Credit cards can be a mixed blessing for retailers. While they help promote higher revenue and cement customer loyalty, they also carry significant baggage in the form of costly service charges. In many cases, processing costs reach levels that can obliterate your bottom line. There’s good news on the payment front, though. The Independent Service Organizations that sell credit card accounts are more willing than ever to strike deals favorable to retailers. That’s a direct result of a marketplace affected in fundamental ways by the recent recession. “The merchant-account industry is maturing and becoming more competitive, which means pricing is becoming cheaper,” explains Paul A. Rianda, an Irvine, California-based attorney specializing in the bankcard industry.
More ISOs, in other words, are chasing fewer retailers. And that’s all for the good. Lower merchant service costs can make a huge difference to your bottom line. “Suppose you are making $100,000 in annual transactions,” says Ronnie Lynch, regional sales director for ISO Enablepay in Albertson, New York. “If you can trim two percentage points off your merchant costs, you’ll get $2,000 more that you can use for extra marketing.” While pursuing a better deal, though, be aware that due diligence is as necessary here as anywhere else in the business world. “Many ISOs who offer good merchant service schedules make their real money in surprise fees,” warns Lynch. As with banks, ISOs are peppering their bills with added charges, such as Payment Card Industry compliance fees, for example. They may be levied to cover the cost of making sure the retailer complies with federal regulations for data security. “The merchant shouldn’t be the one who pays for that,” says Lynch. Then there are regulatory fees to cover the cost of preparing the U.S. Treasury’s 1099K forms, which report annual card transaction totals. “Over the past year, we have started seeing regulatory fees of maybe $4.95 to $9.95 a month,” says Lynch. “Charging such amounts is exorbitant pricing. All that data is already stored in the ISO databases. All they have to do is print out the forms.”
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Each of these two fees can add from $10 to $20 or more each month to the ISO’s bill. But surprise fees aren’t the only issue. The proffered processing rates may be lower than what you’re paying now—but maybe not low enough. “The deal you have right now may not be all that good,” warns Lynch. This is especially so, says Lynch, if you have maintained the same contract for more than three years. Many retailers with older contracts are paying up to 6% or 7% in merchant services charges, including interchange rate markups and per-item fees. “An ISO may promise to cut that down to 5%, but the fact is that no retailer should be paying more than 2% to 3% in total processing fees.” So how can you separate the wheat from the chafe? There’s no doubt that the best way to avoid problems is to check out a prospective ISO with current customers. “If you get a referral from somebody else, that is a good place to start,” says Rianda. “Some of the smaller ISOs that serve specific niches seem to be more merchant-friendly.”
Ask for names of a few current customers. “Any ISO worth its salt will have a referral setup,” says Bill Hearon, president of Effective Payment Management, a consulting firm in West Palm Beach, Florida. “Find out if current customers are able to get through to the ISO during regular business hours. Are they able to speak with a live person rather than just leaving messages on voice mail? And how about after-hours? If a transaction won’t go through at 8 p.m. for example, is there someone available to make things right?” When you’re faced with a transaction that won’t process, time is of the essence. “I have heard many complaints from merchants who stay on hold for 30 to 45 minutes to reach someone in their ISO’s customer service,” says Rianda. A big reason for this problem is that many smaller ISOs are really resellers for larger ones that handle transactions with merchants. And these larger ISOs are becoming still larger, says Rianda, as price competition leads to mergers. “Big ISOs need to run as lean, mean machines and as a result may not be staffed to offer the best customer service.”
Also ask about the ISO’s chargeback policies. “Sometimes an ISO will perceive a chargeback risk to be higher than it should be,” says Rianda. “The ISO will seize the merchant’s funds and place them in a reserve account to be held until the perceived risk is gone.” ISOs differ in how conservative they are in this area, so it is important to research the experiences of current customers. And how about online reporting, which can be a real time-saver for many merchants? “Some ISOs provide daily reports online,” says Rianda. “Others don’t have any online reporting at all, so you end up waiting every month for a paper report.” Given the integral role of the ISO in the credit card machinery, retailers must take care to select the right one. “Processors take care of timely processing of transactions and settlement of balances every evening,” says Hearon. “And they get the retailer’s money deposited to the penny into the right account in a timely way.”
Retailers looking for favorable merchant accounts are faced with a situation similar to that in the cell phone industry: multiyear contracts. “More than 90% of contracts are for three years with automatic renewals,” says Rianda. That can be bad if you find a merchant account with a better price—the most common reason why retailers want to exit contracts early. Yet departing’s not an easy task, says Rianda. If you get caught in one of these contracts, it’s difficult to get out. “One of the biggest issues is the early termination fee,” says Rianda. “Some ISOs don’t have one. Others will charge maybe $300 for the early termination of the three-year contract, which is typical for the industry.” But there is something far more damaging for merchants. “Some contracts call for what is called ‘liquidated damages,’” says Rianda. “The merchant who cancels after one year may have to pay the estimated processing fees for the remaining two years. The penalty calculation is a multiplier of the merchant’s average processing fees prior to the termination.”
Rianda estimates that around one in four ISOs includes liquidation clauses in a contract. They can be expensive, with total penalties running into the thousands of dollars. Note, too, that many contracts prohibit the retailer from shopping around for a second merchant account—presumably a cheaper one—to operate in parallel for the period in which the first merchant account is in effect. ISOs rationalize these fees by asserting their need to obtain a return on the processing equipment they have invested with their retailers, or on their need to rationalize attractive sales incentives. One solution is to look for new, hungry entrants to the ISO world. Newer providers tend to be more open to negotiations. You might even find one willing to cash out your old contract. “ISOs who want you to switch over may offer to pay your termination fee,” says Lynch. “Just be aware that they have to make up that $300 or $400 somehow. That may well be in higher fees.”
Search around a bit and you may find an ISO willing to offer a contract with cost-plus pricing. This term refers to a processing fee based on a specified markup from current interchange rates. That can make a big difference when compared with traditional tiered pricing that’s based on a confusing array of markups determined by the type of card presented by the customer. “Cost-plus pricing has traditionally only been available to larger merchants,” says Rianda. “But in this competitive environment, I see it being offered more often to smaller retailers.” Despite this trend, many retailers are still tied to a tiered pricing schedule because of loyalty to their banks, which typically do not offer cost-plus options. “Consider using an ISO not affiliated with a bank to get the best pricing structure available,” says Hearon. “And if you change your bank, you can keep your card processor.”
Given the rapid changes in the credit card world, it pays to keep a vigilant eye on your payments and to obtain outside help in the form of disinterested account reviews. “If a retailer has not had a complete analysis done within the last year,” says Hearon, “they are more than likely leaving money on the table and negatively impacting their bottom line.”
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Making money is one thing. Protecting your organization—and the assets of your customers—from costly theft is another. Security considerations are becoming more important every year and your customers expect you to be on top of things. “The Federal Trade Commission reports that the No. 1 consumer concern is the theft of their identity,” says Hearon. “There is a phenomenal rise in identity theft, and it is going on not just on websites, but also behind the counter with skimming.” The regulatory authorities have responded to consumer concerns by mandating compliance with PCI regulations. “Find out where your ISO is in terms of PCI compliance,” says Hearon. “Will you, as the retailer, be penalized for not complying?” Only about 15% to 20% of smaller retailers are PCI compliant right now, according to Hearon. Noncompliant retailers can pay as much as $20 monthly in penalties. Hearon estimates that as high as 75% of the data breaches are occurring at small- and medium-size businesses, which usually have less security protection than large retailers. The retailer that does get breached can expect a costly repair process. “The resulting costs for forensics audits, card-replacement costs, assessments and fines can typically range from $40,000 to $80,000,” says Hearon. “That has put some retailers out of business. So you need Breach Data Coverage, similar to business liability insurance, and that can be provided through your ISO. The cost typically ranges from $5.95 to $9.95 per month.”
Customer-data protection is the final piece of the merchant-account puzzle. Every retailer needs to create a credit card acceptance structure that generates profits while reducing risk. Thanks to a more competitive marketplace, ISOs are making it easier than ever to find a realistic balance between profitability and safety.
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When negotiating merchant-account contracts, it pays to be familiar with the credit card industry’s jargon. Here is a brief overview of the dynamics of the system, courtesy of Effective Payment Management in West Palm Beach, Florida.
Consumers obtain their credit cards from issuing banks. Retailers obtain their merchant accounts—that allow them to accept credit cards—from acquiring banks that hand off the mechanics of processing transactions to companies called processors. Processors either market directly to retailers or rely on Independent Service Organizations to negotiate contracts with retailers and provide service for the retailers’ accounts.
For the ability to accept credit cards, the retailer pays a merchant services cost, which is comprised of three elements. The first element is the interchange cost that’s paid to the bank that issues the credit card. The second element is the dues and assessments, paid to associations such as MasterCard, Visa and Discover. These two elements are sometimes referred to as the wholesale cost and are non-negotiable. The third element is the risk management and account management fees of the acquiring bank and its approved processor. Let’s look at each element briefly.
The interchange cost is the fee charged by the bank that issues the credit card to the consumer. This fee consists of two parts: a percentage of the sale amount and a per-item transaction fee. The percentage can range from .05% for a debit/check card to as high as 3.25% for a World Elite Card. The item fee can range from $.05 to $.22. (American Express is not being included in this outline, as its fee structures are quite different from Visa, MasterCard and Discover.) The second element consists of the dues and assessments for the associations. Visa and MasterCard have a set 11% interchange cost with an item fee for Visa of $.0195 and for MasterCard of $.0185. Discover is at .0925% with no item fee.
Remember that amounts are set and non-negotiable for these first two elements of the total merchant services costs. However, there is room to negotiate in the third element, the risk management and account management fees for the actual processing of the cards by the retailer. This element represents payments made to three organizations: the acquiring bank, the processor and the ISO. There are two primary pricing structures used. The oldest version is tiered pricing, where three to five tiers of price levels are established as blanket coverage for all three elements of the merchant services cost. This pricing structure is more costly to the merchant with overall costs that can be as high as 4% to 5%. The alternative version that many retailers take advantage of is referred to as cost-plus or pass-through pricing. In this structure only a small percentage and a transaction fee for processing and risk management are added onto the first two elements of the merchant services cost. This can reduce the bottom line costs for accepting cards by anywhere from 5% to 45% as compared with the tiered pricing. The result can be a total merchant services cost of less than 3%.
With all of this taken into account it should be noted that for every $100 in fees that a merchant pays for accepting credit cards, around $82 to $87 goes to the issuing bank, some $5 goes to Visa, MasterCard or Discover for dues and assessments and some $8 to $13 goes to the authorized processor and acquiring bank. These figures are based on cost-plus or pass-through pricing. If a retailer is on tiered pricing, the authorized processor is receiving more than $8 to $13.
While the processor retains relatively little of the fees paid, it does the lion’s share of the requisite work, according to Effective Payment Management’s president Bill Hearon. “Yet, these key players get a very small portion of the total processing cost for providing the most important element to the retailer,” he says.
Phillip M. Perry is a New York City-based freelance writer.