Credit Card Pricing: How Does It Work?
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.