One of the most complicated tasks in running or setting up a retail business is trying to understand merchant account fee structures for accepting credit and debit cards. The methods through which these fees are calculated are very different from each other and can have an impact on a business’s bottom line. Understanding the two basic pricing structures may not be simple, but with a little time and education on the matter, it can be done and is worth the effort.
This guide is written in a way as to avoid most of the technical jargon used when asking a bank or other merchant account provider to explain it. It should impart a solid understanding of how merchant fees are calculated and assessed. This knowledge can then be used to choose a pricing structure that will be the most beneficial for a particular company by comparing rates and fees in different scenarios.
Types of Merchant Account Fees
The two main types of merchant account fee structures are interchange plus and tiered structures. Each structure is composed of several separate fees. Both structures use some of the same fees, but the way in which they are calculated varies between the two methods. Five main types of fees exist in both plans. However, a pseudo fee called a merchant account minimum that does not fit into any of the major types may or may not be added to some plans. Following are the types of fees:
Percentage Fee
The percentage fee makes up the bulk of all merchant account fees and processing expenses. This fee is a percentage of the gross amount of a credit card transaction. Percentage fees are applied in different ways between interchange plus and tiered pricing structure.
Transaction Fee
A transaction fee is charged each time a merchant transacts with the processing bank. The transaction fee is not based on a sales transaction. Rather, the transaction it refers to is any communication between the merchant and the bank via the machine. Non-sales tasks such as refunds, sending a batch, reconciling a batch and closing a day may all be considered transactions for the purposes of calculating this fee.
Many merchants make the mistake of confusing transaction fees with authorization fees. Authorization fees are actually a type of transaction fee, but they can be charged at a higher rate than other administrative transactions. Transaction fees vary little between the two pricing structures.
Flat Fee
A flat fee is any number of fees charged to a merchant that are not based on transaction volume or the dollar amount of charges processed. Flat fees are the same no matter if a single card is charged for $1 or 1,000 cards are charged for millions of dollars. This type of fee includes the statement fee, membership fee, and cancellation fee. Flat fees also vary little from an interchange plus structure to a tiered structure.
Interchange Reimbursement Fees
Interchange reimbursement fees are the core of what makes up a final merchant account rate. A large part of understanding how merchant fees are assessed is based on understanding the concept of interchange reimbursement fees and how they are applied to credit card transactions processed through a merchant.
The major credit card companies, not the credit card issuers but the big companies such as MasterCard, Visa and Discover publish a schedule of interchange reimbursement fees bi-annually – once in April and again in October. Essentially, these fees are the wholesale rates for different types of credit card transactions. What new merchants don’t realize is that hundreds of different types of transactions exist and each has a different fee associated with it. Memorizing the schedule every six months is next to impossible, but it is handy to have a copy of the schedule whenever trying to reconcile merchant account fees.
Factors that affect what constitutes a specific type of transaction include the method used to process a transaction, the type of card used for the transaction, the information given the bank about the transaction and the type of business performing the transaction. Several other factors may also be figured into determining into which category a transaction falls.
Trying to identify how each transaction is placed into a category is exhaustive and not worth the effort. It is best to take the bank’s word for it. If pressed, they will be able to provide you a breakdown of how the category was determined. The schedule of interchange reimbursement fees is available for download at each credit card company’s website. When assigning the schedule, transactions are said to qualify or reach a qualification for a particular category. With a tiered pricing structure, these terms also refer to which level or tier to which the transaction belongs.
Merchant Discount
While this sounds like it is the opposite of a fee, the term merchant discount is just tricky language for another type of fee. Interchange reimbursement fees are not the fees charged to a merchant. They are the fees the credit card company charges to the processing bank. The processing bank then marks up the fee before passing it on to the merchant. The interchange reimbursement fee portion of the merchant discount goes directly to the credit card companies. The markup portion of the merchant discount is divided up and goes toward such fees as the merchant service provider’s fee and card association dues. Whenever a merchant compares rates or merchant account quotes, it is the merchant discount that is being compared and not the raw interchange reimbursement fee.
Merchant Account Minimum
This type of fee does not fit into any of the three main types of fees. Explaining this non-fee fee requires an article specifically dedicated to the purpose. The amount does not change between fee structures but is set by the merchant service provider. It does, however, vary widely by provider.
Tiered Merchant Account Rates
Most merchant account providers only offer a tiered merchant account pricing structure. Therefore, this is the structure used by the majority of merchants. The rate charged to the merchant is determined by first setting a baseline rate known as the qualified discount rate. In many tiered systems, the two qualified discount rates exist: one for credit cards and one for debit cards. The tiers above the qualified discount rate are considered surcharges that are added to this base rate. Most accounts operate on a three-tiered system, with the first tier above the base called the mid-qualified surcharge and the top tier called the non-qualified surcharge. However, because different qualified discount rates may exist, such as the credit qualified discount rate and the debit rate, the system may have as many as 12 total tiers.
An example of a tiered account with three total tiers starts with the qualified discount rate, which is the lowest possible rate. The next-highest tier is the mid-qualified surcharge tier, which is the sum of the qualified discount rate and the mid-qualified surcharge. The top tier is the non-qualified surcharge tier, which is the sum of the qualified discount rate and the non-qualified surcharge.
A six-tiered system, one of the more common systems among tiered merchant account structures, works very much like a three-tiered system, except that it is a combination of two separate three-tiered systems: one system for credit card transactions and a second for debit card transactions. The qualified debit discount rate is usually lower than the qualified credit discount rate. This is the reason many major retailers have pushed for automated detection of debit cards and clerks are made to strongly suggest that customers use the debit card processing option for purchases.
In rare circumstances, a tiered structure may consist of 20 or more tiers. This occurs when each brand of credit card is given a different qualified discount rate, with each further having a separate credit and debit rate.
To determine if a transaction falls into the qualified discount tier, mid-qualified surcharge tier or non-qualified surcharge tier, the merchant provider creates and maintains what is called a qualification matrix. The qualification matrix uses the interchange reimbursement fee the provider is being charged to determine which tier rate the merchant must pay. The qualification matrix is a tool used by the providers that makes it nearly impossible to accurately compare rates and fees with competitive providers. The matrix used can mean the difference of hundreds or thousands of dollars in fees for two accounts that provide the same quoted rates.
Merchants are advised to take a look at their monthly statement. If the statement has a majority of non-qualified surcharge transaction, it warrants a call and explanation by the provider. In some cases, the provider can apply a different matrix or rearrange the tiers. If not, the merchant may find it to be advantageous to switch to a flat-rate fee structure or an interchange plus structure.
Interchange Plus Merchant Account Structure
To most merchants, the interchange plus merchant account structure sounds more complicated than the tiered structure, but in reality, just the opposite is true. The interchange plus structure is much more transparent and is easier to understand than tiered rates. In most cases, it ends up being the less expensive choice. Interchange plus pricing is simple. The merchant account provider takes the exact interchange reimbursement fee it is being charged and adds a flat markup to it. This completely eliminates any confusion or inconsistencies caused by a providers secret tier matrix.
Interchange plus accounts have two rates that are charged to each transaction instead of each transaction falling into one of three, six, or twelve tiers. The two rates are the interchange markup and the transaction fee.
Interchange markup fees are percentages added onto the interchange reimbursement fee. The percentage is measured in units called basis points. One basis point is equal to 1/100 of a percent. So, a transaction with a 25 basis point markup is 0.25% over the interchange reimbursement fee. The transaction fee is a flat fee based on the type of transaction. A common transaction fee is a $0.15 authorization fee for charge cards.
At one time, interchange plus pricing was available only to large merchants processing over $25,000 in credit card sales each month. Today, due to fierce competition, this pricing structure is becoming more widely available to smaller merchants and new businesses.
Which Structure is Best?
Which structure is best depends on many factors. One business will benefit from a specific tiered structure over some interchange plus structures. In most cases, what determines which structure is the least costly depends on the specific provider and how the tiers are set up. While it is nearly impossible to determine which merchant account will provide the most benefit, one factor is certain: interchange plus is simpler and easier to decipher. It is regarded not as the best pricing structure, but as the fairest and most transparent. This clarity and full disclosure makes interchange plus the better choice for those who like to know how the fees they are charged have been assessed.
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