You just went over your monthly credit card processing statement in detail for the first time, and you might be a little angry. Or maybe you’re somewhat confused. At the very least, you’re a bit flabbergasted.
What is this PCI Compliance Fee? How about this APF thing from Visa? And…wait…are they seriously charging you $15 for printing and sending you this monthly statement you’re holding right now?
Like it or not, the credit card processing industry has a convoluted and antiquated business model. Every player wants to get paid, and everyone upstream thinks they can pass all their costs downstream. Because the industry has only a few upstream providers and limited competition, they’re often able to do exactly that. This is why you see unexpected charges on your statement on services you’ve never heard of and might not even need.
Some folks in the industry are trying to change this power structure so that you, the merchant, can pay a more reasonable rate. The industry is such a large beast, though, that the changes so far are mere variances laid on top of the existing business model of the industry. It doesn’t help that, with or without changes, everyone knows that merchants are forced to use payment card processing services because most customers don’t carry cash anymore. There is, therefore, little incentive to change.
Under these circumstances, your knowledge is your power. If you understand how the industry works, you can intelligently question the charges on your statement and sometimes negotiate them away. Knowledge will also help you find a processor that might be a better fit for your business, so you can keep as much of your hard-earned money for yourself instead of slavishly paying the cost of doing business for the upstream providers.
This article is intended to give you a general framework on how the payment card industry works and explain some of the more typical added charges. We link liberally to other articles on our website so, if you wish, you can dive deeper to get answers for specific issues related to your unique situation.
All The Parties Involved In Processing A Credit Card Transaction
As mentioned above, in the credit card industry, everyone upstream tries to pass their costs downstream. The best way to see where these upstream costs are being added is to understand how a payment card transaction works, so you can see where a charge might be assessed for a particular transaction.
Let’s first take a look at the way you’re charged and who’s charging what.
Why Merchants Are Charged A Percentage And A Flat Fee
When you sign up to take credit card payments, the first thing you might notice is that you are being charged in a somewhat unusual way: your cost for processing a payment card is a combined percentage plus a flat fee. There’s a reason for this, and it has to do with the upstream providers’ equipment costs and financing risk.
In order to process a transaction, the modern credit card industry uses a lot of computer technology, all connected to form a private computer network. Each player in the industry has costs to maintain their part of this network, including paying for hardware, software, and network connection. This maintenance cost is steady, so the upstream providers pass it down to you as a flat fee.
In addition to the computer network, there’s a financing aspect to every payment card charge. A credit card is really a mini loan a bank makes to the credit card holder, so there’s always a risk that the bank won’t be paid back. Even a debit card involves a bit of financing risk in the form of an overdrawn bank account. It’s not hard to understand that a bank would lose more money if someone failed to repay a $1,000 new TV than a $10 lunch. The banks, therefore, want more money for taking the risk of a greater loss. To do that, you express that risk as a percentage of the total purchase.
So, for every payment card transaction, the merchant pays:
Processing charge = financing risk charge + computer network costs
The formula makes sense because it takes into account both the fixed costs and the variable costs involved in using a payment card. (Note that there are some payment processing business models that are only percentage-based. The percentage is usually nearer the higher end of normal, and the technology-related charges are typically consolidated into the percent charge.)
Next, let’s take a look at who’s charging what.
Know The Parties Involved In Payment Processing
In order to understand card processing fees, you also need to know about the parties involved in the industry. Consider these the financial “middlemen” between a customer and a merchant. They include:
- Credit Card Associations: These are the companies that create credit cards, like Visa, Mastercard, and American Express. They set all the rules, determining a fair processing rate for each industry, how to maintain the security and encryption of hardware and software, how and when to advertise to consumers, and so on.
- Credit Card Issuing Banks: These are financial institutions, like Chase, Citi, and Wells Fargo, that issue credit cards to consumers. Some card associations like Discover and American Express take on the role of an issuing bank as well, developing and issuing their own cards. The issuing banks are the ones who assess a consumer’s creditworthiness before deciding whether to issue a card to the consumer. After a consumer makes a purchase, the issuing bank is responsible for checking whether the charges are valid and if the consumer has enough credit on the card to make the purchase. The bank must then approve or decline the purchase, and then front the money to the merchant. At that point, it’s basically a matter of a loan repayment between the issuing bank and the cardholder.
- Credit Card Acquirers: These are also known as acquiring banks, though they don’t all have to be banks in the traditional sense. They could, instead, be financial institutions with bank-like characteristics. They set a merchant up with a merchant account, which is a specialized bank account used solely to receive card payments from issuing banks. Often, a set of pre-approved entities, such as a credit card processor, can also draw from the account. Acquirers act as middlemen, communicating and receiving money from the issuing banks, credit card associations, and credit card processors. They typically get involved in the transaction process after the issuing bank has paid the money for the transaction but before the merchant receives the money. They share the financial risk with issuing banks when a credit card charge is reversed. They also assess the creditworthiness of a merchant and the stability of the business before approving the business to take credit cards. We have a detailed article about acquirers if you wish to learn more about them.
- Credit Card Processors: These are the one-stop-shop companies a merchant deals with to set up payment card processing. You can work with them directly or you might work with one of their resellers. Processors set up the payment processing for you, helping you get a merchant account and making sure you have the right hardware and software to take payment cards. Sometimes, the acquirer and the processor are the same company, but the merchant deals with only the processor part of the business (which means you won’t be able to negotiate down the acquiring side’s wholesale costs). Processors often contract with other service providers and bundle these services to you in one bill. For instance, once you are set up with a processor (usually for an extra fee), you can get a payment gateway to take online payments, an electronic vault to store your customer’s payment card information so repeat customers can check out faster, hardware and software to allow you to take payment cards with mobile devices, and similar value-added services.
- Payment Gateways: These are special portals that route transactions to an acquirer, usually in the case of an online shopping cart. These days, processors typically include some sort of gateway in their offering, so you may not have to find one separately for your business.
Now that we’re familiar with all the major parties involved in payment card transactions, let’s look at how a transaction takes place.
Follow The Money: The Credit Card Payment Transaction Flow
The transaction process begins with a customer using a payment card (credit or debit), whether at a merchant’s store or online.
- Authorization: Once the information on a card is read into the credit card machine or typed into a gateway, the information is sent over the internet to your processor for the next step. Your processor acts as a traffic cop and sends the card information to the appropriate card network (e.g. Visa, Mastercard, Discover, etc.) with a request to be processed. The card network then forwards the processing request to the issuing bank of the credit card, and the bank checks to see if the cardholder has enough credit to cover the purchase. If there are enough credits, and if the card is registered as valid, the purchase is approved and the approval message is sent back to the merchant. All of this is computerized, so it typically takes place in a matter of seconds.
- Submission: The transaction between the merchant and the consumer takes place (i.e. goods or services are exchanged), and the merchant submits the authorized transaction for actual payment. The submission can take place right away or be held up in a batch somewhere along the process and then submitted at the end of the day or past the weekend. The submission first travels to the processor, who, like before, forwards the request to the appropriate card network. The network then sends the submission to the issuing bank. The issuing bank pays the appropriate amount.
- Settlement: The payout from the issuing bank travels by standard inter-bank money transfer methods until the money reaches the merchant account. The card network, the processor, and the bank(s) take their cut of the transaction fees. Only then can the merchant take the money out of the account. If your processor is a third-party processor (also known as a payment service provider) this step is a little different, but the merchant gets the money in the end.
- Disputes: Sometimes, a payment card charge is reversed days or months after the process described above. It could be that the merchandise was defective, or that the card charge was fraudulent/made without authorization; in either case, the cardholder demands the charge to be dropped. The merchant can either agree to a refund or enter into a dispute process to prove that the charge was not made fraudulently. Here additional resources between the banks must be devoted to the dispute, so additional costs can be incurred.
Note that the transaction flow described above doesn’t quite describe a PIN/signature/”true” debit card charge. For PIN debit charges, after your machine or gateway takes the information of a customer’s PIN debit card, the data is still transmitted to your processor, but then the processor routes the information through a debit card network to the issuing bank of the debit card, skipping the card associations. From there, the issuing bank and the acquiring bank communicate and then transfer the money directly between them once it is confirmed that the customer indeed has enough funds to cover the purchase.
Here, because a slightly different path with a simplified computer network is used and because of certain US government regulations (if you’re in the US), the PIN debit charges usually cost less to process than a typical credit card. You can only take PIN debit if you have the right kind of machine and have a merchant account, but the hassle might be worth it if your customers like to pay with debit cards than credit cards.
Looking at the process above, each party that touches a payment card transaction will charge you a fee. So the card associations will charge you a fee, the issuing bank and the acquiring bank will share a fee, and your processor will take a fee. You may even be charged by parties you didn’t even know were involved! For instance, the computer networks (and the security and encryption that run on these networks) are often run by third parties contracted by the banks, card associations, or your processor. That cost is tacked onto the full processing cost as a set fee (such as a PCI compliance fee). If a repeat customer has ordered merchandise online, and you have stored previous card payment information, you might be charged another per transaction or per month/quarter/year fee for secure, PCI-complaint storage of that customer information.
As you can see, all the fees can add up. So how can you negotiate them down?
The Importance Of Interchange: How One Simple Word Affects All Of Your Merchant Account Fees
We’ve gone over a typical payment card transaction flow and you understand that every time an entity touches that transaction, there will probably be a fee (which means sometimes an entity will charge you twice because they touched the transaction twice). Now, let’s look a little closer at these fees and talk about which ones you can do something about and which ones you cannot change.
Wholesale Fees VS Markup Fees
The terms “wholesale” and “markup” get thrown around a lot in the processing industry, so it’s easy to become confused about which fees really fall into which category. At its core, however, the distinction isn’t too difficult to grasp. The two main considerations are 1) which of the parties we’ve discussed ultimately collects the fee, and 2) how fixed the cost is across the industry. Here’s all you really need to know:
- Go to the issuing banks (interchange fees) and the credit card associations (card association fees)
- Are fixed amounts regardless of which processor you use
- Are non-negotiable
- Go your payment card processor, plus any other add-on equipment or software providers such as a payment gateway provider
- Are different amounts from processor to processor
- Are negotiable
As the merchant, you’re the “lucky” one who ultimately covers all these costs. Meanwhile, your credit card processor sits right in the middle of the fee collecting-and-directing process. They decide how to pay the necessary wholesale costs for running your account — while also adding markups to cover their own costs, paying other third-party service providers associated with your account, and turning a profit.
With the right processor, markup fees will be modest. With the wrong processor, you’re in trouble. What’s worse is that some processors make it as difficult as possible to know how much markup you’re paying by using bewildering terms and pricing models that would baffle even the most experienced business owner. For now, just remember that markup fees are different from processor to processor; these are what you should be comparing when preparing to open a new merchant account. Meanwhile, don’t try to shop around for lower wholesale fees or rates from various credit card processors. These rates are consistent throughout the industry and are not negotiable.
There is one more thing you should know about wholesale costs: they tend to differ from industry to industry and from card association to card association. They also tend to differ by the way the card is used–whether it’s an in-person purchase or over the internet. The reason for the difference has to do with risk.
Some industries, such as the gambling industry, are simply more prone to instances of impulsive purchases/chargebacks/fraud than, say, fast-food restaurants. It’s also easier to use a stolen card for an online purchase (aka a card-not-present or keyed-in transaction) than dipping a card in person (aka a card-present transaction). Everyone along the transaction chain wants to be paid more for taking a higher risk, so your costs will change depending on your industry and how your customers typically pay. In other words, if you compare your flower shop rates (low risk) with your buddy’s CBD shop rates (high risk) — even if you use the same processor charging the same markup –, you’ll find that your buddy is paying more.
(Your processing cost also varies by type of card–credit, debit, rewards, corporate–but that has more to do with maintaining profit margins by passing costs down to you than with risk.)
Here’s a table showing some sample pricing models and whether or not you can easily pull out the wholesale fees and markups from the quoted rates:
Sample Quoted Payment Processing Rates
|Pricing Model||Wholesale Rate|
|0.25% + $0.10||Interchange-Plus||Not included|
|$0.10 (+ $99/mo membership)||Subscription||Not included|
|Qualified: 1.79% + $0.10
(Mid-Qualified: 2.19% + $0.15)
(Non-Qualified: 2.99% + $0.20)
|2.90% + $0.30 online
This brings us to the concept of interchange. We’ve briefly touched and defined the term above, but let’s elaborate on this fee a little bit more.
Where Does Interchange Come Into Play?
While we’ve already seen that there are quite a few parties and places in the process flow that can charge fees, most pricing discussions hinge on one particular category of cost: interchange. This is mostly due to the fact that this wholesale fee makes up the majority of the cost of processing cards. Card association fees, also known as assessments — the other main wholesale cost — make up a non-trivial chunk as well, but it’s not nearly as large as the interchange chunk.
The interchange fee is strictly a wholesale fee. It uses the formula financial risk charge + computer network costs. Because the formula relates to risk, the interchange fee can be different depending on your industry–again, lower-risk industries get a lower interchange fee while higher-risk industries get a higher interchange fee.
To complicate matters further, the interchange fee is decided by the card associations, and each card association can assign a different risk number, even to the same industry. In other words, the interchange rate for, say, a bookstore might be different if a customer uses a Visa card instead of a Mastercard card if Visa and Mastercard have simply decided differently on how much risk they wish to take for the bookselling industry. So, bear in mind as we discuss interchange fees below that this number can be different depending on both your industry and the card your customer decides to use for the purchase.
(This industry-dependent risk assessment is in the form of something called a merchant category code or MCC. Businesses that use merchant accounts are assigned an MCC from the list of pre-existing codes provided by the card associations to broadly identify the type of product or service their business offers.)
Despite the card association’s involvement, the interchange fee is ultimately collected by the card-issuing bank. The table below summarizes just a few examples, but there are hundreds of interchange classifications across the card brands. Visit the Visa and Mastercard websites for full lists, but note Discover and American Express do not publish their interchange fees. Interchange fees are reviewed and adjusted on an as-needed basis twice a year by the card associations, in April and October — so yes, your interchange rates can change over time.
Common Interchange Rate Examples
|Basic Credit||1.51% + $0.10||1.80% + $0.10|
|Signature/Traditional Rewards Credit||1.65% + $0.10||1.95% + $0.10|
|Preferred Rewards Credit||2.10% + $0.10||2.10% + $0.10 / 2.40% + $0.10|
|Small Bank (Exempt) Debit||0.80% + $0.15||1.65% + $0.15|
|Big Bank (Regulated) Debit||0.05% + $0.22||0.05% + $0.22|
Due to the central role interchange fees play in the processing industry, the pricing models used by card processors are primarily based on how interchange fees are handled. Before we go any further, take a moment to compare those big bank debit interchange rates in the table above to the rate of 2.9% + $0.30 or even the 2.75% charged by some flat-rate processors. You can start to see the pitfalls of a pricing model that lumps multiple (or all) card and transaction types together and then slaps on one blanket rate to cover them all. Of course, there are pros and cons to each pricing model for different business types, but you should definitely be aware of the wide variety of base costs behind the different card and transaction types.
Now, let’s take a look at the four main pricing models in more detail.
Understanding & Identifying Payment Processing Pricing Models
When it comes to selling merchant accounts, there are four popular methods of pricing: interchange-plus, subscription/membership, tiered pricing, and flat-rate. If you already have an account but don’t know your pricing model, you can identify which one you have by looking for key indicators on your statements.
Remember that the main distinction to be aware of in pricing models is what happens to interchange fees — are they itemized and charged completely separately from the processor’s markup (“pass-through” or “cost-plus” pricing), or are they blended in with the rate markup (blended pricing)? Take a look:
Pricing Model Overview
|Interchange Fees||Model Type||Generally Best For|
|Interchange-Plus||Separate from markup||Pass-through||Most businesses|
|Subscription||Separate from markup||Pass-through||High volume/tickets|
|Tiered||Blended with markup||Blended||Not recommended|
|Flat-Rate||Blended with markup||Blended||Low volume/tickets|
For most merchants, we recommend signing up for one of the pass-through models. Otherwise, you won’t be able to see the true difference between wholesale rates and processor markups.
With the above in mind, let’s look at the various pricing models currently being used by credit card processors.
This is the most transparent pricing model with the most understandable terms and fees. Interchange-plus itemizes wholesale fees and markups and clearly lists them on your monthly statement. This may make your statement a bit more difficult to read overall, but it’s worth it since you’ll know the precise difference between your wholesale fees and rate markups. Interchange-plus rate markups typically consist of both a percentage markup and a per-transaction fee markup, both of which are applied to all your transactions.
This is a newer pricing system, but it’s catching on. It’s similar to interchange-plus in that the wholesale cost of each transaction is charged separately from the markup. The difference is that you do not pay any percentage markup on transactions, but instead pay just a small per-transaction fee. Then, an additional markup is charged as a flat monthly subscription fee. For merchants with large transactions especially, this kind of pricing can save a lot of money without decreasing transparency. Check out Payment Depot (see our review) for a great example of this kind of pricing.
If you aren’t lucky enough to be on interchange-plus or subscription pricing, chances are you’re tied up in a tiered or ‘bundled’ pricing model. Even with the increased popularity of the above “cost-plus” models, the majority of business owners are on a tiered plan. Tiered statements may appear simpler at first, but in reality, this model makes it difficult to thoroughly understand your rates and fees.
Tiered pricing plans categorize credit card transactions into three categories: qualified, mid-qualified and non-qualified. Generally, qualified rates are the lowest. The transaction rates increase for mid-qualified and are highest for non-qualified transactions. Qualified transactions must meet all of the processor’s criteria for processing, such as a swipe/dip in-person with a batch settlement the same day. Failure to meet one or more standards may result in a ‘downgrade’ to mid-qualified or non-qualified tiers.
Some dubious processors take advantage of this more opaque pricing plan to charge merchants excessive markups. You may end up paying a lot more than you want to with little way of determining exactly what you are paying for. This is because processors often fail to disclose which tiers the merchant’s transactions are falling into, making it nearly impossible to determine the true markup rates over interchange.
This is like tiered pricing, but without the tiers. Instead, all transactions cost the exact same percentage and transaction fee, regardless of the wholesale cost. All costs are blended together to create one consistent rate and fee. This tends to make the transaction cost very high, especially for debit transactions. But since processors using flat-rate pricing (like Stripe and PayPal) usually do not charge a monthly fee, this pricing model often makes sense for low-volume businesses.
Putting it all together, below is a comparison table using a couple of types of business models together with numbers plugged in, so you can better see the charges:
|Test Case #1||Test Case #2||Test Case #3|
|Pricing Structure||Subscription||Interchange-Plus||Flat-Rate (Blended)|
|POS & Other Features Included||Yes||No||Yes|
|Sample Interchange Rate*||1.51% + $0.10||1.51% + %0.10||N/A|
|Retail Processing Rate||interchange + 0.0% + $0.10||interchange + 0.2% + $0.08||2.6% + $0.10|
|Fees paid on 100 x $50 transactions||$145.50||$118.50||$135|
|Fees paid on 200 X $50 transactions||$241||$222||$280|
|Fees paid on 200 x $100 transactions||$392||$393||$540|
|Fees paid on 200 x $200 transactions||$694||$735||$1,060|
|* Sample interchange based on Visa non-grocery retail rate for standard cards. Rewards cards incur a higher interchange rate and a merchants’ overall interchange rate will vary, affecting total processing costs. While not every merchant can predict their interchange costs, they can use an estimated number of transactions and average transaction size to calculate markup. Flat-rate processing markup determinations were made using the same assumed interchange rate, but companies that offer flat-rate pricing (such as third-party processors) don’t always disclose how much of their costs are markup, and so the numbers are an approximation.|
Keep in mind that these are estimated numbers using a single interchange rate. Real-world numbers will vary because you will encounter many different cards with different rates, and some transactions may be keyed instead of swiped, incurring a higher interchange as well. However, you can draw some conclusions here. For example, at a high volume, a subscription pricing model is often the best deal — especially if it includes any software subscription fees as well. An interchange-plus model might get the lowest rates but may not include all the extra software, meaning you’ll need to pay extra for it. And a flat-rate blended model is often a good deal for low-volume merchants, but as a business grows it becomes more costly.