As a transaction travels through the network from authorization through settlement, there may be several systems and processes through which it must pass. Each process or system that a transaction passes through may also add value to the transaction. Some of these processes may affect the costs listed below:
- Interchange - The most significant cost, 70% to 90% of the total cost, is charged by the Card Issuing Bank to the Merchant Acquiring Bank and then passed on to the merchant. The interchange fee structure is standardized for all merchant acquiring banks.
- Dues, Fees, & Assessments - The bankcard associations (Visa, MasterCard) charge a fee for each transaction, (approximately 1/10th of 1%), as it goes through the interchange system. This fee is passed to the merchant-acquiring Bank, and then to the merchant.
- Authorization, Capture, & Settlement - The link between the merchant, the Bankcard associations, and the banks (issuing and acquiring), is a Third Party Processor (Data Center). The operational cost of the Data Center for Authorization & Capture, and Settlement is charged to the Merchant Acquiring Bank which then passes it to the merchant. The method in which a merchant passes the transaction to this network can significantly affect these charges (e.g., 950/WATS FGB, SSL, or IP).
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Considering the costs detailed above, the Merchant Acquiring Banks have employed several models to relay these costs to the merchant. The two most popular models are 3-Tier and Cost Plus.
- Advantage - This model may appear to be easier to understand from an accounting or bookkeeping perspective. However, it is not an advantage for the merchant who wishes to understand their costs.
- Disadvantage - There is no standard for which the 150+ transaction categories will aggregate into which of the tiers (AKA Qualified, Mid-Qualified, and Non-Qualified) and set pricing for each tier is at the discretion of each processor. A processor may tease the merchant with a low Discount, or Qualified, rate while placing most of the transaction categories into Mid- or Non-qualified tiers. In this case the effective rate, or actual average cost of a transaction, would be much higher than a processor with a higher discount rate and a more equitable distribution between the tiers.
- Disadvantage - Since the acquirer can realize a larger profit margin when a transaction falls into a Mid- or Non-qualified transaction tier, it is not to their advantage to educate their merchant on methods of reducing costs by preventing those transaction downgrades. For example, a merchant can reduce downgrades by inputting the Cardholders' Address (AKA AVS - Address Verification System).
- Advantage - There is a standard for each of the 150+ transaction categories - it is the standard set by Visa and MasterCard, the standard every processor pays to the associations.
- Advantage - An acquirer that is willing to set their merchant up on a Cost Plus has a different perspective on the relationship. The relationship then becomes more of a partnership and both parties then have a vested interest in forming a stronger bond. It is to the advantage of the acquirer and the merchant now to review the transactions to ensure that any downgrades are not the result of an action that could have been prevented and thus to properly qualify the transactions.
- Advantage - The Cost Plus model uses the interchange rate set by Visa and MasterCard, as a baseline, and then applies a set markup fee. By pricing the account in this manner, the merchant not only pays a set fee per transaction, but they are aware of what transactions they are processing. Cost Plus is transparent to the merchant and thus enables identifying the reason downgrades occur and, hopefully, how to resolve them.
Which pricing model is better? In general, it is the Cost Plus. The negative aspects of 3-Tier pricing already mentioned are further exacerbated by the typical processor's desire to consider all transactions on a "worse case" basis and slide the majority into the Mid-Qualified or Non-Qualified tiers. Since 3-Tier is considered the "standard" rate, the Association for Financial Professionals (AFP) analyzed price increases and found that the blended 3-Tier rate had increased by four percent in the last year, with 24 percent of these merchants reporting increases of 10 percent or more: 18 percent report a 10-24 percent increase and 6 percent report an increase of more than 25 percent. This disparity in costs transferred to the merchants can not occur with a Cost Plus model.
Cost-Plus pricing removes the mystery from the merchant's monthly statement while, in general, giving the merchant lower prices. It is our experience at Terminal Velocity Processing that converting a merchant to a Cost-Plus model, while saving any given merchant between 25 and 75 basis points, will save the average merchant 50 basis points off their interchange fees. Combine this with a strategic partnership designed to continuously reduce the payments processing operating expense and you have a winning combination today and tomorrow.
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