Accepting credit cards in your business is something of a two-edged sword. On one hand, they’re extremely convenient for your customers, which generally translates into more sales. At the same time, processing a credit card transaction costs money, and the fees associated with maintaining a merchant account cost even more money. These expenses eat into your profits and increase your overall cost of doing business. Nonetheless, as customers increasingly turn away from paying with cash and use credit or debit cards whenever possible, most businesses will have to accept credit cards in order to remain competitive.
Determining in advance how much a merchant account is going to cost you with any degree of certainty is a nearly impossible task. There are literally hundreds of competing processors out there, each charging different fees and rates. Processing rates themselves are affected by a bewildering number of variables, one of which is the pricing model offered by your merchant account provider.
The overall cost of your merchant account is going to be a combination of the rates you have to pay your processor for each credit/debit card transaction and the fees that you also have to pay, usually on a monthly or yearly basis. While we’re going to focus on processing rates for this article, be aware of this: Fees are generally the same for a given merchant account provider, regardless of the size of your business. If your provider charges $99 a year for PCI compliance, you’ll pay that fee whether you have $100,000 in annual sales, or $1 million. So, for small or micro-sized businesses (or new businesses just starting up), fees are probably going to be the biggest expense you incur by having a merchant account. For larger businesses with higher sales volumes, processing rates will usually be your biggest expense.
What Types of Pricing Models Are There?
Obviously, you’ll want to get the lowest processing rates you can get, right? In theory, lower processing rates should lead to less of the money from your sales going to your processor and more of it staying with you. In actual practice, it’s much more complicated than that.
Let’s start by looking at the general types of pricing models for setting processing rates. There are four of them: 1) tiered pricing, 2) interchange-plus pricing, 3) subscription/membership pricing, and 4) blended pricing.
Tiered pricing is, unfortunately, still the most common pricing model available, and the one most processors offer to their merchants. We don’t like it. Tiered pricing simplifies a huge number of processing rates into three basic tiers: qualified, mid-qualified, and non-qualified. Which tier a particular transaction will fall into depends on a number of criteria, which are set by the processor. These criteria include things such as card-present versus card-not-present transactions, whether the transaction was processed on the same day it occurred, and which one of a host of possible categories the items purchased fall into. Tiered pricing may seem tempting, because it simplifies a lot of variables into just three tiers, making your monthly statement much easier to decipher. Unfortunately, while the numbers may be easier to understand, they’ll often be a lot higher than you were expecting. Tiered pricing models make it impossible to tell how much of a processing charge is going to the issuing bank, the credit card associations (i.e., Visa, Mastercard, etc.), and how much is going to your merchant account provider. Tiered pricing also leads to a very deceptive marketing gimmick: the provider will advertise the lowest possible (i.e., qualified) rate, but most transactions won’t actually be qualified, and will process at a much higher rate.
Interchange-plus pricing, on the other hand, breaks down the charges going to the issuing bank and credit card associations, allowing you to see the markup they’re charging you for processing your transaction. This is a much more transparent pricing model, but it also makes your statements harder to read. In most cases, that will be a small price to pay, as interchange-plus pricing rates are usually lower overall than tiered rates.
Subscription/membership pricing is a little different. You’ll still pay the interchange rates that go to the issuing banks and credit card associations, but instead of paying a percentage markup to your processor, you’ll pay a monthly membership fee and a fixed per-transaction charge. Depending on the nature and size of your business, this pricing model can potentially result in even lower overall costs than interchange-plus pricing. However, very few processors currently offer it. For an example of subscription pricing, see our review of Payment Depot.
Flat/blended pricing is similar to tiered pricing, but the three tiers are blended together into a single flat rate for all transactions. This rate is, naturally, quite a bit higher than what you’d pay under a tiered plan. However, the lack of a monthly fee can make it more affordable overall for small or seasonal businesses. Square and PayPal use blended pricing.
What Is Interchange-Plus Pricing?
While the actual numbers can get pretty complex, at its core interchange-plus pricing is quite simple. The pricing model consists of two elements: an “interchange” and a “plus.” The interchange is the percentage of the transaction that must be paid to both the issuing bank and the credit card association. Because your processor has to pay this charge, they’ll pass it on to you. The plus is the amount over and above the interchange costs that you’ll also have to pay to your processor. It’s their markup for processing your transaction, and it’s designed to cover their costs of doing business – and also to generate a profit.
Interchange-plus pricing is sometimes referred to by alternate names, such as interchange pass through pricing or cost-plus pricing. These different terms all refer to the same thing.
Interchange-plus pricing rates are usually expressed as the interchange rate plus a markup, which can be a percentage, a flat, per-transaction fee, or both. Payline Data, for example, currently charges interchange + 0.20% + $0.10 per transaction for a retail transaction.
So, how much will the interchange cost you? These fees are set directly by the credit card associations, and they can get pretty complicated. There are different rates for debit and credit cards, for example, as well as different rates for different types of credit cards. Card-present and card-not-present transactions also have different rates, as they reflect the level of risk the issuing bank is taking in extending credit for a given transaction. If you really want to dig deeper into the subject, official rate information from Visa and Mastercard is also available online.
Here’s an example of how this all works in practice:
You own a retail store and have a merchant account with Payline. A customer comes in and purchases an item for $100.00 (including tax). He pays with a Mastercard Consumer credit card. The interchange cost is 1.580% + $0.10, or $1.68. Payline passes this cost to you, plus they charge a markup of 0.20% + $0.10, or $0.30. Your total cost for taking the credit card is $1.98, or 1.98%.
How Will Interchange-Plus Pricing Save Me Money?
The fundamental flaw with the traditional tiered-pricing model is that it hides the interchange costs and allows processing companies to charge more of a markup. By consolidating a wide variety of rates into a smaller number of tiers, processors can essentially “round up” to the highest rate in each tier. While this may make your monthly statement a lot easier to read, it also means you’ll be paying higher rates for a lot of transactions – and you probably won’t be able to tell which transactions are being charged abnormally high rates.
By showing you the actual interchange costs, interchange-plus pricing allows you to more easily see what the markup is. This in turn encourages processors to set more reasonable markups. The credit card processing industry is highly competitive, and processors know that many merchants will sign up with the company that offers them the lowest rates. This transparency in separating out interchange and markup costs generally results in lower overall rates, and most interchange-plus pricing plans will cost you less money than a tiered-pricing plan. However, you should be aware that there’s nothing stopping a processor from charging you an unreasonably high markup. The difference is that it will be a lot easier to spot, especially if you shop around.
What About American Express?
American Express is different! Unlike Visa and Mastercard, American Express credit cards are issued directly by American Express – a financial services company. Thus, American Express serves as both the issuing bank and the credit card association. This should lead to lower rates, right? Wrong! Remember that American Express requires its cardholders to pay off their balance in full every month. While this is a sound financial practice for consumers, it also deprives Amex of the opportunity to charge interest on the unpaid credit card balances. They make up for this by charging significantly higher processing rates than Visa or Mastercard.
Until very recently, accepting American Express cards was a real hassle, requiring merchants to sign up directly with American Express. In 2014, however, American Express introduced their OptBlue Pricing plan, which allows merchants to accept Amex cards through their regular merchant account provider. Processing rates are still higher than Visa or Mastercard, but it’s a definite improvement over the older arrangement. While not all merchant account providers support OptBlue Pricing, most of our preferred providers include it as part of their accounts.
In general, we really like interchange-plus pricing. It has the potential to save you a lot of money, and it’s definitely much more transparent than traditional tiered-pricing plans. Most of our preferred providers offer it. In fact, many of the best and most innovative processors in the industry (such as Dharma and Payline) offer it exclusively.
Unfortunately, that’s not always the case. Until fairly recently, interchange-plus pricing was only available to larger, more-established businesses. Processors felt that they could compensate for offering lower rates by only making it available to merchants who had a very high monthly sales volume. Traditional small businesses were stuck with tiered pricing plans, and forced to pay a premium for being small businesses.
Today, getting interchange-plus pricing is easier than it’s ever been. However, it’s not a guaranteed thing. Some processors still don’t offer it at all. Many other processors offer both tiered and interchange pricing, and they usually don’t disclose this fact in their advertising. A lot of these processors also rely on independent sales agents, who will – naturally – try to sign you up with a more expensive tiered pricing plan. If you want interchange-plus pricing, you’ll have to ask for it.
It’s also worth noting that interchange-plus pricing is not a 100% guarantee of lower rates. Processors are still able to make money at your expense by charging above-industry-average markups as part of their pricing plan. The difference is that it’s much easier to see that they’re doing it, at least if you shop around before signing up with a processor.
You also need to consider the overall cost of your merchant account, especially if you’re a smaller business. As we’ve noted above, your rate plan is only one part of the equation. While it might be the largest part of that equation, you also need to look closely at monthly and annual fees before signing up with any processor. The availability of interchange-plus pricing is not a guarantee that you’ll be getting the best overall deal.
Our best advice is to shop around before settling on a particular provider. If you want to save yourself a lot of time and aggravation in doing so, check out what the best providers in the industry have to offer first.