Credit card processing fees are a longstanding pain for merchants. This post is the first in a series in which I’ll answer common payment questions. I won’t shy away from controversy, and I’ll explain how processing fees are derived and passed to merchants. Throughout, I’ll suggest ways to reduce processing costs.
The first challenge is understanding the industry jargon.
Card Associations. Visa, Mastercard, American Express, and Discover.
Card Brands. Same as Card Associations.
Cardholder. The person whose name appears on the credit card.
Issuing Bank. Also, “issuer.” The financial institution (usually a bank) that creates the credit card and distributes it to its customer, the Cardholder. An Issuing Bank earns an Interchange Fee every time its credit card is used. Interchange Fees are passed along to merchants.
Payment Network. Also, “the network,” “the payments ecosystem,” “the payments industry.” Payment Network describes all companies and technology that issue credit cards and accept and process credit card payments.
Processor. Also, “payment processor.” A company that produces technology to allow merchants to accept credit card payments. Examples are Fiserv (formerly First Data), Chase Paymentech, Bank of America Merchant Services, and Stripe. A Processor can be a range of companies and technologies that focus on the flow of money from checkout to the merchant’s checking account.
Mid-qualified Transactions. In the Tiered Pricing model, the rate charged by Processors to merchants for Mid-qualified Transactions is higher than Non-qualified Transactions but lower than Qualified Transactions. Each Processor determines how to qualify transactions. There is no industry standard or government regulation. Examples of typical Mid-qualified Transactions are those made with a rewards or luxury card and, in some cases, when the payment is completed over the phone or via the mail (MOTO — mail order, telephone order).
Non-qualified Transactions. In the Tiered-pricing Model, the rate for Non-qualified Transactions is generally the highest. Examples of Non-qualified Transactions are usually all ecommerce purchases and those made with luxury, corporate, and high-reward travel cards.
Qualified Transactions. In the Tiered-pricing Model, the rate for Qualified Transactions is the lowest that a processor will charge a merchant. Qualified Transactions carry the lowest risk and are made with most basic credit cards — i.e., non-rewards, no annual fee, standard.
Rates and Fees
Card Association Fee. Also, “assessments,” “assessment fee,” “association fee.” A fee charged to the merchant by the Processor for each transaction and given to the Card Brands as compensation. The Card Association Fee and Interchange fee comprise the Wholesale Fee.
Discount Rate. Also, “merchant payment processing fees,” “processing fees,” “merchant discount rate.” The final, all-in rate that a merchant pays per transaction for processing. The Discount Rate includes Interchange, Card Association Fee, and Markup Fees.
Downgrade. Also, “transaction downgrade.” When a Processor categorizes a payment as something other than a Qualified Transaction. A Downgrade is bad (but often unavoidable) for merchants because it results in a higher processing cost. Each Processor has its own criteria for downgrading transactions.
Flat-rate Pricing. Also, “simplified flat-rate pricing,” “all-in pricing,” “bundled pricing.” A single, all-in fee from a Processor to a merchant for all transactions, regardless of the type. Stripe, for example, offers flat-rate pricing of 2.9 percent + 30 cents per transaction.
Interchange. Also, “interchange fee,” “interchange rate.” A term to describe the roughly 400 different fees that are earned by an Issuing Bank to compensate for issuing credit and funding the payment transaction. Interchange is revenue for the bank that issues the credit card. For example, when a customer pays with a Chase Freedom Visa credit card, Chase (the issuing bank) receives the Interchange. Interchange rates are set by the Card Brands and collected by the Processor. Interchange and Card Association Fee comprise the Wholesale Fee.
Interchange Plus. A pricing model wherein the merchant is charged the Interchange, the Card Association Fee, and a Markup Fee. Unlike Flat-rate Pricing and Tiered Pricing, Interchange Plus offers transparency into how the fees are constructed and charged. Interchange Plus is Interchange + Card Association Fee + Markup Fee (a percentage, usually, charged by the Processor).
Markup Fees. Also, “markup,” “markup rate.” Fees charged to merchants above Interchange and Card Association Fee. A Processor collects and retains Markup Fees as compensation for its services.
Tiered Pricing. Also, “bucket pricing.” The process of setting payment processing fees around tiers or categories — typically three or more. The most common are Qualified, Mid-qualified, and Non-qualified. A Processor determines the tiers and fees. A Processor also classifies transactions by tier based on the risk. The online sale of a diamond ring is riskier than the in-person sale of a cup of coffee. The diamond ring transaction would be Non-qualified while the coffee would be Qualified. Riskier transactions are typically Mid-qualified and Non-qualified, which carry higher fees.
Wholesale Fee. Also, “wholesale rate.” The combination of Interchange and Card Association Fee. Every Processor must pay the Wholesale Fee but can add Markup Fees.
FAQs start below and continue in subsequent installments to this series. Terms from the Payments Glossary are capitalized.
Many Issuing Banks offer pricing like 2.9 percent + 30 cents. Why are there two fees — a percentage fee and a flat fee — for each transaction?
Flat fees cover the operating expenses and generate profits for the payment networks. Processing credit card transactions requires specialized, complex, and connected computer systems that work flawlessly 24/7. It also requires many employees to manage and implement. This massive network of computers and humans costs a lot of money to build, maintain, and secure. These operating expenses are generally fixed. For example, Visa reported its 2019 operating expenses at $7.98 billion, an increase of 4 percent from 2018.
The flat fee that accompanies every transaction is the Payment Network’s way of recouping operating expenses. A large transaction (e.g., a diamond ring) uses about the same level of computing power as a smaller one (e.g., a cup of coffee). Thus a flat fee ensures that the Payment Network can cover its expenses and generate a (sizeable) profit, regardless of the transaction amount.
Percentage-based fees mostly go to the Issuing Bank to compensate for granting credit.
Indeed, a purchase with a credit card is similar to a loan. When buyers fail to pay their credit card loan (the minimum balance due), the Issuing Bank will typically charge about 21 percent interest.
The higher the transaction value, the greater the risk for the Issuing Bank. Thus, for taking larger risks by funding larger purchases, issuing banks want a larger fee.
Together, the percentage and late fees translate into a tremendously profitable business for banks.
I see that most Interchange fees are less than 2 percent. But my Processor charges much more than that. Why?
If Interchange is revenue for the Issuing Banks and a Card Association Fee is revenue for the Card Brands, how do Processors get paid? The answer is Markup Fees, which are the additional fees that Processors charge to merchants above Wholesale Fees.
Markup is charged to the merchant in various ways. Sometimes it’s bundled into Flat-rate Pricing (one single rate, such as Stripe’s 2.9 percent + 30 cents). Sometimes Markup Fees are more transparent. This is Interchange Plus, which is Interchange plus agreed-upon Markup Fees.
Sometimes Markup Fees are baked into the transaction fees. For example, Stripe’s 2.9 percent + 30 cents is higher than the average Interchange rate of 1.8 percent. Thus Stripe’s Markup is roughly 1.1 percent, on average.
Markup Fees can appear outside of the transaction. Often, a Processor will take a lower profit margin on transaction fees to generate higher profits from other services.
Here’s a list of common fees from Processors.
When choosing a Processor, consider all Markup Fees. Some will be disclosed. Others will be hidden or buried into a transaction fee.
Merchants frequently look only at Wholesale Fees (Interchange and Card Association Fees) when comparing Processors. That’s a mistake because Markup Fees can be expensive. For example, I’ve seen Processors charge $300 for early contract termination.
Remember that Wholesale Fees cannot be negotiated. No Processor can change them. Markup Fees, on the other hand, are negotiable. If you have significant volume, speak to the Processor’s sales team. Demonstrate how a reduction in Markup Fees will help your business become a profitable, long-term partner.