E-commerce merchants depend on credit card payments. But the processing fees associated with these payments are notoriously confusing. This post is the second in a series where I will often answer payment processing questions.
The first part, "Part 1: Learning the Jargon," contained a comprehensive glossary of industry terms as well as explanations of fixed versus percentage fees. Readers may want to review this glossary because I have used the defined terms below, where each defined term has capital letters.
Among the most frequently asked questions from merchants involve the various pricing models. That is what I will address in this post.
What are the pricing models for treatment and the advantages and disadvantages of each?
There are three common models for trading prices. Each has its advantages and disadvantages. Understanding the models will help you find the best prices for your business. If your processor puts you in the wrong model, you would probably pay higher than necessary fees.
Model 1. Fixed price. The standard model offers traders easy to understand prices. You get a standard price for all transactions: card-present (in-store), card-not-present (e-commerce) and manually entered (mail and telephone orders). It is the same price regardless of the type of credit card used and the type of product purchased. Examples of lump sum processors are Stripe, Square and PayPal.
Fixed-rate pricing is controversial, but it is not necessarily bad. Behind the scenes, the processor calculates and pays all different exchange fees and wholesale fees, and then adds a selection. The processor then collects all of these into a fee.
If a merchant accepts payment for a low-cost card, such as a basic Mastercard without reward, the processor will benefit because it will pay an exchange rate of about 1.6 percent and charge the merchant about 2.9 percent, usually – resulting in a 1 , 3 percent profit. But if the merchant accepts a luxury rewards card, the exchange rate would be much higher and potentially smaller than the flat rate – resulting in a loss for the processor.
The controversy surrounding flat payment processors is that they are allegedly breaking evenly (avoiding a loss) on high-cost transactions. This is difficult to know because the exchange rates are hidden.
The benefits of flat pricing:
- Traders know exactly how much each transaction will cost.
- Simple monthly statements.
- Ability to create budgets and forecasts and adapt business methods based on known costs.
- Treat premium reward cards, business cards and luxury cards for the same fee as a base card.
Disadvantages of flat rates:
- Processors add markup fees to wholesale fees. The selection can be significant or minimal. There is no way to know how much markup is added. Some processors (a few bad actors) reportedly add excessive markings.
- Hidden fees. Some processors add markup fees everywhere. Merchants should look carefully at all fees, not just the flat rate. For example, check for unreasonable cancellation fees or ridiculous account setup fees.
- Too expensive. If its customers pay with basic (non-rewards, non-corporate) credit cards, a merchant may overpay for processing.
Model 2. Tiered Pricing. The Tiered Pricing model segments transactions into levels (buckets). The processor then rates each transaction based on its level. The three common levels are qualified, intermediate and non-qualified. Each one has a different price. However, many processors add subsets, resulting in six or more levels. Such twisted levels are often, but not always, opportunities for processors to increase profits.
I have explained the three levels in the glossary "Part 1". In short, qualified transactions are low risk, such as card transfer and PIN-supported payments. Mid-qualifying transactions include mail and telephone orders as well as rewards and cashback cards. Non-qualified transactions are card-not-present, luxury cards and generally all e-commerce transactions. Qualified transactions have the lowest processing cost; Unqualified have the highest.
Level pricing can be controversial as the processor determines the levels. The card brands (Visa, Mastercard, American Express, Discover) only set the exchange fees and card association fees. In addition, the processor decides how to classify each transaction. There is no industry monitoring or regulation of how processors do this. Thus, traders must understand exactly how their processor will categorize and charge for each type of transaction.
Another controversy has been the marketing tactics of some processors. Some (but not all) offer merchants fantastic cheap prices while hiding the fact that it is only for qualified transactions. Merchants should require written answers to the following questions.
- Are you just quoting the eligible price?
- What are your other levels and their prices?
- Describe the criteria for classifying my transactions?
- How would my current transactions end up in each level?
- Explain your company's policy for downgrading qualified and intermediate qualified transactions?
- Can your company add or change levels and classification principles? Will you notify me of these changes? How far in advance?
- What would my monthly statement look like? Will the statement describe how my transactions were classified?
- Can I dispute your classification of each transaction?
The benefits of Tiered Pricing:
- Level pricing can reduce processing costs as long as most transactions are qualified.
- Monthly statements are easier to follow than Interchange Plus (described below) but more confusing than standard pricing statements.
Disadvantages of Tiered Pricing:
- Processors can downgrade transactions to increase fees.
- Marking fees are hidden.
- Multi-level processors can produce confusing statements.
- Understanding how a transaction is classified or downgraded can be difficult.
- Classification criteria can be hidden.
Model 3: Interchange Plus. Interchange Plus offers the most transparent pricing. The processor simply transfers the exchange and card association fee directly to the merchant with an agreed markup fee. "Interchange Plus" refers to the combination of Interchange, Card Association Fees and Markup.
Unfortunately, many processors offer the Interchange Plus model only to high volume retailers. For example, Stripe requires interested merchants to submit a form and disclose monthly volume. If the volume is too low, Stripe starts with standard pricing until a trader reaches the minimum transaction volume.
The benefits of Interchange Plus:
- Transparent pricing with clearly defined selection fees.
- No hidden fees, usually.
Disadvantages of Interchange Plus:
- Monthly statements are often long, confusing and difficult to read as there are hundreds of exchange fees.
- Usually offered to merchants with high payment volume.