The Issue with Downgraded Credit Card Transactions

The Issue with Downgraded Credit Card Transactions

A friend of mine recently told me that 90 percent of his company’s credit card transactions are processed at mid- or non-qualified rates, known as “downgrades” in industry speak. His business provides web hosting services mostly to small e-commerce merchants, which automatically places it in the high-risk category of the payment processing industry.

The high-risk designation, however, is not the issue here. After all, if you look at Visa’s and MasterCard’s interchange tables, on which all pricing models are based, what you see is that rates are determined by the interplay of two criteria: type of card and type of acceptance (card-present or not). The qualification tiers are used solely by the processors. So the issue is the tiered pricing model itself. Let’s see why this is so.

Tiered Pricing Basics

The tiered pricing is still by far the most widely used model by payment processors, well ahead of the interchange plus and flat rate merchant account models. The reason is that it is, on its surface, quite easy to understand. You get one rate for all “qualified” transactions and a higher one for your “non-qualified” ones. Some processors will mix it up by adding a “mid-qualified” rate for payments that fall somewhere in between the other two.

In theory the qualification tier for each transaction would be determined by applying the following guidelines:

  • Qualified. These are all credit card payments that:
    • Are processed in accordance with the rules and standards established in the merchant agreement and
    • Involve a regular consumer type of card.
  • Non-qualified. These are all credit card payments that:
    • Involve a special type of card (reward, purchase, commercial, etc.) or
    • Are not processed in compliance with the rules set out in the merchant agreement or
    • Do not comply with some applicable security requirement.
  • Mid-qualified. These are all credit card payments that:
    • Are key-entered, rather than swiped through a point-of-sale (POS) terminal or
    • Involve a special type of card.

It is immediately evident that the difference between a mid-qualified and a non-qualified designation can be quite murky. But even if we focused solely on the difference between the qualified and non-qualified tiers, it could be tricky to tease it out.

The Issue with Downgrades

Looking at the above definitions, it is clear that it is left largely to the processor’s own discretion to determine whether a transaction gets a qualified designation or not. Even if you can understand the terms of your merchant agreement, which by itself would be quite an achievement, your processor can typically make amendments at will.

We have previously analyzed in detail the cost-efficiency of the tiered pricing model and have repeatedly advised against using it, however merchants invariably tell us that pricing is not the main issue here. No one wants to be overcharged, of course, but what we keep hearing is that what merchants want, more than anything else, is predictability. They want to be able to calculate exactly how much payment processing will cost them for any give transaction volume, so that they can plan in advance for their monthly expenses.

Well, the tiered pricing model offers no predictability. Add to it the fact that most transactions are processed at a rate substantially higher than the applicable interchange fee and you get a real strong case against it.

Credit Card Processing Takeaway

The reason the tiered model persists is that its main alternative — the interchange-plus pricing — is much harder to wrap your mind around and does not make it any easier to calculate your processing costs in advance, as each transaction’s rate is independently determined.

We still recommend the interchange-plus pricing model, but there is another option that you may want to consider. By giving you one single rate for all transactions, the flat rate pricing does allow processing costs to be easily calculated in advance and in some cases may even be more cost-efficient than the interchange-plus model.

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