January 2010 – Channel Crossing: Payment Processing

The Lowdown on Interchange Fees

A recent Wall Street Journal article reported that U.S. banks collected $45.3 billion last year from credit- and debit-card fees
charged to merchants–about 75 percent came from interchange fees set by the two major card brands, Visa and MasterCard. Interchange fees, long a part of the card acceptance system, are the fees that a merchant’s bank (the “acquiring bank”) pays the card-using customer’s bank (the “issuing bank”) as cards are accepted for purchases. Set by the card brands, and typically updated twice each year, there are more than 400 interchange categories for the two major brands combined. Over the last several years, regulator inquiry and merchant clamor across the globe have turned the spotlight squarely on the costs associated with card acceptance.

KNOWING WHAT YOU PAY TO MANAGE INTERCHANGE
For the majority of merchants, interchange fees make up the largest component of processing costs. For card-not-present merchants, it typically represents over 2 percent of each credit card transaction. Managing these fees, particularly for card-not-present transactions, can save merchants thousands or millions of dollars annually depending on their transaction volume. Qualifying for the best interchange rate on a per-transaction basis is a complicated process and it starts with knowing what you’re paying. Knowing your true costs begins as a function of how you are billed for processing.

Typically, there are two different ways merchants are billed for processing, which includes interchange costs. The first is a “discount rate,” whereby the processor charges a percentage-of-sale discount on gross sales. These arrangements may also include a fixed per-item fee for each sale, as well as card brand Assessment fees and the processor’s own fees. The second method is on a “pass-through” (often called “cost-plus”) basis, which distinguishes all sets of fees that you are being charged. Discount rates can obscure actual costs and make it impossible to know if you are qualifying for optimal interchange fees for your transactions.

Opting for pass-through billing allows merchants greater visibility into their true interchange costs. For instance, many transactions–for one reason or another–suffer from so-called “downgrades.” That’s to say, they don’t qualify for the best, i.e., cheapest, interchange rate. Sans specific breakouts of interchange fees in their billing and reporting, merchants have no idea when they are losing dollars because of downgrades. And, given the sea of qualifying rates, this is a critical point of breakdown for many merchants on the interchange fee front.

The pass-through model and a complementary reporting platform that specifically accounts for interchange costs is a good start to navigating the thousands of pages of regulations that guide major card brand interchange qualification. Most merchants have neither the time nor the resources to master the rules and regulations of interchange qualification. Their processors and processing platforms, however, should.

Following are key steps to saving on interchange:

• Choose pass-through and not discount rate.
• Scrutinize your processor’s set-up protocol before you begin sending transactions through a new platform: How have they categorized my business (using so-called “Merchant Classification Codes” or MCCs? Am I transmitting transaction data in the best formats?).
• Ensure full, complete and accurate data transmission (bad data and inaccurate formats are the beginning steps to downgrades and lower interchange qualification rates).
• Establish benchmarks and analyze data (if your interchange rates are increasing or decreasing over time, you need to identify causes and solutions).

CHOOSING THE RIGHT PAYMENT PLATFORM
The complexity of card acceptance is lost on most of us. Interchange, in and of itself, is extremely complicated and most merchants feel powerless when trying to minimize their interchange costs. This makes it essential for merchants to partner with a trusted, educated payment processor whose expertise is in their area of commerce and whose platform is designed accordingly. For example, expertise in large-scale point-of-sale (POS) transaction processing is not the same as expertise in card-not-present (CNP) direct-to-consumer sales. Interchange rules and regulations vary significantly between and among commerce categories, and the logic of both your account leaders and their platform should be wired to your interests.

Partnering with your payment platform provider gives back to merchants some of the power to understand the sea of interchange rates, making it possible to manage, control and minimize the fees associated with card acceptance.

Dave Burrows is vice president, product management for Massachusetts-based Litle & Co., a leading card-not-present merchant account, processing and services provider. He can be reached via e-mail at dburrows@litle.com.