “Mid-Qualified Transactions.” Processors charge “Qualified” fees for transactions processed in a manner that exactly matches the description provided by the merchant when the merchant’s credit card processing account was set up. For example, if the merchant had stated in its application for a processing account that it will be processing consumer types of cards over the internet, the transaction will be classified as a “Qualified Transaction” and processed at the most advantageous rate, e.g. 2.25% + $0.25. However, if the card was a rewards card, the transaction will be classified as a “Non-Qualified Transaction” and the merchant will be charged a higher rate, e.g. 3.25% + $0.25. The processor will establish in the Merchant Processing Agreement the exact criteria that will be used to classify each transaction.

It is important to understand that in a tiered pricing structure the processor needs to set the “Non-Qualified” rate at a level that is sufficiently high to ensure that no transaction is processed at a loss. As a consequence, the fee that the merchant pays for the processor fee component of the total processing charge will vary by interchange fee program classification. In the above example, the processor ends up collecting 1.30% + $0.15 for the rewards card transaction (1.95% + $0.10 is the interchange). However, if the transaction received a Commercial Card Not Present classification by Visa, the interchange fee would be 2.55% + $0.10. The transaction would again be classified as “Non-Qualified” and the merchant would again be charged 3.25% + $0.25 but the processor would collect a smaller fee for its services (0.70% + $0.15).

The tiered pricing model has one advantage over the interchange plus: it is simpler and the merchant knows exactly how much it pays for “Qualified” and “Non-Qualified” transactions. The disadvantages, however, far outweigh the advantages. Even though the tiered pricing structure provides concrete rates, it is often difficult to understand the qualification guidelines. Moreover, because the “Non-Qualified” rate needs to be set above 3.00% to ensure that the processor is not losing money on transactions involving a few high-priced types of business-to-business and purchasing cards, the merchant will end up overpaying for the more widely used rewards cards. A typical e-commerce or MO / TO merchant processes far fewer business-to-business or purchasing cards than it does rewards cards. Additionally, the interchange plus model ensures that debit cards are processed at lower rates than credit cards, as their interchange rates are substantially lower. A typical tiered model lumps debit cards together with credit cards.

Summary. The interchange plus pricing model is not simple, as each transaction is settled not at a pre-defined rate but at a rate that is equal to the sum of the interchange fee that the Credit Card Associations charge plus a fixed service fee that the processor charges. Yet, given that the interchange fees are determined by Visa and MasterCard and that neither the processor, nor the merchant has any influence over it, the only fee that can really make a difference, is the processor’s service fee. The examples above show how widely the processor’s fee can range in a tiered pricing model. The interchange plus model offers the exact opposite, where for each card transaction the merchant is charged the same processor fee.

When the interchange plus pricing model is backed by a good reporting solution, merchants can easily see exactly how much the processor charges for its services. With a tiered pricing model this is rarely possible, as processors typically limit the reporting to showing the number of transactions and processing volumes by qualification groups. When a processor submits a pricing proposal to a merchant, the only meaningful way to compare it to the current pricing structure is to compare the proposed processor’s fees to the current one’s. Because it is not always easy to estimate these costs, we recommend that once a year merchants conduct an independent audit of their payment processing services.