All you ever wanted to know about card processing courtesy of Reddit

cut and pasted from Reddit* post, 2015:

Qualification – I work in the credit card processing industry, for a company that helps other businesses secure the most competitive processing. The industry can be very opaque, and even some people who work for a specific processor aren’t given the full details, but rather enough to make a sale to a business.)

In credit and debit card transactions, there are multiple parties involved and getting paid:

  • Issuing banks (provide credit cards to customers; set interchange rates; collect interchange as their profit)
  • Card associations (MasterCard, Visa, etc; set assessments; collect assessments as their profit)
  • Processors (the company that handles the details of a transaction; sets pricing terms for markup; collects that as their profit)
  • Acquiring banks (settles the transaction; is paid by the processor)

In some cases, processors are also their own acquiring bank. And also in some cases, companies positioning themselves as ‘processors’ are really just resellers of another processors’ services. (See why this gets confusing??)

Interchange, Assessments, and Markup

There are three main components of card processing costs: interchange, assessments, and markup.

Interchange and assessments are the same for everyone and every pricing type, period. It’s just a matter of whether you see it or it’s hidden from you. These are the non-negotiable rates and fees that are charged for card processing.

Interchange is paid to issuing banks (the banks that give customers credit cards) and is generally the biggest cost of processing. Interchange is a series of ‘categories’ for different transaction types, and each category has a rate associated. That rate is the lowest amount you can pay for a transaction, if no one else made any money.

There are hundreds of interchange categories. Examples of categories are swiped credit card, swiped rewards credit card, keyed credit card, swiped PIN debit card, etc. etc. There are loose rules that can be assumed under ideal circumstances, like a swiped card will be less expensive to process than a keyed card, a rewards card is more expensive than non-rewards, etc.

Every transaction a business swipes (or keys in) falls into an interchange category, and the business pays the rate for that category for that transaction. (They pay through their processor.) Let’s say that the rate for a category called Retail Swiped Credit is 1.5%. That means that the amount of the transaction the business is paying (through the processor) to the issuing bank is 1.5% of that transaction. So if the business has a $100 retail swiped credit card transaction, the issuing bank gets $1.50.

Assessments are the fees that are paid to the card associations. (Visa, MasterCard, etc.) Again, these are fixed costs, and they’re added on to your processing. (Some shady processors may pad assessments, so it’s important to always get interchange and assessments passed at true cost if you’re looking to get the most competitive processing.)

Markup is the only real place that businesses have bargaining power. Markup is what the processor makes off of a business’s transactions. There are multiple pricing models. Which pricing model the processor uses can have a huge effect on whether or not the business has competitive processing.

Again, the only place businesses have negotiating room for credit card processing is on what a processor charges OVER the cost of interchange + assessments. Which brings us to…

Pricing Models

There are a few different pricing models, with their own pros and cons. (Some mostly cons.) The most common are:

  • Tiered (or “bundled”)
  • Interchange-plus
  • Flat rate
  • Subscription

Tiered or bundled pricing is generally the most expensive and least transparent. While any pricing method can be questionable, tiered is probably the easiest way to get ripped off. With tiered pricing, the processor groups a business’s transactions into “tiers”. There are usually 3: Qualified, Mid-Qualified, and Non-Qualified. The processor assigns a rate to each tier, and determines which of the business’s transactions go where. The Qualified tier will have the lowest rate, while the Non-Qualified tier will have the highest.

The biggest problem is that processors can change which transactions are routed to which tier whenever they want. Tiered pricing is most often how processors claim to be able to save businesses tons of money on processing, but usually don’t. What happens is that a processor will quote a nice, low rate for Qualified transactions.. but then not actually route any of a business’s transactions through that tier. Instead, they’ll send transactions through their more expensive Mid-Qualified or Non-Qualified tiers.

Let’s say that the processor has decided that retail swiped credit cards are mid-qualified, and that the Mid-Qualified tier has a rate of 3.25%.

Remember, you’re paying the interchange rate no matter what. From our earlier hypothetical, the retail swiped credit interchange rate is 1.5%. With tiered pricing, the business owe 1.5% to the issuing bank no matter what, but if the processor decides the transaction is “Mid-Qualified” now they’re paying 3.25% for that transaction. (Plus assessments, and any other fees charged by the processor.) This type of overpaying is very common with tiered pricing.

The rate they associate is intended to cover everything.. interchange, assessments, and their own markup/profit. The reason this is so opaque is that the business don’t know how much they’re paying in non-negotiable costs (interchange + assessments) and how much they’re paying the processor for processor’s profit.

Interchange-plus pricing is usually more transparent and less expensive, but it’s still not a silver bullet. With interchange plus, businesses will want to make sure that they’re truly getting pass-through pricing. This means that they’re paying interchange and assessments at the true cost, and then paying the processor a separate markup or fee. When it’s not bundled all together, businesses can see exactly what they’re paying and to whom, and make sure that they’re paying a competitive low markup rate. Usually, they’ll pay a small percentage of the transaction and a per-transaction fee.

With interchange-plus/true-pass through pricing, for the same example of a retail swiped credit transaction, they’ll pay 1.5% on the transaction (for interchange) and the assessments due to the credit card association (Visa/MC, etc.) and those will be listed as their own line items. Then they’ll also pay the processor their markup, as a separate piece of the puzzle. Most of the time, this will be a percentage and a per-transaction fee, such as 0.5% + $0.20.

With this type of pricing, the business may be able to negotiate better terms for their type of processing. For example, if they process fewer high-ticket transactions, they’d want a lower percentage of the total even if it meant a slightly higher per-transaction fee. If they run a lot of lower-cost transactions, they could do better by having a lower per-transaction fee in exchange for a slightly higher percentage of the total.

Flat rate pricing offers simplicity, but at a higher cost. Flat-rate is the model offered by Square, PayPal, etc. – usually around 2.7% and maybe a per-transaction fee. From that, they pay out the interchange + assessments, and keep the rest. On some transactions, that means they keep a higher percentage than other transaction types. It’s not the most competitive form of pricing, but it’s fine for a lot of businesses.

Again, the reason the amount they make varies is because they pay the interchange, but they aren’t charging the business the actual interchange, they’re charging more. So if the business has one transaction that falls into swiped retail credit interchange category at 1.5% and one that falls into the swiped PIN debit at, for example, 0.7%, the flat rate processor will make more money on the PIN debit transaction. Even though it’s cheaper for them to process, the business won’t see a savings. They’re still paying the processor the flat rate of 2.75% + per-transaction fee.

Subscription pricing is somewhat new, and still gaining traction. With subscription pricing, the business pays the actual cost for interchange + assessments, and a flat monthly fee and per-transaction fee. There is no percentage markup paid to the processor.

Some processors try to make this seem like there is no markup. That’s technically true in the sense that there isn’t a percentage markup, and that they don’t make money as a percent of the business’s volume. But of course they do still make money.

Another questionable marketing tactic is that subscription pricing processors don’t always explain to businesses that their pricing is ON TOP OF the costs of interchange and assessments. So if a business sees a subscription pricing offer of $29.95 month and $0.30 per transaction, that doesn’t mean they can just multiply the number of transactions in a month by .30 and add the monthly fee and know what the processing costs will be for that month. It still means that the business pays interchange and assessments, and THEN the per-transaction fee and monthly fee.

Other notes I thought of because of the ELI5 thread – debit transactions do NOT get funds to a business any faster than credit transactions.

Surcharging debit cards is NOT allowed in the United States. (Arco lost a lawsuit regarding this.) Visa and MasterCard both have clear statements on it.

Surcharging credit cards IS allowed in 40 states as of 2013, when Visa and MasterCard lost a lawsuit.

American Express is almost always more expensive for a business to process than any other card. However, they’re aware of that and trying to change it, having rolled out a new pricing structure fairly recently.

Debit cards are (usually) more expensive for businesses to process on small total transactions because of a change called the Durbin Amendment. It has nothing to do with the size of the business though. Additionally, and ironically, businesses are not allowed to require a minimum purchase amount for debit cards. (Minimum purchase amounts ARE permitted for credit cards.)

There’s a LOT involved in processing, and I could go on for pages and pages, but hopefully this was a good primer and a look at why there’s so much conflicting and confusing info out there. Processors offer different pricing models, rates, and terms, even to similar businesses, which is why it’s very hard to assume that what one business has or does is the same for all business that take cards.

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1 Comment

  1. Pingback: Technology for markets and farmers: EMV (or chip and pin technology) for cards | Helping Public Markets Grow

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