Tiered Pricing VS. Interchange Plus
Understanding how credit card processing fees are determined and how different merchant account pricing models work can save your business hundreds of dollars a month in transaction costs.
Understanding what goes into determining fees
Probably the biggest reason that merchant account pricing schemes can be so complicated for the business owner is that the mechanics going on behind the scenes are also extremely complex. For instance, if we refer to a "transaction," we are not referring to the simple act of swiping and charging a card — we're referring to any interaction between the merchant and the processing bank. If a card is refused, for example, the merchant will still pay a transaction fee. When a merchant clears his account batch, he may also pay a transaction fee. There are numerous transactions and numerous associated fees.
It gets more complicated. Things like the type of business accepting the card, the type of card being used, the industry of the business, whether the transfer is online or not, etc., all affect how the transaction will be categorized.
This system of categorization of transaction types is called interchange, and interchange fees are the backbone of credit card processing pricing schemes. Twice a year, the card brands (Visa, MasterCard and Discover) announce their schedules of fees and the various categories that credit card transactions can fall under. A wholesale transaction rate is determined based on the criteria outlined in these fee schedules. Currently, between Visa, MasterCard, and Discover, the categories of interchange fees number over 500. You can peek at Visa's current interchange schedule for an example of what this actually looks like on paper. It's intimidating stuff, but it's not impenetrable, and understanding how it affects your merchant account pricing scheme can save you a ton of money.
Tiered Merchant Account Pricing
Most businesses are on tiered merchant accounts, which are unclear and expensive when compared to newer pricing models.
Tiered merchant accounts work on a system of "qualification" to determine which rate tier a merchant's transaction falls into. These are also called "bins," "rate buckets" or "buckets." So, a very simple example might look like this:
- Qualified Discount Rate: 1.XX%
- Mid-Qualified Discount Rate: 2.XX%
- Non-Qualified Discount Rate: 3.XX%
It's not usually quite that simple, and there may be various in-between tiers, as well as differences between credit and debit card charges, etc. But the point is that the Qualified Discount Rate represents the lowest fees a merchant can pay. It's no coincidence that acquirers (merchant service providers) will consistently advertise the lowest qualified discount rate.
Problematically, however, the merchant rarely actually sees those savings. Transactions are frequently "downgraded" to a lower level of qualification, meaning the merchant loses more money in the transaction. The reasons a transaction may be downgraded are, frankly, great for acquirers at the expense of the business owner. The type of card is one thing that will cause a transaction to be downgraded. The brand, whether it's a private or business card, whether it's a Cash Back or Rewards card, and other things are all handled differently by different account providers.
Of course, business owners don't have the luxury of deciding what kind of cards their customers may use to pay, and they end up paying unnecessary fees each time a customer pays with a card that does not fall into the acquirer's strict definition for qualification. Furthermore, the method used to charge a card matters.
For example, keying in the credit card number as opposed to swiping the card will almost always cause a downgrade. Not verifying the address of the card by asking the zip code will often cause a downgrade. What's more, the various rate tiers obscure the actual interchange fees being applied. The merchant pays fees based on questionable criteria set by the acquirer for the acquirer's benefit, with little relation to the interchange fees that govern the wholesale price of the fee in the background.
It's impossible to know for certain, and difficult to estimate which rate bucket a transaction will fall into until after the transaction has taken place. That also makes it impossible to avoid paying unnecessary fees when using a tiered merchant account.
Interchange Plus Pricing
Traditionally, Interchange Plus pricing accounts have only been available to businesses that do a high volume of credit card sales — usually $25,000 or more. However, the market for merchant accounts is more competitive these days, and now smaller businesses (and even brand new ones) can get accounts that work on this pricing structure.
It's straightforward, with only two rates from the credit card processor to consider: the interchange markup percentage fee, and the transaction fee. Merchants pay a consistent, flat fee regardless of the wholesale processing rate, plus a small fee per transaction. So, if your business has a merchant account with a 0.30% rate and a $0.14 transaction fee, you pay the wholesale interchange fee, plus 0.30%, plus 14 cents.
In essence, the wholesale rate (with the processor's markup) is passed directly to the merchant, so your transaction fees are calculated on their actual wholesale cost — not arbitrary criteria set by the processor.
To make finding the best credit card processor even easier, we only allow processor to quote interchange plus pricing here at CardFellow.